By: 1. Kenneth A. Kim John R. Nofsinger And 2. A. C. Fernando

Lecture 10

 Last Lecture Review ◦ Overview of the Board  Board legal duties  May not be the federal law requirement but the state wants BoDs.  Firms profitability and increase in share value  Loyal and fair  Take care of the rule of ethics  Employment practices  Human rights  Environment regulations  Corruptions  Moral obligations

 Board Committees ◦ An Executive Committee ◦ A Finance Committee ◦ A Public Relation Committee  Board Sub Committees ◦ Audit Committee ◦ Compensation Committee ◦ Nomination Committee

 Lecture Outlines ◦ More attention on Directors ◦ What is a “Good Board”?  Experienced members  Having different back ground i.e. technical as well as non technical  Independent board-having fraction of non-insider directors (difficult to find unambiguously independent directors)  Small board

 Good for Goose, good for Gander ◦ One form of board may be/may not be good for others. ◦ Small board may be/may not be good for others firms and vice versa. ◦ Can good board lead to better firm performance?  No positive correlation between the board quality and firm performances.  Normally board are reactive, not proactive  Sometimes inside directors are good for board (e.g. infant or new firms or when the firm has to make any huge financial/investment decision) and some times outside directors (e.g. when audit as well as compensation matters are required)

 Some potential problems with today's board ◦ Outside Directors relationship with the top management (e.g. CEO) ◦ Outside directors full motivation is still a question mark for firm’s board. ◦ Inexperienced as well as busy outside directors are fruitless for the board

More Attention on Directors  Prior to the mid-1980s, the public paid little heed to directors.  Now the situation has changed.  Increased pressure on BODs has resulted in better corporate governance.  The increased takeover market and the new regulatory environment push the directors to do their jobs.

What is a “GOOD” Board?  Experienced members  Technical firms must have technical experts and vice versa.  Its entirely the firms decision.  A board with members having different background can also be beneficial for the firms.

Independent Boards  There must be a high fraction of non-insiders (directors) for a good board ◦ E.g. One of the board primary responsibilities is to evaluate, compensate and possibly fire the CEO. What if the board consists of the following people;  A friend of a CEO  A relative of a CEO  A business collaborator of a CEO

 Its very difficult to find people who are entirely and unambiguously independent of the firm’s management.  Because they all know each other.  Either friends or relatives

Small Board  A board with fewer members might be a better board.  Too many cooks spoil the broth.  Most of the researchers are thinking in the same way i.e. Small boards are more effective than large boards.

 In small boards, every individual will think extra responsibility on his/her shoulder and vice versa.  With larger boards, its very difficult to reach consensus and to get anything meaningful done.

Good for a Goose, Good for a Gander?  What is good for a firm must be/must not be good for others.  Young growth-oriented firms would be looking for more insiders, might be the best people to serve the board.  Larger and more diversified firms may need more directors, keeping in mind the scope of its operations.

 So who will take the decision?  The managers- they may be in the best position to pick a good board but his self- interest may get in the way.  The firm’s outside shareholders – they can vote on the board members and having no power in appointing directors directly, unless they could make the majority.

Can Good Boards Lead to Better Firms Performance?  It is not clear that there is a positive correlation between board quality and firm performance.  Boards may be effectively reactive and may not be effectively proactive (value creator).

 It depends either insider or outsider. ◦ E.g. Committee that determine CEO compensation and are responsible for the firm’s audit may best be served by outsider ◦ But committee that make firm financing and long- term investment decisions may be served best by insider.

Potential Problems With Today’s Board.  One of the main functions of the board is to evaluate top management, especially the CEO. However, for many firms, the board’s chairman is also the firm’s CEO.  Most of the outsiders have some personal tie to the CEO.

 The directors (commonly the outsiders) do not have a significant vested interest in the firm, holding little or no stock.  Are directors capable of providing the time and expertise required to fully understand the major operating and financial decision of the firm? Most directors have their own highly demanding full-time jobs. So how to cope with?

 Some directors simply don’t have the expertise to be a board member.  Some boards are simply large and difficult to actively involve them.  Some directors might not be truly independent, they might be too busy.

 Summary ◦ A BoDs is a body of elected or appointed members who jointly oversee the activities of a company. ◦ BoDs are appointed at the public Annual General Meeting of shareholders. ◦ Types of board are depending upon company status as well as the territory where the company prevails. ◦ Normally, we can see One-Tier board in common law based societies (like US and UK) and Two-Tier board in civil law based societies (like Germany etc).

 BoDs functions involve to hire, evaluate or even fire the top management, to vote in support or against of major proposals as well as financial decisions.  In short, BoDs main primary function is to safeguard the shareholder’s interest.  But the most important factor is to think a lot before selecting your board

◦ Overview of the Board  Board legal duties  May not be the federal law requirement but the state wants BoDs.  Firms profitability and increase in share value  Loyal and fair  Take care of the rule of ethics  Employment practices  Human rights  Environment regulations  Corruptions  Moral obligations

 Board Committees ◦ An Executive Committee ◦ A Finance Committee ◦ A Public Relation Committee  Board Sub Committees ◦ Audit Committee ◦ Compensation Committee ◦ Nomination Committee

◦ More attention on Directors ◦ What is a “Good Board”?  Experienced members  Having different back ground i.e. technical as well as non technical  Independent board-having fraction of non-insider directors (difficult to find unambiguously independent directors)  Small board

 Good for Goose, good for Gander ◦ One form of board may be/may not be good for others. ◦ Small board may be/may not be good for others firms and vice versa. ◦ Can good board lead to better firm performance?  No positive correlation between the board quality and firm performances.  Normally board are reactive, not proactive  Sometimes inside directors are good for board (e.g. infant or new firms or when the firm has to make any huge financial/investment decision) and some times outside directors (e.g. when audit as well as compensation matters are required)

 Some potential problems with today's board ◦ Outside Directors relationship with the top management (e.g. CEO) ◦ Outside directors full motivation is still a question mark for firm’s board. ◦ Inexperienced as well as busy outside directors are fruitless for the board THE END