Balance of Poweron the Board

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Board and C.G.

It is often believed, by stakeholders, social scientists and the regulators alike, that the key to good corporate governance lies in the hands of a company’s Board.

But: How does a Board become good? Is a good Board born or made? Is a Board free to be good?

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The Board’s Role• Provide entrepreneurial leadership• Set strategic objectives of the company• Arrange for resources need to achieve the strategic objectives• Review management performance• Set the company’s values and standards• The bridge between stakeholders

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Entrepreneurial Leadership• Profit, but:• Regard to social responsibility• Prudence• Risk management

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Dominant Personality• Legal division of powers does not stop a dominant leader from

getting his way.• Dominant personalities are often the creators or benefactors

of a company. They earn their power and later misuse it.• Some may even mean well, but prove to be “naadaan dost”.

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Enron Case: Some Lessons• Misleading treatment of transactions in the books.• There are only 2 debits and 2 credits around which the entire

edifice of accounting revolves. It is not difficult to treat one debit (asset) as another (expense); or one credit (liability) as another (income); or vice versa.

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Enron Case: Some Lessons• Audit committee approved seriously misleading accounts.• Willfully looked the other way• Were unable to detect irregularities• Were not provided adequate information• Collusion of External auditors

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Enron Case: Some Lessons• Individuals profited personally from transactions with the

company:• No body noticed it, or could have noticed it.• No body objected to it, or objectors were pacified.• No disclosure of interest• Isolated cases, or a planned robbery.

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Enron Case: Some Lessons• Ineffective Board failed to properly supervise the senior

executives:• Was Board ineffective, or incompetent?• Were senior executives too clever, or were board members too

ready to comply?• Was the Board independent? • What was the composition of the Board?

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Enron Case: Some Lessons• Board ignored whistleblowers:• Did the whistleblowers reach the board?• Was there a defined mechanism for handling whistleblowers?• Was Board simply ineffective, or deliberately ignored the

whistleblowers?• In the end, whistleblowers got their day.• Key Issue: Integrity level of ALL concerned, not just the board or

senior executives.

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Enron Case: Some Lessons• Enron Board had a large number of NEDs, but they had no

leader.• Audit committee was comprised of junior NEDs with no

“power” or initiative to deal with external auditors, or prescribe accounting policies.

• Audit committee did not have “power” to deal with whistleblowers.

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Enron Case: Some Lessons• Board Composition:• Only CEO and Chairman were executive, rest all were supposedly

NEDs• No flow of information between management and Board except

through CEO / Chairman• Entire board virtually a stranger to the real working of the

company.

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What to watch for when appointing Directors• Suitability• Character, personal traits• Collective integrity• Role of Chairman, and CEO• Role and independence of NEDs• Use of Board Committees• Board Succession• Controlling family interests

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Case: Mr. Robert Maxwell• In 1971, DTI declared him unfit to hold stewardship of a

quoted company.• He then expanded his business as private limited companies.

In 1980, he acquired British Printing Corp. Eventually took over UK’s Mirror group, USA’s Macmillan and New York daily times. Mirror got listed.

• No body objected to Mr Maxwell despite DTI report.

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Case: Mr. Robert Maxwell• In Nov 1991, Mr Maxwell died mysteriously. Drowned while

cruising off Canary Islands.• Subsequent investigations showed misappropriation of $1.70

billion from pension funds of his companies.• All companies of Maxwell group had to file for bankruptcy in

1992.

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Collective Integrity• Individual honesty versus collective integrity.• Teams players, or weak directors?• Enron paid $750 million as bonus to senior executives with a

net profit of only $975 million.• Executives had off-balance sheet contracts with Enron• NEDs were being paid for consultancy.

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Balance on the Board• Balance of representation• Balance of ability• Balance of power• Balance of views: objectivity

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Cadbury Code• Regular and frequent meetings• Effective control over the company• Important decisions should not be taken by executives, but

referred to Board. • Definition of which decisions should be referred to Board.• Good board room practices.

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Good Boardroom Practice• Background information must be provided to the directors.• All directors must get the same information and same time to

study it.• Directors should be able to participate.• Certain matters, even if delegate-able should not be delegated

to the executive.

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Good Boardroom Practice• Formalization of meetings’ conduct – avoid unwritten

practices.• Formal induction of new directors• Post-facto approvals should be discouraged.• Proper use of board committees.

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Role of C.E.O.• Executive management of the company.• Answerable to the Board.• Every one else answers to CEO, including executive directors.• Ultimate responsibility for the conduct of the company:• Except when he acts under explicit instructions of the Board.

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Role of Chairman• Run the board, set its agenda, conduct its meetings, lead the

discussions.• Ensure all directors get adequate and timely information.• Bridge between shareholders and board• Ensure evaluation of board’s performance:• Individual directors• Board as a whole

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CEO and Chairman• Should these be two persons?• Does it help to have one person wearing both these hats?• Combined Code recommends separate persons, but A&MA

may permit it.• CEO retiring to become Chairman?• Room for Vice Chairman, or Senior NED

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Board Appointments• Periodic elections, but frequent appointments.• Use of Nominations Committee• Replacement of directors should be done by the whole Board.

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Nominations Committee• Formalization of the process: Principally aimed at looking for

NEDs• Only recommends; the Board decides who to recommend to

shareholders.• Nominations Committee should comprise of NEDs, chaired by

Board chairman or an NED.

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Duties of Nomination Committee

• Identify suitable candidates, evaluate them, rank them.• Assess time and involvement required from NEDs• Performance evaluation of all directors• Succession planning• Review board size and structure• Define role of NEDs

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Nominations Committees in Pakistan• Do they exist?• Do we need them?• If we had them, would they be effective?• What can be done to ensure that they are effective?

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Practical Aspects ofBoard Appointments

• Use head hunters• Use contacts, trade associations, professional bodies, etc.• Formal evaluation form:• Weightage of qualities• Balance needed at the board• Eligibility• Other commitments

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Directors’ Induction• Visits to key locations• Product/Departmental presentations• Meetings with senior management / staff• Meetings with major shareholders• Meetings with external advisers of the company• Formal training, where needed, say in law, technical aspects of

the company, etc.

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Issues of Re-election• Re-election after a prescribed period.• Limit on number of re-elections:• By law on certain companies• By AOA

• Board to explain to shareholders why any particular NED is being proposed.

• Formal evaluation of NED before proposal to re-elect them.

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Issues of Re-election• Even if AOA allow, re-election of NED beyond 2 terms should

be discouraged.• Staggered Board:• Advantages• Problems• Practice in Pakistan

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Succession Planning• Succession of EDs• CEO / Chairman

• Succession of NEDs• Aspects of Succession:• Outside appointments• Grooming of existing EDs• Movement from ED to NED, or NED to ED• Orderly, efficient and effective

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Performance Evaluation• Should individual directors be evaluated:• By whom? Chairman or NomCom• How? Formal or informal• Who should the results be conveyed to?

• Process and Procedure• Using a ratings form / Higgs list of questions• Using external agency

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Two-tier Boards• Senate & Parliament Style• Upper Board: all NEDs• Lower Board: all EDs plus NE Chairman

• The Cromme Code (Germany)• Public disclosure of compliance• Division of tasks between two levels of the board.

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Two-tier Boards• Problems:• Size: up to 20 members• Dilution of effect of better members• Cost• Speed of decision making

• Advantages:• Executives have accountability to NEDs• Speed through division of work• Better representation of all stakeholders

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