1.1 Purpose
The board of directors developed as a means of capturing wisdom and experience and applying these to problems faced by the organisation at large. The board is where power and authority lie and where responsibility and accountability are to be found. It is a mechanism for synthesising the views of a range of experts who exercise collective responsibility in the long-term interests of the business.
The codes and laws governing board behaviour differ by jurisdiction and the regulations and legal structures under which they are created vary from country to country. Nevertheless, all boards essentially have the same purpose.
As a minimum, that purpose is to accomplish the formal objectives set out in the company’s foundation documents. Board directors do this by utilising the powers vested in them by those foundation documents and by law and regulation. In exercising these powers they should attempt to balance the legitimate interests of all stakeholders, both inside and outside the organisation.
1.2 Responsibilities
Specific board responsibilities vary according to jurisdiction and the prevailing board structure. The responsibilities of a unitary board in a UK company are subtly different from those of a supervisory board in Germany, for example. Regardless of governance structure, the key responsibility of all boards is to balance the interests of the company, shareholders and other stakeholders by ensuring long-term growth that is sustainable and profitable. This involves oversight of the executive through ongoing active questioning, constructive challenge and support. Specifically:
Performance
To support the CEO and management in establishing the optimal strategy for the business, to monitor the implementation of that strategy and to challenge and support the executive in the discharge of their duties.
Succession
To take full responsibility for the board’s own succession including that of the chairman and the CEO, and to ensure that the company has appropriate systems in place for effective succession at senior-executive level.
Compliance
To ensure that the business meets all its regulatory obligations, whether structural, behavioural or financial, and to secure the confidence of investors by upholding the highest standards of corporate governance.
Risk management
To understand the financial, operational and reputational risks faced by the company and the sector in which it operates, ensuring that all necessary measures are taken to mitigate and control those risks.
Reputation management
To have an understanding of and explanation for all decisions and actions taken by the company, ensuring these are properly communicated, whether the company is in crisis or not.
Social impact
To set the tone at the top of the company, to understand the company’s place in society and to provide the executive with the external perspective — “bringing the outside in.” To recognise that regulatory compliance may not be enough to satisfy ethical expectations.
This is not an exhaustive list. However, we believe that no outside director can properly fulfil his or her many responsibilities without deep knowledge of what the company does and an emotional commitment to how it does it. The most effective director is both the representative of the stakeholders and an ambassador for the business.
1.3 The long term
By looking after the long-term interests of the company, directors can foster an environment that creates sustainable value for all stakeholders.
Short-term thinking stifles the ability of company boards to make the bold investments in the future that will secure the long-term health of the business, which is the board’s ultimate responsibility.
A long-term vision for the business is a necessary precursor to the development of strategy, guiding the board and management as they look beyond the five-year horizon.
Is the board focused on the long term?
We recommend that boards ask themselves the following questions:
- Does our board understand the need for a long-term vision?
- How clearly can the directors articulate the long-term vision and values of the business?
- How engaged is our board in debating strategy with management, or is it handed down as a fait accompli?
- To what extent do we cultivate long-term investors and explain our vision for the business to them?
- Does our board seek outside advice on critical issues?
- Are all the directors required to have a long-term stake in the business?
- Do we assess whether new director candidates will uphold the long-term vision of value creation for the business?
If long-term considerations are going to prevail over short-term interests, then the board has to be bold and courageous in exercising its collective responsibility, setting the tone for the business to think about its mission in a different way.
Directors do not have to accept that their hands are tied, that they are there to do the bidding of shareholders who may be only fleetingly involved with the company. They can make a difference by committing themselves more deeply and exclusively to the business and by ensuring that all board activities and interactions with management and investors are underpinned by a clear understanding and articulation of the organisation’s long-term vision and values.
1.4 Accountability
Historically, most boards of directors did not feel the need to answer to anyone beyond the owners of the business, and indeed owners and directors were sometimes the same people. Over the years, however, boards have become accountable to an ever-growing list of stakeholders.
While shareholders were usually the original constituency to whom obligations were owed, these constituencies have expanded to include, at a minimum, employees and customers. More recently, the social impact of a company’s operations, both negative and positive, has meant that all boards must take account of any group or individuals who might be affected by corporate action, regardless of whether or not such persons are in a direct relationship with the company. So, suppliers, regulators, non-governmental organisations (NGOs), lobbyists, academia, potential recruits, etc., all extend the list of stakeholders.
Beyond this, boards are expected to be aware of the company’s overall social impact and to justify and defend their activities in terms of the public interest, not just that of the owners.
Accountability and responsible business
In most markets boards are deemed to be accountable to the shareholders at the General Meeting. However, in all markets local company law addresses accountability and has different emphases. Usually the definition is broadened to include a selection of other stakeholders, i.e. people to whom the company can be seen as owing a duty or people who depend upon it in some other way.
For example, in Italy, there is more emphasis on accountability to the controlling shareholders, and in countries where there are employee representatives on the board, these are also accountable to their employee electorate. In Norway, the board is accountable to the company, which includes not only shareholders and owners, but also creditors, employees and others. In the Netherlands, the board is accountable to all stakeholders. In the UK, the board is accountable to the shareholders and the company itself, although it is obliged to have a broader constituency in mind.
Thus beyond existing codes and law, there is general acceptance of the concept that companies have obligations beyond just shareholders and the requirement to produce profit.
Originally, obligations were largely owed to owners, promoters and those who had invested in the success of the business for reward. Growing recognition of social market pressures then led many jurisdictions to expand the list of interested parties to include “stakeholders” and those on whom the company relies for its wider success, e.g. employers, customers, local communities, etc. Today’s concern seeks to establish whether companies and directors owe obligations to society at large in return for their licence to operate and, if so, what these might be.
1.5 Regulation
Boards do not operate in a vacuum, insulated from the pressures of accountability. Both law and regulation delineate what they can and cannot do and how they should go about their work.
Once upon a time, there was only the law. Both civil codes and common law set out the duties of directors in limited form. Founding shareholders and owners were supreme and as for the interests of subsequent investors it was a case of “caveat emptor”. Other stakeholders had not yet been identified, nor their interests protected.
In recent years, the law has been deemed insufficiently comprehensive to regulate all aspects of corporate behaviour. More importantly, it lacks the flexibility to be changed quickly to deal with emerging responsibilities or abuses and with the evolving pace of public expectations.
Consequently, authorities have turned increasingly to regulation and codes of conduct to guide board behaviour. Sometimes they have promoted self-regulation but results have been mixed.
Most national governance codes are based on the principle of comply or explain. Whilst reasonable, the principle’s effectiveness depends on the quality of the explanation in the event that a company does not comply with a recommendation. Given that most codes are largely silent on what comprises a proper explanation, the adequacy of comply or explain is an issue for the outside director to consider carefully.
A particular challenge for directors is the proliferation of codes of conduct and best practice recommendations at investor, regulator, national and supranational level. Corporate governance is now both an industry and a field of academic study. Directors will need professional guidance to understand the sometimes conflicting signals coming from these many sources.
1.6 Structures
In this publication we identify those aspects of being a director that are common to all types of boards, but especially those of listed companies. However, different governance systems operate throughout the world and have created a range of different board structures.
It is important to remember that the dynamics of the board and the role of the outside director will vary to reflect what type of board structure is in place. The role may also be slightly different in state-owned or in family-controlled businesses.
In Europe, two forms of board structure predominate: 1) unitary or single-tier, in which supervision and management are combined in a single body; and 2) supervisory or two-tier, in which supervision and management are respectively assigned to separate bodies. The responsibilities of a supervisory board are necessarily fewer, lacking the management dimension.
Unitary board
A unitary board consists of a chairman, outside directors and at least one representative of management. Within this basic model there are many variants:
- In some countries, one individual performs both the chairman and CEO roles
- Unitary boards often have a senior independent director or equivalent
- Independent directors are usually in the majority
- Some outside directors may not be independent
- Management may be represented by the CEO as well as other executives
- Day-to-day management of the company is handled by a senior executive team often referred to as the executive committee, appointed by and responsible to the CEO.
Supervisory board
A supervisory board consists of a non-executive chairman and outside directors. Some jurisdictions have co-determination laws governing board composition, meaning that up to 50 per cent of board members must be employee representatives elected by employees. In the two-tier system, the management function is in the hands of a separate legal entity, often referred to as the executive board, which is chaired by the CEO and overseen by the supervisory board.
In some countries, for example France, Italy and the Netherlands, company law permits companies to choose between two or even three alternative board structures.
Family-controlled businesses, state-owned enterprises and cooperatives often have board structures that reflect their unique circumstances. This means that they can conform to listed company governance requirements where relevant but choose to ignore them when not.
The role and responsibilities of the outside director in an organisation where there is a majority shareholder are not materially different from those of a director in a listed company with a broad shareholder base. However, they may be harder to execute and properly discharge, and require direction and determination to maintain true independence.
All structures should provide the opportunity for outside directors to properly discharge their responsibilities, with protections in place for them in the event of dispute. This should be a comfort to board members, who of course can always exercise the power of resignation.
Larger and more complex companies sometimes form an advisory board, whose purpose is to provide additional specialist expertise without the legal constraints or obligations imposed on board directors.