More stringent governance procedures are making board meetings difficultMore stringent governance procedures are making board meetings difficult

THE BOARD - strategic apex of companies.

The Board of directors and how it is organised

Let us consider a 'typical' Board of Directors of a large company quoted on the London Stock Exchange.
First, the board will be divided between executive and non-executive directors. In these days of the Combined Code of Corporate Governance, very few listed companies have no non-executive directors. They are also seen as important by investors, who believe that the detached and essentially shareholder-oriented perspective of non-executive directors is vitally important.

Executive directors will usually consist of the Chief Executive, who is responsible for managing the company, the Finance Director and a number of other executive directors with either functional roles, like Human Resources director, or executive management roles, like Divisional Chief Executive.

The non-executive directors will usually include the Chairman, Deputy Chairman or senior non-executive director, and other non-executive board members.

The Chairman

The role of Chairman can vary considerably from company to company, depending on individual predilections, personality and company needs or history.

Some chairmen's roles are restricted to managing the board and their influence will not stretch far into the company. In other cases a more involved chairman may be quite actively engaged in the internal affairs of the organization, in particular in leading the process of strategy formulation and strategic leadership. But, as a minimum, all chairmen will have certain basic roles.

The first, as the name implies, is to manage the board and its meetings, and to make sure that the governance functions of the board are properly performed. In doing this, most chairmen are closely supported by the Company Secretary, who will support the board and take meeting minutes, but is not normally a board member.

The chairman will take the lead in the appointment and removal of other directors, in particular, the chief executive. An understanding and skilful chairman can be of very great assistance to a chief executive who is open to having an experienced mentor.

Chairmen are also an important point of contact for investors who have messages that they wish to pass to management. It is usual for investors who have a problem with the performance or management of a company to approach the chief executive first, and if they feel that this contact has not achieved the desired effect, to go to the chairman.

A last port of call, if neither chairman nor chief executive is sympathetic, is the deputy chairman, or senior non-executive director. If this happens, matters will have reached a pretty serious pass and heads are likely to roll.

Executive and Non Executive Directors

In most companies, the Chief Executive and Finance Director will conduct normal communication and contacts with the financial markets. They will routinely present to investment institutions once or twice a year.

This means quite a lot of presentations for CEOs of larger companies, some of whom estimate that they spend up to 40% of their time on matters connected with the financial markets and press.

Finance directors are important supporters for chief executives in presenting to investors, as their intimate grasp of the "numbers" lets the CEO deal with broader aspects of strategy. Finance directors also tend to deal with the extensive communication that routinely passes between City analysts, the financial press and companies.

Although all directors are in theory equal in law, it is not at all unusual for executive directors to feel that they are less equal than their non-executive "peers". For example, it would not be all that normal for each director to have an equal say on the appointment of a deputy chairman or even a new non-executive director. That decision is likely to be made by the chairman and the other non-executives, in consultation with the chief executive.

In many companies, there is quite a sharp divide between non-executive and executive directors. It is quite usual for executive directors to meet before board meetings to make sure that all are 'singing off the same hymn sheet' in the way they handle issues in front of the non-executives, and, in turn, for non-executive directors to meet informally with the chairman.

Many companies have some kind of executive committee that has formal powers delegated to it by the board. Such committees are usually chaired by the chief executive and contain executive directors and other senior executives with significant corporate responsibilities. It is often this kind of committee that deals with the real business of directing the company, leaving the full board with the role of responding to propositions put to it by the executive through carefully prepared presentations.

The non-executive role has undoubtedly moved on from that likened by Lord Boothby in the 1960s as being 'like a permanent warm bath'. He described his duties: "No effort of any kind is called for. You go to a meeting once a month in a car supplied by the company. You look both grave and sage."

Changed it may be, but there is still an issue about how well a non-executive can really know the organisation, and in particular the financial detail. Often, therefore, non-executive directors are very dependent on the information fed to them by the executive. This means that the relationship between the chairman and chief executive is particularly important in ensuring that non-executive directors get a 'full and fair' view of what is really going on inside the company.

This problem is exacerbated by the amount of time that non-executive directors spend on the role. Many of them are very busy people with a heavy executive workload elsewhere or multiple non-executive and other responsibilities. According to the Independent Director Survey published in 2003 by IRS (Independent Remuneration Solutions) in association with 3i, on average independent directors of companies with turnover in excess of £1 billion spend an average of 22 days per annum on their duties. This breaks down as 12 formal meeting days, 7 days preparing and travelling, and three days on plant visits and other non-formal occasions.
If we add in the difficulties of interpreting what is happening through the medium of board papers and presentations, then it is not difficult to understand that by the time non-executive directors come to exercise their powers to check the executive, matters may have reached crisis point.

Non-executive 'failure to act' on deteriorating performance before it hits financial crisis has also been a repeated feature of corporate life, from Sears through Equitable Life, Marconi and Enron in more recent times.

On April 25 2002, Lord Young of Graffam, in his departing speech as president of the Institute of Directors, questioned whether it can ever be possible for non executives working on a part-time basis to know enough about what is going on in an organization to blow the whistle on bad practise and decision-taking. Why bother with non-executives at all, he asked.

Meetings and Committees

Continuing with our look at boards, it would accurate to say that they function mainly through formal meetings, either of the whole board or of special-purpose sub-committees.

Obviously, there will be informal contacts, particularly between chairmen and chief executives, and sometimes non-executive directors may be informally consulted on particular matters. Such 'soundings' may be about business decisions or matters of procedure. In this case, they may be initiated by the chief executive, after consultation with the chairman, or conducted by the company secretary, by agreement with the chief executive.

Regular Board Meetings

Formal meetings of a board will usually consist of regular board meetings. The annual number of meetings is generally eight to twelve.

Board meetings preceding the company annual general meeting and reporting of results to the City are usually 'three line whip' affairs.

Whilst board meetings always have formal agendas and minutes, they can occasionally be dramatic and interesting, such as the one where a newly appointed chief executive sat outside whilst the board wrangled over a bid by one of its non-executive members to be appointed to the role. The unfortunate new appointee was notified after lunch that the job he had been offered was no longer available. However, this scale of drama is very rare!

Most board meetings tend to centre around presentations of results by the chief executive and finance directors, with further presentations on issues or proposals requiring board approval. Directors are at liberty to raise any issue under the 'any other business' item at the end of the meeting, but in practise, seldom do. There is a strong tendency for many board meetings to be rather formal affairs, with little spontaneity, exploration of ideas or learning.

Boards will usually have sub-committees, two of which have an important role to play in ensuring good corporate governance.

The Remuneration Committee

As its name implies, this body is mandated to determine the level and makeup of the remuneration of directors, and often to agree policy guidelines for senior executive pay more generally.

The Committee will usually employ an independent firm of compensation consultants to give them advice rich with research data on the executive pay market and on significant trends in pay and benefits. Some people have tended to lay blame for burgeoning top executive pay at the door of such consultants, but this is rather unfair, as they usually simply report their research and comments, but do not make any decisions. These are supposed to be made by the committee, which is normally made up of the chairman and all or most of the non-executive directors.

The group of people, who, if they so decided, could have a dramatic impact on top executive compensation, are members of FTSE 100 Remuneration Committees. Readers can find who they are by reference to company annual reports.
Criticisms of Remuneration Committees are well publicised and not invalid. Certainly, as we shall see, there is a certain 'brotherhood' of top managers with a shared perception that generosity given may mean generosity received.

One of the authors was called many years ago by a remuneration consultant who was advising his company on top executive pay. "You will have no problems in getting through a big rise for X" (the CEO), he said. On being asked why, he said that he happened to know that the chairman of the Remuneration Committee had himself received a very generous increase in his role of chairman/CEO of another company!

The Audit Committee

The second body of importance is the Audit Committee, formalised as one of the Cadbury recommendations (now part of the Combined Code on Corporate Governance). Generally, the purpose of this committee is to make sure that the company is managing its financial affairs in an effective, honest way and that proper standards of probity and accuracy are reflected through the financial planning, reporting and control procedures.

In practise, the Audit Committee, comprising solely non-executive directors although advised by executives and outside experts, is heavily dependent on the finance director and in particular, the company's auditors.

The law requires auditors to give an opinion on whether the financial statements presented in the company's annual report and accounts "give a true and fair view" of the state of the company's affairs and its profit and cash flow statements at a particular date. In addition, the auditors will report to the Audit Committee on any shortfalls in standards or practise of accounting.

If the auditors feel that they have reason, they can 'qualify' a company's accounts, which means that they are not satisfied that the accounts, for whatever reason, do give an accurate picture of the state of the company. Needless to say, finance directors pay great attention if the reasons for qualification appear to be serious.

Auditors and the Audit Committee therefore have great potential power. So why is there so much concern at present?

In recent years, firms of auditors have been exposed to great pressure to reduce the cost of the audits of large companies. Auditing fees have declined. For many of the big accounting companies, a neat way out of this bind was to build a consulting business that hopefully could leverage on the relationships already established through the audit. In time, the growth of consulting meant that the audit took second place in generating revenues, with the inevitable conflicts of interest that, for example, seem to have characterised the relationships between Andersen and Enron.

But, far more important, is the increase in sophistication and complexity of the ways in which large companies use financial, tax, funding and accounting 'innovations' to improve apparent and actual performance. This all makes the work of auditors more complex and difficult, and the financial affairs of some companies are so full of 'smoke and mirrors' that it is not at all easy to judge what a "true and fair view" might actually be. To exacerbate matters, the really smart brains tend to gravitate to the more creative end of finance and not so much to auditing.

Other Meetings

Boards will have other gatherings than the strictly formal meetings. These will be different from company to company, but it is not unusual for a day or more to be spent each year at an offsite strategy discussion between management and non-executive directors.

Sometimes companies will rotate board meetings around their various locations to give non-executive directors a feel for what the company actually does, but these events can be rather superficial.

Finally, non-executive directors may be invited to management conferences, where, over a few drinks, they might have some chance of getting a real sense of what is going on inside the company!

Many people are beginning to feel that large company boards, as currently constituted, are not capable of regulating the affairs of complex international enterprises, nor of making a quality contribution to their direction. Given the somewhat incestuous nature of the relationships between the 'great and good' of management, and the increasing influence of investors and others in the financial markets over careers and reputations in management, we may be getting a glimpse of a closed system of mutual interest that is not necessarily there to further the interests of society at large.

Directors' duties and corporate governance

Corporate governance has received a lot of attention in recent years. The laws and rules that affect governance derive from a wide variety of sources.

The duties and restrictions that will limit what directors of companies can do or direct what they should do derive from statute law, common law and case law. The main statute is the Companies Act 1985. The directors of a company listed in the UK also have to abide by the Listing Rules published by the Financial Services Authority regulating the freedom to act without shareholder consent and communications between listed companies and its shareholders and potential investors. The Listing Rules include the Combined Code on Corporate Governance as an appendix and listed companies are expected to comply with its provisions.

In addition there are a huge array of guidelines issued by such institutions as the Investor Protection Committee, made up of representatives of such bodies as the Association of British Insurers and the National Association of Pension Funds.

On top of this, numerous committees, usually chaired and manned by members of the great and good of the business world, have deliberated and reported on such matters as the duties of directors, open reporting and executive compensation.

Nowadays, the annual reports of quoted companies contain compendious sections on corporate governance containing statements of company provisions in relation to codes of best practise in an array of different fields from health and safety and compensation policy to accounting and financial disclosure and environmental protection. So there is no lack of guidance for companies on standards and best practise when it comes to directing a quoted company in an honest, ethical, safe and environmentally friendly manner.

In Europe, for example, there are 39 Codes governing the behaviour and actions of directors of companies. As is often the case, the UK leads the way, having adopted 11 Codes and having many guidelines published by investor bodies such as the Association of British Insurers. The ABI guidelines cover such matters as executive compensation, share capital management, duties of directors and shareholders, disclosure, social responsibility, share incentive schemes and many others.

Here is a 'potted' version of the legal position regarding the duties, responsibilities and liabilities of directors. These are not combined under one authority, but arise under the Companies Act, common law, court judgments and other statutes, rules and regulations:

But, if we come to the crucial question: on whose behalf are directors exercising their powers, the answer seems pretty unequivocal. Directors are acting on behalf of the owners of the company and the owners are the shareholders.

Shareholders own the company and directors must act in good faith in the best interests of the company. Where there is a conflict between a director's personal interests and those of the company, the director must always favour the company. A director owes his duties to the company only, but directors need to have regard to the interests of the company's stakeholders (shareholders, employees, the general public, creditors and other business partners).

In practise, this means that the bulk of director's obligations are to further the interests of shareholders. As investment is mainly carried out on behalf of shareholders by fund management institutions, they tend to exercise massive proxy influence over directors, although this may not be the strict legal position.

When asked what obligations directors had when a company was bid for by a potential acquirer, an experienced City lawyer said that, "For practical purposes, directors would be sensible to regard their duties as being 99% towards maximising the value of the company for shareholders".

An observer of the whole corporate governance scene is left with the strong sense that, whatever the words may say, the thing that really matters in the end is what the financial markets think.

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