Corporate Governance

By: 1. Kenneth A. Kim John R. Nofsinger

And 2. A. C. Fernando

The Board of Directors

Lecture 10

Last Lecture Review◦ Overview of the Board

Board legal duties May not be the federal law requirement but the state

wants BoDs. Firms profitability and increase in share value Loyal and fair Take care of the rule of ethics

Employment practices Human rights Environment regulations Corruptions Moral obligations

The Board of Directors

Board Committees◦ An Executive Committee◦ A Finance Committee◦ A Public Relation Committee

Board Sub Committees◦ Audit Committee◦ Compensation Committee◦ Nomination Committee

The Board of Directors

Lecture Outlines◦ More attention on Directors◦ What is a “Good Board”?

Experienced members Having different back ground i.e. technical as well as

non technical Independent board-having fraction of non-insider

directors (difficult to find unambiguously independent directors)

Small board

The Board of Directors

Good for Goose, good for Gander◦ One form of board may be/may not be good for

others.◦ Small board may be/may not be good for others

firms and vice versa.◦ Can good board lead to better firm performance?

No positive correlation between the board quality and firm performances.

Normally board are reactive, not proactive Sometimes inside directors are good for board (e.g.

infant or new firms or when the firm has to make any huge financial/investment decision) and some times outside directors (e.g. when audit as well as compensation matters are required)

The Board of Directors

Some potential problems with today's board◦ Outside Directors relationship with the top

management (e.g. CEO)◦ Outside directors full motivation is still a question

mark for firm’s board.◦ Inexperienced as well as busy outside directors

are fruitless for the board

The Board of Directors

More Attention on Directors

Prior to the mid-1980s, the public paid little heed to directors.

Now the situation has changed. Increased pressure on BODs has resulted in

better corporate governance. The increased takeover market and the new

regulatory environment push the directors to do their jobs.

The Board of Directors

What is a “GOOD” Board?

Experienced members

Technical firms must have technical experts and vice versa.

Its entirely the firms decision.

A board with members having different background can also be beneficial for the firms.

The Board of Directors

Independent Boards

There must be a high fraction of non-insiders (directors) for a good board

◦ E.g. One of the board primary responsibilities is to evaluate, compensate and possibly fire the CEO. What if the board consists of the following people; A friend of a CEO A relative of a CEO A business collaborator of a CEO

The Board of Directors

Its very difficult to find people who are entirely and unambiguously independent of the firm’s management.

Because they all know each other.

Either friends or relatives

The Board of Directors

Small Board

A board with fewer members might be a better board.

Too many cooks spoil the broth.

Most of the researchers are thinking in the same way i.e. Small boards are more effective than large boards.

The Board of Directors

In small boards, every individual will think extra responsibility on his/her shoulder and vice versa.

With larger boards, its very difficult to reach consensus and to get anything meaningful done.

The Board of Directors

Good for a Goose, Good for a Gander?

What is good for a firm must be/must not be good for others.

Young growth-oriented firms would be looking for more insiders, might be the best people to serve the board.

Larger and more diversified firms may need more directors, keeping in mind the scope of its operations.

The Board of Directors

So who will take the decision?

The managers- they may be in the best position to pick a good board but his self-interest may get in the way.

The firm’s outside shareholders – they can vote on the board members and having no power in appointing directors directly, unless they could make the majority.

The Board of Directors

Can Good Boards Lead to Better FirmsPerformance?

It is not clear that there is a positive correlation between board quality and firm performance.

Boards may be effectively reactive and may not be effectively proactive (value creator).

The Board of Directors

It depends either insider or outsider.

◦ E.g. Committee that determine CEO compensation and are responsible for the firm’s audit may best be served by outsider

◦ But committee that make firm financing and long-term investment decisions may be served best by insider.

The Board of Directors

Potential Problems With Today’s Board.

One of the main functions of the board is to evaluate top management, especially the CEO. However, for many firms, the board’s chairman is also the firm’s CEO.

Most of the outsiders have some personal tie to the CEO.

The Board of Directors

The directors (commonly the outsiders) do not have a significant vested interest in the firm, holding little or no stock.

Are directors capable of providing the time and expertise required to fully understand the major operating and financial decision of the firm? Most directors have their own highly demanding full-time jobs. So how to cope with?

The Board of Directors

Some directors simply don’t have the expertise to be a board member.

Some boards are simply large and difficult to actively involve them.

Some directors might not be truly independent , they might be too busy.

The Board of Directors

Summary◦ A BoDs is a body of elected or appointed members

who jointly oversee the activities of a company.◦ BoDs are appointed at the public Annual General

Meeting of shareholders.◦ Types of board are depending upon company status as

well as the territory where the company prevails. ◦ Normally, we can see One-Tier board in common law

based societies (like US and UK) and Two-Tier board in civil law based societies (like Germany etc).

The Board of Directors

BoDs functions involve to hire, evaluate or even fire the top management, to vote in support or against of major proposals as well as financial decisions.

In short, BoDs main primary function is to safeguard the shareholder’s interest.

But the most important factor is to think a lot before selecting your board

The Board of Directors

◦ Overview of the Board Board legal duties

May not be the federal law requirement but the state wants BoDs.

Firms profitability and increase in share value Loyal and fair Take care of the rule of ethics

Employment practices Human rights Environment regulations Corruptions Moral obligations

The Board of Directors

Board Committees

◦ An Executive Committee◦ A Finance Committee◦ A Public Relation Committee

Board Sub Committees◦ Audit Committee◦ Compensation Committee◦ Nomination Committee

The Board of Directors

◦ More attention on Directors◦ What is a “Good Board”?

Experienced members Having different back ground i.e. technical as well as

non technical Independent board-having fraction of non-insider

directors (difficult to find unambiguously independent directors)

Small board

The Board of Directors

Good for Goose, good for Gander◦ One form of board may be/may not be good for

others.◦ Small board may be/may not be good for others

firms and vice versa.◦ Can good board lead to better firm performance?

No positive correlation between the board quality and firm performances.

Normally board are reactive, not proactive Sometimes inside directors are good for board (e.g.

infant or new firms or when the firm has to make any huge financial/investment decision) and some times outside directors (e.g. when audit as well as compensation matters are required)

The Board of Directors

Some potential problems with today's board◦ Outside Directors relationship with the top

management (e.g. CEO)◦ Outside directors full motivation is still a question

mark for firm’s board.◦ Inexperienced as well as busy outside directors

are fruitless for the board

THE END

The Board of Directors