GOVERNANCE STRUCTURES
Governance Structures: The systems which an organization is directed and controlled.
*Explain the theories that define the governance structures of the board (Common question in exams)
3.1 THEORIES THAT DEFINE THE GOVERNANCE STRUCTURES OF THE BOARD
Agency Theory
❖ Agency Theory brings two perspectives of the board, that is, ownership and control. It states that the shareholders (owners) delegate their authority to the managers (controllers) to control all the activities in the organization.
❖ The Agency Theory states that the managers are characterized self-interest, such that
they serve their own interest and make their own profits at the expense of the company. This is as a result of various circumstances such as;
a) Low wages
b) Lack of proper internal control systems leaving the managers with a lot of freedom
c) Managers are not assured of their job security
Stewardhip Theory
❖ For Stewardship Theory, the goals of board of directors and their managers are aligned with the managers being increasingly motivated to act in the best interest of the organization and to focus on intangible rewards such as personal growth.
Resource Dependency Theory
❖ This theory states that there is need for environmental linkages between the firm and outside resources and therefore directors serve to connect the firm with external factors co-opting the resources needed to survive.
❖ Therefore, it is the duty of the directors to ensure that all the essential resources needed in
the organization are brought to the organization.
Advantages of Resource Dependency Theory
1. The environmental linkages could reduce transaction costs associated with environmental interdependency.
2. Firms are able to extract useful resources and thus enhancing their legitimacy in the society.
3. There is improvement in the performance of the organization due to amalgamation of resources.
4. Through the resource dependence role, directors bring resources such as specialized skill and expertise.
5. The organizations need to acquire resources leads to the development of exchange relationships between organizations.
*How the RDT could promote good governance is the same as Advantages of RDT in exam
Stakeholder Theory
❖ Board members work to understand and represent the different interests of individuals and groups who have a stake in the organization.
❖ A stakeholder is any person who is affected the decisions of the organization,
performance of the organization and has an interest in the running of the organization.
❖ All stakeholders should be treated equally.
❖ According to this theory, the managers are seen to be the agents of all the stakeholders and not just the owners.
3.2 BOARD STRUCTURES
❖ One-tier Board of Directors: Also known as unitary board of directors, it is a single body of directors that makes strategic decisions of a company. It includes both executive directors and non-executive directors.
❖ Two-Tier Board of Directors: A system in which a company is governed two
distinct boards of directors, a management board and a supervisory board. Management board is accountable to supervisory board and makes decisions related to operational and tactical direction of the company. The supervisory board makes decisions about long- term strategic direction of the business.
*Dec 2021 1(d) – Characteristics of one-tier board
*Reasons why one can change from two-tier board of directors to one-tier board of directors is the same as the Advantages of one-tier of board of directors is an exam (Derived from its characteristics)
Differences between One-Tier and Two-Tier Boards
1. Composition
The unitary board of directors is composed of executive directors (employees of the company) and non-executive directors (independent external directors). But those directors sit on a single board.
In a two-tier system, the supervisory board makes decisions on the long-term decisions of the company whereas the management board is held accountable the supervisory board regarding the tactical and operational decisions of the company. The supervisory board is also responsible for the hiring and firing of the management board whereas the supervisory board is directly elected the shareholders and includes senior board members and/or employee representatives.
2. Segregation/Division of Roles
In a one-tier board, there is no clear separation of duties as both the executive and non-executive directors sit on the same board. On the other hand, in a two-tier board, two different boards are present, with the management board clearly responsible for undertaking management roles and the supervisory board exists for purposes of checks and balances and policy making.
3. Decision Making
The process of decision making in a unitary board is faster because all the decisions and resolutions are made and approved a single board.
On the other hand, in a two-tier system, the decisions made the management board must be approved the supervisory board for implementation, which can take time. This delay can prolong if the two boards disagree on a certain agenda.
4. Stakeholder Indulgence
The composition of unitary board of directors does not allow for different kinds of stakeholder representation. This is because a single board cannot accommodate a large number of directors and therefore non-executive directors are the only independent input in a unitary board.
In a two-tier system, the management and supervisory boards are different, it provides a chance to add representatives of more stakeholders especially representatives of employees.
5. Role of Chairman and CEO
In a one-tier board, the Chairman of the board and the CEO sit on a single board.
In a two-tier board, the supervisory board is led the Chairman of the company and the management board is led the company’s CEO.
6. Communication and Supervision
In a unitary board, the executives and non-executives sit on a single board. Therefore, all the decisions have an ongoing input of both of these directors. In this way, the non-executive directors who are primarily responsible for the supervision of executive directors can actively seek their duty.
In a two-tier system as the boards meet separately, the supervisory board cannot actively hold management board accountable and only gets the information which management board disseminates to them.
3.3 COMPONENTS OF GOVERNANCE STRUCTURES
***Collective- consists of both administrative and policy functions
3.4 BOARD SIZE
*Discuss the Board of Directors structure in relation to the size of the board (3 marks)
a) The size of the board should be of optimum size.
b) The board should be of such a number that enable the requirements of the company’s business to be met.
c) The size of the board should not be too large to undermine an interactive discussion during board meetings or too small such that the inclusion of wider expertise and skills to improve the effectiveness of the board and the formation of its committees is compromised.
CORPORATE GOVERNANCE BEST PRACTICES/CHARACTERISTICS OF AN EFFECTIVE BOARD
1. Building a strong qualified Board of Directors which consists of a mix of skills and competencies.
2. There must be establishment of clear and separate roles and responsibilities of every board.
3. Emphasize integrity and ethical dealings.
4. It should have an effective risk management system.
5. The board should evaluate performance and make principled compensation decisions.
REASONS FOR EVALUATING GOVERNANCE STRUCTURES
1. To be accountable to the members of the organization.
2. To improve cultural legitimacy.
3. To strengthen the decision making processes.
4. To encourage people to update their skills.
5. To keep in-track to achieve the goals of the organization.
6. To cope with unexpected crises and changes.
29/09/2022
3.5 COMMITTEE STRUCTURE
***standing committees mostly asked, research main functions of remuneration, nomination, executive and risk management committees.
STANDING COMMITTEES
1) Nominating Committee
It is a committee that evaluates the Board of Directors and examines the characteristics needed in board candidates.
Roles of the Nomination Committee
1. They regularly review the structure, size, composition of the Board and makes recommendations.
2. Measures balance between EDs and NEDs, i.e. balance of power.
3. It ensures there is appropriate management of diversity, i.e. ethnicity, gender, geographical diversity, mix of skills/professional fields etc.
4. Ensures there is appropriate balance of power domination in executive selection the chairman.
5. Evaluates the balance of skills, knowledge and experience.
6. Prepares a description of the role and capabilities required.
7. Prepares for succession planning of CEO, Chairman and Directors.
8. Identify and nominate for the approval the board candidates to fill board vacancies.
9. They make recommendations to the board for directors’ re-appointment after lapse of their contracts which is usually 3 years.
10. They ensure directors operate independently for the benefit of shareholders.
11. Evaluates senior managers to gauge performance.
2) Remuneration Committee (Common in exams)
It consists of up to 5 members elected the Board, mostly consisting of NEDs.
Functions of Remuneration Committee
1. To make recommendations to the Board on the company’s policy on the remuneration for directors and senior management that consists of fair and transparent procedures.
2. To review and approve the management’s remuneration proposals with reference to the Board’s corporate goals and objectives.
3. To make recommendations to the Board on the remuneration packages of all EDs and senior management, including benefits in kind, pension rights etc.
4. To review and approve the compensation payable to EDs and senior management in connection with any loss or termination of their office or appointment.
5. To consult with the Chairman and CEO about their remuneration proposals for other executive directors.
6. To ensure that the executive directors’ remuneration should be competitively structured in line with the remuneration for other directors in the same industry and should be aligned with the business strategy and other objectives of the company.
*What are some of the Elements of the Board Remuneration Framework?
1) It should contain the directors’ fees, attendance allowances and bonuses.
2) A good remuneration should be sufficient and linked to performance.
3) A good remuneration should be aligned with the business strategy and long-term objectives of the company.
4) The ED’s remuneration should be competitively structured in line with other directors in the same industry.
5) The directors’ remuneration should be sufficient to attract and retain directors to run the company effectively.
6) The remuneration of NEDs should be competitive and line with the remuneration for other NEDs in the same industry.
3) Audit Committee (Commonly asked committee in exams)
*Best Practices of an Audit Committee? (Corporate governance mechanisms)
• It should have 3-5 members
• It should have non-executive directors to provide an independent analysis of
• The chairperson of the committee should not be the chairman of the Board
• Membership should be elected the Board
• Members should have sufficient knowledge of the company
• Members should have sound business background
• Members should be financially literate with at least one member being a qualified accountant
Functions of an Audit Committee
1. To review the annual and interim financial statements before submission to the Board.
2. To consider and recommend the appointment, remuneration and any question on resignation or dismissal of the external auditor.
3. To discuss with the external auditor before the audit on the nature and the scope of the audit and to ensure coordination where more than one audit firm is involved.
4. To discuss problems and reservations arising from the interim and final audit.
Internal Control Systems: Processes and procedures implemented in an organization to ensure it achieves its objectives in an efficient and effective manner.
4) Risk Management Committee
It is an independent committee of the Board of Directors that evaluates significant risk exposures of the company and assesses management’s actions to mitigate the exposures in a timely manner (including one-off initiatives, and ongoing activities such as business continuity planning and disaster recovery planning & testing).
Roles of Risk Management Committee
1. To develop a risk management framework.
2. To educate the board on matters concerning risk.
3. Puts measures in the board to identify, reduce and solve the risk associated with the organization.
4. Conducts training on the staff concerning the risk.
5. It approves the risk management policy.
6. They monitor the risks taken in an organization.
7. They advise the board on matters of risk.
8. They determine the risk appetite of the organization.
*Risk appetite refers to the amount of risk an organization is willing to take or accept in order to meet their strategic objectives
9. They provide leadership in identification and assessment of risk.
10. They ensure timely communication about risk management processes.