02 Functions of the Board

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sharply in recent years and now stands at about four years.

Accountability is an integral component of corporate governance. The board should consider the following issues when

assessing the performance of management:

how to monitor actual performance against plans and budgets;

board analysis of information provided by external and internal auditors; and communication to the management team if corrective action is required, including a system to monitor the effectiveness

of corrective action taken.

The board should also have in place a process to review its performance in view of:

its performance goals;

directors (and managements) compensation arrangements; and

the need for any changes to the board or management team, particularly the processes required to facilitate such changes.

[1220] Succession planning

The boards responsibility for the ongoing prosperity of the company requires it to satisfy itself that there is an appropriatesuccession plan in place to cover the CEO and other critical management positions. It is unlikely that the nonexecutive

directors would want, or be able, to nominate candidates for particular positions, but it is good practice for them to carry out an

annual review of managements plan, to satisfy themselves that the matter has been considered by management and that proper

arrangements are in place.

Whilst strictly speaking the election of directors is a matter for shareholders, in practice the board must take the initiative, and

appointments are ratified at the next annual general meeting. It is therefore essential that the board continually review its own

composition and effectiveness. Many large companies choose to constitute a nomination committee for this purpose. In any case,

it is part of the chairpersons role to ensure the continued review and consideration of a succession plan. Advice from external

sources may be useful both in reviewing the current boards suitability, and in identifying potential candidates for appointment.

[1230] Setting the goals of the companyIt is important that clear goals for the company be set and that the board is satisfied that they are in line with the shareholders

aspirations for the ongoing prosperity of the company, and any requirements of the constitution.

In order to discharge its duty to shareholders, the board must satisfy itself that there is an appropriate strategic plan in place

which is capable of achieving the goals which have been established and which will allow the board to assess the performance of

management.

These issues are considered in detail in the Strategies and Processes, tab commencing at 4000.

[1240] Monitoring performance and compliance

The budget and the nonfinancial performance indicatorsThe budget is the primary measure of the companys performance and it is essential that the board be satisfied that it is in line

with the plan and appropriate to the companys circumstances. In addition to the budget a number of performance indicators,

both financial and nonfinancial, must be selected and agreed upon so that the board and management are able to monitor

progress and take corrective action when necessary. The boards role in establishing these indicators can vary, but an effective

board will take a proactive approach (see 4400 and following for further discussion).

Compliance with the law

A companys reputation is a valuable asset and its loss can be extremely damaging. Boards, therefore, have a responsibility to

see to it that a good reputation is earned and preserved. As a first step an effective board will require that the company obey all

relevant laws and the board should be aware of the requirements of specific legislation and common law that are of importance

to the company. In addition, appropriate policies should be established and monitored. Prudent directors will be familiar with the

Australian Standard on Compliance Programs: AS 38062006 which sets out procedures that companies can use to ensurecompliance with the law. In most companies the board will wish to allocate some time to satisfying itself that the management

understands the parts of the law applicable to the company, that satisfactory provisions have been made to ensure compliance,

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Cop right 2008, CCH Australia Ltd


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and it will monitor compliance to the extent necessary to satisfy itself that the company is obeying the law.

The boards role

It is not only necessary for appropriate goals, plans, budgets, performance indicators, policies and codes to be put in place the

companys performance against them must be monitored. Although most of this work will be done by management, the board is

responsible to shareholders for ensuring that the goals are being achieved, the plans and budgets adhered to, and the policies andcodes implemented. An effective board will therefore agree with management how this is to be done; the methods of reporting

and the frequency with which individual matters are to be considered have to be laid down, and the agreed timetable must be

adhered to.

The companys accounts and finances

Among the boards most fundamental responsibilities are those of protecting the companys assets, ensuring that its debts are

paid as they fall due and reporting the financial situation of the company to the shareholders through the annual, halfyearly, and

sometimes quarterly statements. The Corporations Act 2001 requirement that the directors make, and sign, a declaration that the

financial statements of the company comply with the relevant standards and regulations, and are true and fair, imposes a very

serious obligation, as do the requirements concerning insolvent trading. The courts finding in Commonwealth Bank of Australia

v Freidrich and Ors (1991) 9 ACLC 946 (the National Safety Council case) that its chairperson, Mr Eise, was personally liable

for $97 million, drove home to all directors that their personal responsibility was real. In that case the judge said:

"... the stage has been reached when a director is expected to be capable of understanding his companys affairs to theextent of actually reaching a reasonably informed opinion of its financial capacity. Moreover, he is under a statutory

obligation to express such an opinion annually.

I think it follows that he is required to be capable of keeping abreast of the companys affairs, and sufficiently abreast of

them to act appropriately if there are reasonable grounds to expect that the company will not be able to pay all its debts

in due course and he has reasonable cause to expect it."

Several other judgments have reinforced the need for directors to take adequate steps to satisfy themselves as to the accuracy of

the financial statements and records.

Aspects of financial reporting of which directors need to be aware in discharging their obligations are discussed in detail in Tab

6 "Financial Reporting", commencing at 6000.

[1250] Relations with auditors and shareholders

Relations with the auditors

The shareholders are responsible for appointing the external auditors, although in practice they will look to the board for a

recommendation if any change is necessary. While the auditors opinion on the financial statements does not reduce the

directors responsibility for them, it does provide a very valuable reassurance to the board, as well as to the shareholders, and it

is most important that the board satisfy itself that the scope of the audit is adequate and that the auditors are acting

independently. The issue of auditor independence is one of the main focuses of the amendments introduced by the Corporate

Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 (CLERP 9), and these are discussed further

at 6860.

The spectacular company collapses in recent years should serve to remind directors that merely having an auditor is not enough;they stand as a warning that the board must maintain a working relationship with the external auditors. It is usual for most of this

work to be delegated to the audit committee of the board (see 6500) but it is good practice for the full board to meet the

external auditors annually and to satisfy itself that the "management letter" has been properly dealt with.

Over the last decade companies have made increasing use of internal auditors, which are sometimes inhouse departments and

sometimes services outsourced from accounting firms. The scope of the internal audit function varies greatly according to the

needs of the company. The following are common areas covered by internal audit:

the system of internal controls

various operating procedures

the efficiency with which management functions are carried out, and

the systems by which risks are being mitigated.

An effective internal audit process can provide directors and senior management with considerable reassurance and the board

should pay close attention to the scope of the audit program and the degree of independence with which the internal auditors

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operate.

Relations with shareholders

Directors should never forget that they have been elected by the shareholders to watch over their interests and that they have an

obligation to communicate with them. Of necessity, the board has to delegate most of these functions to the chairperson or the

CEO, but it is important for the board to take a close interest in what is done in its name.The board is likely to be particularly interested in matters concerned with:

the annual and halfyearly reports (and quarterly reports if applicable)

the AGM and any EGMs that may be required

the annual report

any prospectuses or other aspects of capital raising

matters related to takeovers, and

major announcements that may affect the share price.

[1260] Reviewing board performance

Regular formal reviews of the performance of executives are generally recognised as a valuable way of improving their

effectiveness, and over the last decade there has been a growing recognition that similar reviews of boards are equally

worthwhile. The conduct of board reviews is discussed in the Review of Board Performance tab commencing at 8000.

In deciding who is to do what, a useful rule of thumb is:

Management formulates,

The board ratifies,

Management implements,

The board monitors.

Over the last two decades, life in Australias boardrooms has changed dramatically. Directors now feel much more accountable,

both to the shareholders and to the law, and they are taking their responsibilities more seriously. The Korn Ferry surveys showthat, since the early 1980s, the amount of time the average director puts into his/her duties has approximately doubled, rising

from about 13 days to about 26 days per year and the great increase in the number of committees means that time spent on

board duties is more productive. Boardroom discussions now tend to be more focused and the questioning of management more

serious. Perhaps more importantly, many new methods and procedures have been developed, which have increased the

effectiveness of directors, and board structures and composition are being approached more professionally.

Despite the great changes that have occurred the process of change is far from over. The law is still changing rapidly,

shareholder pressures are still increasing and a great deal of thought is being given to ways of improving board effectiveness.

While a broad consensus has been reached on many governance issues, there are others still under debate and yet others which

have hardly been considered at all. It can be expected that there will be a great deal more change in the boardroom in the next 10

years.

The expected pace of change reinforces the need for a board to review its own performance as well as the effectiveness of itsprocesses. In his report into the failure of HIH Insurance (Vol 1, pg 118), Owen J states:

In reviewing its own governance practices, a board should bear in mind that corporate governance is a means to an

end and not an end in itself.

This comment graphically illustrates the interrelationship between the principles of corporate governance and the companys

performance, both financial and nonfinancial. Board review should be aimed at progressing towards the companys goals.

[1270] Risk management

Adventurous strategies may well lead to enhanced company performance but they are also likely to increase the risks associated

with business operations. Since the board is responsible for preserving and enhancing the investment entrusted to it in perpetuity,

it must also be responsible for the companys risk profile, for seeing to it that the risks faced by the company have been

identified and quantified, and that the material risks are being properly managed. An effective board will consider the method

and extent of its own involvement, but at all times the directors should be satisfied that the risks that the company is running are

understood and are being properly managed.

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Principle 7 of the ASX Corporate Governance Principles and Recommendations requires the company to establish a sound

system of risk oversight and management and internal control. Recommendation 7.1 states:

"Companies should establish policies for the oversight and management of material business risks and disclose asummary of those policies."

Recommendation 7.2 goes on to say:

"The board should require management to design and implement the risk management and internal control system to

manage the companys material business risks and report to it on whether those risks are being managed effectively. The

board should disclose that management has reported to it as to the effectiveness of the companys management of its

material business risks."

It is suggested that the appropriate policies should include internal compliance and control systems, and a mechanism for

assessing their effectiveness. As part of its oversight for the risk management and internal control system, the board should

review the effectiveness of the implementation of that system at least annually. The board retains responsibility for assessing the

effectiveness of the companys systems for management of material business risks. In addition, a company is encouraged to

consider having an internal audit function, which should be independent of the external auditor and overseen by the audit

committee. A board committee is an efficient mechanism for focusing the company on appropriate risk oversight, risk

management and internal control. The appropriate committee may be the audit committee, a risk management committee or

another relevant committee. Ultimate responsibility for risk oversight and risk management rests with the full board, whether ornot a separate risk management committee exists. Management should establish and implement a system for identifying,

assessing, monitoring and managing material risk throughout the organisation. Frameworks for risk management include the

AS/NZS4360 (Standards Australia) andRisk Management within the Internal Audit Process (The Institute of Internal Auditors

Australia & Standards Australia, 2002).

Recommendation 7.3 states:

"The board should disclose whether it has received assurance from the chief executive officer (or equivalent) and thechief financial officer (or equivalent) that the declaration provided in accordance with section 295A of the Corporations

Act is founded on a sound system of risk management and internal control and that the system is operating effectively in

all material respects in relation to financial reporting risks."

The integrity of the companys financial reporting depends on the existence of a sound system of risk oversight, management

and internal control. This requirement is designed to encourage management accountability.

Recommendation 7.4 states:

Companies should provide the information indicated in the Guide to reporting on Principle 7.

The Guide to reporting on Principle 7 requires any departure from best practice recommendations 7.1, 7.2, 7.3, or 7.4 to be

included in the corporate governance section of the annual report. A summary of the companys policies on risk oversight and

management of material business risks should be made publicly available, ideally by posting it on the companys website, in a

clearly marked corporate governance section.

[1280] Statement of matters reserved for the board

Once the board has decided what it will do itself and what will be delegated to management, the allocation of responsibilities

should be set out in writing and discussed with management to ensure that both the CEO and the board understand clearly thelimits of managements authority. This includes which matters are to be referred to the board for information, and which matters

the board wants to decide.

It is sometimes argued that everyone knows what a managing directors job is but companies vary so much in size,

complexity and other ways that the function is not always the same. Even in very similar companies, there is room for

differences about the matters in which the board wants to be involved. Perhaps the most simple and obvious is the limit to the

CEOs authority on capital expenditure, but there are many other areas where boards hold different views. Moreover, it should

be open to a board to increase the amount delegated as they gain confidence in a new CEO. There have been serious

misunderstandings in the past that have led to substantial damage to the companies concerned, and sometimes to the hasty

departure of the CEO.

The contents of a statement of matters reserved for the board will vary from company to company. A statement of matters might

include the following:

Appointments

Appointment of the CEO.

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Appointment or removal of the secretary to the board.

Senior management appointments.

Membership and terms of reference of board committees.

Board and senior management

Delegations of authority to the CEO (eg capital expenditure limits).

Ratification of the organisation chart.

Approval of remuneration and incentive policies.

Approval of senior management remuneration.

Management contracts.

Overseas visit approvals.

Approval of succession plans.

Disclosure of conflicts of interest.

Assessment of the organisations and CEOs performance.

Assessment of board performance.

Matters concerning the governance of the organisation.

Relations with the members and stakeholders

Arrangements for the Annual General Meeting, and other members meetings (if any).

Matters relating to reports as required by the Corporations Act 2001.

Suggestions for nomination of directors for election by the members.

Financial matters

Approval of annual financial statements and directors reports.

Approval of accounting policies. Approval of the internal audit plan.

Any question of borrowing or giving security over assets.

Treasury policies including foreign currency and interest rates.

Bank accounts and signatories.

Acceptance of audit reports including management letters.

Business strategy and company performance

Approval of company objectives.

Approval of strategic plan.

Approval of proposals for major expansion or closures.

Approval of budgets.

Approval of priorities and performance indicators.

Capital expenditures

Approval of the capital expenditure budget and alterations to it.

Approval of spending and project priorities.

Approval of individual expenditure items above $...

Lease or purchase of buildings

Major transactions not included in the budget or outside the ordinary course of business

Actions or transactions which might involve questions of legality or propriety

Internal controls and reporting systems

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02 Functions of the Board

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