Corporate Governance in the Aftermath of the Global Financial Crisis, Volume II

Zabihollah Rezaee

• Publisher: Business Expert Press
• Year: 2018
• ISBN:
  9781631571510
• Topic: Business
• Subtopic: Business General
• Index: Business

Corporate governance has evolved as a central issue for public companies in the aftermath of the 2007–2009 global financial crisis. Corporate governance is a process (journey) of managing corporate affairs to create shareholder value and protect interests of other stakeholders. This book presents a road map for various functions and measures of corporate governance. The participants in the corporate governance process are the board of directors, executives, stakeholders, internal and external auditors, financial analysts, legal counsel, and regulators. This book is organized into four separate volumes; each volume can be utilized separately or in an integrated form. The first volume consists of five chapters that address the relevance and importance of corporate governance as well as the framework and structure of corporate governance. The second volume consists of four chapters that present the three prevailing corporate governance functions of oversight, management, and monitoring. The third volume consists of four chapters that address corporate governance functions performed by corporate gatekeepers, including policy makers, regulators, standard-setters, internal auditors, external auditors, legal counsel, and financial advisors. The fourth volume consists of five chapters that address the emerging issues in corporate governance, including governance for private companies and nonprofit organizations and convergence in global corporate governance.

CHAPTER 1

Oversight Function

Introduction

The oversight function of corporate governance is vested in a company’s board of directors, which is elected by its shareholders to represent and protect their interests. A vigilant board of directors that proactively oversees strategic decisions, management’s plans, decisions, and actions as well as compliance with all applicable laws, rules, regulations, standards, and best practices can be very effective in achieving good governance and protecting stakeholders’ interests. The primary responsibility of the oversight function is the appointment of the chief executive officer (CEO) and concurrence with the CEO’s selection of other senior executives (top management team) to run the company for the benefit of its shareholders. Public companies are legally required to have a board of directors, and many private companies and not-for-profit organizations (NPOs) (e.g., hospitals, churches, universities) also have a similar governing board.

In the aftermath of the global financial crisis of 2007–2009, it is expected that the boards of directors will engage more proactively in the oversight function, especially in an ever-increasingly complex business environment, governance practices, strategic priorities in dealing with global economic and political uncertainties, and the potential risk of cybersecurity. The success of the board in fulfilling its oversight responsibility depends on the ethics, independence, composition, structure, resources, diligence, experience, and skill sets of the entire board, as well as members’ working relationships with other participants in the corporate governance structure (e.g., management, external auditors, and investors). This chapter presents the corporate governance oversight function of boards of directors to fulfill their fiduciary duty of protecting shareholder interests.

Role of the Board of Directors

The board of directors, as representative of shareholders, has the fiduciary duty of protecting the interests of shareholders by establishing proactive strategic missions, goals, and objectives to create long-term shareholder value and oversee managerial decisions and actions in effectively implementing these strategic goals. Management may also initiate these strategic goals; however, they should be approved and overseen by the company’s board of directors. Thus, the primary responsibilities of the board of directors are to: (1) hire a competent and ethical CEO; (2) oversee the hiring of other top executives (chief financial officer [CFO], controller, treasurer, operational managers); (3) monitor management’s sustainable strategic, financial, and operational goals in achieving long-term shareholder value; (4) oversee succession planning for top executives (CEO, CFO); and (5) replace the executives and officers if they become incompetent and/or unethical.¹

In performing their oversight function, boards of directors should avoid micromanaging managerial and operational decisions and actions. To effectively discharge their fiduciary duty as stated in its governing documents, including the articles of incorporation, the bylaws, and shareholder agreements, directors should develop a proper balance between their advisory role of engaging in the company’s strategic decisions and the oversight role of monitoring management’s operational, investment, and financing activities and performance. The board of directors usually comprises both insiders (senior executives) and outsiders (independent directors), although the listing standards of national stock exchanges require directors serving on audit, nominating, and compensation board committees be totally independent. Nevertheless, the entire board is considered representative of shareholders, responsible for protecting shareholders’ rights and interests, and should be engaged in an oversight function rather than a managerial function. The board is ultimately responsible for the company’s business affairs, and governance state laws generally require the formation of a board of directors for corporations to represent shareholders and make decisions on their behalf.

The board of directors is the cornerstone of the company’s corporate governance structure and has the primary role of safeguarding the interests of shareholders and other stakeholders. State statutes and corporate governance reforms assign the oversight function of corporate governance to the board of directors. Almost all states have a similar statute authorizing and empowering the board to direct, oversee, and control a company’s business affairs and to govern its activities. Shareholders have the statutory right to nominate and elect the board, and in many states to approve major decisions and/or transactions, such as the sale of major assets, mergers and acquisitions, or dissolution of the company.

The best practices of corporate governance suggest that the board of directors: (1) engage in long-term and sustainable strategic planning and decisions to improve the business sustainability of creating value for shareholders; (2) oversee managerial operations, risk assessment, cybersecurity, and financial reporting; (3) hire the most competent and ethical executives to manage the company’s operation for the best benefit of shareholders and remove them when they become incompetent or unethical; (4) engage in evaluation, education, and succession planning for executives; and (5) ensure the board independence, objectivity, diversity, effectiveness, education, and evaluation. In summary, to effectively fulfill the above-mentioned responsibilities, the board of director should appoint executives (CEO, CFO) to manage the company, determine their compensation, oversee managerial strategies, decisions, actions, and performance, engage in succession planning for top executives, approve all corporate reports and communications with shareholders, and oversee financial and audit processes.

In the aftermath of the 2007 global financial crisis and related corporate governance reforms, the board of directors has made significant improvements, and yet challenges persist. The 2014 PricewaterhouseCoopers survey results indicate the following²:

• Directors want to spend more time and focus—65 percent of them want focus on cybersecurity, and 47 percent want more attention on IT strategy.
• During the year 2014, the average shareholder support for directors was 96 percent, and around 10 percent of directors failed to receive 70 percent support. Thus, directors are more sensitive to negative voting.
• During the 2014 proxy season, shareholders continued to support compensation plans at high levels. About 84 percent of directors somewhat agree that “say on pay” voting has made the authorities to look at compensation disclosure in a different way. Nearly three-quarters of them agree that say on pay has led to an increased shareholder dialogue and has changed the way the board communicates about compensation.

According to Bainbridge and Henderson (2013), the three components of management, oversight, and service make up the board’s duties.³ The board of directors plays an essential role in management’s decision-making process. Management decisions such as mergers, selling corporate assets, and issuance of stock, among others, must first be approved by the board. Even simple tasks like filing a lawsuit sometimes need to be first approved. Despite all this, the board’s main function is to oversee the day-to-day tasks of management, while they delegate the specifics of the decisions and tasks to management. It is crucial that the board is comprised of independent members who have occupations elsewhere, so that the concept of directors acting to oversee the whole process is established. Following this, other than making major decisions for a corporation, a board’s other duties include hiring and firing management, and setting goals and visions.

The service aspect of the board includes giving guidance and advice to management and the CEO. This point emphasizes the importance of having independent outside members on the board of directors, so that in this situation they can provide to management their impartial opinions offered from different perspectives. It is inevitable for huge corporations to face the problem of agency costs, which is when principals and their agents have differing goals in mind, leading to agents receiving incentives to not act in the best interest of their principals. To keep these agents in line, a group of monitors will conduct the behavior of these agents to ensure that there are no irrational short-term benefit decisions made. While the ultimate group of monitors would in effect be the shareholders, they do not possess the legal right to punish these agents. Hence, the board of directors will serve as those agents instead as they oversee the actions of management. However, as long as these directors have stock holdings, the chances are that they will side more with management than they would with shareholders.

Hence, Bainbridge and Henderson (2013) suggest corporations to adopt Board Service Providers (BSPs) to increase accountability and to reduce the risk of breaking corporate governance.⁴ The BSP, a business entity that would be chosen and hired to be a corporation’s board, would take the place of a traditional board of directors, which in effect would reduce the liability of directors. The process of selecting members of a BSP would be similar to how members of a board of directors are selected currently. The first BSP would be chosen and they would serve until the next year, where they could be renominated again. Shareholders would also be able to vote on the removal of these members. A BSP would be similar to a resource that is outsourced from corporations. The BSP would have a contact person who would communicate and meet with the CEO to discuss big decisions. A corporation could hire whatever mix of individuals it requires on its BSP, reducing the chances of adding unwanted individuals on the board because of “window dressing.” Compensation will take place in the form of billings of annual feels for their services. However, a corporation could feel free to pay a BSP in equity. As mentioned previously, one perk of outsourcing board duties to a BSP is to reduce liability risks for directors. If there were any misbehavior, the BSP could be sued and liability would be held at the entity level, as opposed to an individual or joint level for directors. In general, a BSP is quite similar to the current system in place for a board of directors, with the main distinction being that the BSP should be seen as an “it,” as opposed to a board of individuals.

An effective oversight function of the board of directors requires corporations govern themselves more effectively and restore public trust and investor confidence by following the following six essential tasks as described in the Committee of Economic Development’s Policy Brief.⁵

1. Redefining the mission of the corporation and the roles of the Board of Directors and the CEO: Redefining the corporation’s goals and the board’s roles can lead to long-term shareholder value by focusing on long-term sustainable performance instead of just the achievement of short-term performance. The Board of Directors should provide high performance through balancing risk-taking and management incorporated with integrity.
2. Revamping the leadership process: The training for leaders should incorporate management development processes to give them the experience and skills needed to strategically carry out risk management with integrity. Leaders can benefit from this kind of training as they face more of these types of challenges. The corporation should implement such development through providing educational courses and by assigning a broader range of tasks.
3. Refocusing the process for CEO selection and for other promotions into high corporate positions: The result of the first two tasks is the process for selecting a new CEO who can carry out the corporation’s goals with high performance, strategy, and integrity. The CEO should not only have competence but must also create a culture of integrity and ethics in order to build trust and a good relationship with the public. A corporation needs both integrity and competence to thrive in business.
4. Reformulating operational objectives for performance, risk, and integrity: Companies must create a set of reasonable operational objectives that will improve economic performance, integrity, and risk management and should cover both financial and nonfinancial factors. Sustained economic performance can be examined through return on assets, cash flow, earnings per share, and other long-term performance indicators. While these performance measures are typically used to measure a company’s success, it is equally important for a company to consider nonfinancial factors. These factors are employee satisfaction and morale, understanding the impacts of new technology, acquisitions, and products on business, and building strong relationships with customers. Risk management is not about prohibiting risk-taking, but simply to understand the extent of risks, so that the company is still protected in the event that adverse outcomes occur. Risk functions can exist within or outside of the organization. Functions within the organization should have independent members who can present to a corporation’s business leaders all the systemic risks in...

Table of contents

• Cover
• Half Title Page
• Title Page
• Copyright Page
• Contents
• Preface
• Acknowledgments
• Chapter 1 Oversight Function
• Chapter 2 Board Committees
• Chapter 3 Managerial Function
• Chapter 4 Monitoring Function
• Index