Chapter 2: Governance structures (first quadrant of the 11 Cs model) – compliance and configuration

Question 1

Outline the three main theories of corporate governance.

Answer 1

• Agency theory: boards are the fiduciaries that resolve the agency problem inherent when there is a separation of ownership and control
• Stewardship theory: to be successful, an organisation’s structure needs to allow coordination between management and owners i.e. there is no conflict of interest between managers and owners (opposite of agency)
• Stakeholder theory: the boardroom needs to take into account the wider views of society

Each of these theories assumes that structure is the key predictor of board performance

Question 2

What are the two Cs relating to board structure?

Answer 2

• Compliance - Is the board compliant?
• Configuration - do the boards have appropriate configuration? UTBCDT

Question 3

Boards can logically fall into one of four types

Answer 3

Unitary:
- All executive board
- Majority executive board
- Majority independent NED
Two tier:
- The two-tier board - supervisory and management board

Question 4

Name some basic considerations for the board structure - RSC

Answer 4

• Ratio of EDs/NEDs
• Board size
• Committees

Question 5

What does the UK Code say about the ratio of EDs/NEDs?

Answer 5

• The board should include an appropriate combination of executive and non-executive directors (in particular independent NEDs) such that no individual can dominate the board’s decision taking
• at least half of the board (excluding the chair) should be a NED whom the board considers independent

Question 6

What does the King Code say about the ratio of EDs/NEDs?

Answer 6

King Code: majority of directors should be independent NEDs, but also adds that at least two executive directors on the board – the CEO and CFO

Question 7

Does the UK Code specify a minimum/maximum number of directors?

Answer 7

No - there is often an assumption that there is a sweet spot which effective board functioning will occur and this is dependent on a variety of factors - between 9 and 11 directors is average in the UK

Professor Bob Sutton: ‘Why Big Teams Suck: Seven (Plus or Minus Two) is the magical number once again – goes back to short term memory theory – performance problems and interpersonal friction can exponentially increase once over 9

Question 8

Why are committees utilised by boards?

Answer 8

• Compliance perspective - UK Code requires an audit, remuneration and nomination committee as a minimum
• method of expanding work, increasing efficiency and investigating important issues in more detail
• created for whatever the current strategy may be

Question 9

What are the chair considerations? SFE

Answer 9

• Chair and CEO split
• Chair not a former CEO
• Chair as an ED or NED

Question 10

What are the director considerations? TDR

Answer 10

• Tenure
• Diversity
• Remuneration

Question 11

What can we say about tenure?

Answer 11

• Chair should not remain in post for more than 9 years but can be extended for effective succession planning and the development of a diverse board
• Average tenure of a FTSE 150 is 4.3 years
• Higgs Review: recommends six years for NEDs

Question 12

Why is diversity important an important characteristic in appointing a director?

Answer 12

This allows for ethical inclusion and stakeholder voice. A good board should include in its membership, directors who represent their constituent stakeholders because it is the right thing to do and because it helps improve board decision-making

Question 13

What did the Hampton Alexander review targets show?

Answer 13

There have been improvements in gender diversity, although most women are NEDs and only 5% are chairs/CEO

Question 14

What did the DiversityQ FTSE 100 Board Diversity Report 2020 show?

Answer 14

• 6% male, 3.8% female
• 99 senior BAME people – 19 executive and 80 NEDs
• CEOs: 7 Asian or any other minority and 0 Black
• 49% have no BAME representation – although number of foreign directors is up to 30%

Question 15

Why is director remuneration linked to the configuration?

Answer 15

• Base pay: basic view is that directors will be rationally motivated to perform their board duties in line with the remuneration they receive
• Incentive schemes: be designed to support strategy and promote long-term sustainable success.
  o Basel Committee: the failure to link remuneration schemes to long term business strategy > counter the interests of the bank and its stakeholders.
• Equity involvement: studies have shown positive correlation between stock ownership and firm performance in directors

Question 16

Name some examples of some board tasks - FRI

Answer 16

• Board meeting frequency – at least once every quarter – UK 7.7 times per year – Turkey 29.9 per year
• Board review – FTSE 350 boards are required to review themselves every year and be reviewed by an external evaluator at least every three years.
• Board induction and development – ensure ‘match fit’ to perform their duties

Question 17

What are the four categories of board structure?

Answer 17

• Basic set-up - RSC
• Chair set-up
• Director set-up - TDR
• Board tasks - MRI