Read Lubna’s blog insights where she takes a fresh look at governance to create stronger countries and business
What does good governance look like and why is it important?
As a commercial lawyer, I have worked in government and the private sector and sat on commercial and voluntary leadership teams and boards. Over the years I have become more interested in – actually, very passionate about – the importance of governance.
In a way it sounds such a dull subject and yet poor governance brought down companies such as ENRON, Worldcom and Arthur Andersen with a knock-on effect to the man in the street, with losses to pension fund investments and the loss of jobs for 21,000 ENRON employees in 40 countries. Poor governance was behind the world financial crash of 2008 – and many people around the world are still suffering as a consequence.
Governance is not straight forward. There are rules, but often how those rules are applied requires judgment. And governance and public perception and expectations also change over time.
So I want to add my own contribution to everyone who is thinking about and aiming for good governance. I am changing the focus of my blog to concentrate on this subject and I hope others will share with me their views.
As a starting point, I set out here the basic legal framework and board structure that are needed for good governance.
1. Start with the company’s board of directors
You can learn a lot from looking at the disclosure made about a company’s board of directors in its annual report. The level of quality of a company’s governance is reflected in its board composition and responsibilities.
We all know that the board’s ultimate responsibility is to the shareholders and to govern a company’s management.
Too often we have all seen bad practices often resulting in fatal failures – more so in the past than now – where the board is a servant to the CEO, who is also the Chairman of the Board.
So here is my checklist of key areas to help you evaluate the objectivity and effectiveness of a board.
2. Size of the Board
There is no universal agreement on the optimum size of a board of directors.
A large number of members represents a challenge in terms of using them effectively or having any kind of meaningful individual participation. An average board size is nine and most boards range from three to 31. As Dr Roger Barker of the Institute of Directors says: “Being the wrong size may limit a board’s effectiveness. Too many members and meetings can become protracted, with cabals developing, and potentially poorer decision-making – with some choosing to let others do the hard work.”
The two critical board committees that must be made up of independent members are
- The Compensation Committee
- The Audit Committee
3. How independent is the board?
A key attribute of an effective board is that it is comprised of a majority of independent outsiders. An outsider is someone who had never worked at the company, is not related to any of the key employees and has never worked for a major customer or service provider.
However, when I said governance is not straight forward, even the definition of ‘independence’ can vary. This Law Gazette article shows how the definition of independence varies between Singapore, Malaysia and the United Kingdom.
There are four important board committees
There are many more committees depending on corporate philosophy, and which is determined by the ethics committee.
5. Conflicts of interest on a board
Companies must disclose any transactions with executives and directors in a financial note entitled “Related Transactions” which discloses any actions or relationships that can cause conflicts of interests. Many board meetings start by asking all directors to state any conflicts of interest, which is a useful process and reminder of the need to declare this.
6. Board performance and evaluation
The composition and performance of a board of directors says a lot about its responsibilities to a company’s shareholders. A board loses credibility if there are material shortcomings in the way members conduct themselves and the way board meetings are held. Simple standards can radically improve performance, such as
- Audits of boards process against external benchmarks
- Audits of director skills against external benchmarks
- Psychometric profiling to discover strengths and development needs of individual directors
- Executive coaching and appraisals
Evaluating board performance is a useful tool and the practice is growing. Spencer Stuart says: “Annual assessments have become the norm for boards in many countries, with nearly all listed companies in Canada, France, the U.K. and the U.S. conducting some sort of assessment each year. The practice is also widespread in Italy and Spain and is gaining attention in many Asia Pacific markets, where the issue of board effectiveness is moving up on the corporate governance agenda.
However, there are different views as to how best to do this. Should you just ensure compliance or look at the impediments stopping true board effectiveness? Good evaluation should identify and maximise strengths and tackle weaknesses.
All of these points are important for good governance, but if I had to prioritise one area it would be recruiting the right people and mix of people for a board. These are the people who set the tone, challenge each other and ensure that shareholders get best value from their board.
What would you prioritise and how would you define good governance?