ROLE OF BOARD OF DIRECTORS IN CORPORATE GOVERNANCE

ROLE OF BOARD OF DIRECTORS IN CORPORATE GOVERNANCE People often question whether corporate boards matter because their day-today impact is difficult to observe. But, when things go wrong, they can become the center of attention. Certainly this was true of the Enron, Worldcom, and Parmalat scandals. The directors of Enron and Worldcom, in particular, were held liable for the fraud that occurred: Enron directors had to pay $168 million to investor plaintiffs, of which $13 million was out of pocket (not covered by insurance); and Worldcom directors had to pay $36 million, of which $18 million was out of pocket.( Adams et al 2008). As a consequence of these scandals and ongoing concerns about corporate governance, boards have been at the center of the policy debate concerning governance reform and the focus of considerable academic research. Because of this renewed interest in boards, a review of what we have and have not learned from research on corporate boards is timely. Much of the research on boards ultimately touches on the question “what is the role of the board?” Possible answers range from boards’ being simply legal necessities, something akin to the wearing of wigs in English courts, to their playing an active part in the overall management and control of the corporation (Adams et al 2008). No doubt the truth lies somewhere between these extremes; indeed, there are probably multiple truths when this question is asked of different firms, in different countries, or in different periods. Given that all corporations have boards, the question of whether boards play a role cannot be answered econometrically as there is no variation in the explanatory variable. Instead, studies look at differences across boards and ask whether these differences explain differences in the way firms function and how they perform. The board differences that one would most likely to capture are differences in behaviour. Unfortunately, outside of detailed field work, it is difficult to observe differences in behaviour and harder still to quantify them in a way useful for statistical study. Consequently, empirical work in this area has focused on structural differences across boards that are presumed to correlate with differences in behavior. For instance, a common presumption is that outside (non-management) directors will behave differently than inside (management) directors. One can then look at the conduct of boards (e.g., decision to dismiss the CEO when financial performance is poor) with different ratios of outside to inside directors to see whether conduct varies in a statistically significant manner across different ratios. When conduct is not directly observable (e.g., advice to the CEO about strategy), one can look at a firm’s financial performance to see whether board structure matters (e.g., the way accounting profits vary with the ratio of outside to inside directors). One problem confronting such an empirical approach is that there is no reason to suppose board structure is exogenous; indeed, there are both theoretical arguments and empirical evidence to suggest board structure is endogenous ( Hermalin and Weisbach, 1988, 1998, and 2003). This creates problems for the estimation of structure-conduct and structure-performance regressions. Corporate governance came as a result of crash of blue chip companies in Europe and United States of America in the 20th Century and 90s has continued to work in those chimes. The board of directors have roles to play in ensuring that good corporate governance principles are upheld by all stakeholders in the day to day operations of a corporate organization. They should be able to ensure that the following issues are properly addressed such as preparing and reporting accounting information that would be in line with International Financial Reporting Standards (IFRS) and reflects true and fair view of the affairs of the company, Totals disclosures in all ramifications, citizenship, embarking on good Corporate Social Responsibility (CSR) programmes that would affects the environment, communities and society at large and upholding ethical codes by employees. However, in the United States of America, the supreme court and the Federal Sentencing Guidelines for organizations (FSGO) hold the board of directors responsible for the conduct of their employees (Ferrel and Ferrel 2010).Most firms have decided to implement ethics and compliance programmes to prevent misconducts and diminish the risk associated with employees wrong doing. The 2004 amendments to the FSGO hold the governing authority, usually the board of directors, responsible for ethical leadership including an effective ethics programme and internal ethics audit. In addition, an ethics officer with adequate resources is required to report directly to the board or a committee of the board. Even though the majority of employees want to do the right thing, many people don’t know the exact nature of the law and are totally surprised when they are charged with violations that were never anticipated. Corporate governance is a concept or philosophy that emerged following the growth of corporations in the 20th century. After the stock market crash of 1929 in America, scholars and experts began to advocate and argue for corporate governance mechanisms that would allow shareholders to keep companies in check. In the latter half of the 20th century this continued, with corporate governance structures being introduced to control managers and to ensure that their actions and decisions are in line with shareholders interests. Furthermore, management need to know how ethical decisions are made and the environment that influences ethical decision making. Managers face the same, risks as others but managers should be aware of those special risks associated with customer contact and interaction with their relevant stakeholders. While there may be significant and meaningful aspects of ethics that can be taught to employees that will help them live a better life, there should be some foundational concepts taught to business employees that will help them obtain a holistic understanding of business ethics. Many managers have difficulty understanding that ethics requires going beyond minimal legal requirement. Trying to find a framework that helps managers see the benefits of conducting oneself according to the highest ethical standards is difficult indeed. The best opportunity for achieving this goal would be an understanding of stakeholders that shape and form ethical issues and evaluating a description of how leadership corporate culture, formal ethical programmes and individual character are important to ethical decision making. In addition, organizations with strong ethical cultures and full formal ethics programmes are less likely to observer misconduct. Hence when the board of directors create a good ethical climate, it will enable them achieve good corporate governance in their organization. Benefits of Corporate Governance Good corporate governance ensures corporate success and economic growth Strong corporate governance maintains investors’ confidence, as a result of which, company can raise capital efficient and effectively It lowers the capital cost There is a positive impact on the share price It provides proper inducement to the owners as well as managers to achieve objectives that are in the interest of the shareholders and the organization. Good corporate governance also minimizes wastages, corruption, risks and mismanagement. It helps in brand formation and development. It ensures organization is managed in a manner that fits the best interest of all. Corporate governance is an important part of strategic management that can improve firm performance. Despite its importance, many people are unclear about what corporate governance is precisely. Both managers and investors should understand what corporate governance is and the role that it plays in firms. Being aware of what corporate governance is will allow them to see how it affects their respective businesses. Responsibilities of the board in corporate governance OECD(2004) posits that the corporate governance framework should ensure the strategic guidance of the company, the effective monitoring of management by the board, and the board’s accountability to the company and the shareholders. A. Board members should act on a fully informed basis, in good faith, with due diligence and care, and in the best interest of the company and the shareholders. B. Where board decisions may affect different shareholder groups differently, the board should treat all shareholders fairly. C. The board should apply high ethical standards. It should take into account the interests of stakeholders. D. The board should fulfill certain key functions, including: 1. Reviewing and guiding corporate strategy, major plans of action, risk policy, annual budgets and business plans; setting performance objectives; monitoring implementation and corporate performance; and overseeing major capital expenditures, acquisitions and divestitures. 2. Monitoring the effectiveness of the company’s governance practices and making changes as needed. 3. Selecting, compensating, monitoring and, when necessary, replacing key executives and overseeing succession planning. 4. Aligning key executive and board remuneration with the longer term interests of the company and its shareholders. 5. Ensuring a formal and transparent board nomination and election process. 6. Monitoring and managing potential conflicts of interest of management, board members and shareholders, including misuse of corporate assets and abuse in related party transactions. 7. Ensuring the integrity of the corporation’s accounting and financial reporting systems, including the independent audit, and that appropriate systems of control are in place, in particular, systems for risk management, financial and operational control, and compliance with the law and relevant standards. 8. Overseeing the process of disclosure and communications. E. The board should be able to exercise objective independent judgment on corporate affairs. 1. Boards should consider assigning a sufficient number of non-executive board members capable of exercising independent judgment to tasks where there is a potential for conflict of interest. Examples of such key responsibilities are ensuring the integrity of financial and non-financial reporting, the review of related party transactions, nomination of board members and key executives, and board remuneration. 2. When committees of the board are established, their mandate, composition and working procedures should be well defined and disclosed by the board. 3. Board members should be able to commit themselves effectively to their responsibilities. F. In order to fulfill their responsibilities, board members should have access to accurate, relevant and timely information. Kell(2009) posits today’s corporate citizenship is defined by a clear call to environmental, social and governance responsibility and it links directly to three fundamental functions of boards and their directors’ duties to the companies and shareowners they serve: Protecting stakeholder rights and interests Managing risk Creating long-term business value . Protecting Stakeholders Rights and Interests Kell(2009) observes that the Organization of Economic Corporation and Development(OECD) principles call on businesses to recognize and safeguard stakeholders’ rights, including legitimate interests and information needs. These Principles call on boards to be truly accountable to shareholders and to take ultimate responsibility for their firm’s adherence to a high standard of corporate behavior and ethics. Effective corporate governance requires due diligence in rallying the support and commitment of the broad network of business stakeholders, including shareowners, employees, customers and communities. If stakeholders are adversely affected by a company’s actions, shareowner value will suffer. With the growth in pension and insurance funds and other institutional investors, shareowners are increasingly also company stakeholders, such as employees or customers. Therefore, these groups’ needs are increasingly interconnected. The UN Global Compact’s ten principles similarly call on boards to address critical dimensions of concern to stakeholders. Boards that recognize the value of a holistic approach to stakeholder engagement, particularly in the environmental, social and governance realms, find that shareholders are similarly committed to such issues. This includes ongoing communication with stakeholders about material concerns, as well as regular disclosure about company performance, ideally linked to periodic financial reporting. responding to stakeholder concerns can have other direct business benefits: Widespread consensus is that the long-term costs of corruption are high for both society and business. Anti-corruption measures can strengthen relationships with stakeholders by building a culture of trust and collaboration. When companies enact anti-corruption initiatives that include empowering employees, this in turn can cultivate good reflexes on the part of individuals to address workplace dilemmas. Employees who work where their rights and needs are respected tend to be more productive, delivering higher quality work than those who are routinely mistreated High standards of integrity, transparency and disclosure can be influential in restoring public and investor trust in the private sector. They are also a starting point for ongoing, constructive dialogue with stakeholders, such as communities, who are affected by and can, in turn, help determine a business’s performance. OECD Principles of Corporate Governance First published in 1999, the OECD Principles assist governments in improving the legal, institutional and regulatory framework that underpins corporate governance and ultimately helps preserve financial and economic stability. The Principles provide practical guidance for corporate governance best practices, including protection of shareholder rights and board responsibilities, to stock exchanges, investors, corporations, and others. Updated in 2004, following a spate of corporate scandals, the Principles now contain even stronger recognition of the importance of stakeholders in corporate governance as well as emphasizing the need for timely, accurate, and transparent disclosure mechanisms and communication. Managing Risks New understandings of business risk show that boards have a legal and fiduciary responsibility to manage environmental, social and governance risks. Directors need to be informed and prepared to manage these long term concerns alongside typical corporate directives. By addressing and managing these risks effectively, boards can position their businesses to perform well financially and secure a long-term license to operate. By failing to do so, boards can undermine their company’s reputation. More and more companies are extending their internal controls to encompass a range of ethics and integrity issues. Many investment managers examine the rigor and quality of these controls as evidence that companies are undertaking good business practices and are well managed: Proactively identifying possible human rights concerns allows a business to more effectively address potential risks. Initiatives such as the IFC-led Equator Principles — a financial industry benchmark used by more than 60 financial institutions worldwide to determine, assess and manage social and environmental risk in project financing — and the Dow Jones and FTSE4Good Sustainability Indexes have made it increasingly apparent that socially responsible practices can improve access to financial markets and reduce capital costs. The competitive advantage of risk management gained through anti-corruption includes ensuring alignment with customer expectations, safeguarding reputation, and meeting demands of ethical investment funds, pensions, and other investors. Creating Business Values Core to the role of any board is guiding corporate strategy and creating wealth for shareholders. Many new business opportunities are emerging to address corporate citizenship priorities. Forward-thinking businesses are best placed to benefit. Immediate benefits cited by leading companies include improved reputation, higher employee retention rates, greater productivity, and cost benefits through operational improvements and innovation in products and services. The most effective corporate citizenship and sustainability strategies are led from the top, incorporate a wide range of stakeholder views and are aligned them with the company’s business priorities. This ensures a more efficient and strategic allocation of resources to these initiatives, which may generate new business opportunities: Improved labor practices in supplier operations can translate into improved productivity and reduced reputational risks. Better working conditions improve the efficiency of the supply chain. Human rights strategies, such as preventing discrimination in the workplace and promoting gender and ethnic equality in business processes, have been shown to secure diversity and increase innovation in products and services. A diverse workforce and wider customer base guide development within new markets and previously untapped customer demographics. Environmental programmes can provide financial benefits, such as reducing operating costs, leading to new markets and technologies, improving employee morale and increasing employee health. Good management of environmental, social and governance performance has been shown to strengthen reputation and brand value are important business assets Voluntary Initiatives Voluntary initiatives such as the OECD Principles, the UN Global Compact, the IFC-led Equator Principles, the International Corporate Governance Network (www.icgn.org) and numerous others seek to complement regulatory frameworks while encouraging innovation and proactive management among companies who are ready to be leaders in good practice. In cases of poor governance or weak governments, voluntary initiatives can also help set an ethical bar that would otherwise be absent(Kell 2009).. IFC, the private sector arm of the World Bank Group, is helping board directors and company managers understand sustainability-related risks and opportunities alongside other aspects of core business decisions and processes. IFC also promotes this understanding through the international platforms of the Global Corporate Governance Forum and the Equator Principles, a finance industry benchmark for assessing sustainability in private sector investments.