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CORPORATE GOVERNANCE: THE BOARD OF

DIRECTORS AND STANDING COMMITTEES
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ThesyllabusforPaperF1/FAB,AccountantinBusiness,requirescandidatestounderstandthemeaning
ofcorporategovernanceandtheroleoftheboardofdirectorsinestablishingandmaintaininggood
standardsofgovernance.

Specifically,theStudyGuidereferstotheseparationofownershipandcontrol,theroleofnonexecutive
directorsandtwoofthestandingcommitteescommonlyestablishedbypubliccompanies.Thisarticle
providesanintroductiontocorporategovernanceandsomeofthebasicconceptsthatunderpinit,and
explainstherolesoftheboard,thedifferenttypesofcompanydirectorandstandingcommittees.

WHATISCORPORATEGOVERNANCE?
ThesimplestandmostconcisedefinitionofcorporategovernancewasprovidedbytheCadburyReportin
1992,whichstated:Corporategovernanceisthesystembywhichcompaniesaredirectedandcontrolled.

Thoughsimplistic,thisdefinitionprovidesanunderstandingofthenatureofcorporategovernanceand
thevitalrolethatleadersoforganisationshavetoplayinestablishingeffectivepractices.Formost
companies,thoseleadersarethedirectors,whodecidethelongtermstrategyofthecompanyinorderto
servethebestinterestsoftheowners(membersorshareholders)and,morebroadly,stakeholders,such
ascustomers,suppliers,providersoflongtermfinance,thecommunityandregulators.

Itisimportanttorecognisethateffectivecorporategovernancereliestosomeextentoncompliancewith
laws,butbeingfullycompliantdoesnotnecessarilymeanthatacompanyisadoptingsoundcorporate
governancepractices.Significantly,theCadburyReportwaspublishedintheUKshortlyafterthecollapse
ofMaxwellCommunicationsplc,alargepublishingcompany.Manyoftheactionsthatbroughtaboutthe
collapse,suchastheconcentrationofpowerinthehandsofoneindividualandthecompanyborrowing
fromitspensionfundinordertoachieveleveragedgrowth,werelegalatthetime.

TheOrganisationforEconomicCooperationandDevelopmentpublisheditsPrinciplesofCorporate
Governancein2004.Theseare:
Rightsofshareholders:Thecorporategovernanceframeworkshouldprotectshareholdersandfacilitatetheirrightsin
thecompany.Companiesshouldgenerateinvestmentreturnsfortheriskcapitalputupbytheshareholders.
Equitabletreatmentofshareholders:Allshareholdersshouldbetreatedequitably(fairly),includingthosewho
constituteaminority,individualsandforeignshareholders.Shareholdersshouldhaveredresswhentheirrightsare
contravenedorwhereanindividualshareholderorgroupofshareholdersisoppressedbythemajority.
Stakeholders:Thecorporategovernanceframeworkshouldrecognisethelegalrightsofstakeholdersandfacilitate
cooperationwiththeminordertocreatewealth,employmentandsustainableenterprises.
Disclosureandtransparency:Companiesshouldmakerelevant,timelydisclosuresonmattersaffectingfinancial
performance,managementandownershipofthebusiness.
Boardofdirectors:Theboardofdirectorsshouldsetthedirectionofthecompanyandmonitormanagementinorder
thatthecompanywillachieveitsobjectives.Thecorporategovernanceframeworkshouldunderpintheboards
accountabilitytothecompanyanditsmembers.

TOWHOMISCORPORATEGOVERNANCERELEVANT?
Corporategovernanceisimportantinallbutthesmallestorganisations.Limitedcompanieshavea
primarydutytotheirshareholders,butalsotootherstakeholdersasdescribedabove.Notforprofit
organisationsmustalsobedirectedandcontrolledappropriately,asthedecisionsandactionsofafew
individualscanaffectmanyindividuals,groupsandorganisationsthathavelittleornoinfluenceover
them.PublicsectororganisationshaveadutytoservetheStatebutmustactinamannerthattreats
stakeholdersfairly.

Mostoftheattentiongiventocorporategovernanceisdirectedtowardspubliclimitedcompanieswhose
securitiesaretradedinrecognisedcapitalmarkets.Thereasonforthisisthatsuchorganisationshave
hundredsoreventhousandsofshareholderswhosewealthandincomecanbeenhancedor

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compromisedbythedecisionsofseniormanagement.Thisisoftenreferredtoastheagencyproblem.
Potentialandexistingshareholderstakeinvestmentdecisionsbasedoninformationthatishistoricaland
subjective,usuallywithlittleknowledgeofthedirectionthatthecompanywilltakeinthefuture.They
thereforeplacetrustinthosewhotakedecisionstoachievetherightbalancebetweenreturnandrisk,to
putappropriatesystemsofcontrolinplace,toprovidetimelyandaccurateinformation,tomanagerisk
wisely,andtoactethicallyatalltimes.

Theagencyproblembecomesmostevidentwhencompaniesfail.Inordertomakeprofits,itisnecessary
totakerisks,andsometimesrisksthataretakenwiththebestintentionsandaresupportedbythemost
robustbusinessplansresultinlossoreventhedemiseofthecompany.Sometimescorporatefailureis
broughtaboutbyinappropriatebehavioursofdirectorsandotherseniormanagers.

Asalreadymentioned,intheUK,corporategovernancefirstcameintothespotlightwiththepublicationof
theCadburyReport,shortlyaftertwolargecompanies(MaxwellCommunicationsplcandPollyPeck
Internationalplc)collapsed.Tenyearslater,intheUS,theSarbanesOxleyActwaspassedasa
responsetothecollapseofEnronCorporationandWorldCom.Allofthesecasesinvolvedcompaniesthat
hadbeenhighlysuccessfulandrunbyafewverypowerfulindividuals,andallinvolvedsomedegreeof
criminalactivityontheirpart.

Therecentcreditcrisishasbroughtaboutrenewedconcernaboutcorporategovernance,specificallyin
thefinancialsector.Althoughtherootsofthecrisisweremainlyfinancialandoriginatedwithadverse
conditionsinthewholesalemoneymarkets,subsequentinvestigationsandreportshavecalledinto
questionthepolicies,processesandprevailingculturesinmanybankingandfinancerelated
organisations.

APPROACHESTOCORPORATEGOVERNANCE
Mostcountriesadoptaprinciplesbasedapproachtocorporategovernance.Thisinvolvesestablishinga
comprehensivesetofbestpracticestowhichlistedcompaniesshouldadhere.Ifitisconsideredtobein
thebestinterestsofthecompanynottofollowoneormoreofthesestandards,thecompanyshould
disclosethistoitsshareholders,alongwiththereasonsfornotdoingso.Thisdoesnotnecessarilymean
thataprinciplesbasedapproachisasoftoption,however,asitmaybeaconditionofmembershipofthe
stockexchangethatcompaniesstrictlyfollowthiscomplyorexplainrequirement.

Somecountriespreferarulesbasedapproachthroughwhichthedesiredcorporategovernance
standardsareenshrinedinlawandarethereforemandatory.ThebestexampleofthisistheUS,where
theSarbanesOxleyActlaysdowndetailedlegalrequirements.

THEROLEOFTHEBOARDOFDIRECTORS
Nearlyallcompaniesaremanagedbyaboardofdirectors,appointedorelectedbytheshareholdersto
runthecompanyontheirbehalf.Inmostcountries,thedirectorsaresubjecttoperiodic(oftenannual)re
electionbytheshareholders.Thiswouldappeartogivetheshareholdersultimatepower,butinmost
sectorsitisrecognisedthatperformancecanonlybejudgedoverthemediumtolongterm.Shareholders
thereforehavetoplacetrustinthosewhoactontheirbehalf.Itisrarebutnotunknownforshareholders
tolosepatiencewiththeboardandremoveitsmembersenmasse.

TheroleoftheboardofdirectorswassummarisedbytheKingReport(aSouthAfricanreporton
corporategovernance)as:
todefinethepurposeofthecompany
todefinethevaluesbywhichthecompanywillperformitsdailyduties
toidentifythestakeholdersrelevanttothecompany
todevelopastrategycombiningthesefactors
toensureimplementationofthisstrategy.

Thepurposeandvaluesofacompanyareoftensetdowninitsconstitutionaldocuments,reflectingthe
objectivesofitsfounders.However,itissometimesappropriatefortheboardtoconsiderwhetheritisin
thebestinterestsofthoseservedbythecompanytomodifythisorevenchangeitcompletely.For
example,NCRCorporationisaUSproducerofautomatedtellermachinesandpointofsalesystems,but
itsoriginslayinmechanicalaccountingmachines(NCRrepresentsNationalCashRegister).Ascash
registerswouldquicklybecomeobsoletewiththeemergenceofmicrochiptechnology,thecompanyhad
toadaptveryrapidly.Whitbreadplcoriginatedasabrewerinthe18thcenturyintheUK,butinthe1990s
redefineditsmissionandobjectivescompletely.Itisnowahospitalityandleisureprovider(itsbrands
includePremierInnandCostacoffee)andhasabandonedbrewingcompletely.

Thedirectorsmusttakealongtermperspectiveoftheroadthatthecompanymusttravel.Management
writerWilliamOuchiattributestheenduringsuccessofmanyJapanesecompaniestotheirabilitytoavoid
shorttermkneejerkreactionstoimmediateissuesinfavourofconsensusoverthebestdirectiontotake
inthelongterm.

STRUCTUREOFTHEBOARDOFDIRECTORS
Thereisnoconvenientformulafordefininghowmanydirectorsacompanyshouldhave,thoughinsome
jurisdictionscompanylawspecifiesaminimumand/ormaximumnumberofdirectorsfordifferenttypesof
company.Tescoplc,alargemultinationalsupermarketcompany,has13directors.SwirePacificLimited,
alargeHongKongconglomerate,has18directors.Smallerlistedcompaniesgenerallyhavefewer
directors,typicallysixtoeightpersons.

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Theboardofdirectorsismadeupofexecutivedirectorsandnonexecutivedirectors.

Executivedirectorsarefulltimeemployeesofthecompanyand,therefore,havetworelationshipsand
setsofduties.Theyworkforthecompanyinaseniorcapacity,usuallyconcernedwithpolicymattersor
functionalbusinessareasofmajorstrategicimportance.Largecompaniestendtohaveexecutive
directorsresponsibleforfinance,IT/IS,marketingandsoon.

Executivedirectorsareusuallyrecruitedbytheboardofdirectors.Theyarethehighestearnersinthe
company,withremunerationpackagesmadeuppartlyofbasicpayandfringebenefitsandpartly
performancerelatedpay.Mostlargecompaniesnowengagetheirexecutivedirectorsunderfixedterm
contracts,oftenrollingoverevery12months.

Thechiefexecutiveofficer(CEO)andthefinancedirector(intheUS,chieffinancialofficer)arenearly
alwaysexecutivedirectors.

Nonexecutivedirectors(NEDs)arenotemployeesofthecompanyandarenotinvolvedinitsdayto
dayrunning.Theyusuallyhavefulltimejobselsewhere,ormaysometimesbeprominentindividualsfrom
publiclife.Thenonexecutivedirectorsusuallyreceiveaflatfeefortheirservices,andareengagedunder
acontractforservice(civilcontract,similartothatusedtohireaconsultant).

NEDsshouldprovideabalancinginfluenceandhelptominimiseconflictsofinterest.TheHiggsReport,
publishedin2003,summarisedtheirroleas:
tocontributetothestrategicplan
toscrutinisetheperformanceoftheexecutivedirectors
toprovideanexternalperspectiveonriskmanagement
todealwithpeopleissues,suchasthefutureshapeoftheboardandresolutionofconflicts.

Themajorityofnonexecutivedirectorsshouldbeindependent.Factorstobeconsideredinassessing
theirindependenceincludetheirbusiness,financialandothercommitments,othershareholdingsand
directorshipsandinvolvementinbusinessesconnectedtothecompany.However,holdingsharesinthe
companydoesnotnecessarilycompromiseindependence.

Nonexecutivedirectorsshouldhavehighethicalstandardsandactwithintegrityandprobity.Theyshould
supporttheexecutiveteamandmonitoritsconduct,demonstratingawillingnesstolisten,question,
debateandchallenge.

Itisnowrecognisedasbestpracticethatapubliccompanyshouldhavemorenonexecutive
directorsthanexecutivedirectors.InTescoplc,therearefiveexecutivedirectorsandeight
independentnonexecutivedirectors.SwirePacificLtdhaseightexecutivedirectorsand10non
executivedirectors,ofwhichsixareindependentnonexecutivedirectors.

Anindividualmaybeaccountableinlawasashadowdirector.Ashadowdirectorisapersonwho
controlstheactivitiesofacompany,orofoneormoreofitsactualdirectors,indirectly.Forexample,ifa
personwhoisunconnectedwithacompanygivesinstructionstoapersonwhoisadirectorofthe
company,thenthesecondpersonisanactualdirectorwhilethefirstpersonisashadowdirector.Insome
jurisdictions,shadowdirectorsarerecognisedasbeingasaccountableinlawasactualdirectors.

UNITARYVTWOTIERBOARDS
Theunitaryboardmodelisadoptedby,interalia,companiesintheUK,US,AustraliaandSouthAfrica.
Thecompanysdirectorsservetogetherononeboardcomprisingbothexecutiveandnonexecutive
directors.

InmanycountriesincontinentalEurope,companiesadoptatwotierstructure.Thisseparatesthose
responsibleforsupervisionfromthoseresponsibleforoperations.Thesupervisoryboardgenerally
overseestheoperatingboard.

PaperFAB,AccountantinBusiness,focusesmainlyontheunitaryboardsystem,thoughknowledgeof
bothmodelsisrequiredforsubsequentstudiesforPaperP1,Governance,RiskandEthics.

KEYPOSITIONS
Thechairmanofthecompanyistheleaderoftheboardofdirectors.Itisthechairmansresponsibilityto
ensurethattheboardoperatesefficientlyandeffectively,getthebestoutofallofitsmembers.The
chairmanshould,forexample,promoteregularattendanceandfullinvolvementindiscussions.The
chairmandecidesthescopeofeachmeetingandisresponsiblefortimemanagementofboardmeetings,
ensuringallmattersarediscussedfully,butwithoutspendinglimitlesstimeonindividualagendaitems.In
mostcompaniesthechairmanisanonexecutivedirector.

Thechiefexecutiveofficer(CEO)istheleaderoftheexecutiveteamandisresponsibleforthedayto
daymanagementoftheorganisation.Assuch,thisindividualisnearlyalwaysanexecutivedirector.As
wellasattendingboardmeetingsinhisorhercapacityasadirector,theCEOwillusuallychairthe
managementcommitteeorexecutivecommittee.Whilemostcompanieshavemonthlyboardmeetings,it
iscommonformanagement/executivecommitteemeetingstobeweekly.

Thesecretaryisthechiefadministrativeofficerofthecompany.Thesecretaryprovidestheagendaand
supportingpapersforboardmeetings,andoftenforexecutivecommitteemeetingsalso.Heorshetakes
minutesofmeetingsandprovidesadviceonproceduralmatters,suchastermsofreference.The
secretaryusuallyhasresponsibilitiesforliaisonwithshareholdersandthegovernmentregistrationbody.
Assuch,thenoticeofgeneralmeetingswillbesignedbythesecretaryonbehalfoftheboardofdirectors.

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Thesecretarymaybeamemberoftheboardofdirectors,thoughsomesmallercompaniesusethis
positionasameansofinvolvingahighpotentialindividualatboardlevelpriortobeingappointedasa
director.

SEGREGATIONOFRESPONSIBILITIES
ItisgenerallyrecognisedthattheCEOshouldnotholdthepositionofchairman,astheactivitiesofeach
rolearequitedistinctivefromoneanother.Inlargercompanies,therewouldbetoomuchworkforone
individual,thoughinMarks&Spencer,alargelistedUKretailorganisation,onepersondidoccupyboth
positionsforseveralyears.

Thesecretaryshouldnotalsobethechairmanofthecompany.Asthesecretaryhasakeyroleinliaising
withthegovernmentregistrationbody,havingthesamepersonoccupyingbothrolescouldcompromise
theflowofinformationbetweenthisbodyandtheboardofdirectors.

STANDINGCOMMITTEES
Thetermstandingcommitteereferstoanycommitteethatisapermanentfeaturewithinthe
managementstructureofanorganisation.Inthecontextofcorporategovernance,itreferstocommittees
madeupofmembersoftheboardwithspecifiedsetsofduties.Thefourcommitteesmostoften
appointedbypubliccompaniesaretheauditcommittee,theremunerationcommittee,thenominations
committeeandtheriskcommittee.

TheSyllabusandStudyGuideforPaperF1/FABrequirestudentstostudyonlytwocommittees.These
aretheauditcommitteeandtheremunerationcommittee.

AUDITCOMMITTEE
Thiscommitteeshouldbemadeupofindependentnonexecutivedirectors,withatleastoneindividual
havingexpertiseinfinancialmanagement.Itisresponsiblefor:
oversightofinternalcontrolsapprovaloffinancialstatementsandothersignificantdocumentspriortoagreementby
thefullboard
liaisonwithexternalauditors
highlevelcompliancematters
reportingtotheshareholders.

Sometimesthecommitteemaycarryoutinvestigationsandmaydealwithmattersreportedby
whistleblowers.

REMUNERATIONCOMMITTEE
Thiscommitteedecidesontheremunerationofexecutivedirectors,andsometimesothersenior
executives.Itisresponsibleforformulatingawrittenremunerationpolicythatshouldhavetheaimof
attractingandretainingappropriatetalent,andfordecidingtheformsthatremunerationshouldtake.This
committeeshouldalsobemadeupentirelyofindependentnonexecutivedirectors,consistentwiththe
principlethatexecutivesshouldnotbeinapositiontodecidetheirownremuneration.

Itisgenerallyrecognisedthatexecutiveremunerationpackagesshouldbestructuredinamannerthatwill
motivatethemtoachievethelongtermobjectivesofthecompany.Therefore,theremuneration
committeehastoofferacompetitivebasicsalaryandfringebenefits(theseattractandretainpeopleof
therightcalibre),combinedwithperformancerelatedrewardssuchasbonuseslinkedtomediumand
longtermtargets,shares,shareoptionsandeventualpensionbenefits(oftensubjecttominimumlength
ofservicerequirements).

PUBLICOVERSIGHT
Publicoversightisconcernedwithensuringthattheconfidenceofinvestorsandthegeneralpublicin
professionalaccountancybodiesismaintained.Thiscanbeachievedbydirectregulation,theimposition
oflicensingrequirements(including,whereappropriate,exercisingpowersofenforcement)orbyself
regulation.AstheUSoperatesarulesbasedsystemofgovernance,theseresponsibilitiesaredischarged
bythePublicCompanyAccountingOversightBoard,whichhasthepowertoenforcemandatory
standardsandruleslaiddownbytheSarbanesOxleyAct.IntheUK,regulationistheresponsibilityofthe
ProfessionalOversightteamoftheFinancialReportingCouncil.

SAMPLEQUESTIONS
Candidatesmayfinditusefultoconsiderquestionsonthistopicidentifiedinexaminersreportsaswellas
thepilotpaper.Aspastquestionpapersarenotmadeavailable,thefollowingquestionsareincludedin
thisarticleasexamplesoftypicalrequirements.Itmustbeemphasisedthatthesequestionsarenottaken
fromtheactualquestionbank.

Samplequestion1:

LLLCompanyislistedonitscountrysstockexchange.Thefollowingindividualsserveonthe
boardofdirectors:

Asifisanonexecutivedirectorandisthechairmanofthecompany.
BertrandistheCEOandisresponsibleforthedaytodayrunningofthecompany.

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Chanisaprofessionalaccountantandservesasanonexecutivedirector.
Donnaisthefinancedirectorandisanemployeeofthecompany.
Estherisalegaladvocateandservesasanonexecutivedirector.
Frederikisthemarketingdirectorofamanufacturingcompanyandservesasanonexecutivedirector.

WhichofthefollowingisthemostappropriatecompositionofdirectorsforLLLCompanys
auditcommittee?
AChan,DonnaandEsther
BAsif,BertrandandFrederik
CAsif,EstherandFrederik
DChan,EstherandFrederik

ThecorrectanswerisD.Executivedirectorsshouldnotserveontheauditcommittee.Thiseliminates
optionsAandB.OptionDisthebestchoice,astheauditcommitteeshouldhaveatleastonedirector
withexpertiseinfinance.

Samplequestion2:
Whichofthefollowingisadutyofthesecretaryofalistedpubliccompany?
AMaintainingorderatboardmeetings
BClarifyingthetermsofreferenceoftheboardmeeting
CEnsuringthatalldirectorscontributefullytodiscussionsatboardmeetings
DReportingtotheboardonoperationalperformanceforthelastquarter

ThecorrectanswerisB.OptionsAandCareresponsibilitiesofthechairman,whileoptionDisthe
responsibilityoftheCEO.

Samplequestion3:
TheboardofdirectorsofJJJCompanyhasdecidedtoincreasethebasicsalaryofitschief
executiveofficerby20%inordertobringherpayintolinewiththoseoccupyingsimilar
positionsintheindustry.

Thisactionwillachievewhichofthefollowingpurposes?
AImprovetheprospectofretainingthechiefexecutiveofficer
BIncreasetheproductivityofthechiefexecutiveofficerbyatleast20%
CMotivatethechiefexecutiveofficertoachievelongtermtargets
DCreategreaterjobsatisfactionforthechiefexecutiveofficer

ThecorrectanswerisA.

Thebasicpayofferedbyacompanyservesasabeacontoattractapplicants,andcanalsodeterthe
presentincumbentofapositionfromseekingopportunitieselsewhere,especiallyiftheyperceive
themselvestobeunderpaidatpresent.

Asubstantialpayincreaseisunlikelytoachieveasignificantincreaseinproductivityorincreaselongterm
motivation(thoughpayincreasescanhaveashorttermimpactonmotivation).Jobsatisfactionisderived
fromfactorsotherthanremuneration,suchaschallengesinherentintheworkandthenatureofthetasks
performed.

WrittenbyamemberofthePaperF1/FABexaminingteam

Lastupdated:20Apr2015

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