Examine the board's composition, effectiveness

The composition of boards of directors is one of the areas targeted by good governance organizations such as GMI.

The Corporate Library, which is part of GMI, developed a checklist to help investors evaluate the independence and potential effectiveness of a board. These include:

  • Size of the board. There’s no magic number, but the average board size is 9 to 10 members. Boards that are too large may be unwieldy; boards that are too small may not be able to handle the workload.

  • Number of independent outsiders on the board. A majority is considered ideal by many observers.

  • The presence of executive, audit, compensation and nominating committees. Compensation and audit committees should be made up of independent directors. Some observers believe that the audit committee chairman should be a qualified or registered accounting practitioner — but again, there is no universal agreement on this point.

  • Limited directorships. A board member generally should serve on no more than three boards, and the boards should not have conflicting interests.

  • Disclosure. Companies must disclose transactions with executives, directors and other related parties that might constitute a conflict of interest.

Common convention holds that directors should own enough shares in the company so that they have a vested interest. On the other hand, corporate governance advocates caution against directors who have such large shareholdings and option grants that their judgment could be impaired by the desire to see the share price rise through accounting maneuvers for a short-term gain.

Directors should be paid adequately for their time on board business, and to compensate them for their expertise and experience.

Reporter's Notebook

Studies and reports by auditing and consulting firms can provide ideas for stories. Moulishree Srivastava of LiveMint, the online business publication, used the expertise of a partner at Grant Thornton India as a jumping off point for a story on corporate governance challenges facing Indian family businesses. These include:

  • Attracting independent directors
  • Opening up to private equity investment
  • Thwarting fraud and managing risk

Read the story: http://bit.ly/HArSyV

“Independent” directors — outsiders with no connection to the company — should limit their shareholdings to less than 5 percent to maintain their independence, according to corporate governance experts. The percentage varies across countries; a new Companies Bill in India, expected to be enacted in 2012, proposes outside directors limit their share ownership to a 2-percent maximum.

Major Differences Between Direction and Management

Directors Managers
Decision-making Required to determine the future of the organization and protect its assets and reputation. They also need to consider how their decisions relate to stakeholders and the regulatory framework. More concerned with implementing board decisions and policies.
Duties, Responsibilities They have the ultimate responsibility for the company’s long-term prosperity. Directors are normally required by law to apply skill and care in exercising their duty to the company and are subject to fiduciary duties. They can be personally liable if they are in breach of their duties or act improperly. They can be held responsible sometimes for the company’s acts. Not usually bound by directional responsibilities.
Relationship with Shareholders Shareholders can remove them from office. In addition, a company’s directors are accountable to the shareholders. Appointed and dismissed usually by directors or management; they seldom have any legal requirement to be held to account.
Leadership Provide the intrinsic leadership and direction at the top of the organization. Day-to-day leadership is in the hands of the CEO; managers act on the director’s behalf.
Ethics, Values Play a key role in determining the company’s values and ethical positions. Must carry out the ethos, taking direction from the board.
Company Administration Responsible for the company’s administration. Related duties associated with the company’s administration can be delegated to management, but this does not relieve the directors of their ultimate responsibility.
Statutory Provisions In many countries, there are numerous statutory provisions that can create offenses of strict liability under which directors may face penalties if the company fails to comply. These statutory provisions do not usually affect managers.

Source: Chris Pierce, “The Effective Director,” London: Kogan Page, 2003.

Shareholders elect directors when they are proposed by the board, usually at annual meetings. In Asia, companies commonly have controlling shareholders who can control the nomination and election of board directors.

Term limits can vary by company and by country, but board terms generally last from one to three years.

For an overview of the responsibilities of boards and best practices, see: http://bit.ly/HDB765