7.2 Responsibilities of the Board of Directors

Boards of directors provide both an oversight of management and an advisory role to management. The most important responsibility of a board member is to be fully engaged, always prepared for meetings and to know the affairs of the company. As stated in a previous chapter, board members are legally bound to exercise a duty of care and be loyal to the company and shareholders. They must make decisions a prudent person would make and must understand the transactions they are authorizing. As an example of a board of directors that was not fully engaged consider the following:

Puda Corporation was a U.S. domiciled Delaware public company that's only assets were coal mines in China. It turns out that in 2009, without the board's knowledge, Ming Zhao, the chairman of the company, transferred all of Puda's interest in Chinese coal mining companies to himself. Thus, without the board's knowledge, Puda Corporation became a shell company that no longer owned the mining operations that had been its only source of revenue. Traditionally, Delaware courts have imposed a high standard for plaintiffs to demonstrate directors' failure to oversee management. However, in this case, the Delaware courts said this was not just gross negligence but a lack of good faith. They chastised the board with the following words: "If you're going to have a company domiciled for purposes of its relations with its investors in Delaware and the assets and operations of that company are situated in China that, in order for you to meet your obligation of good faith, you better have your physical body in China an awful lot." Because they didn't spend time in China, the independent directors allegedly failed to notice that the company's entire asset base had been transferred out of the company, even though the transfers were reported in Chinese government documents. The Court also viewed the directors as at least partially responsible for allowing the company to repeatedly file false and misleading statements with the SEC from 2009 to 2012. Another problem in this case was that when faced with the mounting evidence of fraud, the independent directors of Puda Coal, who constituted a majority of the board, concluded that the better part of valor was to resign. While this reaction may perhaps have been understandable, the Delaware opinion suggests that not only would such a resignation not cure prior failings, but that in the circumstances the resignation itself might be a breach of fiduciary duties, as it left the company wholly controlled by the errant CEO. Indeed, directors had a duty to stay and help clean up the mess.

Most directors agree that the two major responsibilities of the board of directors is (1) to recruit, incent, evaluate and oversee the chief executive officer (CEO) of the corporation and (2) to provide advice and feedback on company strategy. Also, based on the CEO's recommendations, they help recruit, incent, evaluate and oversee other executive officers of the company.

Good boards of directors evaluate the performance of the CEO annually and provide feedback that helps the CEO improve. (The CEO then does the same for his or her direct reports with board of director input.) One company uses the following survey, completed by each board member and summarized and conveyed personally to the CEO by the board chair, for evaluating its CEO:

One of the most difficult issues for a board of directors is to determine appropriate compensation packages for company's executives. The compensation committee usually makes pay recommendations that are approved by the full board. Other major responsibilities of the board of directors include approving budgets and corporate strategy, monitoring financial position and overseeing financial reporting, auditing and internal controls and approving annual operating plans, mergers/acquisitions, capital budgets, etc.

It is absolutely critical that boards of directors spend sufficient time of company issues to completely understand them. Unfortunately, too often, while the C-suite gets a daily dose of strategy and risk, the board gets only glimpses of strategies and problems. The C-suite's ability to transfer their knowledge of strategic risks is paramount to the board's oversight and understanding. Unfortunately, some CEOs may be unwilling to unveil the full scope of risk facing a company because it may be seen or felt as an admission of weakness.

As their representatives, the board of directors assists shareholders in solving the principal-agent problem by performing two critical roles: oversight and advisory. The board fulfills its oversight role by monitoring management and ensuring that management is acting in the best interest of shareholders. The board oversees legal and regulatory compliance, such as financial reporting requirements, industry-specific regulation, and the external audit. The board measures the company's performance against its strategy and goals, evaluates and reviews management's contribution to company results, and, as stated above, ultimately hires and fires the CEO In order to assist in the fulfillment of these responsibilities. The board establishes subcommittees such as the audit committee and compensation committee. It is important to note that the board is expected to ensure that financial statements are stated fairly; however, the board is not expected to prepare the statements themselves. The board functions independent from management. The roles of the board should remain separate from the roles of management.

In its advisory role, the board offers advice to management regarding corporate strategy, operations, and risk management. The board does not usually propose a corporate strategy; rather, management proposes a strategy, and the board evaluates and provides feedback about the strategy. The board ensures that management's plan will maximize shareholder value and use corporate assets effectively; the board does this by asking questions, providing important perspectives, and pushing back against management. Important issues that a board might consider include (but are not limited to) defining target customers, deciding which products and services to offer and how to differentiate products and services from those of competitors, identifying geographic areas in which to operate, and identifying new opportunities for growth.

The author of this book has served on eight different corporate boards of directors, including four public company boards and four private company boards. Some of the interesting board decisions he has been a part of are:

• Sold a company to a large foreign corporation (chaired the special committee that negotiated the sale)

• Chaired the committee to hire a new CEO

• Fired a CFO

• Approved the purchase of several billion dollars of capital expenditures, new plants in foreign countries, radio stations, etc.

• Approved and helped take companies public (issue an IPO)

• Chaired the investigations of company frauds

• Decided to build new factories and make major investments in foreign countries

• Approved major acquisitions and mergers, including a hostile takeover

• Determined and approved executive compensation strategies and levels

• Chaired finance committees that borrowed hundreds of millions of dollars

• Help determine strategy for several companies, including investments in new products, geographic locations, etc. Made large manufacturing investments in the Philippines, Malaysia and in Eastern Europe.

• Helped fire a board member who didn't disclose his lack of independence

• Served on and/or chaired the audit, compensation, nomination/governance, safety and long-range planning committees of companies.

• Negotiated with regulators to deter an investigation into the company's financial practices.

• Made the decision to change the accounting for revenues and to restate a company's financial statements.

• Consolidated a company's dual classes of stock into one class.

• Change a board from a "classified board" to a "non-classified board" and from plurality voting to majority voting.

• Considerably reduced an executive's equity compensation.

• Many other similar major decisions

Each of these decisions required considerable debate, thought and dialogue among the board members. In some instances, outside advisors such as attorneys, bankers and forensic accountants were retained.

According to the National Association of Corporate Directors' (NACD) 2013-2014 corporate governance survey, here's what directors thought were the most important issues they deal with:

• Strategic planning and oversight…….……..59.5% of respondents

• Corporate performance & valuation….…..44.6% of respondents

• Risk oversight…………….…………………………..32.8% of respondents

• CEO succession…….………………………….…….29.3% of respondents

• Executive & leadership development….….20.2% of respondents

• Financial oversight/internal controls……...19.9% of respondents

• Director recruitment & succession………...17.4% of respondents

• Board effectiveness…………………….………….13.3% of respondents

• CEO compensation…………….………………….. 9.7% of respondents

According to the same survey, in 2013 the average board of director member spent approximately 235.9 hours per year serving on a board. Those hours are broken down into the following types of activities:

In terms of the size of boards of directors, again, according to the NACD survey, the average board size in 2013-14 was 8.8 members with larger companies having more directors than smaller companies. The following chart summarizes the number of directors serving on the full board, the audit committee, the compensation committee and the nominating/governance committee of different size companies.