F1 CORPORATE GOVERNANCE: THE BOARD OF DIRECTORS AND STANDING COMMITTEES (2)

STRUCTURE OF THE BOARD OF DIRECTORS

There is no convenient formula for defining how many directors a company should have, though in some jurisdictions company law specifies a minimum and/or maximum number of directors for different types of company. Tesco plc, a large multinational supermarket company, has 13 directors. Swire Pacific Limited, a large Hong Kong conglomerate, has 18 directors. Smaller listed companies generally have fewer directors, typically six to eight persons.

 

The board of directors is made up of executive directors and non-executive directors.

Executive directors are full-time employees of the company and, therefore, have two relationships and sets of duties. They work for the company in a senior capacity, usually concerned with policy matters or functional business areas of major strategic importance. Large companies tend to have executive directors responsible for finance, IT/IS, marketing and so on.

Executive directors are usually recruited by the board of directors. They are the highest earners in the company, with remuneration packages made up partly of basic pay and fringe benefits and partly performance-related pay. Most large companies now engage their executive directors under fixed term contracts, often rolling over every 12 months.

 

The chief executive officer (CEO) and the finance director (in the US, chief financial officer) are nearly always executive directors.

 

Non-executive directors (NEDs) are not employees of the company and are not involved in its day-to-day running. They usually have full-time jobs elsewhere, or may sometimes be prominent individuals from public life. The non-executive directors usually receive a flat fee for their services, and are engaged under a contract for service (civil contract, similar to that used to hire a consultant).

NEDs should provide a balancing influence and help to minimise conflicts of interest. The Higgs Report, published in 2003, summarised their role as:

 

·           to contribute to the strategic plan

·           to scrutinise the performance of the executive directors

·           to provide an external perspective on risk management

·           to deal with people issues, such as the future shape of the board and resolution of conflicts.

 

The majority of non-executive directors should be independent. Factors to be considered in assessing their independence include their business, financial and other commitments, other shareholdings and directorships and involvement in businesses connected to the company. However, holding shares in the company does not necessarily compromise independence.

 

Non-executive directors should have high ethical standards and act with integrity and probity. They should support the executive team and monitor its conduct, demonstrating a willingness to listen, question, debate and challenge.

 

It is now recognised as best practice that a public company should have more non-executive directors than executive directors. In Tesco plc, there are five executive directors and eight independent non-executive directors. Swire Pacific Ltd has eight executive directors and 10 non-executive directors, of which six are independent non-executive directors.

 

An individual may be accountable in law as a shadow director. A shadow director is a person who controls the activities of a company, or of one or more of its actual directors, indirectly. For example, if a person who is unconnected with a company gives instructions to a person who is a director of the company, then the second person is an actual director while the first person is a shadow director. In some jurisdictions, shadow directors are recognised as being as accountable in law as actual directors.

 

UNITARY V TWO-TIER BOARDS

The unitary board model is adopted by, inter alia, companies in the UK, US, Australia and South Africa. The company’s directors serve together on one board comprising both executive and non-executive directors.

In many countries in continental Europe, companies adopt a two-tier structure. This separates those responsible for supervision from those responsible for operations. The supervisory board generally oversees the operating board.

 

Paper FAB, Accountant in Business, focuses mainly on the unitary board system, though knowledge of both models is required for subsequent studies for Paper P1,Governance, Risk and Ethics.

 

KEY POSITIONS

The chairman of the company is the leader of the board of directors. It is the chairman’s responsibility to ensure that the board operates efficiently and effectively, get the best out of all of its members. The chairman should, for example, promote regular attendance and full involvement in discussions. The chairman decides the

scope of each meeting and is responsible for time management of board meetings, ensuring all matters are discussed fully, but without spending limitless time on individual agenda items. In most companies the chairman is a non-executive director.

The chief executive officer (CEO) is the leader of the executive team and is responsible for the day-to-day management of the organisation. As such, this individual is nearly always an executive director. As well as attending board meetings in his or her capacity as a director, the CEO will usually chair the management committee or executive committee. While most companies have monthly board meetings, it is common for management/executive committee meetings to be weekly.

The secretary is the chief administrative officer of the company. The secretary provides the agenda and supporting papers for board meetings, and often for executive committee meetings also. He or she takes minutes of meetings and provides advice on procedural matters, such as terms of reference. The secretary usually has responsibilities for liaison with shareholders and the government registration body. As such, the notice of general meetings will be signed by the secretary on behalf of the board of directors. The secretary may be a member of the board of directors, though some smaller companies use this position as a means of involving a high potential individual at board level prior to being appointed as a director.

 

SEGREGATION OF RESPONSIBILITIES

It is generally recognised that the CEO should not hold the position of chairman, as the activities of each role are quite distinctive from one another. In larger companies, there would be too much work for one individual, though in Marks & Spencer, a large listed UK retail organisation, one person did occupy both positions for several years.

The secretary should not also be the chairman of the company. As the secretary has a key role in liaising with the government registration body, having the same person occupying both roles could compromise the flow of information between this body and the board of directors.

 

STANDING COMMITTEES

The term ‘standing committee’ refers to any committee that is a permanent feature within the management structure of an organisation. In the context of corporate governance, it refers to committees made up of members of the board with specified sets of duties. The four committees most often appointed by public companies are the audit committee, the remuneration committee, the nominations committee and the risk committee.

 

The Syllabus and Study Guide for Paper F1/FAB require students to study only two committees. These are the audit committee and the remuneration committee.

 

AUDIT COMMITTEE

This committee should be made up of independent non-executive directors, with at least one individual having expertise in financial management. It is responsible for:

 

·           oversight of internal controls; approval of financial statements and other significant documents prior to agreement by the full board

·           liaison with external auditors

·           high level compliance matters

·           reporting to the shareholders.

 

Sometimes the committee may carry out investigations and may deal with matters reported by whistleblowers.

 

REMUNERATION COMMITTEE

This committee decides on the remuneration of executive directors, and sometimes other senior executives. It is responsible for formulating a written remuneration policy that should have the aim of attracting and retaining appropriate talent, and for deciding the forms that remuneration should take. This committee should also be made up entirely of independent non-executive directors, consistent with the principle that executives should not be in a position to decide their own remuneration.

It is generally recognised that executive remuneration packages should be structured in a manner that will motivate them to achieve the long-term objectives of the company. Therefore, the remuneration committee has to offer a competitive basic salary and fringe benefits (these attract and retain people of the right calibre), combined with performance-related rewards such as bonuses linked to medium and long-term targets, shares, share options and eventual pension benefits (often subject to minimum length of service requirements).

 

PUBLIC OVERSIGHT

Public oversight is concerned with ensuring that the confidence of investors and the general public in professional accountancy bodies is maintained. This can be achieved by direct regulation, the imposition of licensing requirements (including, where appropriate, exercising powers of enforcement) or by self-regulation. As the US operates a rules-based system of governance, these responsibilities are discharged by the Public Company Accounting Oversight Board, which has the power to enforce mandatory standards and rules laid down by the Sarbanes-Oxley Act. In the UK, regulation is the responsibility of the Professional Oversight team of the Financial Reporting Council.

 

SAMPLE QUESTIONS

Candidates may find it useful to consider questions on this topic identified in examiner’s reports as well as the pilot paper. As past question papers are not made available, the following questions are included in this article as examples of typical requirements. It must be emphasised that these questions are not taken from the actual question bank.

Sample question 1:

LLL Company is listed on its country’s stock exchange. The following individuals serve on the board of directors:

 

Asif is a non-executive director and is the chairman of the company. Bertrand is the CEO and is responsible for the day-to-day running of the company. Chan is a professional accountant and serves as a non-executive director. Donna is the finance director and is an employee of the company. Esther is a legal advocate and serves as a non-executive director. Frederik is the marketing director of a manufacturing company and serves as a non-executive director.

 

Which of the following is the most appropriate composition of directors for LLL Company’s audit committee?

A Chan, Donna and Esther

B Asif, Bertrand and Frederik

C Asif, Esther and Frederik

D Chan, Esther and Frederik

 

The correct answer is D. Executive directors should not serve on the audit committee. This eliminates options A and B. Option D is the best choice, as the audit committee should have at least one director with expertise in finance.

 

Sample question 2:

Which of the following is a duty of the secretary of a listed public company?

A Maintaining order at board meetings

B Clarifying the terms of reference of the board meeting

C Ensuring that all directors contribute fully to discussions at board meetings

D Reporting to the board on operational performance for the last quarter

The correct answer is B. Options A and C are responsibilities of the chairman, while option D is the responsibility of the CEO.

Sample question 3:

The board of directors of JJJ Company has decided to increase the basic salary of its chief executive officer by 20% in order to bring her pay into line with those occupying similar positions in the industry.

This action will achieve which of the following purposes?

A Improve the prospect of retaining the chief executive officer

B Increase the productivity of the chief executive officer by at least 20%

C Motivate the chief executive officer to achieve long-term targets

D Create greater job satisfaction for the chief executive officer

The correct answer is A.

 

The basic pay offered by a company serves as a beacon to attract applicants, and can also deter the present incumbent of a position from seeking opportunities elsewhere, especially if they perceive themselves to be underpaid at present.

 

A substantial pay increase is unlikely to achieve a significant increase in productivity or increase long-term motivation (though pay increases can have a short-term impact

on motivation). Job satisfaction is derived from factors other than remuneration, such as challenges inherent in the work and the nature of the tasks performed.

 

Written by a member of the Paper F1/FAB examining team

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