Role of the Board
As we have stressed many times, the primary legal responsibility of the board of directors is to ensure that the company on whose board they sit achieves its agreed goal. That is what success for the company means, and that therefore defines successful performance by the board. In owner-managed companies, where the owners are the directors, success in running a company is achieving the agreed goal of the owners, and the success of the company and the performance of the board are one and the same thing.
With larger organisations, however, where ownership is largely or totally divorced from executive management, the role of the board has evolved into a stewardship function. Its role can be summed up as being to:
- determine the appropriate goal for the company
- employ the executive management to deliver that goal
- monitor progress, and
- amend the goal if appropriate or change the executives if they are not delivering.
The over-riding role of the board is to ensure that the executive management delivers the agreed goal, and that is how board performance should be judged.
Attempts to judge performance
In the last thirty years, there have been three globally significant attempts to achieve better clarity in the assessment of the performance of boards of directors of listed companies, together with suggested structuring and systems, essentially to head off potential future problems.
The first initiative was in the UK, following growing mistrust between City investing institutions and big business in the late 1980s. Causes included the Guinness covert share buying in the takeover of Distillers, and the Polly Peck scandal where the founder privately transferred funds abroad. The last straw was probably the collapse of BCCI (Bank of Credit and Commerce International), which was structured with extraordinary complexity to outwit regulation and enable money-laundering and fraud, and Maxwell Communications, which imploded after the death of its founder, Robert Maxwell exposed his raiding of employee pension funds.
The result was the Cadbury Report and the first Corporate Governance Code, which relied on a “comply or explain” approach in an attempt to improve boardroom standards and provide greater accountability to shareholders.
Sadly, though it was felt that standards had indeed improved thereafter, it started a proliferation of extensions to the corporate governance portfolio of regulation, and reams of additional text in annual reports, but it didn’t prevent further embarrassing corporate failures.
The second major development was in the United States, following three huge failures around the turn of this century: Enron, WorldCom and Tyco International.
This led to the Sarbanes Oxley Act of 2002, which mandated detailed practices for big corporates in an attempt to prevent the kind of deceit which brought down these three companies.
Again, the result was an increase in bureaucracy with a view to increasing protection for investors, but sadly it failed to prevent the next disaster, the Crash of 2008, which had its roots in sub-prime lending and where the scale of the risks was hidden by the use of derivatives which the regulations weren’t adequately structured to pick up.
The crisis brought the biggest savings and loan institution collapse in US history, Washington Mutual, and the disappearance of investment bank Bear Stearns and financial services giant Lehman Bros.
This, in turn led to the Dodd-Frank legislation of 2010, again, to provide improved consumer protection, but similarly leading to more bureaucracy, and failing to prevent later scandals such as unethical and illegal practices at Wells Fargo Bank and catastrophically bad risk management at Silicon Valley Bank.
Role of the Auditor
Traditionally, an audit was commissioned by the shareholders to check on the stewardship of the directors. Now, however, all the major stakeholders would look to the auditor’s report to assure them that the company with which they were involved was being soundly run. This in itself, raises issues, as the requirements of the different stakeholding groups varies significantly in terms of the information they need.
Traditionally, the purpose of the audit was to express an opinion on the published accounts, accepting the fact that it might take up to six months to produce those accounts. Some companies would manage to produce a “flash” set of results within a month of the year end, but these were rare. Nowadays, financial results six months old would be regarded as of limited value for most users. Hence, public companies will inform the market of their financial position by issuing profit forecasts and banks will demand unaudited management accounts during the year to inform them of their customer’s solvency.
However, it is arguable that shareholders and potential investors, in particular, are much more interested in the continuing viability of the company’s business model, whether the company is being soundly run and whether it is exercising its responsibility for accountability in an open and transparent way, rather than out-of-date financial reports. Moreover, there needs to be some assurance of its ethical trustworthiness.
Recent failures of companies audited by the big Four accounting firms, contributed to by inadequate investigation, have shown up the limits of today’s audit. The general rule appears to be to take a “safe harbour” approach to auditing, in which the defence will be that the audited company complied with all the required regulations and codes. It brings to mind the remarks of the judge in the 1896 Kingston Cotton Mills case, that “the auditor is a watchdog, not a bloodhound”. It is now generally accepted that this is not good enough in this day and age.
The auditor should be checking whether the Board is doing its job of supervising executive management to ensure that the business is achieving its agreed goal in a culturally acceptable manner.
Role of the NED
One of the important elements addressed by Cadbury was the role of the non-executive director.
At the time of his Report, some City figures boasted literally dozens of directorships, and Cadbury focused attention on the genuine and valuable contribution that appropriately qualified individuals can bring to this role. One of the most important is independent judgement, and as one fund manager once said to this writer, an NED is there “to ensure that the Board is on the straight and narrow”.
However, the information available to the NED is largely restricted to that provided by the executive management, and any further insights are dependent on the individual’s own network of contacts in the industry. The limitations of this were illustrated when the long-established and respected savings institution, Equitable Life, collapsed at the turn of the century, leaving non-execs facing lawsuits, and more recently with the liquidation of construction giant, Carillion, in 2018.
Systematised approach long overdue
So, with the increasing vulnerability of boards of directors and of auditors resulting from the restrictions of current information systems, the time is long overdue for a wider approach coupled with genuine independence of reporting. Bob Worcester, the founder of market research company, Mori, in discussions with this writer about getting useful information to the board, said that he felt market research was where accounting was back in the late 1800s, and that it was due for greater incorporation in management decision-making. That conversation was twenty years ago, and it’s high time for advancement.
To tackle the board’s vulnerability to being caught out by matters outside the conventional internal reporting systems, the directors need a system which is:
- holistic and co-ordinated in the matters it covers, not limited to trading and accounting, and taking account of all the key stakeholders
- forward-looking to pick up trends early
- independent of internal management in collection and interpretation
- current and on-going
- structured to link to business objectives and current management structures
The key reporting elements of what we can call a Board Critical Information and Forecasting System will comprise:
- Board operating performance
- monitoring directors’ compliance with their legal duties
- assessing the board’s management and the internal performance of directors
- Company performance
- culture, including environmental impact, social behaviour and practice, and ethics
- business model, including reviewing the continued appropriateness of the agreed goal and strategy feasibility, the organisation structure and adequacy of resources, the effective of the systems of control and risk management, and accountability and transparency
- compliance, covering statutory and legal rules and the company’s constitution, the corporate governance codes, and industry regulation
- Stakeholder views
To make this an easy and economical system to introduce and to operate, it can be introduced as a permanent set of focus groups, covering each of the main stakeholder groups, with a limited number of representative members selected for each group.
The system will operate as an integrated, permanently on-line system, reporting directly to the office of the chairman, and its independence can be assisted by incorporating supervision by the external auditors, from the time of introduction.
Benefits for the Board
The key attributes of the system are:
- it provides a new and continuous forecasting system, highlighting risks and opportunities to help the Board fulfil its over-riding duty to safeguard the future of the business
- it is focused on delivering on-going performance improvement, thereby providing a valuable holistic new tool to assist the Broad in its role of getting the best out of the management.
In the process, by providing an open and on-going relationship with key stakeholders and recognition of wider stakeholder interests, it helps ensure that the key stakeholders achieve their goals, thereby contributing to the successful achievement of the company’s goals.
Benefits for Auditors and NEDs
For auditors and non-executive directors, the extra insight contributed by all the key stakeholders who have an interest in the business, through a trustworthy and reliable reporting system, provides a new degree of accountability and transparency that enables both groups to better perform the jobs they were appointed to do.