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Kemela Okara reflects on the necessity of increased professionalism in the board of companies.
Following the spectacular collapse of corporate giants in America recently a major consequence has naturally been that of determining new criteria for board appointments especially for publicly quoted companies. New listing requirements of the New York Stock Exchange (NYSE) and NASDAQ approved by their respective boards on the 1st August and 24TH July 2002 respectively provide new rules of independence expected of board members. This is no doubt understandable as companies depend on directors to manage their affairs with the best interests of shareholders and employees as guiding principles. In the Nigerian context this issue is of very high significance. The last banking crisis though largely affecting privately owned banks reflected a failing in management and of the board in its role of overseeing the work of management. Furthermore, with the increased levels of global public investment in the fortunes of quoted companies the criteria for determining who sits on the board of public companies is now of major concern. Investors want to be assured that their companies are in safe hands. Whilst it is critical to have independent board members free from the risk of manipulation by management or their self interest another important issue raised by the problems in corporate America and potentially closer home is one of professionalism. In other words we need to ensure that board members are properly equipped to oversee management and meet the needs of an increasingly sophisticated investing public
Our law as contained in the Companies and Allied Matters Act 1990 (CAMA) describes the director's relationship with the company as a fiduciary relationship. This flows from the fact that though the law recognizes the distinctive personality of companies it also recognizes its limitations in not being able to conduct its affairs by itself. The directors who must act for it must do so in utmost good faith so as to ensure that the company's best interests are protected. The best interest of the company requires that the director preserve the assets of the company, further its business and promote the purposes for which the company was formed. In achieving these objectives the standard by which the directors will be judged is one of care and skill as would be expected of a reasonably prudent director acting in the same circumstances. Additionally the law requires directors to avoid circumstances in which they make secret profits or derive other benefits in the course of managing the company's affairs or utilizing the company's property. Much of our case law endorses this fiduciary relationship and the criteria for determining whether in fact directors acted in the best interests of the company.
Whilst the law is very clear about the duties directors owe their companies it sets out no criteria to guide appointments to the boards of private or public companies. What the law provides for is a description of persons excluded by reason of fraudulent conduct in relation to the affairs of a company or persons who by reason of insolvency, lunacy or infancy are precluded from acting on the board of companies. In other words virtually everyone not falling under any of the enumerated categories can become a director of a company. Whilst there is no intrinsic commercial or public policy reason why this should not be the case the Enron saga is causing a major re-think of corporate policy as it relates to board appointments. In conducting a post-mortem on the reasons behind the collapse of Enron the US Senate Subcommittee that looked at the role of directors in the entire affair said 'Enron's directors protest that they cannot be held accountable for misconduct that was concealed from them. But much that was wrong with Enron was known to the board, from high risk accounting practices and inappropriate conflict of interest transactions, to extensive undisclosed off the books activity and excessive compensation' The Subcommittee also said that on too many occasions the board went along with questionable practices and relied upon auditor and management representation thus failing in its fiduciary duty to the company.
This may be true but the counter argument is that the failing in Enron's case for instance was structural. The point being that the Enron board was bound not to discover the problems because it did not have the requisite structure or duties to cope with the demands of the modern day corporation such as Enron. Demands principally from the investing public, analysts, brokers etc to boost the bottom line which often times leads management to set unrealistic targets. Worse still the board, which depends on management and external auditors for vital information is itself at a loss in the whole process of goal setting. In practice the board oversees the financial health of the company through its audit committee, which has the task of looking into issues in greater detail. Apart from the fact that audit committees meet infrequently they will inevitably rely on management and external auditors for critical information to determine the scope and planning required for the audit the effectiveness of internal control mechanisms and a review of management matters in conjunction with the external auditor. The solution may lie in re-visiting the scope of work assigned to the audit committee. Financial literacy as a requirement for appointment to an audit committee as recommended by the Business Roundtable (BRT) (an association of Chief Executive Officers of leading corporations in America with a combined workforce of over 10m and $3.5 trillion in revenues) is a welcome start. In fact the BRT also recommend many more specialized committees to ensure issues are dealt with in more depth. Professors Healy and Palepu of the Harvard Business School suggest something more radical. Renaming the committee the transparency committee and looking beyond the traditional duties assigned to embrace an assessment of how effective their company's key performance indicators are and how well informed the investing public will be through timely and transparent disclosures. In other words transparency/audit committees need to ensure that investors understand how the company intends to balance its success and risk factors attendant to its adopted strategy for creating value. A practical example is ensuring timely treatment of R&D investment for what it is - an expense.
In our context a step in the right direction was the inauguration of the Peterside Committee on corporate governance in public companies, which presented its report to the Securities and Exchange Commission early last year. Their recommendations reflect the current trend for a more professional approach. Consequently the committee recommends three more board committees in addition to the audit committee namely the board remuneration, management remuneration and nominations committees. Appointees to the audit committee are expected to have some level of financial literacy although the level of literacy is not defined. The committee also recommends that board appointees undergo training on appointment and regularly thereafter. The recommendations of the committee reflect a trend as can be observed from the recommendations of the BRT referred to earlier. Another notable recommendation is that requiring boards to go beyond the half yearly and yearly financial reports and provide investors and analysts with information on the company's progress. To ensure compliance the Peterside Committee recommends that companies issue a statement of compliance vetted by the external auditor before its publication.
Whilst the Peterside Committee does not go so far as recommending steps towards professionalising board membership it implicitly recognizes the changing face of board membership globally. The global trend for membership of audit committees for instance requires a certain degree of financial literacy. The committee endorses this but as indicated earlier it does not set any specific criteria. With the recommendation of more specialized committees certain skill sets or work experience become necessary. The committee in its recommendations however allows the board access to professional input to be paid for by the company.
We may not yet be seeing the dawn of a professional class of board appointees however a greater measure of professionalism will be required of board membership. A public company collapse on the scale of Enron may not be imminent however, with privatization going apace and local and foreign institutional investors eyeing our high performing emerging market the focus will certainly shift to the all important issue of effective management oversight.
Kemela Okara
February 2003
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