The Baltic Course  

Corporate governance

by Eugene Eteris

Corporate scandals over the past few years have produced outrage at the greed of top executives and mistrust as the boards of directors (BoD) went along with the company's misdeeds. The questions of BoD's corruption, incompetence or complacency have been asked in criminal investigations and lawsuits. A popular British weekly has dwelled upon the issue. 

BOD: new challenges and solutions for non-executive directors 

Regulators in America and Europe have already placed new burdens on BoDs, but still the favourite remedy for their decent corporate behaviour was to appoint a new BoD staff who would, ideally, be truly independent and watchful.

Alongside BoD's changing rules, there's still a lot of confusion as to how well can they represent shareholders and what is the best way to do that? Should directors aim to help the CEO by offering advice on every-day management or the overall strategy? The new trend to introduce independent directors is good enough; but do they have to monitor company's managers and make sure that they obey the rules, don't pay themselves too much and generally behave? Who are the BoDs in fact: company's colleagues or "internal cops" or, probably, both?

Non-executive or independent directors are becoming more independent than before, but this is no guarantee that they can do a better job. Recent power struggles at Shell and Hollinger International have shown that well organised and determined non-executive directors can be a powerful force to improve corporate governance by "reining in over-mighty CEOs". Is the correct answer that non-executive directors are to be given more work to do while at the same time keeping them more independent? 

In many big companies directors have found it impossible to be both effective guard dogs and loyal members of the team; actually, most decided to choose the latter option. That happened partly because it's much more comfortable to work with a clever person, whom one must be grateful to at the same time for appointment, than all the time asking awkward and embarrassing questions. It is quite clear that most directors have already taken such an approach, but we have to admit, acknowledges The Economist, that it's the wrong one. 

Photo: Universitu of Cologne

Institute of Labour and Economic Right. Meeting of experts on a theme "New corporate governance Regeln in the U.S.A. and Europa" at the University of Cologne.

BoD's role

The primary function of independent board directors in a large firm is to monitor the company's managers and not to give strategic or managerial advice. Directors should not impair their monitoring role. The reason is clear, i.e. most big firms operate in highly competitive markets, and strategically honest but incorrect advice would be quickly punished by rivals. On top of that, CEOs are not short of professional advice from various outside experts and consultants, not to mention own subordinates. What the market competition still cannot regulate or monitor is the internal working process at the firm, fraud and false accounting, to name a few. Only independent directors can perform these essential tasks and company's duties. 

In order to perform such "delicate" functions, it is essential for BoDs to know enough about the company. Of course, if they think that a firm is headed in the wrong direction, they should say so. But they must remember that their primary duty is to speak for shareholders! And it's not an easy task to implement, as often collegiality trumps independence in the BoDs boardrooms. And if independence is at stake, then millions of shareholders are the losers, which we have witnessed already several times both in the US and Europe.

BoD's composition

A non-executive director and that of the independent BoDs, as opposed to regular board members, used to be a lucrative job for distinguished people, e.g. retired CEOs and politicians, prominent public figures and lawyers, with the sole idea of boosting earnings. The proceedings have changed with Enron in the US and probably with Parmalat in Europe. The latter's company board was bulging with members of the Tanzi family and bigwigs from Parma, which helped them "to round the law" that strictly demanded the listed Italian companies to have independent directors on the board.

According to recent Fortune surveys, 60% of BoD's said they spent more time on board matters in 2003, 85% spent more time on their company's accounts, 83% more on governance practice and 51% on monitoring financial performance. Good beginning makes a good end!

Source: Special report: Non-executive directors. – The Economist, March 20th, 2004, pp.75-77.