Purpose of The BoardEdit
The board of directors are a fundamental to the functioning of the organisation, so much so that Psaros (2009, 67) believes that not only does the board need to uphold the corporate governance, but the corporate governance tone of an organisation is set by the board. Under the agency theory framework, the board are sandwiched between the shareholders of the firm and management. This creates discomfort, as the shareholders demand performance and profitability with the leverage of withdrawing equity from the firm while the managers implement actions which directly affect a firm’s performance. The board, therefore, need to be impartial to both the shareholders and the management team and serve the company as a whole. Within Australia, this is legislated under section 181(1)(a) of the Corporations Act of 2001 which states:
In addition to this, the board are also placed in a position of pressure between the boundaries of performance and conformance (Tricker, 1994). Despite diagrammatically being polar opposites, performance and conformance are inter-linked, as the adjustment of one will inevitably affect the other. Performance is a boundary set by the shareholders, who reap the rewards of a successful firm. As shown in figure 3, performance can be achieved by the board through strategy formulation, implementation and monitoring, succession planning to ensure the firm can continue performing and, to a lesser extent, risk management and crisis management. On the other side, conformance is a boundary largely pushed by society. Conformance is not a way of preventing a firm from performing, but rather to ensure that the interests of society are not overshadowed by performance. An example of firms precariously balanced between these two sections are the big four banks of Australia. Recently, the reserve bank of Australia raised the official cash rate by 0.25% to prevent inflation from building in the future. As a result, the banks, as decided by their boards of directors, raised their interest rates between 0.25% and 0.49%, which exceeded the official cash rate rise. The banks had a vested interest in ensuring their companies continue the level of performance which saw them report multi-billion dollar profits for the 2010/11 financial year, however they failed to realise the implications of conformance with ethics. The public outcry brought in the federal government who are looking to take action to prevent this from occurring in the future. Therefore, while the bank may be performing well for the next financial year, their level of conformance is questionable and therefore this may affect their trading with the public.
The result of the firm being sandwiched by shareholders, management and society is that strategy becomes the key role and purpose of the board. The board must formulate, oversee implementation and monitor corporate strategies that meet the demands of shareholders, management and society, as it is strategy which affects a firm’s performance and conformance. However it is not so simple that a board can devise a single strategy and monitor it over the next decade. The external environment of the corporate world is constantly changing, and flexibility is required to meet the changing resourcing demands, competencies and shareholder expectations. The board therefore are also required to monitor the external environment and devise how they can capitalise on the current environment and formulate a plan to suit. Board meetings are then designed to report on the monitoring of strategy, discuss the effectiveness of current strategies and to propose and formulate adjustments or new strategies. Therefore directors have a key role in being aware of, and accountable for, the strategies implemented.
Babcock and Brown was a company of two halves, one of which had a growth strategy and the other had a requirement to provide financial resources. On one side was Babcock and Brown Ltd (B&B), the firm that investors placed their money into and were benefited by a rising share price and dividend payment. On the other side was Babcock and Brown International Pty Ltd (BBI), which B&B lent money to, so BBI could leverage to access debt to use for the purchase of additional assets to build the value of BBI and, in turn B&B. B&B was therefore a shell company that raised funds from the public market to fund BBI, a private company. The issue arose as the board of directors for B&B was the same as the board of directors for BBI and, as the debt pile of BBI grew, the board of directors for B&B were not interested in mitigating the risk of the shareholders, they were interested in retaining the assets held by BBI, of which they were the shareholders. The result was that the B&B directors did not exercise their powers or discharge their duties in the best interests of the corporation. When everything collapsed, and BBI were forced to sell off the assets to repay the leveraged debt they had with financial institutions, there was not enough value in the assets to pay the shareholders of B&B.
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How Structure and Size Affect Board PerformanceEdit
The structure and size of a board is dependent on the context in which the firm operates. Structure affects the objectivity of the strategies formulated and decisions made, while size is important for reducing the risk of process loss and formality at meetings.
The board is structured into two groups, each required to ensure full functionality of the board. Firstly, Executive directors are working managers within the firm, and provide the board with the first-hand insights of the company’s performance and problems. Secondly, non-executive directors can be anyone whom the board deem competent for the role and who is voted in. Non-executive directors are split into two groups, grey directors and independent directors. Grey directors may have some disclosed dealings or association with the firm. Independent directors, however, cannot have any association or dealing with the firm and must be completely impartial. Independent directorship on a board is critical, as the objectivity they bring to the board ensures management is effectively supervised.
After the board is structured, the chairperson is selected by the board members. The Chairperson of the board holds a pivotal role in the performance and effectiveness of the board. The chair is responsible for structure and leadership of the board members, board meetings and implementation of decisions. Therefore, the chairperson carries the weight of ensuring shareholders expectations are met through keeping the board’s focus on the company, as well as ensuring the corporate governance is upheld. Within Australia, it is critical to limit CEO duality and have the chairperson separate from the CEO as an independent chairperson will ensure shareholder interests are not lost to an independent management regime and agency costs incurred.
There is no set-size for a board of directors, however the board size must be adequate enough to have a range of skills and knowledge diverse enough for the company’s activities, yet it cannot be so large that the board experiences process loss, which is where the outcome of the group is less than the outcome that could have been achieved by the individuals. To overcome process loss, the board will establish committees to ensure proper due diligence is carried out on the aspects that carry the greatest risk for board members. Typically, these committees can cover remuneration, risk assessment, auditing and succession. Committees will typically meet prior to a board meeting, discuss the required issues, prepare board papers and recommendations and then present them to the board at the next meeting. This enables boards to run more formally, efficiently and ensure all members of the board are engaged.
Poor board structure is attributable to Babcock and Brown, who had a board consisting of 9 people, made up of four executives and 5 independents. Various members of the board had a total value of $35Mil invested in the company, with senior executives not on the board holding a further $100Mil. With these values, the weight of the independents in decision making is questionable. The chairman of the board, and company founder Mr Jim Babcock, and the CEO, Phil Green also had a position on the board. There was a divide in the board as Babcock & Brown were experiencing an informal type of CEO duality, as Jim Babcock was based in California and was noted to miss meetings and have Phil Green sit in his place. Phil Green, with his documented aggressive and dominating personality, created a subcommittee for ‘major decision making’ and ‘dividend distribution’. Within this two-man committee, decisions were made as to how much cash BBI would release for dividend distribution through B&B, of which Phil Green was a major shareholder. These amounts were decided in meeting that took less than 10 minutes and were passed through the board with no objection.
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