The Roles and Responsibilities of Boards of Directors

1
The Roles and Responsibilities of Boards of
Directors Lessons of IFCs Experience

• Mike Lubrano / Peter Taylor
• Corporate Governance Unit
• International Finance Corporation
• Seminario Suramericana de Inversiones, S.A.
  Medellin, 11 de julio 2003

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The Directors

• Duties and Responsibilities
• Adding Value
• The Boards Role in Governance

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Structure of Todays Session

• IFCs Experience with Directors
• Directors Nominated by Strategic / Institutional
  Investors
• Role of Directors in Value Creation
• A Digression on Board Committees
• Key Duties of Directors
• Conflicts of Interest and Independent Directors
• Whats to be Done?

4
IFCs Experience with Director Nominees
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International Finance Corporation

• Private Sector Arm of World Bank Group
• Portfolio of US14 Billion
• Investments in More Than 80 Countries
• Many legal traditions
• All Industries / Sizes / Ownership Patterns
• Different business cultures
• Debt and Equity Investments
• Extensive Experience in Structuring Companies

6
IFC-Nominated Directors

• Approx. 200 Board Nominees
• IFC Staff
• Senior Managers
• Technical Specialists
• Resident Representatives
• Retired IFC Staff
• Consultants
• International Specialists
• Local Experts

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IFCs Life-Cycle Approach

• Board Analysis What is Lacking?
• Profiles of Nominee
• Articulate Terms of Reference
• Agreement on Sharing Information
• Criteria for Remaining / Resigning
• Success
• Failure
• Sustainability

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Supporting IFC-Nominated Directors

• Training Program
• US NACD General Director Trainings
• Director Professionalism, Audit Committees,
  Governance Committees, etc.
• Specialized Trainings
• Directors of Financial Institutions
• Entrepreneurial (IT) Companies
• Back-Up From IFC CG Unit
• Global Resources (OECD Global Corporate
  Governance Forum)

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Directors Nominated by Strategic / Institutional
Investors
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Directors Nominated by Strategic/Institutional
Investors Present Special ChallengesThese must
be faced by
IFC / SIG Nominated Directors

• the Investor
• the Company
• the Director

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Why Nominate a Director?

• Investment Oversight (Noses In)
• Technical Expertise (Value Added)
• Prestige for Company
• Improvement of Governance
• Habit
• Free Good?

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Challenges - The Investor Perspective

• Reputational Risk
• Legal Liability?
• Conflicts of Interest
• Disruption of Normal Investment Review /
  Oversight Process
• Resources (Opportunity Costs)

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Challenges - Company Perspective

• Confidentiality / Conflict of Interest
• Interference with Well-Running Board
• Shadow Boards
• Management / Board Relations
• Confusion of Director and Investor Relationship
• Cost

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Challenges - Director Perspective

• Liability
• Existentialism Why am I Here?
• Handling of Confidential Information
• Conflicts / When to Recuse
• Access to Investor Resources / Information
• Reporting

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IFC Approach to Directorship

• Life-Cycle Orientation (Birth, Life, Death)
• Value-Added for the Company
• National Standards / Best Practices
• International Best Practices, Adapted to Local
  Realities
• Training
• In-House
• OECD-Country Director Institutes
• Emerging Markets Director Programs
• Academia, Others
• Governance Directors

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Role of Directors In Value Creation for the
Company
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Professional Directors Add Value for the Company

• Clear Lines of Authority / Accountability
• Stability and Continuity of Firm
• Protection of Shareholder Interests
• Strategic Asset for Management
• Repository of Experience / Perspective
• Reality Check

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Empirical Evidence is Mounting

• Better-Governed Companies Have Wider and Cheaper
  Access to Capital (Claessens)
• Better-Governed Companies Command a Premium from
  Investors (McKinsey survey)
• Companies with Active Boards Perform Better
  Operationally/Financially (Millstein and MacAvoy)
• Better-Governed Are Less Likely to Experience
  Fraud (COSO study)

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Pre-Requisites to Adding Value

• Personal Character
• Integrity, Accountability
• Open-mindedness, Candor
• Collaborative Orientation, Independent Judgment
• High Performance Standards
• Competencies
• Business Experience
• Industry Knowledge
• Financial Literacy
• Understanding of Role/Responsibility of the Board

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Different Directors Add Value in Different Ways
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Essential Value Added

• Approve Corporate Vision / Mission
• Tone at the Top - Integrity / Transparency
• Review Strategic Planning
• Approve Key Policies
• Management Evaluation / Compensation
• Succession Planning

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Key Board Oversight Functions

• Financial Reporting / Internal Controls (Audit
  Committees)
• Material / Special Transactions (Conflicts
  Committees)
• Ensuring Good Governance in Practice
  (Compensation, Nominations, Governance Committees)

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Relations with Management Types of Boards (NACD)
Relationship Type of Board

• Advisory
• Enabler
• Advocate
• Monitor
• Critic / Reality Check

• Advisory
• Entrepreneurial
• Mature
• Sadly, also
• For Show / Neutral
• Disfunctional
• Value Destroying

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Red Flags for Boards

• Lax Corporate Culture
• Poor Communication with Management
• Weak Internal Controls
• Erratic Financial Performance
• Unexplained Variances in Indicators
• Employee Dissatisfaction

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A Digression on Board Committees
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Board Committees Assist Directors to Add Value

• Composed of Board Members
• But May Be Assisted By Non-Members
• In-house and Outside Expertise
• Board-Approved Charters
• Committee Chairmen Set Agendas
• Management Cooperation
• Access to Needed Resources

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Board Committees

• Assist the Board, Do Not Relieve the Full Board
  of Ultimate Responsibility
• Avoids Shirking / No Pontius Pilates
• Makes Boards Efficient / Effective
• Take Advantage of Talent at the Board Level
• Increase Board Member Contribution

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Typical Board Committee Structure
Also Common Nominations Finance Strategic
Planning Ad Hoc Committees
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Board Committee Recommendations

• Committee Structures Should Not Follow a Rigid
  Model
• Combining Functions for Functionality
• Independent Director Committees
• Optimal Committee Structure
• Business-Driven Priorities
• Existing Board Capacity
• Composition of Executive, Non-Executive and
  Independent Directors
• Market for Outside Talent

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Duty of Loyalty / Duty of Care
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Essential Duties of Directors

• Duty of Loyalty
• To Whom?
• Conflicts of Interests / Fiduciary Duties
• Duty of Care
• What Standards?

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Directors Duty of Loyalty

• Director Acts in a Fiduciary, not in a
  Representative Capacity
• Directors Fiduciary Duty is to Act in the Best
  Interest of the Company
• Self-Interest and Duties to Third Parties (e.g.,
  Employers) Present Conflicts of Interest
• Disclosure and Recusal
• Corporate Opportunities

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Directors Duty of Care

• Directors Should Act in Good Faith
• Decisions Must be Made in a Informed and
  Deliberate Fashion
• Receive Necessary Information
• Articulate a Business Rationale
• Business Judgment Rule

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Director Liability

• No Liability if He/She Acted in Good Faith, on an
  Informed Basis, and in the Belief that the
  decision was in the Best Interests of the Company
• Indemnification
• Directors and Officers Liability Insurance

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Prof. Candido Paz-Ares El Mundo al Reves

• Thesis Too Much Attention to Duty of Care
  (gestion indebida) Too Little to Duty of Loyalty
  (apropiacion indebida)
• Legislative, doctrinal and judicial focus has
  been on duty of care this is futile /
  counter-productive
• Violation of duty of loyalty is more insidious,
  easier to detect and prove proper alignment of
  incentives
• Conclusion Focus of Public Policy and Private
  Initiative should be on Duty of Loyalty

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Conflicts of Interestand Independent Directors
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Conflicts of Interest

• Exist When A Partys Duty to the Company
  Conflicts with a Private Interest or a Duty to
  Another (Issue for Duty of Loyalty)
• Director Conflicts
• Personal Interests / Gain
• Interests of Employer / Duty as Employee
• Affiliation with Management
• Affiliation with Other Interested Party
• Inability to Exercise Independent Judgment in
  Best Interests of the Company (Real or Perceived)

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Independent Directors

• Different Approaches Conceivable for Different
  Firms / Business Environments
• Independence For What Purposes?
• What Conflicts Are Likely to Arise?
• Management or Controllers at Issue
• Feasibility
• What Pool of Directors Exists?
• Investor Expectations
• Model Definitions (Codes)

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Independent Directors

• No Recent Employment with the Company
• No Affiliation with Management / Controllers
• Not Affiliated with Material Suppliers, Customers
• No Inter-Locking Boards
• Not Recently Employed by Auditor
• Not Affiliated with a Dependent Charity

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What is to be Done?
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What is to be Done?

• Board Building is a Gradual Process
• Articulate the Role of the Board
• Identify Needed Skills / Experience
• Board Orientation
• Board Committees Enhance Accountability
• Board Evaluation
• Continuing Education
• Directors, Corporate Secy, Management
• Dissemination of Best Practice / Feedback