article 1.1 Flashcards
In the twoe tier board,
a strict division of powers between the management board and the supervisory board is mandatory. This functional division is bolstered by the incompatibility principle that a person cannot be a member of both boards at the same time, and there is usually a prohibition against the supervisory board giving instructions to the management board. in traditional one tier systems, there is no formal division between management and supervision
The two different models taht at first sight look completely different are functionally much less different; indeed, one could say that there is considerable convergence. four observations back this convergence statement
1) taking or participating in key decisions - and in particular monitoring and control - are matters for the (single) board
2) Second, not only the supervisory boards but also the one tier boards are dependent on management for information and advice, sometimes to the extent that management takes over
3) in the one tier board there has also been a certain separation, not only between executives and non executives, but between non independent and independent directors
4) there is also a convergence in the exercise of certain functions such as strategy, reisk management, and internal control
It is one of the most important powers of the board to determine the companys strategy and to monitor its implementation. In most one tier systems this power cannot be delegated to the sub board level and has to be exercised by the entire board. in two tier systems, the management board determines the strategy, usually subject to approval by the supervisory board
There is also no clear cut division between one tier and two tiew systems as to risk management and internal control. In some one tier jurisdictions, the (entire) board is responsible for setting up the risk management and internal control systems, whereas the task of management is limited to implementing these systems. The division comes close to the two tier models, where the management board sets and implements the strategy and the supervisory board monitors the setting up and implementation
Non-executive and independent directors
the composition of the board differs from country to country. The issue of copmosition is more controversial than structure. within shareholder representation, however, a dominant question over the past quarter century has been the mix of executive and non executive directors and the proportion of indenpendent directors on the board.
The concept of independence is complex and controversial.
in formal terms, independence can be defined by a general clause or by a catalog of criteria that may be exhaustive or just contain major examples of independence
It has also been defined as being “free of any business, family or other relationship, with the company, its controlling sahreholder or the management of either, that creates a conflict of interest such as to impair his judgement”
A key problem is the strain between independence and competence. The high expectations placed in independent directors have been only partiall fulfilled. Independent directors seem to have had an impact on replacing executive directors, but this was maily due to pressure from institutional investors. Unless they are professional nnon-executive directors, they are working part time and while being independent, may not have the necessary know-how, either of the business sector or the actual corporation. They are also paid less than the executive directors and thereore may also be less motivated to devote much of their time and energy to the task
Expertise and diversity
Policy debates on board composition now focus as much on the elements of expertise and diversity as on independence. Diversity can come in very different forms, including
background, gender, age, nationality, and residence. The policy focus in europe is almost entirely on gender diversity, with some nods in teh direction of other aspects, especially background and nationality. the importance of g ender diversity is stressed in most countries, but in a number of them no targets or quotas are yet recommended or imposed. In others code provisions recommend targets to be set by the companies themselves and to enforce them on a comply-or-explain basis
Another issue, not directly involving qualifications but still very important for effective board decisions, is directors availability for board meetings and time to prepare for them. This is an issue especially since non executive and supervisory board members, unlike managers, usually work part time for the company. Many corporate governance codes expressly stae that the directors should be in a position to devote sufficient time to their job. Though it is very difficult to spell out more concrete time requirements in law or codes, one possibility would be to limite the number of board memberships any one person can hold
Separation of the functions of chair on the board and CEO
there is considerable convergence between the seemingly divergent one tier and two tier boards. this is confirmed when one looks at the increasing corporate governance tend to ward sparation fo the funciton of the chairman and the CEO
The chairman is responsible for an effective interaction and information flow between the executives and non-executives viz. between the two boards in the two tier systems. Where the chairman is not the CEO, he also maintains regular contact with the CEO and consults with him or her on strategy.
The separation movement is gaining momentum, both in one tier and two tier board countries. While continuity may be good for the company, effeective monitoring may be impaired if the retiring CEO cn change over directly to be chair of the board, and in this new capacity can monitor his or her own former management decisions. This practice is now viewed with increasing skepticism. It is objectionable on two grounds: if the CEO sticks to the existing strategy, monitoring may be lax; on the other hand, he may hesitate to implement a new one
Information streams
information is crucial for the board in exercising its functions, especially monitoring. Apart from information provided by the CEO and, of course, the external auditors, two additional sources of information for the board are available:
Access to the management infomration systems fo the company and directly to the non board members executives and employees: in practice when a board member needs information from the executive level, the request is usually made by the chairman to the CEO. The problem with this practice is that almost all information of the board is filtered by the management. The board tends to get good information fast, but bad information late and asymmetrically. The only independent sources of information are the internal and external auditors, with whom in most cases only board members serving on the audit committee have direct and regular contact
Information from outside experts: It is a controversial issue whether the supervisory board should have access to external advice. The practice appears to be that corporate gvoernance codes give the right to obtain exernal advice, but this right is not generally exercised because it is seen as unfriendly. Asking for exernal advice is a direct challenge to the management. it may also be a defensive step because it allows the board to rebut the charge of mismanagement. If there is a threat of incurring liability, however, the supervisory board will seek external advice.
Board committees: There are many kinds of committees, but three key committees for the most important tasks are recommended by nearly all the national corporate governance codes as well as by the E.U. Recommendation:
tHe nomination committee: has the task of selecting suitable candidates, a task that is hardly relveant incompanies with a controlling shareholder, and of periodically assessing the balance of skills, independence and experience on the board
The remuneration committee: makes proposals for the companys remuneration policy and the remuneration of the individual directors
The audit committee: it is the most important committee. It has the task of monitoring the integrity of the companys financial information, reviewing the internal control and risk management systems at least annually, ensuring the effectiveness of the internal audit function, making recommendations as to the selection of the external auditor, and monitoring the external auditors independence and objectivity. The audit committee has direct access to information that other board members do not have.
Committees should normally be composed of at least three members, but companies with small boards may assign the function of the committee to the board as a whole. Most codes recommend that the committees consist only of board members, but “the use of other s tructures or procedures” are allowed provided that they are “functionally equivalent and equally effective”. However, the rules regarding the composition of the audit committee take this specific task into consideration and tehy are sometimes more demanding than those for other committees.
Cumulative and slate voting
the main agency problem for shareholders in concentrated shoareholder jurisdictions exists between controlling and non controlling shareholders. In some countries - especially those with a two tier board - minorities are protected by having special legal appointment rights to the board. Two forms must be distinguished:
Cumulative voting (e.g. poland and austria)
Slate vogin (e.g. italy)
Employee representation on the board
a way to increase board responsiveness to shareholder interests is to downgrade composition rules which stand in teh way of such responsiveness. The clear candidtae for such attention is the rules which require employee representation on te board. Mandatory employee representation presupposes that conflicts between capital and labor can be sloved within the board by information, discussion, and compromise.
There is an initial issue of how rules requiring employee representation on the board are aligned with the rules on independent directors. it is hardly understandable that independence from a controlling shareholder and independence of employees or union representatives should be treated differently. The european recommendation provides that employees and persons who were employees during the previous three years cannot be considered independent unless they have been eleceted to the board in the context of a workers representation system recognized by law nad provided that they do not belong to senior management
The appointment of labor representatives can be organized in various ways:
the actual appointment may be up to the shareholders, or by nomination by the works council. This nomination may be rejected by the general assembly under certain conditions, but then the works council may present further nominees
More commonly, the labor representatives are elected by the workforce of the company. The voting system for such an election is complicated and costly because of the sheer number of electors. It can rely either on direct election or on election by voting dlegates. The selection process is even more difficult and costly if the voting rights are not limited to the domestic workforce only
Sometimes trade unions have their own seats on the board
The extent of codetermination at the board level varies considerably
it depends on the legal form of the company and its size (below 500 employees: no mandatory employee representation; from 500 to 2000 employees: one third representation, which applies to about 3000 companies; morre than 200 employees: parity applying to about forty companies) the employee representatives are elected by the workforce either directly or indiretly
The most challenging controversial and least empirically confirmed question is what impact mandatory employee representation at the board level has
problematic impact on the size of the board, and of the costs and the slowing down of the decision making process
The impact on the information streams is the most probable. The presence of employee representatives on the board may improve the information available to the board because the information the (supervisory) board receives from the company is filtered by the management
Another impact on decision making occurs because labor issues are mostlikely to be brought tot he board from the workforce in the company as well as from the trade unions
