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The Board of Directors on the Agenda - ® January/February
2010 Year I – No.
1 Editor: Luciano Carvalho Ventura A new cycle This is the
first of a new cycle of the newsletter series begun in mid-1999, and
concluded with the book, “Corporate Governance – Six Years of News” launched
in November 2005, in São Paulo at the Sixth Brazilian Corporate Governance
Congress. This cycle was aimed at
filling the gap in news and general information on Corporate Governance at
the time, by issuing bi-monthly email news in Portuguese and English for
anyone interested in this topic. With
the launch of the book which contains all forty newsletters published over
six years, condensed into 36 editions in the first half and with the
presentation of thirty publications and articles written by us and other
selected authors in the second half, we believe we attained our initial goal. Now, we begin this new cycle with articles
focusing exclusively on the Board of Directors, which, as we all know, is the
core of Corporate Governance. As in the case of past newsletters, this
new cycle will consist of bimonthly editions in Portuguese and English, sent
free of charge via email to all names on our email address list and to anyone
else expressing interest in the new format. They will also be permanently
available on our website (www.lcvgovernanca.com.br).
“Why are
some Boards of Directors better than others?” It is
obvious to anyone who is part of, studies, or observes the Corporate
Governance environment, that some boards of directors perform better than
others, hence the question: Why? In our
opinion, this happens for a number of reasons that we shall discuss
below. The order in which these are
given does not ascribe to them any greater or lesser importance in respect of
an effective board of directors. These reasons can be grouped into the
following three main categories: (i) the method whereby the board was
originally structured or improvements were introduced, (ii) the
qualifications and actions of its members, and (iii) the type of duties
performed by the board of directors. 1 – Structure
of the board of directors. On being
formed or, upon being periodically evaluated, the board must consider the
aspects vital to its effectiveness, which are: a) Joint
development. The basic
structure must be defined with the active involvement of the shareholders or
a group of major shareholders. This is
because it is through the board of directors that they have a say in the
company. Also this involvement in the
board formation generates a commitment to the proposed structure and to the
efficient performance of such shareholders. b) Specific
areas to be addressed. Although
most boards of directors have much in common, the structure or enhancement of
any board must take the following aspects into consideration: *
Company size and type (present and future). Just
as an example, a board of directors that works well for a bank is not likely
to work so well in a capital-intensive industry. Also, if for obvious reasons, the size of
the company is an important factor in forming the board structure, the
company’s projected future size must also be considered in creating the
board. *
Background and interests of the company’s chief shareholders. As
a rule, a board of directors composed of major shareholders and individuals
with in-depth knowledge of the company and its business, and who are genuinely
interested in their role of board member, meets requirements for a good
working structure, unlike the boards of other companies where control is
split between institutional investors or even companies with widely
distributed control, and this must be taken into consideration. *
Political aspects. As
is the case with any group of people, companies live with politics at all
their levels, including the shareholders’. Political aspects between
shareholders must be dealt with at board of director level and not at
executive board level, thereby protecting company business from their
effects. *
Executive Management As a rule, a well-run board of directors was structured
or improved based on both its specific role of regulating agent vis-à-vis the
executive management’s role of regulated agent, and, even more importantly,
on its work based on the degree of qualification and professional experience
of its executives. In other words, a
company comprised of young executives needs a very efficient board of directors
that can guide and supervise these executives more closely than required for
an executive management of more experienced professionals. Moreover, without losing board
independence, harmony between the Chairman of the Board and the CEO,
substantially contributes to good company management at its highest level. *
Control system An
effective board of directors usually has a good system in place for
controlling the company’s assets and operations. Boards that lack reliable control systems
cannot function well, since the implementation or improvement of such a
system is a priority, taking up too much board time and distracting its
attention from its members’ essential duties. *Information
system. In
order for the board of directors to work efficiently, the company must have a
reliable system whereby information is rapidly available and at a
sufficiently high level to enable it to dispense guidance and, above all,
take decisions. If this does not
occur, not only is the board unable to function efficiently, due to the
absence of reliable control systems, too much of its time is taken up in
implementing or improving such system. As a result, board members tend to
devote less time to their official tasks.
c) Structure
of duties. In addition
to joint development and specific formulation policies, more effective boards
of directors also have a structure in place with the following features: *
Objectives and Duties. An effective board is fully aware that its
chief objectives are: to increase company worth over the long-term and to
safeguard all its shareholders’ interests and not just the interests of some,
with due regard for the interests of other company stakeholders. The duties
to be carried out by a board of directors are discussed below in a specific
section. *Composition.
Practice has shown that the most effective boards are
those whose members are selected based on a specific formulation concept,
described above, numbering ideally at around a minimum of five (5) and a
maximum of nine (9) members. Insofar
as possible, a board should seek members from diverse areas but who
complement one another. Ideally, there
should also be a good balance between outside members, independent members,
and in-house members, the latter, whenever possible, being limited to the
CEO, to create the ideal action environment. *Compensation
and Evaluation. In
the past, certain board member fees irrefutably confirmed that “symbolic fees
only produce symbolic contributions”. In other words, the basis for an
effective board of directors is a fair compensation system in line with
market rates, as well as a periodic system of individual and collective
evaluations of each member’s performance, dedication, his/her contribution to
company results, and to the work of the board itself. *
Technical Committees. The
role of Technical Committees is to support and expedite the work of the board
of directors. Effective boards create
these specialized groups based on their needs and the company’s respective
business sector. The nature, technical
competence, and actions of these committees are determining factors in the
quality of a board’s performance. *Meetings Board
of Director meetings are an essential condition to their effectiveness,
particularly since the foundation of this management body is basically
collegiate. Consequently, the quality
of the meetings helps some boards to function more efficiently than
others. Quality in this context is a
frequency of meetings of once a month or, at least, once every two months,
scheduled annually in advance. These meetings must have a fixed agenda of
relevant topics that come under the board’s jurisdiction, based on the nature
of the company, appropriate support material that is available to the board
members sufficiently in advance of each meeting to enable them to prepare
themselves, records of the topic announced, discussed, and approved in
clearly written minutes, which serve as the board’s collective memory. And, lastly, a meeting well conducted by
the Chairman, in terms both of the time taken and of the search for general
consensus. 2 – Board
members’ qualifications and actions. Board
members’ individual and collective qualifications, aligned with their
methods, represent the second block of reasons responsible for the better
performance of some boards. In
individual terms, a board member must have as many as possible of the
following qualifications: a good academic background, practical experience in
his/her specialized area, an overall business administration vision, a
strategic business approach, the ability to read management reports and
financial statements, some international experience, personal experience in
collegiate bodies, a wide range of good contacts in the business community,
and, lastly, political and negotiating skills. In terms of collective qualifications,
pursuant to the Third Edition of Best Corporate Governance Practices of March
2004, issued by the IBGC (Brazilian Institute of Corporate
Governance), we believe that a board of directors is more likely to perform
better, when it is comprised of a wide diversity of experience, knowledge,
and backgrounds, such as, CEO experience, crisis administration experience,
risk identification and control experience, a finance background, accounting
background, familiarity with the company’s business, domestic and
international market background, among others. As a rule, effective boards of
directors consist of motivated professionals with the time available to
prepare themselves, for attending meetings, and for dealing with their
technical committee requirements. 3 – Board
of Director duties. Effective boards of directors dedicate a
significant portion of their time and attention to formulating and monitoring
company strategy, since they are well aware that long-term successful
companies are not those that are merely operationally successful, but chiefly
those that have correctly drawn up their strategies and have carefully
supervised their implementation. The
formulation and supervision of strategies is a board of director role, and
one that requires the cooperation of the executive board, but should not be
left to this executive management, a common error of less effective
boards. Insofar as strategies can also
be regarded as the skill to take advantage of opportunities and minimize
their inherent risks, it is true that only efficient boards pay sufficient
attention to the risk factor, when they draw up their strategies. In other
words, they seek to take advantage of the opportunities that arise while
simultaneously concerning themselves with minimizing the inherent risks.
Further to this strategy duty, unlike boards that function less efficiently,
they also spend considerable time analyzing and discussing the performance of
the competition and their potential future actions, that could impact business.
In respect of the second and extremely important duty of any board of
directors, the selection, development, motivation, evaluation, and
compensation of company executives, the more successful boards of directors
frequently, openly and transparently discuss these aspects in relation to
their chief executives, since they are aware of their lack of powers of
execution in the companies and that they only “act” in their companies via
their executives, when they provide general business guidance. The manner in which they perform the third
core duty of any board of directors, the relationship with the independent
auditors, also ensures their more efficient performance. These independent
auditors who are regarded as faithful and key allies aiding the board of
directors in its duty of monitoring the executive management either have
direct contact, or a more indirect relationship through the company’s Audit
Board, with the board. They attend
meetings in which they explain and render an accounting of their work, unlike
boards that delegate this task to the executive management – a potential
conflict of interest. Lastly, and in relation to the fourth and last of a
board’s key duties, the supervision of company operations, some less
effective boards of directors exceed reasonable limits here. In other words,
they spend too much of their time in such supervision, thus relegating the
other three duties to a secondary level, when, in fact, it is the duty of the
executive management to run a company’s operations, and the board works
better when it limits its actions to supervision from a reasonable distance,
except in circumstances where the company is in crisis to a degree that its
very survival is at risk. Thus, an
inefficient board of directors dedicates the greater part of its meetings to
monitoring the financial aspect of company business, and neglects the more
important areas described above, such as strategy, the risk represented by
competition, performance, executive compensation, etc. The solution here is
to form a financial committee involving some board members experienced in
this area. In conjunction with the
executive management, this committee then calls a technical meeting to
examine the operation in detail prior to the respective board meeting, where
one of the committee members gives a summarized report on company business to
the other members of the board, answers questions and gives the explanations
required. 4 – Conclusion. Relatively few boards of directors fully meet the above requirements and conditions, are correctly structured, comprised of qualified and pro-active members and effectively perform their duties. This does not, of course, mean that only boards meeting these prerequisites work well. Boards work well when they meet a majority of the many requirements described above. What matters most is familiarity with the variables of quality and to have a board undergoing continuous improvement, and never to forget the importance of good Corporate Governance in the company which has always been and still is a direct consequence of the shareholder management – the board of directors – the core of good Corporate Governance.
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