Governance in Practice Flashcards
According to the UK Corporate Governance Code, what are the governance responsibilities of a BOD?
Provide entrepreneurial leadership for the company within a framework of prudent and effective risk management;
Set the company’s strategic aims;
Make sure that the necessary financial and human resources are in place for the company to meet its objectives;
Review management performance;
Set the company’s values and standards; and
Make sure that the company’s obligations to its shareholders are understood and met.
What additional governance responsibilities of the board are identified in the King IV Code?
Ethical conduct and sustainability of the business;
Compliance with laws, regulations and codes; and
Governing the relationships between the company and its stakeholders.
According to the FRC Guidance “Improving Board Effectiveness”, what are the characteristics of an effective board?
An effective board is one that:
Provides direction for management;
Demonstrates ethical leadership, displaying (and promoting throughout the company) behaviour that is consistent with the culture and values it has defined for the organisation;
Creates a performance culture that drives value creation without exposing the company to excessive risk of value destruction;
Makes well-informed and high-quality decisions based on a clear line of sight into the business;
Creates the right framework for helping directors meet their statutory duties under the CA2006, and other relevant statutory and regulatory regimes;
Is accountable, particularly to the providers of the company’s capital (shareholders); and
Thinks carefully about its governance arrangements and embraces evaluation of their effectiveness.
List 10 matters that should be reserved for decision-making by the BOD?
- Approval of overall strategy and strategic objectives;
- Approval of annual operating and capital expenditure budgets;
- Oversight of operations;
- Compliance with legal and regulatory requirements;
- Management/operational performance review;
- Changes in corporate or capital structure;
- Approving the risk appetite of the company;
- Approving the annual report and accounts;
- Declaring an interim dividend and recommending a final dividend; and
- Approval of formal communication with shareholders.
In the UK, what does the board of a large company commonly consist of?
A chairman; Possibly a deputy chairman; A CEO; A senior independent director (SID) (who may also be deputy chairman); Executive directors; and NEDs.
What would be the disadvantages of a large listed company in the UK restricting the total size of its board to 6 members?
At least half the board, excluding the chairman, should be independent NEDs which would leave room for the CEO and one other exec position (CFO). If any of the independent NEDs may be unable to attend a meeting or resign then the composition of the board would not be disrupted.
UK Code “the board should be of sufficient size that the requirements of the business can be met and that changes to the board’s composition and that of its committees can be managed without undue disruption, and should not be so large as to be unwieldy.”
Committees would constitute of the same members as on the other committees and the board which would compromise its independence. Remuneration and Audit Committees should consist of at least 3 independent NEDs and the Nomination Committee should consist of a majority independent NEDs.
UK Code “the value of ensuring that the committee membership is refreshed and that undue reliance is not placed on particular individuals should be taken into account in deciding chairmanship and membership of committees.”
What are the provisions in the UK Code for the size and composition of the BOD of a listed company in the FTSE 350?
PROVISION 11 - at least half the board, excluding the chair, should be non-executive directors whom the board considers to be independent.
CASE STUDY: Dorchester Finance Co. Ltd v Stebbing [1989]
UK Legal Case.
Company brought action against 3 directors (1 Exec and 2 NEDs) for alleged negligence and misappropriation of the company’s property.
Stebbing - exec, qualified accountant and only one involved full time.
2 NEDs - only made rare appearances, one qualified accountant and other with significant accountancy experience.
There were no board meetings.
Stebbing, the exec, arranged for the company to make some loans to clients and as part of this persuaded the NEDs to sign blank cheques for these.
Loans did not comply with the Moneylenders Act and they were inadequately secured.
When the loans turned out to be irrevocable, the company brought action against the directors. It was held that all 3 directors were liable to damages. Stebbing was held grossly negligent and the 2 NEDs were held to have failed to show the necessary level of skill and care in performing their duties as NEDs, even though they had acted in good faith at all times.
CASE STUDY: Re Barings Plc and Others (1998)
Andrew Tuckey, former deputy chairman of Barings Bank, was responsible for the supervision of Nick Leeson, the derivatives trader whole unauthorised speculative trading brought the bank to collapse in 1995.
It was alleged that he had failed to exercise his duty of care to the company. The case was summarised as:
Directors, individually and collectively, have a duty to acquire and maintain sufficient understanding of the company’s business to enable them to discharge their duties properly.
Subject to the AOA, directors are allowed to delegate particular functions to individuals beneath them in the management chain. Within reason, they are also entitled to have trust in the competence and integrity of these individuals. However, delegation of authority does not remove from the director’s duty to supervise the exercise of that delegated authority by the subordinate.
There is no universal rule for establishing whether a director is in breach of his duty to supervise the discharge of delegated functions by subordinates. The extent of the duty, and whether it has been properly discharged, should be decided on the facts in each case.
When there is a question about the extent of the director’s duties and responsibilities, a significant factor may be the level of reward received from the company (higher the reward = greater responsibility expected).
Tuckey had failed in his duties because he did not have sufficient knowledge and understanding of the nature of the derivatives markets and risks involved. He was therefore unable to consider properly matters referred to the committee of which he was chairman.
What is a fiduciary duty of a director?
Directors have a fiduciary duty to the company.
Fiduciary = given in trust.
They make contracts on behalf of the company and also control the company’s property.
What are the 7 statutory duties of directors under the provisions of the UK CA2006?
- Act within powers;
- Promote the success of the company;
- Exercise independent judgement of the company;
- Exercise reasonable care, skill and diligence;
- Avoid conflicts of interest;
- Not accept benefits from third parties; and
- Declare any interest in a proposed transaction or arrangement.
In what circumstances is it acceptable for a director to have an interest in a third party transaction with the company?
A director must declare the interest and its nature with the rest of the board and receive their approval for it to be legal.
E.g. a director may own a building that the company wants to rent.
What is a derivative action for breach of a statutory duty by a director of a UK company?
Director owes their duties to the company, therefore only the company can bring a legal claim against a director.
The UK CA2006 also introduces a procedure whereby individual members of the company can bring a legal action for a derivative claim against a director.
A derivative action may be brought in respect of “an actual or proposed act or mission involving negligence, default, breach of duty or breach of trust by a director of the company”.
A shareholder would have to bring the action against a director in the name of the company. If successful, the company would benefit and not the shareholder.
What are the provisions of the UK DTR for listed companies with regard to related party transactions with the company?
For most related party transactions above minimum size, a listed company is required to:
Make an announcement to the stock market giving details of the transaction;
Send a circular to shareholders giving more details;
Obtain the prior approval of the shareholders for the transaction; and
Ensure that the related party’s associates do not vote on the relevant resolution.
CASE STUDY: M+S (Chairman/CEO Roles)
Feb 2000: Luc Vandevelde appointed as chairman and CEO of M+S when its share price was falling sharply. Appointment attracted criticism but appeared to be a successful short-term measure.
2002: M+S’s fortunes had improved to the point where he relinquished the position of CEO and announced his intention of becoming part-time chairman.
2008: M+S’s CEO, Sir Stuart Rose, was also appointed as company chairman for a limited period until a successor of the CEO role could be identified/appointed. This attracted strong criticism from institutional investors. L+G publicly crtisised this saying it would make it difficult to a successor as CEO.
Shareholders could not prevent the appointment of the new chairman because this was a board decision.
Shareholders were able to vote on the re-election of Sir Stuart Rose as director at the AGM in 2008 whereby 22% opposed his re-election or abstained in the vote.
CASE STUDY: Association of British Insurers (ABI)
2007: ABI stated that it would issue an ‘amber top’ warning to its members over plans by pharmaceuticals company Shire to appoint its CEO as non-exec chairman.
Shire also proposed to replace the CEO with company’s long-standing finance director.
ABI’s director of investment affairs said “The chairman is supposed to oversee strategy and makes sure the board tests it and decision-making is robust. If the chairman was the chief executive who developed the strategy, he is supervising himself. There are risks in that.”.
CASE STUDY: Polly Peck International
FTSE 100 company in the 80’s, run by Asil Nadir as executive chairman.
Company collapsed in October 1990. During its administration process, the system of internal controls at the company’s London head office was found to be virtually non-existent.
As a result, Nadir was able to transfer large amounts of money from the company’s UK bank accounts to personal accounts with a bank in Northern Cyprus without any questions being asked.
After the company’s collapse, Nadir fled to Cyprus before returning to London in 2010 to face trial. He was found guilty of 10 counts of theft totaling £29M and in 2012 he was sentenced to 10 years in prison.
What is the role of a company chairman? Why should this role not be combined with that of the CEO?
Relate primarily to managing the BOD and ensuring the board functions effectively. Key roles are:
Set an appropriate agenda for board meetings;
Ensure that relevant information is provided to the directors, in advance of the meeting;
Encourage open discussions to board meetings, with constructive debate and discussion; and
Encourage all directors to contribute to discussions and decision making.
CEO and chairman roles are the most powerful positions on the BOD. If the same person holds these roles then they could become a dominant influence in decision-making in the company. May be reluctant to encourage challenges from NEDs about the company performance or to question management proposals re the future business strategy. Board becomes ineffective. Ability to act in own self-interests.
The UK Code states: “There should be a clear division of responsibilities at the head of the company between the running of the board and the exec responsibility for running the company’s business. No one individual should have unfettered powers of decision.”
What are the requirements of the UK Code with regard to the independence of the chairman?
PROVISION 9 - the chair should be independent on appointment. The role of the CEO and chair should not be exercised by the same individual. A CEO should not become chair of the same company.
PROVISION 19 - the chair should not remain in the post beyond 9 years from the date of first appointment to the board. This period can be extended for a limited period of time to facilitate effective succession planning and development of a diverse board.
Independence is challenged if the chair:
Has been an employee of company/group in last 5 years;
Has had a material business relationship with company in the last 3 years;
Has received/receives additional remuneration from the company (apart from a director’s fee), participates in the company’s share option or performance-related pay scheme or is a member of the company’s pay scheme;
Has close family ties with company’s advisers, directors, senior employees;
Holds cross-directorships or has significant links with other directors through involvement in other companies/bodies;
Represents a significant shareholder; or
Has served on the board for more than 9 years from the date of their first election.
In what circumstances is it acceptable for an individual to be the chairman of more than one FTSE 100 company at the same time?
Chairmen need to demonstrate that they have sufficient time to perform their role to the standards expected.
The nomination committee should prepare a job description which should:
Include an assessment of the amount of time commitment that should be expected; and
Recognise the need for the chairman to make himself or herself available in a time of crises.
Other commitments should be disclosed to the board before his or her appointment and included in the next annual report + accounts. Any changes to these should be disclosed to the board and included in the next annual report + accounts.
According to the UK Code, what are the roles of NEDs?
PRINCIPLE H - NEDs should have sufficient time to meet their board responsibilities. They should provide constructive challenge, strategic guidance, offer specialist advice and hold management to account.
PROVISION 12 - The board should appoint one independent NED to be the SID to provide a sounding board for the chair and serve as an intermediary for the other directors and shareholders. Led by the SID, the NEDs should met without the chair present at least annually to appraise the chair’s performance, and on other occasions as necessary.
PROVISION 13 - NEDs have a prime role in appointing and removing executive directors. NEDs should scrutinise and hold to account the performance of management and individual executive directors again agreed performance objectives. The chair should hold meetings with the NEDs without the executive directors present.
According to Higgs, what are the 4 broad roles of NEDs?
- STRATEGY - constructively challenge and contribute to the development of strategy;
- PERFORMANCE - scrutinise the performance of management in meeting agreed goals and objectives and monitor the reporting of performance;
- RISK - satisfy themselves that financial info is accurate and that financial controls and systems of risk management are robust and defensible;
- PEOPLE - responsible for determining appropriate levels of remuneration of exec directors and have a prime role in appointing/removing senior management and in succession planning.
List 6 circumstances in which a NED would not normally be considered independent.
- Has been an employee of the company within the last 5 years;
- Has a material business relationship with the company;
- Receives additional remuneration from the company (other than a director’s fee);
- Has close family ties with any of the company’s advisers, directors or senior employees;
- Represents a significant shareholder; and
- Has served on the board for more than 9 years since date of first election.
To comply with UK corporate governance requirements, what measures should be taken if a company appoints a NED who is not considered independent?
Board should state its reasons if it determines a director is independent notwithstanding the existence of relationships or circumstances which may appear relevant to its determination.
What are the 3 committees recommended by the UK Code and what is their composition?
- Nomination Committee - MAJORITY INDEPENDENT NEDS. Chairman should be board chairman or an independent NED.
- Audit Committee - (statutory requirement). ALL INDEPENDENT NEDS, large CO’s min 3, small co’s min 2. Small CO’s board chairman may be a member but not chair in addition to the independent NEDs but only if independent on appointment as chairman. At least 1 member should have recent and relevant financial experience.
- Remuneration Committee - ALL INDEPENDENT NEDS, large CO’s min 3, small co’s min 2. Board chairman may be a member but not chair but only if considered independent on appointment as chairman.
Criticisms of the effectiveness of NEDs?
- A lack of knowledge about the business and operations of the company;
- Insufficient time spent with the company;
- The weight of opinion of the executive directors of the board; and
- Delays in decision-making.
What are the respective roles of a management board and a supervisory board in a two-tier board structure in Germany?
MANAGEMENT - responsible for managing the company. Led by the chairman of the managing board (who is the CEO), its members are appointed by the supervisory board. Develops company strategy, in co-op with the supervisory board and is responsible for its implementation. Responsibility for risk management and the preparation of the annual financial statements.
SUPERVISORY - responsible for the general oversight of the company and of the management board. Members elected by shareholders (except in public companies with over 500 employees) then min proportion of the board must consist of representatives of employees. Led by company chairman. Advises management board and must be involved in decision-making on all fundamental matters affecting the company. Audit committee entirely consists of supervisory board members.
What are the criticisms of the two-tier board structure?
Boards too big (up to 20 members). Can result in inefficient meetings.
Common that former managers appointed to supervisory board, may be tempted to retain influence over the actions and operational decisions of their successors (against the purpose of the supervisory board).
Companies with more than 500 employees are required to have workers’ representatives or trade union reps on the supervisory board. Over 2000 employees required to have even greater percentage of reps on the board. Requirement under German law.
These reps often lack competence to consider strategic issues or are not independent from the company.
Concerns of information leaks can damage communications between the boards.
In the UK, what are the responsibilities or rights regarding new appointments to the board of the nominations committee, the BOD and the company’s shareholders?
Nomination committee should search for the new director(s) and make recommendations to the board.
The board should consider the recommendations of the committee and in normal circumstances should be expected to accept the recommendation.
Chairman should work closely with the nominations committee through this process.
PRINCIPLE J - Appointments to the board should be subject to a formal, rigorous and transparent procedure and an effective succession plan should be maintained for the board. Both appointments and succession plans should be based on merit and objective criteria and should promote diversity of gender, social and ethnic backgrounds, cognitive and personal strengths.
PROVISION 17 - the board should establish a NC to lead the process for appointments, ensure plans are in place for orderly succession to the board and oversee the development of a diverse pipeline for succession.
PROVISION 20 - Open advertising and/or an external search consultancy should generally be used for the appointment of the Chair and NEDs.
What are the responsibilities of a nomination committee?
Regularly review the structure, size and composition of the board and make recommendations to changes;
Succession planning for directors and other senior executives;
Review the leadership needs of the organisation (exec + non-exec), ensuring continued ability for it to remain competitive;
Up to date/fully informed re strategic issues and commercial changes affecting the company and its market;
Identifying/nominating candidates to fill board vacancies. Evaluate balance of skills, knowledge, experience and diversity of the board. Prepare description of the role and capabilities required;
Appointment of chairman - committee should prepare JD inc. time commitment expected;
Prior to appointment, appointee should be required to disclose any other business interests that may result in a conflict of interest + report on any future business interests that could result in a conflict;
NEDs - ensure they receive formal appointment letter setting out clearly what is expected of them in terms of time commitment, committee service and involvement outside board meetings;
Review results of board evaluation process that relate to its composition;
Annually review time required from NEDs. Performance evaluation should be used to assess whether the NEDs are spending enough time to fulfill their duties; and
Work/liaise with all other board committees.
According to the UK Code, what should be the composition of a nominations committee in a FTSE 350 company and who may be its chairman?
Majority independent NEDs.
Board chairman or independent NED may chair. Board chairman should not chair when dealing with the appointment of its successor.
What were the recommendations of The Davies Report (2011)?
FTSE 100 companies should aim to have a minimum of 25% female representation on the board by 2015;
Quoted companies should be required to disclose each year the proportion of women on their board, in senior positions and in the whole organisation. The UK Code should require listed companies to establish a policy for boardroom diversity, including measurable policy objectives. They should also disclose each year a summary of this policy and report on the progress towards achieving the policy objectives;
The UK Code requires the nominations committee to report on its work in the annual report. In line with this requirement, companies should disclose meaningful info about their appointment process and how they address the issue of diversity;
When searching for a new board appointee, companies should occasionally advertise the position, because this may result in greater diversity among applicants;
Executive search consultants should draw up a voluntary code of conduct for their industry which addresses gender diversity and best practice, with regard to search criteria and nomination processes for appointments to the boards of FTSE 350 companies.
What are the provisions of the UK Code relating to nominations and appointments to the board?
There should be a formal, rigorous and transparent procedure for the appointment of new directors to the board.
Search for candidates should be conducted, and appointments made, on merit, against objective criteria and with due regard for the benefits of diversity on the board.
Satisfy itself that plans are in place for orderly succession for appointments to board/senior mgmt to maintain appropriate balance of skills and experience in the company/board and to ensure progressive refreshing of the board.
Should be a NC to lead the process for board appointments and make recommendations to the board. Majority of members should be independent NEDs.
NC should evaluate balance of skills, experience, independence and knowledge of the board and in light of this prepare a description of the role and capabilities required for a particular appointment.
What issues should an individual consider before accepting the offer of an appointment as independent NED of a listed company?
Can commit to the role in the time the company expects;
Will be able to make a positive contribution to the effectiveness of the board;
If company is not performing well, they have time, desire and capability to make an impact and help turn the company’s fortunes around;
There is no risk that the directors could be held liable for any breach of duty and that there is sufficient D+O liability insurance as protection against this risk;
Fee offered is adequate;
There will be a suitable induction programme; and
There will be sufficient support from the company secretary and secretariat.
How much time should NEDs be required to commit to the company, and should this be a contractual commitment?
Terms of engagement should be agreed in a formal letter of appointment.
This will include the expected time commitment.
Typically NEDs may be expected to commit between 15 and 30 days each year and more for a committee chairman.
Why is it desirable to plan for board succession?
PRINCIPLE J - Appointments to the board should be subject to a formal, rigorous and transparent procedure, and an effective succession plan should be maintained for board and senior management. Both appointments and succession plans should be based on merit and objective criteria and, within this context, should promote diversity of gender, social and ethnic backgrounds, cognitive and personal strengths.
PROVISION 17 - board should establish a NC to lead the process for appointments, ensure plans are in place for orderly succession to both the board and management positions, and oversee the development of a diverse pipeline for succession.
PROVISION 23 - the annual report should describe the work of the NC, including the process used in relation to appointments, its approach to succession planning and how both support a diverse pipeline.
Avoids disruptions to the company’s decision-making processes or changes in policy or direction.
Newly appointed individuals have opportunity to learn about their role prior to the actual succession date.
Positions such as CEO, Chairman, CFO are all important positions and it is therefore undesirable to have these vacant for more than a short time.
What are the requirements of the UK Code regarding the re-election of directors?
PROVISION 17 - the board should establish a NC to lead the process for appointments, ensure plans are in place for orderly succession to both the board and senior management positions, and oversee the development of a diverse pipeline for succession. The chair of the board should not chair the committee when it is dealing with the appointment of their successor.
PROVISION 18 - All directors should be subject to annual re-election. The board should set out in the papers accompanying the resolutions to elect each director the specific reasons why their contribution is, and continues to be, important to the company’s long-term success.
PROVISION 20 - Open advertising and/or an external search consultancy should generally be used for the appointment of the chair and NEDs. If an external search consultancy is engaged it should be identified in the annual report alongside a statement about any other connection it has with the company or individual directors.
What should the induction of a new director consist of?
Providing copies of minutes of previous meetings and copies of any current strategy docs approved by the board;
Visits to key company sites;
Product presentations;
Meetings with senior management and staff;
Meetings with external advisers of the company, such as the auditors or company’s solicitors; and
Meetings with major shareholders (should the shareholders want one). The UK Code states that as part of the induction process, directors should be offered the opportunity to meet with the company’s major shareholders.
What is the difference between induction and training?
INDUCTION - “leading someone in”. Involves providing info and assistance to the director to become familiar with requirements of their role.
TRAINING - ongoing requirement for all directors throughout their time on the board. Ensures directors remain up-to-date and fully informed about matters that are relevant to their role. May involve technical training, such as training in new financial accounting standards or tax rules for members of the audit committee and the finance director, or updating in the risks relating to cybercrime.
