p1 Acca Lesson4

© accountingclassroom.com 2008 Student Notes for ACCA P1-Professional Accountant

The Board of Directors

Topic 4


Session Objectives

� Explain and evaluate the roles and responsibilities of boards of directors

� Describe, distinguish between and evaluate the cases for and against, unitary and two-tier board structures

� Describe the characteristics, board composition and types of, directors (including defining executive and non-executive directors (NED)


Session Objectives

� Describe and assess the purposes, roles and responsibilities of NEDs

� Describe and analyse the general principles of legal and regulatory frameworks within which directors operate on corporate boards


Session Objectives

� Define, explore and compare the roles of the chief executive officer and company chairman

� Describe and assess the importance and execution of, induction and continuing professional development of directors on boards of directors


Session Objectives

� Explain and analyse the frameworks for assessing the performance of boards and individual directors (including NEDs) on boards


What is Board of Directors

(BOD)?

� Board of Directors is a group of people legally charged with responsibility and authority to govern an entity.

� Directors, individually and collectively, have a duty for corporate governance


Board of Directors of Non-

Profit Organisations

� BOD of non-profit organisations report to stakeholders, that is, local communities.

� Generally they are part-time body (volunteers).

� They:

� Meet occasionally

� May not know each other well

� May not receive adequate training


“Director” versus “Trustee”

� Historically nonprofits set up as “trusts”were controlled by “trustees”. Each could have specific responsibilities and duties

� Corporate term for trustees is “director”. All have same broad responsibilities and duties


Key Roles of Directors ( Based

on Combined Code)

� Provide entrepreneurial leadership

� Represent company view and account to the public

� Decide on a formal schedule of matters of board decisions

� Determine the company’s mission and strategic aims

� Select and appoint CEO, chairman and other BOD



on Combined Code)

� Set the company’s values and standards

� Ensure company’s management is performing the job correctly

� Establish appropriate internal controls that enable risk to be assessed and managed

� Ensure necessary financial and human resources are in place



on Combined Code)

� Ensure that obligations to shareholders / stakeholders are met

� Meet regularly to discharge duties effectively

� Assess and report own performance annually to shareholders

� Submit themselves for re-election at regular intervals ( max 3 years)


Additional Key Roles for Listed

Companies

� Appoint appropriate NEDs

� Establish remuneration committee

� Establish nomination committee

� Establish audit committee


Duties of a Board Member

� Duty of obedience:

� Duty of care

� Duty of loyalty


Duty of Obedience

� Must be faithful to mission

� Be knowledgeable about the “business”

� Exhibit proper stewardship and governance of legal and fiscal responsibilities


Duty of Care

� Most important duty owed by director

� Perform level of care an ordinarily prudent person would in similar circumstances

� Stay abreast of financial health

� Understand programmatic accomplishments

� Generally monitor operations


Duty of Loyalty

� Standard of faithfulness to nonprofit

� Personal or constituent interests put aside

� Decisions made in best interest of nonprofit


Potential Problems Faced by

BOD

� Boards largely rely on management to report information to them thus allowing management to obscure problems and true state of the company

� BOD meeting only occasionally may be unfamiliar with each other making it difficult for board members to question management


Potential Problems Faced by

BOD

� CEOs often have forceful personalities, sometimes exercising too much influence over the rest of the board

� The current CEOs performance is judged by the same directors who appointed him / her making it difficult for an unbiased evaluation


Role of Board

� Strategic Management

� Control

� Shareholder and market relations


Strategic Management

� BOD is responsible for setting the context for the development of strategy of the company

� Strategic development also consist of assessing the opportunities and threats facing the business.

� This involves screening of strategic proposals and implementing appropriate strategies


Control

� Responsible for monitoring and control of the activities of the company

� Responsible for the financial records of the company and that the financial statements drawn up are based on appropriate accounting policies and ensure financial information is accurate

� Responsible for the direction of the company and ensuring that managers and employees work towards strategic objectives that have been set.


Shareholder and Market

Relations

� Responsible for raising the profile of the company and promoting the company’s interests in its own and possibly other market places

� Responsible for managing its relationships with its shareholders

� Responsible for maintaining relationships and dialogue with the shareholders, in particular the institutional shareholders.


Board Structure


Unitary Boards: Issues

� NED expertise: Required not just for supervising but for running the company

� NED empowerment: As responsible as executives. Actively involved from an early stage

� Compromise: Less extreme decisions developed prior to need for supervisory approval


Unitary Boards: Issues

� Responsibility: A single decision making unit with wide viewpoints suggests better decisions

� Reduction of fraud, malpractice: Wider involvement in actual management of company

� Improved investor confidence


Two-tier Boards

� Two-tier boards are primarily associated with France and Germany.

� They exist primarily due to:� Codetermination: The right to be informed

and involved in decisions that affect them

� Closer Relationships: Banks have closer relationship by becoming shareholders


Advantages of Two-tier Boards

� Clear separation between those that manage the company and those that own it or must control it for the benefit of shareholders

� Implicit shareholder involvement in most cases

� Wider stakeholder involvement implicit through use of workers representation


Advantages of Two-tier Boards

� Independence of thought, discussion and decision since board meetings and operations are separate

� Direct power of management through the right to appoint members of the management board


Two-Tier Boards: Problems

� Dilution of power through stakeholder involvement

� Isolation of supervisory board through non-participation in management meetings

� Agency problems between the two boards

� Added bureaucracy and slower decision making


Composition of the Board

� The Board is a link between owners and controllers of company.

� It monitors management on behalf of shareholders.

� It includes:� Chairman

� CEO

� Directors

� At least 50% of the board should be constituted by NEDs.


Board Meetings

� Agenda should strike a balance between long- and short-term issues

� Every director should have an opportunity to place items on the agenda

� All topics should have supportive information, risks and alternatives identified.

� Meetings should be regular and attendance expected

� Chairman should direct proceedings allowing ample time for discussions


Roles of NEDs


Independence of NEDs

� Should not be an employee in last 5 years

� Should not have had material business relationship with company in last 3 years

� Should not have received other remuneration from the company besides directors fee

� Does not have any family ties with the firm


Independence of NEDs

� Should not hold cross-directorships in other companies

� Should not be a significant shareholder

� Does not serve on board for more than 9 years


Why Should NEDs be

Independent� Provide an objective view of board

decisions

� Provide expertise and communicate effectively

� Provide shareholders with an independent voice on the board

� Provide confidence in corporate governance

� Reduce accusations of self-interest in behaviour of executives


Advantages of NEDs

� Monitoring

� Expertise

� Perception

� Communication

� Discipline


Disadvantages of NEDs

� Unity

� Quality

� Liability


Separate Roles of Chairman

and CEO

� Chairman runs the board and CEO runs the company.

� Board not dominated by a single powerful individual

� Clear division of responsibilities


Separate Roles of Chairman

and CEO

� Only small companies can have the same person as the CEO and Chairman

� Board appoints the chairman who may be full-time or part-time. The chairman is usually a NED

� Appointment of chairman counterbalances the CEO


Chairman’s Responsibilities

� Ensure that board sets and implements the company’s direction and strategy effectively

� Act as company’s lead representative, explaining aims and policies to outside world


CEOs Responsibilities

� Take responsibility for the performance of the company as determined by board’s strategy

� Report to the chairman and / or BOD


Need for Splitting the Role

� No one should have unfettered power of decision

� Chairman should be independent in the same way as NEDs


Reasons for Splitting the Role

� Representation

� Accountability

� Temptation

� Unity

� Ability

� Human Nature


Directors Induction

� Primarily aimed at NEDs, however should be the same for new EDs

� For an internally promoted director it would depend on the person’s background

� Break the ice with the board


Induction Process

� Each company should have own process

� Guidelines:� Comprehensive

� Customised

� Contain select written information + presentations and site visits

� Give a balanced and real overview

� Not information overload

� List of all induction material

�


Induction Process

� Give an understanding of the nature of the company, its business and the markets

� Link with the company’s people

� An understanding of the company’s main relationships


Objectives of Induction

� Communicate vision and culture

� Communicate practical procedural duties

� Reduce the time for the individual to become productive

� Welcome on the board

� Ensure retention of individuals


Induction Package

� Director’s Duties

� Company Strategies

� Board Operations


Director’s Duties

� Brief outline of the role of a director and a summary of his/her responsibilities and ongoing obligations under the Corporations Act.

� The company's policies on:� Matters reserved for the board

� Matters reserved for CEO/Senior management

� Other relevant policies and procedures of which the director should be aware

� Internal mandatory induction procedure.

� Disclosure of directors notifiable interests agreement (for signing)


Company Strategies

� Current strategic/business plan and budgets for the year with revised forecast, and three/five year plan.

� Latest annual report and half year report as appropriate.

� List of major domestic and overseas subsidiaries, associated companies and joint ventures.


Company Strategies

� Details of any major litigation, either current or potential, being undertaken by the company or against the company.

� The corporate profile

� Company Brochures, mission statement

� Treasury issues such as financing and dividend policy


Board Operations and Issues

� Up to date copy of the company's Constitution.

� Minutes of the last 4 to 6 board meetings.

� Schedule of dates of future board meetings and board subcommittees if appropriate.



� Description of board procedures covering details such as:� when papers are sent out

� the normal location of meetings

� how long they last

� an indication of the routine business transacted

� Brief biographical and contact details of all directors of the company, the company secretary and other key executives.



� Details of board subcommittees and committee charters

� Where the director will be joining a committee, copies of the minutes of meetings of that committee during the previous 12 months.


Directors CPD

� Purposeful, systematic activity by individuals and their organisations to maintain and develop the knowledge, skills and attributes which are needed for effective professional practice.


CPD Requirements

� Companies need to provide resources for skilling and reskilling directors including NEDs

� Chairman addresses these needs for the Board as a whole

� Chairman also leads in identifying development needs of individual directors

� Company secretary facilitates the process

� NEDs need to take time out for CPDs


Why CPDs

� Ensure directors have sufficient skills to be effective

� Bring to notice the challenges and changes in business environment

� Improve board effectiveness

� Support directors in personal development


Duties of Directors

� General Duties

� Duty of Skill and Care

� Fiduciary Duties

� Statutory Duties


General Duties

� “A director of a company must: (a) act in accordance with the company’s constitution; and

(b) only exercise powers for the purposes of which they are conferred.”

� “A director must exercise independent judgement. This duty is not infringed by his acting: (a) in accordance with an agreement duly entered into by the company that restricts the future exercise of discretion by directors; or

(b) in a way authorised by the company’s constitution.”


Duty of Skill and Care

� “A director of a company must exercise reasonable care, skill and diligence. This means the care, skill and diligence that would be exercised by a reasonably diligent person with:

(a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company; and

(b) the general knowledge, skill and experience that the director has.”


Power of Directors

� Limited by:

� Articles of association

� Shareholder resolution

� Provision of law

� Board decisions


Liabilities of Directors

� Liability of directors is unlimited

� The directors will be liable to sanction for a civil penalty or a criminal offence.


Penalties

� If a director is in breach:� Any contract made by the director will be

void

� They may be personally liable for damages in compensation for negligence

� May be forced to restore company property at their own expense


Appointment of Directors

� All directors are appointed through nomination committee and should be subject to election by shareholders at the first AGM

� Re-election at intervals of no more than 3 years


Terms and Removal

� NEDs should be appointed for specific terms subject to re-election and company act provisions

� Any time over 6 years rigorous review and over 9 years annual re-election required


Director’s Service Contract

� Legal document includes:

� Key dates

� Duties

� Remuneration details

� Termination provisions

� Constraints

� Other ordinary employment terms

� Notice or contract periods should be set at one year or less


Removal of Directors

� May be vacated by:� Statute

� Death

� Personal bankruptcy

� Under a provision in either the articles of association or through shareholder resolution

� Resignation from office

� Absence from more than 6 months


Disqualification of Directors:

Causes

� Allowing the company to trade while insolvent

� Not keeping proper accounting records

� Failing to prepare and file accounts

� Being guilty of 3 or more defaults in complying with companies legislation

� Failing to file tax returns and pay tax

� Taking actions that are deemed to be unfit in the management of a company


Disqualification of Directors:

Period

� Period of disqualification for a period between two and 15 years

� While disqualified, a director cannot:� Be a director of any company

� Act like a director, even if there is no formal appointment

� Influence the running of a company through the directors

� Be involved in the formation of a new company


Key Areas of Conflict between

Directors and Company

� Directors contracting with their own company

� Substantial property transactions

� Contracts with listed companies

� Loans to directors


Disclosure

……of all information concerning transactions involving directors in the notes in annual accounts


Insider Dealing / Trading

� Illegal purchase or sale of shares by someone, usually a director, who possesses inside information about a company’s performance and prospects which, if publicly available, might affect the share price

� Inside information is not available to the market or general public

� Such transactions are fraudulent

� Reason: When a director accepts employment, he makes a contract with the company to put the company’s interest before his own


Performance Evaluation of

Directors

� Board should undertake a formal and rigorous evaluation of its own performance, committees and individual directors

� Important provision of the code: � The board of directors should state in the

annual report how they undertake the process of evaluating the board's committees and individuals' performance


Evaluating the Performance of

Board

� Who will do the evaluation

� Who is being evaluated

� What is to be covered

� How is it to be done

� What is done with the information collected


Guidance on Performance

Evaluation

� Should be done at least once a year

� Individual evaluation of directors should consider their individual contributions and time commitment to the role.

� The chairman should consider the strengths and weaknesses of the board using the results of the evaluations.

� And non-executive directors should be responsible for the evaluating the chairman of the board.


Other Measures

� Are results/performance comparable with competitors?

� Are board decisions regularly reviewed to measure the impact of decisions taken?

� Do all directors contribute effectively?

� Is there effective leadership from the chair?


Evaluation of Non-executive

Directors: Basis

� Preparation and attendance at board meetings

� Time spent understanding the company’s business outside of the boardroom

� Quality and value of boardroom contributions

� Contributions to risk assessment and strategic development


Evaluation of Non-executive

Directors: Basis

� Readiness to challenge and probe any assumptions

� Are areas of concern followed up

� Behaviour and performance gain board respect

� Current awareness and keeping up to date and the expressing of views and listening to others.


Reporting Performance

� The board cannot only measure performance - it must report on it. This is usually done in the annual report and statement of accounts.

� Public and private companies submit their reports as returns to Companies House.

� There is no one format or style, with content and length varying enormously.

p1 Acca Lesson4

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