Corporate Governance and

Corporate Finance

Topic 3
Board of Directors Duties and Responsibilities

Prepared by: Dr. Hassan M. Hafez

Financial Advisor, FRA, CMA-KSA
Associate Professor of Finance
Faculty of Business Administration and International Trade - MIU
Figure 2.2 Toyota Corporation’s corporate governance structure.
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CASE I

Board of Directors Responsibilities

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Board Responsibilities

The corporate governance framework should ensure the strategic

guidance of the company, the effective monitoring of
management by the board, and the board’s accountability to the
company and the shareholders.

oThe board is expected to provide both advisory and

oversight functions.

oIn an advisory capacity, the board consults with

management regarding the strategic and operational
direction of the company. Attention is paid to decisions that
balance risk and reward.

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Board Responsibilities

o Board members are selected based on the skill and

expertise they offer for this purpose, including previous
experience in a relevant industry or function.

o This perspective is referred to as the “dual mandate” of

the boards of directors.

o In its oversight capacity, the board is expected to monitor

management and ensure that it is acting diligently in the
interests of shareholders.

o The board hires and fires the chief executive officer,

measures corporate performance, evaluates management
contribution to performance, and awards compensation 15-6
Board Responsibilities

o It also oversees legal and regulatory compliance, including

the audit process, reporting requirements for publicly
traded companies, and industry-specific regulations.

o In fulfilling these responsibilities, the board often relies on

the advice of legal counsel and other paid professionals,
such as external auditors, executive recruiters,
compensation consultants, investment bankers, and tax
advisors.

o Effective board members are individuals that can capably

complete both advisory and oversight responsibilities.

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Board Responsibilities

o The responsibilities of directors are separate and distinct

from those of management. Directors are expected to
advise on corporate strategy but do not develop the
strategy. They are expected to ensure the integrity of the
financial statements but do not prepare the statements
themselves. The board is not an extension of
management. The board is a governing body elected to
represent the interests of shareholders.

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CASE I

Board of Directors Independence

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Board Responsibilities

o independence is evaluated by the degree to which a

director is free from conflicts of interest that might
compromise his or her ability to act solely in the interest
of the firm.

o Independence is critical in that it ensures that directors

are able to take positions in opposition to those of
management when necessary.

o In the United States, the New York Stock Exchange

(NYSE) requires that listed companies have a majority of
independent directors. It also requires solely independent
audit, compensation, and nominating and governance
committees 15-10
Board Responsibilities

o A “controlled company”—one with more than 50 percent

voting power held by a single person or entity—is exempt
from the requirements of an independent compensation
and nominating committee but not audit committee.

o There are many examples of boards comprised of highly

capable directors who went along with management
decisions that later proved disastrous. For example, the
board of Enron failed to rein in management actions that
were later held to be criminal. Similarly, the boards of
many large financial institutions appeared to have
acquiesced to management in the trading and retention of
mortgage-backed securities with low credit quality, which
precipitated the financial crisis of 2008 and required 15-11
a
The operations of the Board

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Board Responsibilities

o The chairman is responsible for setting the agenda,

scheduling meetings, and coordinating actions of board
committees. As such, the chair holds considerable sway
over the governance process by determining the content
and timing of matters brought before the board.

o Traditionally, the CEO has served as the chairman of the

board in most U.S. corporations. In recent years, however,
it has become more common for a nonexecutive director
to serve as chair. Given the advising and oversight
responsibilities of the board, several obvious conflicts
could arise from a dual chairman/CEO

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Board Responsibilities

o Board actions take place either at board meetings or by

written consent. At a board meeting, resolutions are
presented to the board and voted upon. An action is
complete when it receives a majority of votes in support.
When the board acts by written consent, a written
resolution is circulated among board members for their
signatures. The action is complete when a majority of the
directors have signed the document.

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Board Responsibilities

o In addition to attending meetings of the full board,

independent directors meet at least once a year
in executive session, in which executive directors are
not present. This practice was mandated by SOX.
Although no formal actions are taken at these meetings,
executive sessions give outside directors an opportunity to
discuss candidly the performance of management,
operating results, internal controls, and succession
planning. The lead independent director presides over
these meetings.

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Board Responsibilities

o In addition to attending meetings of the full board, independent

directors meet at least once a year in executive session, in
which executive directors are not present. This practice was
mandated by SOX. Although no formal actions are taken at
these meetings, executive sessions give outside directors an
opportunity to discuss candidly the performance of
management, operating results, internal controls, and
succession planning. The lead independent director presides
over these meetings.

o Directors report spending approximately 20 hours per month on

board matters. According to the National Association of
Corporate Directors (NACD), the full board of directors convenes
eight times per year either in person or over the phone, and a
typical meeting lasts 7 hours 15-16
Board Responsibilities

o most directors believe that the agenda is structured to make efficient

use of their time and that 20 hours per month is sufficient to satisfy
their duties.

o Board agendas cover a wide variety of topics that include strategic,

operating, leadership, and compliance issues. According to the NACD,
financial statement reviews, merger and acquisition and capital
investment activities, and compliance are discussed in approximately
80 percent or more meetings. Foundational issues such as strategy,
risk, and technological disruption are discussed between 67 and 75
percent of the time. Talent-related and cultural issues such as
corporate culture, talent management, and succession planning are
discussed in approximately half of meetings. Boards spend the least
amount of time reviewing their own performance and culture: board
succession, board performance, and boardroom culture are discussed
only a third of the time
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Board Agenda Topic Q1 Q2 Q3 Q4

Financial statements 98% 98% 98% 99%

M&A 89% 90% 96% 88%

Capital investments 86% 79% 84% 88%

Compliance 85% 88% 84% 89%

Shareholder engagement 83% 77% 78% 77%

Changes to the competitive landscape 79% 79% 85% 77%

Risk management 69% 76% 74% 71%

Executive compensation 67% 47% 39% 67%

Corporate strategy 64% 68% 76% 73%

Technological disruption 59% 70% 65% 65%

Corporate culture 49% 60% 57% 55%

CEO evaluation 49% 16% 14% 54%

Talent management and human-capital strategy 42% 54% 59% 52%

CEO succession 41% 41% 45% 52%

Board-succession planning 36% 41% 34% 49%

Board performance 35% 16% 21% 46%

Boardroom culture 35% 27% 29% 40% 15-18

CASE I

Netflix: Radical Transparency in the Boardroom

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Board Responsibilities

o Netflix takes a unique approach to information sharing with

the goal of significantly and efficiently increasing
transparency among the CEO, the executive team, and board
of directors. Its approach incorporates two unique practices.
First, board members periodically attend (in an observing
capacity only) monthly and quarterly senior meetings. By
directly observing management, directors have a greater
understanding of the issues the company faces, the
analytical approach management takes to evaluate them,
and the trade-offs involved. They also build personal
relations with the executive team and witness their
leadership styles in a work setting.

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Board Responsibilities

o Second, board communications are structured as

approximately 30-page online memos in narrative form that
not only include links to supporting analysis but also allow
open access to all data and information on the company’s
internal shared systems, including the ability to ask clarifying
questions of the subject authors. As a result, directors are
extensively prepared for meetings and can focus on
discussion and debate, rather than waste board time
listening to presentations. According to Netflix CEO Reed
Hastings, “The board isn’t going to have the confidence to
make hard decisions unless they really understand the
market and the company.” According to a Netflix director,
“This level of data, this level of access, and this level of
conversation greatly facilitates our ability to be good board
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members.
Board Committees

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1. The Audit Committee

o Audit committees meet an average of eight times per year either in

person or over the phone, and a typical meeting lasts approximately
three hours.

o  Ninety-seven percent of directors believe that the audit committee is

effective in its oversight of the financial reporting process

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The Audit Committee

• Overseeing the financial reporting and disclosure process

• Monitoring the choice of accounting policies and principles

• Overseeing the hiring, performance, and independence of the external

auditor

• Overseeing regulatory compliance, ethics, and whistleblower hotlines

• Monitoring internal control processes

• Overseeing the performance of the internal audit function

• Discussing risk-management policies and practices with management

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2. The Compensation Committee

o The compensation committee is responsible for setting the

compensation of the CEO and for advising the CEO on the
compensation of other senior executives.

o Compensation committees meet an average of six times per year for

three hours. Eighty-nine percent of directors believe the compensation
committee can properly manage CEO compensation.

o There is no minimum committee size. The obligations of the

compensation committee include the following:

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The Compensation Committee

• Setting the compensation of the CEO

• Setting and reviewing performance-related goals for the CEO

• Determining an appropriate compensation structure for the CEO, given

these performance expectations

• Monitoring CEO performance relative to targets

• Setting or advising the CEO on other officers’ compensation

• Advising the CEO on and overseeing compensation of nonexecutive

employees

• Setting board compensation and hiring consultants to assist in the

compensation process, as appropriate
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3. The Governance Committee

o The governance committee is responsible for evaluating the

company’s governance structure and processes and recommending
improvements, when appropriate.

o The nominating committee is responsible for identifying,

evaluating, and nominating new directors when board seats need to
be filled. The nominating committee is also typically in charge of
leading the CEO succession-planning process.

o The nominating and governance committee meets an average of four

times per year for two hours. Despite the independence of this
committee, the CEO often has significant input into the choice of
directors nominated to the board. This is true whether or not the CEO
holds the dual role of chairman.

o In most companies, the nominating and governance committees are

combined into a single committee with these responsibilities: 15-27
The Governance Committee

• Identifying qualified individuals to serve on the board

• Selecting nominees to be put before a shareholder vote at the annual

meeting

• Hiring consultants to assist in the director recruitment process, as

appropriate

• Determining governance standards for the corporation

• Managing the board evaluation process

• Managing the CEO evaluation process

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Specialized Board Committees

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Case I. Merck and Co.

The board of Merck & Co. convenes a Research Committee to monitor its
drug discovery and development process:
“The purpose of the Research Committee is to assist the Board in its
oversight of matters pertaining to the Company’s strategies and
operations for the research and development of pharmaceutical products
and vaccines by:

Identifying areas and activities that are critical to the success of Merck’s
drug and vaccine discovery, development and licensing efforts;
Evaluating the effectiveness of Merck’s drug and vaccine discovery,
development and licensing strategies and operations;
Keeping the Board apprised of this evaluation process and findings; and
Making appropriate recommendations to the President of Merck Research
Laboratories, the CEO and to the Board on modifications of strategies
and operations
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Case II. Cisco Systems Co.
The board of Cisco Systems has a Finance Committee that monitors a
broad range of financial activities:

The Finance Committee reviews and approves Cisco’s global investment

policy; reviews minority investments, fixed income assets, insurance risk
management policies and programs, and tax programs; oversees Cisco’s
stock repurchase programs; and also reviews Cisco’s currency, interest
rate, and equity risk management policies.

This committee is also authorized to approve the issuance of debt

securities, certain real estate acquisitions and leases, and charitable
contributions made on behalf of Cisco

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Case II. General Mills Co.
Reviews public policy and social trends affecting General Mills;

Monitors our corporate citizenship activities and sustainability programs;

Evaluates our policies in the context of emerging corporate social
responsibility issues; and

Reviews our policies governing political contributions and our record of

contributions.

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