Roles and Responsibilities of 21st Century Board

8/17/2019 Roles and Responsibilities of 21st Century Board

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Roles and Responsibilities of 21st Century Board

Adrian Fong, Chinese University of Hong Kong


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1. Introduction and Research Objectives

One of the main difficulties with practising corporate governance1 in Hong Kong is the fact that

boards have a difficult time understanding their roles and duties.2 A survey found, in 1998, that

many directors in Hong Kong did not understand their duties.3

With each passing financial crisis and corporate scandal, the board has become an increasing

essential body with new directives and obligations it needs to fulfil. This has translated into newlegal roles, responsibilities and obligations. But more than that, constantly evolving corporate

governance practices – the Hong Kong Stock Exchange (“Exchange”) implemented the newCorporate Governance Code in 2012 – have also introduced another set of roles andresponsibilities for the board. As such, the board of directors, especially those in Hong Kong, canno longer be incognizant of their duties.

4

The future success of Hong Kong as a global economic and financial centre depends on the

continued success of its companies. This can only happen if the board is at the forefront in practising corporate governance by understanding and fulfilling its roles and responsibilities.

In light of the board’s increasing importance to corporate governance, this study aims to exploreand consolidate the roles and responsibilities of the 21

st century board of directors. It begins by

briefly noting the historical and legal framework of the board, explores contemporary issues and

responsibilities regarding corporate governance, and then considers the future direction of theresponsibilities of board. Through this study, Hong Kong boards should have a clear and

comprehensive framework of their roles and responsibilities in the 21st century. Observing

existing problems, this study also seeks to recommend different practices which will enable boards to practise corporate governance more effectively.

1 The definition of corporate governance follows the popular one established in the Cadbury report as “the system bywhich companies are directed and controlled”. See GJ Rossouw, A van der Watt & D P Malan, ‘Corporategovernance in South Africa’, Journal of Business Ethics, vol. 37, no. 3, 2002, pp. 289. 2 G Jones, Corporate governance and compliance in Hong Kong , LexisNexis, Hong Kong, 2012, p. 255.

Surprisingly, the Companies Ordinance in Hong Kong is silent on the general role of a director; instead, theOrdinance lays out a list of legal responsibilities where the board has a role to play (such as the approval of the

company balance sheet). This has made it somewhat difficult for directors to ascertain their specific role in a

company.3 A Majid, CK Low & K Arjunan, ‘Company Directors’ Perceptions of Their Responsibilities and Duties: A HongKong Survey’, Hong Kong Law Journal , vol.28, no. 1, 1998, pp. 24-25.4

S Ho, Corporate Governance in Hong Kong: Key Problems and Prospects, 2nd end, School of Accountancy, HongKong, 2003, p. 32. “Corporate Governance is the foundation of our capital market and one of the key elements inmaintaining investor confidence… [H]ong Kong’s success as an international financial centre to a considerableextent hinges on the concerted efforts we have made in the past to enhance our corporate governance regime …[T]he Government’s policy direction is clear – we must maintain our market quality and continue to enhance ourcorporate governance.” See F Ma, Corporate Governance in Hong Kong, Government of Hong Kong, 2005,retrieved 10 July 2012, ‹www.info.gov.hk/gia/general/200508/25/P200508250121.htm›. See also, A Young,'Reforming directors' duties in Hong Kong: the journey, stakeholders and oversights', International Company andCommercial Law Review, vol. 23, no. 4, 2012, pp. 142: “corporate governance law reform in Hong Kong should beof interest to international investors”.


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2.

Historical and Legal Framework

2.1. Historical Framework

The most basic and fundamental duty of a director, and collectively of the board, is its fiduciaryduty to the company.

5 This duty is one that is long-established and was best expressed in the case

of Dorchester Finance Co Ltd v Stebbing 6 where it was noted that a director must act in good

faith with honesty in the interests of the company, while exercising a reasonable care and adegree of skill as may reasonably be expected from a person with his knowledge and

experience.7 This basic duty may be further subdivided into different branches and has been

summarized by the Companies Registry.8

The detailed roles and duties of the directors have evolved through precedential case law,

reports, historical changes, and, in some cases, by political and economic necessity.9 However,

the basic fiduciary duty remains the same for the directors.

Enron as a Failure of the Board

The United States Senate launched a subcommittee hearing and investigations into the Enron

board after the scandal. Amongst other reported findings, the Senate noted that the board

members failed in their most basic fiduciary duty to the company.10

The board had noticed

numerous questionable activities by the management but chose to ignore them to the detriment ofthe shareholders.

11 These facts leave no doubt that a failure by the board into its most basic and

fiduciary duty can result in the failure of a company.

5 See Percival v Wright [1902] 2 Ch 421 (HC). “The basic legal duties of directors are to act in good faith in theinterests of the company and for a proper purpose’ and to exercise care and skill.” Committee on CorporateGovernance, Hampel Report , 1998. 6 Dorchester Finance Co Ltd and another v Stebbing and others [1989] BCLC 498, [501]. 7 In Re City Equitable Fire Insurance Co Ltd [1925] Ch 407, Romer J formulated these three propositions by which

to measure a company director’s skill and care. In doing so, he established the superstructure of the modern law inthis sphere. S Chan, Directors’ duties in Hong Kong: Codify or Not?, Hong Kong Institute of Accredited

Accounting Technicians ,2009, retrieved 11 July 2012, ‹www.hkiaat.org/images/uploads/articles/Director.pdf›.8 Companies Registry, A guide on directors’ duties, Companies Registry, 2009, retrieved 10 June 2012,

‹www.cr.gov.hk/en/publications/docs/director_guide-e.pdf›. These principles were well-established in mid-1900sthrough a number of cases in England, and transplanted into Hong Kong. See Re Smith and Fawcett Ltd [1942] Ch

304 (CA), which established, amongst others, the discretion of directors, and Re Lands Allotment Co [1894] 1 Ch

616 (CA) which dealt with the role of directors as trustees of the assets of the company. 9

Corporate governance, although conceptually known, was not a popular phrase until the late 1900s when growingscandals in the corporate world led to a call for reform in the corporate governance structure in order to restore

investor confidence. The wave of committees (from UK: Cadbury and Hampel Reports; South Africa: King Reports,

Sarbanes-Oxley Act) reviewed industry practices and noted the importance of corporate governance, in relation to

the board of directors, to business prosperity and accountability. As of now, after the financial crisis, another wave

of reports (Walker Report & King Report III) are starting to transform corporate governance again.10 Permanent Subcommittee on Investigations, The Role of the Board of Directors in Enron’s Collapse, U.S.

Government Printing Office, 2002, retrieved 8 June 2012, ‹www.gpo.gov/fdsys/pkg/CPRT-107SPRT80393/pdf/CPRT-107SPRT80393.pdf›. 11 Ibid .


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2.2. Statutory Framework and Compliance

Legislation, such as the Companies Ordinance in Hong Kong (and the Sarbanes-Oxley Act in the

United States, which reverberated internationally), have become the main driving force for the

increase in responsibilities of the board of directors. One such obligation now enshrined inlegislation is the duty of the board to approve and sign off on the balance sheet.

12 There is an

obligation to follow all legislation; severe criminal and civil penalties can arise if this is not

followed.

The Star Bio-Tech Case

Brightline Futures Company (“Brightline”) was a substantial shareholder of Star Bio-TechLimited. As a substantial shareholder, it had the obligation to report its changes of interests in theshares of Star Bio-Tech. Failure to do so cost Brightline and Cai, its director, fines to the

Securities and Futures Commission.13

The HSBC Case

Recently, HSBC was hit with a number of charges including lax anti-money laundering controls,mis-selling financial products, and possible global interest rate-rigging.

14 These charges led to

HSBC making provisions for billions of dollars to cover fines and other costs.15

All boards should be reminded that the company has a basic obligation to follow the legal dutiesimposed upon it by law. Thus, the board has the responsibility of ensuing and setting up a culture

where laws and regulatory rules are followed. A Chartered Secretary or a lawyer should be

present to serve as a guide to the board on their legal responsibilities where uncertainties arise.

Chartered Secretaries also assist keeping the board up-to-date on corporate governance practices.16

3. Corporate Governance: Crucial Responsibilities of the 21st Century

Board

A board of directors which only conforms to legal obligations is a 20th

century board in that it

represents the past – complying with the lowest common denominator of corporate governance

12 Companies Ordinance 1997, section 129B.

13

Securities and Futures Commission, SFC Successfully Prosecutes Brightline Futures Company Limited and MrCai Yuan for Contravening the Securities (Disclosure of Interests) Ordinance, 2001, retrieved 21 June 2012,‹www.sfc.hk/sfcPressRelease/EN/sfcOpenDocServlet?docno=01PR24›. 14 S Slater & M Scuffham, HSBC takes $2 billion hit for U.S., UK scandals, Reuters UK, retrieved 31 July 2012,

‹http://uk.reuters.com/article/2012/07/31/uk -hsbc-earnings-idUKBRE86T07O20120731›.15 Ibid . 16 The importance of a company secretary, mandated by Companies Ordinance, was noted in the Cadbury report,

and most recently in OECD 2011 Report ( Reform Priorities in Asia: Taking Corporate Governance to a Higher Level ). Indeed, the new Exchange Listing Rules now mandate the use of a suitable candidate, such as a Chartered

Secretary, for each issuer alongside directions for yearly professional training.


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practices.17

A board which views its role as a negative role – where its members strive only to‘do no harm’ – is not practicing true corporate governance. Indeed, the era of the boardroomwhere chairman could “speak a few slow words… [directors] would agree to everything…signsomething…and the board meeting would be over” is long gone as the board has gained newimportance since the 1800s.

18 The board is no longer a ‘rubber stamp’ for policies.19

Instead, corporate governance, which is the responsibility of the entire board, is a positive duty todirect and control the company. This point is above contention and essential to understanding the

21st century board.

20

The responsibilities of the 21st century board regarding corporate governance can be divided into

the following: monitoring and oversight of the company, accountability to shareholders, board

evaluations, and nominating directors and senior management.

3.1. Monitoring and Oversight of the Company

The board has the responsibility of monitoring the company and ensuring that the necessarycontrols over the activities of the company and the management are in place and working.21

This

role means that board has a continuing duty to oversee the company and its supervisory

processes.22

Sino-Forest Corporation

Sino-Forest is a company listed in Canada that sold forestry-related products. Amongst its assets,it claimed to have vast holdings of forestry land in China. However, subsequent investigations

discovered that these assets were overstated or nonexistent, causing the Ontario Securities

Commission to file fraud charges in May 2012 against the Sino-Forest and its executives, most

notably Allan Chan.

23

The perpetuation of such a large-scale fraud escaped the vision of the board of directors (many

whom reside in Hong Kong). In a report by an independent committee made up of Sino- Forest’s

17 While these duties should not be codified into company law for all boards, Hong Kong boards should nonetheless

follow these for the benefit of themselves, the company, the shareholder, and for the furtherance of Hong Kong’scompany. These principles also apply to small-and-medium enterprises (SME), although some recommendations

will have to be adapted based upon the individual circumstances of an organization (for example, some companies

may only have one director, who is also the founder). 18 R Monks & N Millow, Corporate Governance, 5th edn, John Wiley & Sons, West Sussex, 2011, p. 252.19 S Bainbridge, Corporate governance after the financial crisis, Oxford University Press, New York, 2012, p. 44.20

S Arcot & V Bruno, In Letter but not in Spirit: An Analysis of Corporate Governance in the UK , p. 5, 2006,retrieved 15 July 2012, ‹http://www2.lse.ac.uk/fmg/research/RICAFE/pdf/RICAFE2-WP31-Arcot.pdf›;See also P Macavoy & I Millstein, 'The Active Board of Directors and its Effect on the Performance of the Large

Publicly Traded Corporation ', Journal of Applied Corporate Finance, vol. 11, no. 4, 199, pp. 8-20. 21 Cadbury, s. 2.5. 22 B Manning, 'The business judgement rule and the director’s duty of attention: time for reality ', Business Law

Review, vol. 39, 1984, pp. 1494. 23 V Lu, Sino-Forest probe continues though company may not defend itself at OSC hearing , Toronto Star,2012,retrieved 6 July 2012, ‹www.thestar.com/business/article/1225411--sino-forest-probe-sifting-through-millions-of-documents-mostly-in-chinese›.


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board of directors after the discovery, it noted various challenges in producing an accurate report

of the business. Amongst these challenges was the complexity and lack of visibility of the

company’s structure and the non-cooperation by the company’s executives towards theinvestigation.

24 The committee said in January that “a full account of the company’s activities

and business ties may never be possible.”25

Recommendations:

Continuing duty to understand - The board should always make sure it has a fullunderstanding of the business structure and model in order to govern and monitor it

effectively.

Where it does not, the board must take proactive measures to gain a full understanding ofthe business. This is especially necessary if the board feels the management is

unforthcoming with the information, a sign of possible impropriety.

Monitoring the company - The job of monitoring the board has largely fallen to thestandard audit committee in recent years. Yet monitoring involves the efforts of the entire board. An internal report into the WorldCom scandal, involving CEO Bernard Ebbers, onthe board states that “While [the] board did not appear to know about the company'saccounting fraud, it was so passive that it had little chance of discovering it”.26

It is recommended that the boards also take time to visit personally major assets, factories,

auditors and call business partners to truly understand the state of the company. It cannot

fall to the board to gain information only from the management of the company. All thesesteps are corporate governance practices applied not by sitting in a boardroom receiving

information from the management, but through active governance essential to monitoring

the company.

Where the board feels like the management is engaged in illegality, it is also recommended

that it takes immediate action, even to point of removing the management.27

Review of internal controls - The Turnbull Report and the OECD White Paper onCorporate Governance in Asia recommend that the board of directors develop and maintain

adequate internal controls.28

This would include measures to “help ensure the quality of

24 The Independent Committee of the Board Of Directors of Sino-Forest Corporation, Final Report , Sino-Forest

Corporation, 2012, retrieved 3 June 2012, ‹www.sinoforest.com/Uploads/SFC%20-

%20Final%20IC%20Report%20Redacted%20-%20Jan31%202012.pdf›. 25 C Donville and L Hill, Sino- Forest Engaged in ‘Fraudul ent Scheme,’ OSC Alleges, Bloomberg, 2012, retrieved28 July 2012, ‹www.bloomberg.com/news/2012-05-22/sino-forest-disclosure-grossly-misleading-osc-says.html›,emphasis added.26 J Hopkins, Report: WorldCom board passive, USA Today, 2003, retrieved 19 June 2012,

‹www.usatoday.com/money/industries/telecom/2003-06-09- board_x.htm›.27 A Naciri, Internal and external aspects of corporate governance, Routledge, New York, 2010, p. 60; S Green,

Sarbanes-Oxley: and the board of directors, J. Wiley & Sons, Hoboken, 2005, p. 48-49 28 M Page & L F Spira, The Turnbull Report Internal Control and Risk Management Executive Summary, Institute

of Chartered Accountants of Scotland, retrieved 15 July 2012, ‹http://icas.org.uk/home/technical-and-


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internal and external reporting” by developing systems to generate relevant and reliableinformation about the company.

29 The Exchange has recently recommended the board take

a lead role in developing provisions for the reporting of financial impropriety and whistle- blowing.

30

But more than that, this study recommends the boards create an internal controlscommittee. Boards must lead the way in setting up systems to monitor the compliance bythe company with legal standards and regulatory requirements.

31 Heading the committee

would be an independent non-executive director with experience in monitoring and

establishing internal control procedures. Such a committee would help prevent problemssuch as those suffered by HSBC.

Internal controls cover such important responsibilities as risk management, effectiveness of

compliance and the ability of the company to deal with sudden circumstances.32

The boardneeds to focus its efforts on pre-empting potential problems – a much more cost-effectiveand efficient solution than that of fixing up problems and restoring trust in a company.

3.2.

Accountability to Shareholders

The board has a responsibility to its shareholders, which elects the directors. One of the board’sresponsibilities is to report to the shareholders on the performance of their duties.

33 Although

boards are required by law to create an accurate report at the end of the financial year to

shareholders,34

it is important that boards continue to strive to ensure reporting practices and

financial statements are transparent and accountable.

Corporate governance reports required by the Exchange are often only nominally andtechnically completed, without much detail as to the actions of the board. The board, both in

public and private companies, needs to make sure shareholders are able to use the reports tofigure out the current financial condition of the company.

3.3.

Board’s Responsibility to Evaluate

Northern Rock

research/research-centre/research-publications/the-turnbull-report--internal-control-and-risk-management--

executive-summary/›. OECD, White Paper on Corporate Governance in Asia, priority 4, 2003, retrieved 3 July2012, ‹www.oecd.org/dataoecd/48/55/25778905.pdf›. 29 The Institute of Chartered Accountants in England and Wales, Internal Control: Guidance for Directors on the

Combined Code, provision 16-19, European Corporate Governance Institute, 1999, retrieved 15 July 2012,‹www.ecgi.org/codes/documents/turnbul.pdf›.30 Hong Kong Stock Exchange, Appendix 14, 2012, C.3.8., retrieved 8 June 2012,

‹www.hkex.com.hk/eng/rulesreg/listrules/mbrules/documents/appendix_14.pdf›. 31 M Lipton, The Future of the Board of Directors, Harvard Law School Forum on Corporate Governance and

Financial Regulation, 2010, retrieved 23 July 2003, ‹http://blogs.law.harvard.edu/corpgov/2010/07/06/the-future-of-the-board-of-directors/›. 32 Hong Kong Stock Exchange, Appendix 14, C 2.3. 33 Cadbury, s. 3.4, emphasis added. 34 Companies Ordinance 1997, section 129D.


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Northern Rock plc, a bank in the United Kingdom, practised a reckless strategy approved by its

board of directors which failed to consider potential risks. In 2007 the bank collapsed because of

its lack of liquidity, and the Treasury Committee of the United Kingdom House of Commons setout to examine what had happened.

Northern Rock completed a board evaluation before the crisis hit:“The Chief Executive and all of the Non- Executive Directors were appraised by theChairman whilst the appraisal of the each of the Executive Directors was completed

by the Chief Executive. [After talking with the entire board, except the Chairman]…[the] Senior Independent Director conducted the appraisal of the Chairman”.

35

The annual statement did not state the results of the evaluation, except to say that the company

was functioning effectively.36

Contrast that image with a review of the company by the Treasury Committee which noted

several failures of corporate governance. Amongst them, it noted that the board did not have

significant levels of banking expertise. The chairman of the board, Matt Ridley, was an academicwhile Adam Applegarth, board member and CEO, was not a qualified banker. Reviewers later

asked why none of the “non-executive directors seems to have made the simple inquiry as to whya modest mortgage bank…was playing at the casino end of the capital markets”.

37

Board evaluations

Board evaluations are well-planned assessments of the board that evaluate the unique culture,dialogue, and needs of the board in hopes of revealing strengths and the issues that hinder

optimal board performance.38

Although it might be said that evaluations are for the sole purpose

of making sure the board are performing adequately, at the heart of the evaluation should be a

desire for the board to seek areas of improvement. Board evaluations have been recently addedto the Corporate Governance Code as a Recommended Best Practice.39

Recommendations:

Assessments of the board and senior management - It is easy to equate board evaluationswith the idea of directors being ‘judged’. Yet board evaluations are not tests to grade performance.

35 Northern Rock plc, Annual Report and Accounts 2006 , 2006, p. 16, retrieved 3 July 2012,

‹http://companyinfo.northernrock.co.uk/downloads/results/res2006PR_AnnualReportAndAccounts.pdf›, emphasisadded. 36 Ibid. 37

W Sun, J Stewart & David Pollard, Corporate governance and the global financial crisis: international perspectives, Cambridge University Press, New York, 2011, p. 63. 38 Cornerstone of the Board the New Governance Committee, Getting the Most from Board Evaluations, Spencer

Stuart, retrieved 12 July 2012, ‹http://content.spencerstuart.com/sswebsite/pdf/lib/Cornerstone-GettingtheMostBdEval%203_04.pdf›. 39 The Exchange recently proposed the addition of regular evaluations of the entire board and of individual directors

to the Corporate Governance Code. However, the provision, a recommended best practice regarding the evaluation

of individual directors, was rejected by a majority of issuers. Hong Kong Exchanges and Clearing Limited,

Consultation Paper on Review of the Code on Corporate Governance Practices and Associated Listing Rules , at

para. 191, 2011, retrieved 8 July 2012, ‹www.hkex.com.hk/eng/newsconsul/mktconsul/documents/cp2010124.pdf ›.


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It is recommended that board evaluations be established for the purpose of assessing areas

of possible improvement by measuring the board in relation to the corporate strategies orthe vision set out by the board.

40 A successful board evaluation is not one that points out

non-performing directors or management and then seeks to remove them. It suggests

perhaps how the board can better serve its shareholders and management. It seeks todevelop the board by pointing out certain issues or possible conflicts and then strives to letthe board find a way to overcome the situation.

41

An ‘add value’ process - A continual issue with existing board evaluations is that they are

often treated as exercises which simply must be done to maintain compliance with rules,instead of used as a tool of corporate governance.

It is recommended that boards treat such evaluations as not merely another step in

corporate governance, but as a way to add value into the company.42

The evaluation is to be taken seriously, with directors and management open about critiquing and stating the

deficiencies of expertise or problems on the board.

Use of third-party evaluators - Directors and senior management are naturally hesitant tocritique others in front of the chairperson or other directors, a phenomenon most likely

present in Northern Rock. It is recommended that a third party takes control of the

interview process and report these findings to the Chairperson or committee in charge ofthe evaluation process (i.e. the nomination committee).

43

Third-party evaluators (such as other distinguished directors, Chartered Secretaries, or business leaders) permit directors to be candid about other directors and management,

allowing them to freely speak about possible failures of the board. Ultimately, this is for

the benefit of the board and the company.

Sometimes, such as at Northern Rock, boards tend to evaluate themselves very well. It is

recommended that the third party evaluator spend some time attending board meetings to

try to see the self-evaluations are justified. 44

They would look for evidence of board

40 See Cornerstone of the Board the New Governance Committee, Getting the Most from Board Evaluations. 41 Ibid . 42 In one case study example, the CFO during a board evaluation remarked that the board was “The Board is ok;they don’t get in my way. But I’d kill for someone to ask me a question about global corporate finance in a boardmeeting that made me really think.” After learning about this, action was taken and the board pre-reading

information was changed dramatically. Two years later, the same CFO interviewed during the board evaluation said:“This board is night and day from the board we had 2 years ago. They’re fantastic – a true corporate asset…I askonly one thing from this year’s board evaluation – 45 minutes on the agenda when I can just have “open discussion”with the board from time to time on key strategic issues.” See B Behan, Best Practices in Board Evaluation and

Director Evaluation, Slideshare, 2009, retrieved 1 August 2012, ‹http://www.slideshare.net/BoardAdvisor/best- practices-in-board-evaluation-and-director-evaluation›. 43 R Charam, Boards that deliver, Jossey-Bass, San Francisco, 2005, p. 43. 44 S Bowman, The Problem with Board Evaluations, Conscious Governance, 2008, retrieved 19 July 2012,‹www.conscious-governance.com/Nonprofit-Executive-Articles/Steven-Bowman/the-problem-with-board-evaluations.html›.


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processes, board compliance and corporate governance practices.45

The third-party

evaluator could then report on whether or not the board’s self -evaluation is justified, and ifnot, where it can improve. In this way, third-party evaluators also provide an objectiveview of the board.

Individual Evaluations – Recently, the Exchange suggested provisions in the CorporateGovernance Code regarding the practice of evaluations for individual directors. This wasrejected by a majority of issuers and ultimately not adopted.

46

This study continues to recommend the practice of individualized evaluations for directors

and C-level executives by third-party evaluators. It allows directors to comment on the performance of their peers, such as mentioning that an independent director rarely

challenges the management.47

By doing so, it is hoped that directors can have unfiltered

advice on where to improve.

Evaluation-Cycle - It is recommended that the board follow a structure of:

(i) questionnaires(ii) interviews

(iii) third-party reviews(iv) a formal review of the results along with the creation of recommendations

(v) application of the recommendations, and

(vi) follow-up on the recommendations.

The unique nature of each board may give rise to different techniques for the optimal

evaluation. Boards should experiment with different methods to see which one allows forthe most accurate evaluation of the board.

Company Evaluations

Company evaluations remain possible future innovations which boards should attempt to do.

Company evaluations are similar to board evaluations, except in scope. Company evaluations

appraise both the board and the company. They cover the dynamics of the corporation, take intoaccount the strategic objectives and evaluate the company in relation to its potential.

It is recommended that boards, which are uniquely situated to lead this directive, establishcompany evaluations with an independent non-executive chairing and a third-party evaluating.

The company evaluation would then review and evaluate the company’s performance in relationto its strategic objectives laid out by the board in order to assess areas of weakness and plans for

future improvement. Doing so allows the company to know where it must improve to ‘addvalue’.

45 Ibid.

46 Hong Kong Exchanges and Clearing Limited, Consultation Paper on Review of the Code on Corporate

Governance Practices and Associated Listing Rules. 47 W Sun, J Stewart & David Pollard, p. 63. A Au, S Boren & E Angelis, Improving board effectiveness: Five

principles for getting the most out of a board assessment , Spencer Stuart, 2012, retrieved 6 July 2012,

‹www.spencerstuart.com/research/articles/1568/›.


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3.4.

Role of the Board in Choosing the Board and Senior Management

The historical practice where the board and senior management were made up of friends of the

“existing networks of the chairman…”

48

is no longer a reality for many large companies. The useof a nomination committee has introduced some consistency and independence into the process.

Nevertheless, private and smaller companies, especially family-dominated ones,49

have yet to

make the shift, damaging its potential. The ability for the board to choose the best directors andsenior management to lead the company is essential in the 21

st century.

Recommendations:

Nomination committee - The Corporate Governance Code now mandates the use of anomination committee.

50 However, many private and SME companies still do not use a

nomination committee.51

It is recommended that all boards establish a nomination committee in order to find thecorrect directors and executives who will add value to their board and company. In doing

so, it is also recommended that nominating committees of listed companies be transparent

to the board and shareholders, through the annual report, about their procedure for

choosing directors and reasons for choosing those specific directors and management.52

Direction of the company - The general direction of the company is an important point tofactor in when choosing directors and management. For example, if the company looks to

be heading into a mergers and acquisition period, it may be necessary to get lawyers or businesspeople familiar with the situation. A board whose long-term strategy is to merge

the company with other businesses might consider hiring a CEO with that particular

business experience.

Skill diversity - An important part of choosing the right director consists of knowing wherethe current board lacks skills. This is best done through board evaluations overseen by a

nomination committee which creates performance appraisals to see where the board lacksexpertise.

53

48 A Kakabadse & N Kakabadse, Global boards: one desire, many realities, Palgrave Macmillan, New York, 2009,

p. 228. 49

A Lau, J Nowland & A Young, ‘In search of good governance for Asian family listed companies: a case study onHong Kong', Company Lawyer , vol. 28, no. 10, 2007, pp. 306-311.50 It found in 2009 that 63% did not have a nomination committee. Hong Kong Exchanges and Clearing Limited,

Consultation Paper on Review of the Code on Corporate Governance Practices and Associated Listing Rules, para.

124. 51 A Lau, J Nowland & A Young, pp. 306. 52 Methods for selecting candidates should be disclosed in the annual report along with reasons why the chosen

director or management fits those criteria. 53 South African Institute of Chartered Accountants, Summary of Report on Governance for South Africa – 2009

(King iii), principle 1.23, 2009, retrieved 4 July 2012, ‹www.auditor.co.za/Portals/23/king%20111%20saica.pdf›.


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It is recommended that the evaluation is to be taken seriously, with candidates and

evaluators open about critiquing and stating their deficiencies of expertise. The modern-

day board and management is one that has the necessary skills and talents needed (whetheraccountancy, legal, business or entrepreneurial) to help the company succeed. Choosing

board members may also involve looking into the services, such as established networks,

that directors can provide to the company.

54

Although boards operate as a group ofdirectors collectively, effective good corporate governance in the 21st century requires the

board to specialize and diversify.55

Diversity candidates - Norway’s policy of mandating a minimum number of women on the

board of directors56

has opened the discussion57

of whether or not other jurisdictions, suchas Hong Kong, should start making companies diversify their corporate boards.

58

Instead of seeking women for the sake of placing women on the board, it is recommended

that companies, and their nomination committees, ensure that comprehensive diversity59

is present on the board. They must make sure they are taking into account the range and

diversity of talents and skills. It was found that the women who replaced the men after Norway mandated that 40% of the board should be women were generally more qualifiedand had a greater diversity of skills then than men they replaced.

60

Hong Kong boards cannot allow that to happen. They must make sure their procedures forchoosing new directors includes diversity as an important element and that they do not

exclude women and other minorities. Standard Chartered published, in March 2012, a

report on women on boards of the Hang Seng Index noting few women were in the boardrooms. Only 9% of directors were women; only one company had a female CEO and

a female chair. 41.7% of boards had no females.61

As was stated by a HKICS study, “Hong

54 Bainbridge, p. 49. 55 I Kesner, 'Directors' Characteristics and Committee Membership: An Investigation of Type, Occupation, Tenure,

and Gender', The Academy of Management Journal , vol. 31, no. 1, 1988, pp. 67: “Specialization by members, forexample, leads to greater efficiency, expediency, and flexibility.” 56 P Hamill, A Ward & J Wylie, 'Stronger Boards: Are Women the Answer?' Accountancy Ireland , vol. 43, no. 5,

2011, pp. 26-29. 57 Amongst others, R Adams & D Ferrera, "Women in the Boardroom and their Impact on Governance and

Performance", Journal of Financial Economics, vol. 94, no. 2, 2009, pp. 291-309. 58 Deloitte, Women in the Board: a global perspective, p. 12, 2011, retrieved 3 July 2012,

‹www.deloitte.com/assets/Dcom-

Global/Local%20Assets/Documents/Enterprise%20Risk%20Services/dttl_CorpGov_WomenInTheBoardroom_220212.pdf›. 59 A Durbin, Optimizing Board Effectiveness with Gender Diversity: Are Quotas the Answer? International Finance

Corporation, retrieved 29 June 2012,

‹www.ifc.org/ifcext/cgf.nsf/AttachmentsByTitle/PSO21_Gender/$FILE/IFC_PSO_21_72311.pdf›.60 P Hamill, A Ward & J Wylie, pp. 26-29. “Evidence would suggest, however, that most of the women in the newlyappointed positions had significantly higher educational and business qualifications than the males which they

replaced and sit next to on the boards.” 61 A Banerji & K Vernon, Standard Chartered Women on Boards: Hang Seng Index 2012, Community Business,

2012, retrieved 8 June 2012, ‹www.communitybusiness.org/images/cb/publications/2012/WOB_Eng_2012.pdf›.


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Kong’s [companies] are denying themselves the benefits of the views and contributionsthat could be made by one half of the Hong Kong society.”62

In an era of globalization, international directors are also becoming essential, even for local

companies, to help bring diversity of experience. This is especially applicable if the

international director has previous business experience in the same sector.

63

It isrecommended, where possible, that companies have an international element in their boardcomposition.

CEO and succession – Beyond choosing the CEO, boards should always have a succession

plan ready for senior management in case of emergencies. Ultimately, the dynamics ofeach company make each succession-plan a unique exercise. Nevertheless, it is

recommended that the nomination committee take a lead role in the process of succession-

planning.

5. Future Direction of the Board: Its Role and the ‘Add Value’ Proposition

An incidental effect of the wave of corporate governance reports stressing the board’s role inmonitoring the company has left many directors with the view that corporate governance is

simply monitoring the company.64

A survey of British directors showed that they were becoming

more risk-adverse with too much focus on compliance.65

Yet the 21st century board – the board

that Hong Kong needs – is no longer simply to prevent misdeeds; the board needs to figure outhow to transform its role into one that adds value to the company.

This doctrine, henceforth stated as the ‘add value’ proposition, is one that believes that the board

has a more important role to play in the company.66

The 21st century board is one that makes the

company better by enhancing its value and developing the company.67

This study has already

mentioned several practices that add value; the following recommendations suggest additionalvalue-adding practices.

Recommendations for ‘add value’ practices:

62 Hong Kong Institute of Company Secretaries, The Duties and Responsibilities of Independent Non-Executive Directors of Hong Kong Listed Companies, p. 22, 2003, retrieved 17 June 2012,

‹www.hkics.org.hk/media/publication/attachment/1966_INED%20%28Sept%202003%29.pdf›. 63 C Mallin, International corporate governance: a case study approach, Edward Elgar Pub, Cheltenham, 2006, p.

305. 64

The Companies Ordinance left directors with many administrative and compliance duties. M Bruce, Rights andduties of directors, 11th edn, Bloomsbury Professional, Haywards Heath, 2011, p. 8. 65 “The growing burden of regulation is stifling growth and innovation among the Unit ed Kingdom's biggest businesses, according to research commissioned by City law firm Eversheds…The equity analysts felt that boarddirectors are increasingly risk-averse, focusing too much on compliance and red tape and not enough on business

growth”. See 'Regulation makes directors too cautious says Eversheds survey', Company Lawyer , vol. 27, no. 3,2006, pp. 92. 66 The idea of a “progressive board” is a central element in Charam, Boards that deliver .67 K Andrews, 'Rigid Rules Will not Make Good Boards ', Harvard Business Review, vol. 60, no. 6, 1982, pp. 34-47.

This concept was briefly mentioned in preceding paragraphs but explored more fully in-depth here.


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Dialogue between the management and the board - The board’s value to the company is based on the board’s ability to test and help management. The board, essential a ‘team’,68 must work effectively as a group under the chairman to provide leadership and advice to

the management.69

It is recommended that the board and management evaluate their group dynamics anddialogue through board evaluations. Both parties must ensure there is mutual dialogue between both parties; management should be providing accurate, timely and necessary

information on the status of the company; the board should reciprocate with performance

of its duties and the practice of corporate governance.

Focusing on substantive issues (strategy) - It is important for boards to not get invested inminute details of the company.

70 Instead, it is recommended that boards focus on

substantive issues: finding the right long-term strategy; monitoring health, performance

and risk; choosing the right CEO; creating a plan of succession; and developing anappropriate method for CEO compensation.

71

In particular, strategy is an important avenue which the board needs to explore because of

its essential role in adding value to a company. Companies rise and fall on their strategy.Strategic planning involves both the board and the management; it requires that both parties be actively engaged in the process of mapping out a plan for the company, the

board in deciding the strategy and the management in applying and reporting on its successin practice.

72

Board Strategy in Hong Kong

The change from the board’s role as one of purely oversight to also being involved instrategy has reached the largest companies.

73 Hang Seng, in 2007, published its annual

report without specifically listing strategy as one of the board’s responsibilities.

74

In 2011,the board’s responsibility for strategy was placed first.75

In Café de Coral’s annual reports,

68 S Murphy & M McIntyre, ‘Board of director performance: a group dynamics perspective’, CorporateGovernance, vol. 7, no. 2, 2007, pp.209 – 224. 69 Ibid . 70 Charam, p. 61. 71 Ibid., p. 74. 72 The board’s strategic role can include responsibilities such as: ordering strategic reviews, endorsing or refusing

management’s strategic plans, deciding on mergers and acquisitions, disposing of major assets, and raising capital.D Nordberg, Corporate governance: principles and issues, SAGE, London, 2011, p. 127. 73 A Chen, J Osofsky & E Stephenson, Making the board more strategic: a McKinsey Global Survey, University of

Laval, 2008, retrieved 23 July 2012,

‹https://www.cas.ulaval.ca/files/content/sites/cas/files/documents/Centre_documentation/TOP10/Mckinsey_BoardStrategic.pdf›. 74 Hang Seng Bank, Annual Report 2007 , 2008, retrieved 3 July 2012,

‹www.hangseng.com/hsb/eng/abo/ir/air/ar2007/pdf/ar2007e.pdf›. 75 Hang Seng Bank, Annual Report 2011, p. 19, 2012, retrieved 23 July 2012,

‹http://www.hangseng.com/cms/fin/file/statement/ar_2011_full_en.pdf›.


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it was noted that the board led the strategic direction of the company and the management

was only responsible for executing that strategy.76

Recommendations:

Strategy as a responsibility - As a representative of the company and its shareholders,

the board is responsible for the decisions and strategies used, which will in turnrepresent either the success or the failure of the company. As such, the board should

feel compelled to contribute to the strategy process, especially regarding long-term

strategy.77

It is recommended that the board review its procedures to make sure it has a say in

the strategy process. The management must recognize that the board is a source ofdirection, accountability and leadership within the company.

78 When the board can

give advice to a company, point out potential problems that a strategy might face and

give constructive criticism, this adds value to the company.

Being active – When a strategy is presented, the board should be asking the rightquestions in part and giving the right answers in part.79

In a sense, this cannot be

codified or placed on a to-do list for the board because of the unique nature of each

company. But it involves the active use of the knowledge, expertise and experienceof the directors to ask and probe the strategy in order to refine it and test it against

possibilities.

Strategic system - It is recommended that the board use the strategic direction system:

(i) information gathering, (ii) strategy creation, (iii) assessment of risks, (iv) setting

out the strategy, (v) evaluating performance relative to the strategy and (vi)

developing the strategy to meet changing circumstances.

80

76 The extract from Café de Coral’s annual reports, shows a board that has not abdicated its responsibility towardsstrategy. “…overall strategy and direction for the Group, overseeing the Group’s businesses and providingleadership in strategic issues…When the Board delegates aspects of its management and administration functions tomanagement, clear directions are given as to the limits of the authority...” See Café de Coral, Annual Report 2011,Café de Coral Holdings Limited, 2012, retrieved 17 July 2012, ‹www.cafedecoral.com/web/download/are2011.pdf›. 77 A correct attitude was displayed by one director when he noted that “…the director dares to ask questions becausehe knows that he is responsible. I am responsible, therefore I have the right to be informed.” See O Roche,Corporate governance & organization life cycle: the changing role and composition of the board of directors,

Cambria Press, Amherst, 2009, p. 237. 78 As a CEO noted of a board of directors: “I saw them as a great resource, because directors have done [all this

before].” Charam, p. 118. 79 B Garratt, Thin on top: why corporate governance matters and how to measure and improve board performance, Nicholas Brealey Pub, London, 2003, p. 35. 80 B Garratt, p. 188. See E Lukac & D Frazier, 'Linking strategy to value', Journal of Business Strategy, vol. 33, no.

4, 2012, pp. 49 – 57 which also describes the ways to add value to a company: defining strategy, mapping strategicinitiatives to value and strategic support. Boards and directors should “ensure that (i) strategy is dynamic andrelevant to the circumstances; (ii) structures are flexible to respond to and exploit change; (iii) systems are adaptable

but robust; and (iv) their performance is measured and strategic course correction made in real time.” See VRamakrishnan, 'High performing boards: going beyond compliance', Journal of Business Strategy, vol. 33, no. 2,

2012, pp. 38 - 48.


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One example an area where long-term strategy is needed is the board’s role indeveloping a scheme to help choose and cultivate the next CEO of the company.

Strategic direction committee - Despite the importance of strategy to a company’ssuccess, it is surprising to note how many boards still do not have a strategy

committee.81

It is recommended that boards create a specific committee to help oversee the

strategic decision making, and this committee would then report to the board. Thecommittee’s directive would include taking in current trends, creating a long-termstrategy and overseeing its implementation in the short term. The head of the

committee should be experienced in formulating or leading a strategy session.

Risk management as part of strategy - Given risk management’s important role in astrategy, it is imperative that boards ultimately direct the risk strategy and ‘appetite’of the company.

82

Using independence to add value - the Exchange recently amended its Listing Rules,

effective 31 December 2012, to mandate that one-third of the board be independent non-

executive directors (INED).83

However, INEDs84

are not a panacea for solving all the ills

of a corporation.85

A distinct issue with INEDs are that some of them are independent in name only – following the legal requirements for independence

86 – and may be unwilling to criticize the

chairperson or the CEO. While executive directors may have elements of independence,INEDs have a unique capacity and ability to add value to the company. True independence

is a state of mind87

and willingness to challenge the status quo.

It is recommended that INEDs ensure they practise true independence as this adds value to

the board and company; ideas and strategies may be re-evaluated and adjusted when

questions and critiques are posed by the INEDs.88

81 O Bordean, A Borza & V Maier, 'The Involvement of Boards in Strategy Implementation', Review of International

Comparative Management , vol. 12, no. 5, 2011, pp. 990.82 South African Institute of Chartered Accountants, princ. 4.4-4.5. 83 While mandating a certain number of INEDs appears to be a good way to guarantee independence, the existence

of INEDs on the board does not automatically mean the existence of independence on the board. Shareholders

should be wary about equating the two. 84

Generally, boards are divided into three types of directors: executive directors (individuals who also participate inthe management of the company like the CEO/CFO), NEDs (individuals who are brought from the outside but have

a direct interest in the company), and INEDs (individuals brought from the outside who have no direct interest in the

company beyond their directors’ fee).85 Bainbridge, p. 78. 86 Hong Kong Stock Exchange, Main Board Listing Rules. 87 Hong Kong Institute of Directors, Guide for Independent Non-Executive Directors, 2010, retrieved 3 June 2012,

‹http://www.hkiod.com/document/INEDguide/Guide_INED_E_small.pdf›. 88 INEDs in Hong Kong, and around the world, tend to be business professionals who have more than one

directorship in the field. As such, they do not devote their entire time to the management of one company. Multiple


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Leadership in establishing 21 st

century practices – Corporate governance now entails awide range of responsibilities for companies beyond the traditional framework. 21

st century

practices include corporate social responsibility, respect for human rights, andenvironmental awareness and social awareness.

89

The board of the 21st century must take a lead role in establishing these practices. It is

recommended that at least one board meeting a year is devoted to exploring possible new

methods to practise 21st century corporate governance. By implementing corporate

governance practices before they become the norm, the board has a chance to be ahead of

the curve, thus adding value to the company. It is hoped that boards will be able to pre-empt corporate governance norms and become leaders in developing new practices for

their company.90

6. Conclusion

The 21st

century board is not something that can be legislated.91

It remains a mixture of codesand best practices – principles which must be voluntarily done by each board. But when itsucceeds, it makes the company more competitive, prevents mismanagement and protects

shareholders. Every CEO, director, shareholder, and the broader community should want and

demand a board which practises the highest level of corporate governance.

This study started out by covering the historical and contemporary roles of the board of directors.

Such roles include monitoring and oversight of the company, board evaluations and choosingnew directors. But this study, above all , tries to emphasize the future direction of the board – the‘add value’ proposition. This movement was suggested in the Hampel Report : “the emphasis onaccountability has tended to obscure a board’s first responsibility – to enhance the prosperity of

the business over time”,

92

and was noted again by Ram Charan: “boards are…still not living upto their potential of providing truly good governance – that is, governance that doesn’t just prevent misdeeds but actually improves the corporation.”93

While the above does not purport to fully list out every role and responsibility of the board, it

does map out contemporary issues and recommendations that should be put into place. Every

Hong Kong company’s competitor is now not only the competitor down the street but thecompany half-way across the world. If the boards are not practicing the highest level of corporategovernance here, then another competitor who is will succeed.

directorships allow the company to gain the best experience. However, it dilutes the time able to be spent on onecompany. INEDs must make sure they have enough time to direct vision, oversee management, and acquire

sufficient knowledge about the company and be prepared to spend time to review such knowledge. 89 M Lipton, The Future of the Board of Directors. 90 Recently, the Hong Kong Stock Exchange published a Consultation Paper on the Environmental, Social and

Governance Reporting Guide. The purpose was to seek views on a proposed ESG Guide for companies. 91 SH Goo & A Carver, Corporate governance : the Hong Kong debate, Sweet & Maxwell Asia, Hong Kong, 2003,

p. 168-169. 92 Committee on Corporate Governance, Hampel Report , princ. 1.2. 93 Charam, p. ix.


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This study aims to spark a discussion amongst the boards of each company into how they can

add value to their company as part of their duties, while fulfilling their other roles and

responsibilities.94

Recommendations can only be broad-based since each board is uniquelydifferent in culture and structure and will need to adapt recommendations to their own distinctive

company. Yet all boards in the 21st century are connected by a single thread – the need for them

to pursue corporate governance at the highest level.

94 Such a role is no longer simply a task of a director, but a duty – a duty to the stockholders and other interested parties to direct and supervise the company and the executive management. B Tricker, Essential director , Profile

Books, London, 2003, p. 2-3.


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