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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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Chapter 4: Board of Directors Roles and Responsibilities
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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Chapter 4: Board of Directors Roles and Responsibilities
(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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Chapter 4: Board of Directors Roles and Responsibilities
(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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Chapter 4: Board of Directors Roles and Responsibilities
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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Chapter 4: Board of Directors Roles and Responsibilities
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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Chapter 4: Board of Directors Roles and Responsibilities
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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Chapter 4: Board of Directors Roles and Responsibilities
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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Chapter 4: Board of Directors Roles and Responsibilities
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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Chapter 4: Board of Directors Roles and Responsibilities
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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Chapter 4: Board of Directors Roles and Responsibilities
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
Chapter 5: Board Committee Roles and Responsibilities
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Chapter 5: Board Committee Roles and Responsibilities
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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Chapter 5: Board Committee Roles and Responsibilities
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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Chapter 5: Board Committee Roles and Responsibilities
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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Chapter 5: Board Committee Roles and Responsibilities
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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Chapter 5: Board Committee Roles and Responsibilities
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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Chapter 5: Board Committee Roles and Responsibilities
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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