Characteristics of Good Board Governance

Board Governance

Introduction

In order for an organization to achieve good outcomes, its board should be characterized by good governance. Good governance often includes characteristics such as accountability, diversity of representation in the board room, the ability to develop a consensus view, transparency, application of the rule of law, and understanding that the board bears responsibility to both shareholders and stakeholders. Essentially, boards are complex, but they exist for a simple reason—to ensure an effective organization (Bowen, 2008). This paper will explain why boards are need, what their functions are according to Bowen (2008), what boards should consider in effective governance, what their basic duties are and why they are important, how CEO and board roles relate to effective leadership of the board, the importance of Sarbanes-Oxley, and the important aspects of board machinery.

Why Boards?

Boards are helpful when they are comprised of individuals who provide expertise and guidance for organizations that lack direction, experience, and insight. Bowen (2008) explains that a board can help an organization develop a shared sense of purpose as well as social, economic and political contexts for examining tough decisions that the organization must make. The board represents a collective of responsible agents that can give checks and balances to an organization by supplying judgment and protecting against self-interest.

Additionally, non-profits and for-profit organizations can both benefit from having boards to provide oversight, particularly for regulatory purposes. The corporate form of organization provides certain legal protections, and boards are a requirement for corporate organization. So just for the sake of organizing purposes, the board is a key component for success.

Bowen’s Five Themes and Eight Board Functions

Bowen’s (2008) five themes that pertain to board effectiveness are relationships, key skills; investments; differences and similarities between for-profit and non-profit governance; and the rewards of serving on the board. These themes are important to keep in mind when discussing boards because they highlight some of the important aspects of what makes a board work. Specifically, these themes refer to what Bowen (2008) describes as: 1) the relationship between the board and the CEO/president, and why it should be a partnership to be strengthened; 2) why it is important to bring people to the board who have key attributes for effective leadership as well as the courage to act; 3) investing up-front in ways and means that will ensure good and effective governance; 4) understanding how governance of for-profits and non-profits should and should not be the same; and 5) understanding how serving on boards of both for-profit and non-profit organizations can be rewarding.

Boards have a big responsibility in organization because they provide essential functions regarding leadership and oversight. The eight functions that boards provide are: 1) to pick the CEO to lead the organization; provide encouragement as well as advice; make evaluations of the leader, provide compensation, and, if necessary, replace the CEO; 2) provide discussion for and review of strategic directions before giving approval; 3) oversee the monitoring of performance; 4) make certain the organization is responsible and effective in its operations; 5) provide support for policy recommendations and all decisions that are made; 6) to act as a kind of shield or barrier between the CEO/president of the organization and the public, stakeholders, or shareholders; 7) make certain the organization has sufficient human and financial resources for pursuing strategies and objectives; and 8) ensure that suitable candidates are nominated to the board and that effective governance is carried out (Bowen, 2008). The board is essentially there to make sure the organization is as effectively pursuing its goals and objectives as possible. It should be comprised of experienced leaders who understand both the organization itself and the industry. They should also have an understanding of the external environment, such as the political, economic, and social factors that could impact the organization’s ability to achieve its goals.

Important Factors for Boards to Consider in Effective Governance

Important factors for boards to consider in effective governance include what Zhao (2010) indicates as the essence of effective governance in the US, which is “the separation of ownership and control” (p. 495). What this means is that shareholders of the public organization are not able to control the organization so long as it remains public; should it go private, that is another matter. But with respect to public companies the idea of effective governance is that it separate ownership from control. The levers of control should be held by people who put all stakeholders’ interest front and center—not just a few shareholders. This is why there are voting rights restrictions in the US: “voting right restrictions are legal; these limit a shareholder to voting a certain percentage of the corporation’s total share capital, regardless of share ownership position” (Ewmi, 2005, p. 10).

However, one important factor according to Bukhvalov and Bukhvalova (2011) is that boards spend less time focusing on monitoring organizational leaders and more time demonstrating leadership themselves. On the other hand, Kiel and Nicholson (2005) argue that boards should really focus on evaluating the organization’s performance and making sure the organization is meeting its objectives. The two approaches or recommendations by these researchers essentially summarize the spectrum of what a board should seek to accomplish: on the one end, it should show good leadership; on the other end, it should be a good steward of the organization by overseeing performance and making sure objectives are reached—and if not finding out why not and deciding on what steps to take next.

Basic Board Duties and Why They are Important

The most basic board duties consist of representing stakeholders and of leading the organization in such a way as to help it achieve its objectives. To accomplish these duties, Owen (2003) recommends a two board system like what is seen in Germany: in the two board system, there is one board focusing on oversight and another board focusing on representation. In the US, the aim is to keep ownership out of control in public companies; in Germany, the aim is to be inclusive because owners are stakeholders, too. The solution in Germany is to have two boards dividing up the duties; one set of duties for each board—representing ownership for one; providing oversight of the organization for the other. In the two board system, the supervisory board consists of shareholders and workers in the company, while the management board consists of directors of the organization, and it is the supervisory board that oversees the management board.

Although a two board solution may work for Germany, in the US it is not a common approach. The boards of the US try to balance stakeholder interest with the needs of the organization simultaneously. It is one reason boards in the US are often complex affairs.

CEO and Board Roles and Their Relation to Effective Leadership of the Board

The CEO of the organization is often the public face of the company. The perfect example of this is Elon Musk of Tesla, SpaceX, and now (most likely) Twitter. Musk receives the public approbation and scorn when the organization does anything that affects the public. If Tesla shifts production to China, Musk is either praised or condemned by members of the public, as the company’s CEO. The CEO is essentially the public lightning rod. Yet, the board is just as responsible as the CEO for making decisions in a company. When Eisner was CEO of Disney, it was not just he making decisions but also the board—and there were a great many fights over what those decisions should be and especially how the CEO should be compensated (Downes et al., 2007). Eisner succeeded at Disney just as Musk has succeeded at Tesla for a simple reason: they managed to get along well with the board for the most part. Together, when the CEO and the board, has a good relationship, the organization is usually able to operate at a greater degree of effectiveness than when that relationship is soured. In a good supportive relationship, the CEO will manage the organization’s executive team so as to keep the company moving forward, and the board will set the goals to be achieved and provide counsel for the CEO. The board will scrutinize issues and decisions, ask questions, and help the CEO to see the best course of action. The CEO will act so as to achieve the goals established by the board. When the CEO willingly seeks out the advice of the board it shows trust in the board’s wisdom; when the board makes suggestions but permits the CEO to make the decisions, the board shows trust in the CEO’s abilities. This two-way flow of trust is needed for effective leadership on both parts.

Requirements and Importance of the Sarbanes-Oxley Act

Sarbanes-Oxley came about as a result of corporate scandals like the one at Enron, where bogus accounting allowed fraud to transpire for years before finally being exposed to the detriment of shareholders. The Act set the standard for corporate governance. One such issue is the audit committee: the for-profit company must have an audit committee that is comprised of members who are independent from the management and the company. The corporation also must maintain good distance between itself and its auditors so that there are no conflicts of interest. This is important because if there is closeness, it can lead to auditors overlooking red flags out of a sense of friendship or loyalty to the board. This is essentially what happened with Enron and the auditing firm Arthur Andersen. The Act also obliges the CEO and the CFO of the for-profit company to certify financial statements. Additionally, it obliges companies to disclose material changes in the organization’s finances or operations. The Act protects whistleblowers from retaliation and it criminalizes the destruction of any document that might be needed in an official proceeding.

For non-profits, the Act specifically relates to them on the points of whistleblower protection and document retention. These points are the only two in the Act that bear, legally, on non-profits; but on all the other points it is recommended that non-profits adhere to the spirit of the Act by following in the same manner as for-profits on matters of auditing, reporting, etc.

These requirements are helpful for governance because they promote transparency and accountability—two characteristics that were missing from governance in the late 1990s and early 2000s. The case of Enron is a perfect example of how governance got away with hiding fraud and shifting blame onto others. Sarbanes-Oxley has helped to prevent that kind of opaqueness from infiltrating governance.