acct450_ch4and5

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Chapter 4: Board

of Directors Roles

and

Responsibilities

Chapter 5:Board Committee

Roles and

Responsibilities

L. Murphy Smith

Texas A&M University

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Chapter 4: Board of Directors Roles and Responsibilities

Identify the difference between decision management and decisioncontrol.

Understand the role of the board of directors.

Understand that the board of directors is ultimately responsible for

the business and its affairs.

Provide an overview of what the oversight function entails.

Identify and explain the fiduciary duties of the board of directors.

Gain awareness of the variety of board models.

Identify the board attributes that affect the quality of monitoring and

oversight.

Illustrate the importance of an independent board of directors.

Become familiar with the best practices of determining directors¶

compensation.

Identify and describe the determinants of an effective board of

directors.

Become familiar with board accountability, evaluation, and the legal

obligations and liabilities facing outside directors of public

companies.

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The board of directors is ultimately responsible for the company¶s business affairs and governance as stated in its governing documents,

including the articles of incorporation, the by laws, and shareholder

agreements.

Many state laws require a corporation to form a board of directors torepresent shareholders and make decisions on their behalf.

The success of the board of directors depends on the composition,

structure, resources, diligence, and authority of the entire board, as well as

their working relationships with other participants of corporate

governance, including management, external auditors, internal auditors,

legal counsel, professional advisors, regulators, standard-setting bodies,

and investors.

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(1) R epresent shareholders and create shareholder value.

(2) Align the interests of management with those of shareholders while protecting the interests of

other stakeholders (customers, creditors, suppliers).

(3) Define the company¶s mission and goals.

(4) Establish or approve strategic plans and decisions to achieve these goals.

(5) A ppoint senior executives to manage the company in accordance with the established

strategies, plans, policies, and procedures.

(6) Oversee the company¶s performance by setting objectives, establishing short-term and long-term strategies to achieve these objectives, and assessing the performance of senior executives

in fulfilling their responsibilities without micromanaging.

(7) A pprove major business transactions and corporate plans, decisions, and actions according to

the bylaws.

(8) Develop and approve executive compensation, pension, post-retirement benefits plan, and

other long-term benefits, including stock ownership and stock options.

(9) R eview financial reports, including audited annual financial statements, quarterly reviewedfinancial statements, and other important financial disclosures such as management discussion

and analysis (MD&A) earnings releases and reports filed with regulators (SEC) or

disseminated to the public.

(10) R eview management¶s report on the effectiveness of internal control over financial reporting.

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(11) Provide counsel to the company¶s senior executives, especially the CEO, on material

strategic decisions and risk management.

(12) Ensure the company¶s compliance with applicable laws, rules, and regulations.

(13) A pprove the company¶s major operating, investing, and financial activities.

(14) Set the tone at the top by promoting legal and ethical conduct throughout the company.

(15) Evaluate the performance of the board, its committees (e.g., audit, compensation, and

nominating), and the members of each committee.(16) Hold the board, its committees, and directors accountable for the fulfillment of the

assigned fiduciary duties and oversight functions.

(17) A pprove dividends, financing, capital changes, and other extraordinary corporate

matters.

(18) Oversee the sustainability of the company in creating long-term shareholder value and

protecting interests of other stakeholders.

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Fiduciary duty means that, as shareholders¶ guardians, directors must be trustworthy,acting in the best interest of shareholders, and investors in turn have confidence inthe directors¶ actions.

MANDATED BY LAW AND SPECIFIED IN COMPANIES CHAR TERS ANDBYLAWS

The corporate governance literature presents the following fiduciary duties of boardsof directors:

Duty of due care

Duty of loyalty

Duty of Good Faith

Duty to Promote SuccessDuty to Exercise Diligence, Independent Judgment, and Skill

Duty to Avoid Conflict of Interests

Fiduciary Duties and Business Judgment R ules.

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Board committees normally function independently from each other, are providedwith sufficient resources and authority, and are evaluated by the board of directors.

THUS board committee are a subset of the board and perform specific functions thatassist the board in discharging its advisory and oversight responsibilities.

Public companies usually have the following board committees:

Audit committee

Compensation committee Governance committee

Nominating committee

Disclosure committee

Other standing or special committees

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Board Models:

One-Tier Board Model - consists of both inside (executive) directors andoutside (nonexecutive) directors. Inside directors are perceived as thedecision managers and outside directors are assumed to have the power

and duty to monitor those decisions.

Two-Tier Board Model - The two-tier board system, consisting of asupervisory board and a management board, better known as the German

board model, establishes different authorities and responsibilities for members of each board.

Modern Board Model - the structure of the modern board based on thetwo components of strategic board and oversight board is the naturaloffshoot of the emerging corporate governance reforms.

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Director Education and Evaluation:

Corporate governance reforms and best practices issued by a number of

organizations recommend continuous education and evaluation of the

board of directors.

Evaluation of the company¶s board should be performed formally and

regularly (at least annually) through either self-evaluation, independent

committee evaluation (audit, compensation, nominating), or outside

consulting evaluations.

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Director Liability:

One way to influence directors¶ ethical conduct and create more

accountability for them is to increase their legal liability for poor

performance and business misconduct.

Directors are not reasonably expected to have first-hand knowledge

of all company business affairs under their oversight capacity.

Nevertheless, directors are responsible for ascertaining the validity,

reliability, and quality of information provided to them. In most

circumstances, directors make decisions by relying on information

furnished by corporateofficers, employees, and professionals, including legal counsel and

accountants. Thus, the effectiveness of their performance depends

on the validity and quality of the information provided to directors.

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Summ

aryThe primary responsibilities of the board of directors are to (1) define the

company¶s mission and goals; (2) establish or approve strategic plans and

decisions to achieve these goals; (3) appoint senior executives to manage

the company in accordance with the established strategies, plans, policies,

and procedures; and (4) oversee managerial plans, decisions, and actions

in achieving sustainable shareholder value while protecting the interestsof other stakeholders.

The business judgment rule provides directors with broad discretion to make

good faith business decisions and implies that directors, when making

business decisions, must be reasonably informed.

Investors, in general, are in favor of the separation of the positions of theCEO and the chairperson of the board of directors

Corporate governance best practices suggest that companies designate one

director to take the lead at executive sessions that do not include

management.

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Summary - Continued

Board characteristics, including composition, authority, responsibilities,resources, independence, and compensation, significantly influence itseffectiveness.

To be independent, a director should not have any other relationships with

the company other than his or her directorship that may compromise thedirector¶s objectivity and loyalty to the company¶s shareholders.

The evaluation of board performance should be completed for mally andregularly (at least annually) through either self-evaluation, independentcommittee evaluation (audit, compensation, nominating), or outsideconsulting evaluations.

Board accountability can be classified into accountability to shareholders for protecting their rights and interests, accountability for the effectiveness of its operation, and accountability for its involvement in the company¶sstrategic decisions to ensure enduring performance and success.

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Chapter 5: Board Committee Roles and Responsibilities

Provide an overview of the functions of board committees.

Understand the roles and responsibilities of board committees.

Be aware of the objectives of establishing board committees.

Become familiar with the duties, responsibilities, and composition of the

audit, compensation, nominating, governance, and special committees.

Understand the process and emerging practices for the election of corporate

directors.

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The establishment of board committees can bring more focus to the board¶soversight function by giving proper authority and responsibilities and by

demanding accountability for these committees. Listing standards of

national stock exchanges require that listed companies form at least three

board committees that must include audit, compensation, and nominating

committees. Public companies often, in addition to these three mandatory

committees, have governance and other committees such as finance, IT,and disclosure.

Average number of directors 9-15


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Audit Committee

Lawmakers (SOX), regulators (SEC rules), and listing standards of national stock exchanges (NYSE, Nasdaq, AMEX) generally require public committees to havean audit committee, which must be composed of independent directors with no

personal, financial, or family ties to management.

Standards R elating to Listed Company Audit Committees outline theserequirements, which relate to:

1) Audit committee members to be independent.

2) Audit committee members to select and oversee the issuer¶s independent account.

3) Procedural process for handling complaints regarding the issuers accounting practice.

4) The authority of the audit committee to engage advisors.

5) Funding for the independent auditor and any outside advisors engaged by theaudit committee.

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Audit Committee Relationships with Others

Audit Committee Board of Directors

Works with other committees, assists board by bringing specialization and expertise in the

areas of financial reporting, internal controls, risk management, and audit activities.

Audit Committee Management

Asks appropriate questions pertaining to the company¶s corporate governance structure,

internal controls, financial reporting, audit activities, risk assessment, codes of ethics, andwhistleblower programs. Management should provide sufficient information.

Audit Committee External Auditors

Directly responsible for hiring, compensating, and firing external auditors, as well as

overseeing their work. External auditors are held ultimately accountable to the audit

committee and should submit their reports of the audit on ICFR and the audit of financial

reporting to management via the audit committee.

Audit Committee Internal Auditor

Should be responsible for hiring, overseeing, compensating, and firing the head of the

internal audit department (CAE), and internal auditors should report their audit findings

directly to the audit committee, being ultimately accountable to that committee.

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Audit committee composition is discussed in terms of size, independence,qualifications, attributes, and resources:

Audit Committee Size - The size of the committee usually ranges from three to

six members, whereas the SEC rule and listing standards for public companies

require at least three independent members and should be composed for at least

three months.

Audit Committee Independence - The audit committee should be composed of

independent, nonexecutive, outside directors. The emerging corporate governance

guidelines on audit committee independence should assist public companies in

avoiding potential conflicts of interest due to committee members¶ excessive

contractual or consulting ties to the company or its management.

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Member Qualifications - At least one member of the audit committeeshould be designated as a financial expert. The company¶s board of

directors should apply the SEC¶s definition and consider audit committee

members¶ experience and knowledge in determining which members

qualify as financial experts and, if none qualify, recruit at least one

member who meets the required qualifications.

Audit Committee Authority/Resources - SOX, recognizing the

increased responsibilities assigned to audit committees, authorizes them

to engage independent counsel and other outside advisors as they

determined necessary and requires the company to provide appropriate

funding for such advisors.

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Compensation Committee

The compensation committee is usually formed to determine the compensationand benefits of directors and executives.

Structure: The committee should be composed of all independent directors whorotate periodically.

R esponsibilities: committees have a set of responsibilities which they need to

follow stricktly. Proxy Statement Disclosure: The committee is directly responsible for ensuring

that all aspects of executive compensation are fully and fairly disclosed in in theannual proxy statement.

Committee responsibilities:

1. Evaluation of directors.

2. Design and implementation of director compensation plans.

3. Evaluation of senior executives.

4. Design and implementation of executive compensation plans.

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Other Committees

Corporate governance committee should be composed of both executive and nonexecutive directors and be responsible for developing and monitoring the company¶s governance principles, including the roles and responsibilities of directors and officers.

Nom

inating comm

ittee is usually responsible for evaluating and nominating a new director to the board, and it also facilitates the election of the new director by shareholders.

Other: Public companies may form other standing or special committees to deal with issues requiring particular expertise, such as the following:

Finance committee to oversee financial activities.

Outside directors committee to maintain board independence.

Executive committee to approve managements decision, plans , and actions on a behalf of entire board.

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acct450_ch4and5