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3.2: A Board’s Role -A Governance Perspective

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    What does the phrase “direct the affairs of the company” really mean? To provide greater clarity, numerous individuals and organizations have developed more specific descriptions in recent years. One frequently cited description was developed by the Business Roundtable:

    • First, the paramount duty of the board of directors of a public corporation is to select the chief executive officer (CEO) and to oversee the CEO and senior management in the competent and ethical operation of the corporation on a day-to-day basis
    • Second, it is the responsibility of management to operate the corporation in an effective and ethical manner to produce value for shareholders. Senior management is expected to know how the corporation earns its income and what risks the corporation is undertaking in the course of carrying out its business. The CEO and board of directors should set a “tone at the top” that establishes a culture of legal compliance and integrity. Management and directors should never put personal interests ahead of or in conflict with the interests of the corporation
    • Third, it is the responsibility of management, under the oversight of the audit committee and the board, to produce financial statements that fairly present the financial condition and results of operations of the corporation and to make the timely disclosures investors need to assess the financial and business soundness and risks of the corporation
    • Fourth, it is the responsibility of the board, through its audit committee, to engage an independent accounting firm to audit the financial statements prepared by management, issue an opinion that those statements are fairly stated in accordance with Generally Accepted Accounting Principles and oversee the corporation’s relationship with the outside auditor
    • Fifth, it is the responsibility of the board, through its corporate governance committee, to play a leadership role in shaping the corporate governance of the corporation. The corporate governance committee also should select and recommend to the board qualified director candidates for election by the corporation’s shareholders
    • Sixth, it is the responsibility of the board, through its compensation committee, to adopt and oversee the implementation of compensation policies, establish goals for performance-based compensation, and determine the compensation of the CEO and senior management
    • Seventh, it is the responsibility of the board to respond appropriately to shareholders’ concerns
    • Eighth, it is the responsibility of the corporation to deal with its employees, customers, suppliers and other constituencies in a fair and equitable manner.Business Roundtable (2005), p. 2.

    Milstein, Gregory, and Grapsas (2006) take a somewhat broader perspective. First, they note, the board needs to take charge of its own focus, agenda, and information flow. This enables a board to provide management with meaningful guidance and support. It also helps the board focus its attention appropriately, determine its own agenda, and obtain the information it needs to make objective judgments. Second, the board must ensure that management not only performs but performs with integrity. Selecting, monitoring, and compensating management and, when necessary, replacing management, therefore continue to lie at the heart of board activity. Third, the board must set expectations about the tone and culture of the company. The standards of ethics and business conduct that are followed—or not followed—throughout a company impact the bottom line in many ways. “Tone at the top” should be a priority throughout the company and not viewed simply as a compliance matter. Fourth, the board should work with management to formulate corporate strategy. After agreeing to a strategic course with management through an iterative process, the board should determine the benchmarks that will evidence success or failure in achieving strategic objectives and then regularly monitor performance against those objectives. Fifth, it is the board’s duty to ensure that the corporate culture, the agreed strategy, management incentive compensation, and the company’s approach to audit and accounting, internal controls, and disclosure are consistent and aligned. And sixth, it is the board’s duty to help management understand the expectations of shareholders and regulators. Boards can help management recognize that shareholders have a legitimate interest in more meaningful input into the board selection process, in terms of both nominating procedures and voting methods. Similarly, boards can help management recognize and address the concerns that excessive compensation raises among shareholders, regulators, rating agencies, and others.Milstein, Holly, and Grapsas (2006, January).

    Both descriptions are useful for developing a basic understanding of a board’s responsibilities. In broad terms, they fall into three categories: (a) to make decisions, (b) to monitor corporate activity, and (c) to advise management. The key issue here is deciding which board posture is appropriate at what time. While the law, corporate bylaws, and other documents frame many of the decisions a board must make, such as appointing a CEO or approving the financials, they do not provide much guidance with respect to the most important decision a board must make—when must board oversight become active intervention? For example, when should a board step in and remove the current CEO? When should directors veto a major capital appropriation or strategic move?

    Lists never can fully capture the complexity and intricacies of the governance function because they do not consider the specific challenges associated with different governance scenarios. In particular, the precise role of a board will vary depending on the nature of the company, industry, and competitive situation and the presence or absence of special circumstances, such as a hostile takeover bid or a corporate crisis, among other factors.

    The Nature of the Company, Industry, and Competitive Situation

    It seems self-evident that a board’s role depends largely on the nature and the strategic challenges of the company and the industry. The challenges faced by small, private, or closely held companies are not the same as those of larger, public corporations. In addition to their traditional fiduciary role, directors in small companies often are key advisers in strategic planning, raising, and allocating capital, human resources planning, and sometimes even performance appraisal. In large public corporations, directors are focused more on exercising oversight than on planning, on capital allocation and control rather than on the raising of capital, and on management development and succession activities rather than on broader human resources responsibilities.

    Public company ownership patterns are not homogeneous either, and different ownership structures may call for different governance approaches. The first, and most common, board situation is one in which a corporation has no controlling shareholder. In that case, directors should behave as if there is a single absentee owner whose long-term interests they serve. A primary responsibility for the board in this scenario is to appoint and, if necessary, change management, just as an intelligent owner would do if he were present. Commenting on individual director’s responsibilities in these circumstances, Buffett (1993) writes,

    In this plain-vanilla case, a director who sees something he doesn’t like should attempt to persuade the other directors of his views. If he is successful, the board will have the muscle to make the appropriate change. Suppose, though, that the unhappy director can’t get other directors to agree with him. He should then feel free to make his views known to the absentee owners. Directors seldom do that, of course. The temperament of many directors would in fact be incompatible with critical behavior of that sort. But I see nothing improper in such actions, assuming the issues are serious. Naturally, the complaining director can expect a vigorous rebuttal from the unpersuaded directors, a prospect that should discourage the dissenter from pursuing trivial or non-rational causes.Buffett, annual letter to Berkshire Hathaway shareholders (1993).

    The second situation occurs when the controlling owner is also the manager. At some companies, such as Google, this arrangement is facilitated by the existence of two classes of stock endowed with disproportionate voting power. In these situations, the board does not act as an agent between owners and management, and directors cannot affect change except through persuasion. Therefore, if the owner or manager is mediocre—or worse, is overreaching—there is little a director can do about it except object. And if there is no change and the matter is sufficiently serious, the outside directors should resign. Their resignation will signal their doubts about management, and it will emphasize that no outsider is in a position to correct the owner or manager’s shortcomings.Buffett (1993).

    The third public corporation governance situation occurs when there is a controlling owner who is not involved in management. This case, examples of which are Hershey Foods and Dow Jones, puts the outside directors in a potentially value-creating position. If they become unhappy with either the competence or integrity of the manager, they can go directly to the owner (who may also be on the board) and make their views known. This situation helps an outside director, since he need make his case only to a single, presumably interested owner who can immediately make a change if the argument is persuasive. Even so, the dissatisfied director has only that single course of action. If he remains unsatisfied about a critical matter, he has no choice but to resign.Buffett (1993).

    It will also be readily apparent that the role of the board will vary depending on the size of the company, the industries it serves, and the competitive challenges it faces. Global corporations face different challenges from domestic ones; the issues in regulated industries are different from those in technology or service industries, and high growth scenarios make different demands on boards than more mature ones. Finally, in times of turbulence or rapid change in the industry, boards often are called on to play a more active, strategic role than in calmer times. Special events or opportunities, such as takeovers, mergers, and acquisitions, fall into this category.

    The Presence or Absence of Special Circumstances, Such as a Hostile Takeover Bid or a Corporate Crisis

    Company crises can take on many different forms—defective products, hostile takeovers, executive misconduct, natural disasters that threaten operations, and many more. But, as boards know very well, they all have one thing in common: They threaten the stock price and sometimes the continued existence of the company. Some examples follow:

    • In June 2008, with encouragement from federal regulators, JP Morgan executed a takeover bid for Wall Street giant Bear Stearns to prevent the bank’s collapse as a consequence of the U.S. mortgage debt crisis. The $240 million acquisition price represented a substantial discount on its share price at the end of trading the week before, which valued the bank at around $3.5 billion.
    • In 2002, when allegations of insider trading against Martha Stewart were reported, the stock price of Martha Stewart Omnimedia fell some 40% in just 3 weeks.
    • In 1993, an allegation of E. coli contamination in the beef served by the Jack in the Box hamburger chain caused the company’s share price to plummet from $14 to about $3 in a matter of hours.
    • In 1985, A. H. Robins, the maker of the Dalkon Shield, an intrauterine device, was forced to declare bankruptcy, after collapsing under a wave of personal injury lawsuits.

    As these examples attest, there are few situations in which directors’ fiduciary duties to shareholders are so clearly on view as in times of crisis.Jones (2007).

    This page titled 3.2: A Board’s Role -A Governance Perspective is shared under a CC BY-NC-SA 3.0 license and was authored, remixed, and/or curated by Anonymous.