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Today there is no doubt that a company's operational and financial performance are significantly optimized by the efficacy of its Board of Directors. This has been consistently validated through my 20+ years working with and advising boards and is supported by numerous studies published in peer-reviewed journals. The concept of a Board of Directors, which first emerged in the early 20th century, was founded to represent the shareholders of the company in carrying the compass to direct the company in its business journey. The board carries the responsibility for its decisions to all stakeholders, playing a critical role in promoting corporate governance and the resilience of the company. For this to occur, the board must be conscious of its obligations. Unfortunately, few directors have the awareness and the willingness to grasp this notion. In this article, I illustrate the analogy of the company brain.
In the wake of the global financial crisis, there has been a substantial proliferation in the corporate governance dialogue around the world. This has become a central focus following the crisis, particularly due to the financial upheavals that affected developed economies and the corporate ruins that underscored serious governance flaws. The significance of good governance was accentuated by events such as the collapse of Lehman Brothers and scandals involving major corporations like Enron. A notable issue has been ill boards that led to lack of transparency and manipulation of financial statements, glitches that were not widely anticipated in developed economies until recent years. Experts argue that strengthening corporate governance boosts shareholder confidence in the oversight exercised by company boards. Even prior to the crisis, scholars acknowledged the impact of good governance and the paramount role of the Board of Directors in enhancing the company's value and enriching shareholder wealth.
First, let’s agree on what corporate governance truly means. It is defined in various ways, but one of the simplest, yet most powerful, and widely accepted definitions was introduced by Sir Adrian Cadbury, who described it as “the system by which companies are directed and controlled”. So, three words; system, direction, and control. The OECD later provided a complementary definition, describing governance as the relationship and interaction between three-line segments of a triangle; the shareholders, the board, and the management of a company.
Corporate governance is regarded as indispensable in the modern business landscape, as it enables the realization of corporate objectives, safeguards shareholder rights, and ensures compliance with internal company policies and regulatory requirements. Strong governance frameworks are widely believed to boost investor confidence, providing shareholders with assurance that their investments are protected through sound governance systems, I often call it the investor seatbelt. In any organizational setting, be it medium or large in size, family-owned or corporate, effective governance is seen as a key driver of sustainability, growth, and profitability.
The growing prominence of governance, both nationally and internationally, is driven by the evolving competitive landscape of global business. A robust corporate governance framework is essential to ensure that management, under the board oversight, acts in the best interests of the company and its shareholders. When suitably implemented, such a framework can improve access to capital and lead to optimized decision-making processes.
This framework follows a methodology that is internationally recognized and adopted globally by institutional investors and major development financial institutions. It is designed to ensure a company's sustainability and long-term success by fostering transparency, accountability, and effectual oversight. It underlines six parameters.
A strong ‘commitment to governance’, with clear policies that address the pledge from the shareholders, board of directors, and management to instill good governance practices.
The ‘board of directors’ plays the pivotal role in this framework and is comprised of competent directors with a diversity of skills and adequately structured to oversee the strategy, management, and performance of the company.
The ‘internal controls’ where internal audit, risk, and compliance functions are robust to ensure the effectiveness of operations, accuracy in reporting, and compliance with policies, procedures, laws, and regulations.
‘Disclosure and transparency’ are integral, ensuring both financial and non-financial information are relevant, faithful, and timely represent material events to shareholders.
‘Equitable shareholder practices’ where all shareholders are treated evenly, minority shareholders’ rights are not abused, and in the case of a family-owned business, family policies are followed to safeguard the sustainability of the business for future generations.
‘Stakeholder engagement’ mechanisms are in place to address inquiries and grievances, fostering open communication and reinforcing trust within impacted communities. Together, these parameters construct a governance system that promotes sustainability, growth, and shareholder confidence.
Now let’s dive into the analogy of the brain. The human brain sits at the top of the human body and functions by receiving input from the five senses - sight, sound, touch, taste, and smell. It processes this information and then makes a decision, sending signals to the appropriate body part for action. Simple decisions, such as standing, sitting, or breathing, are processed in nanoseconds, while more complex decisions, like changing jobs or buying a new house, require extended processing time, often taking days, weeks, or months to reach a decision. The brain does not directly execute actions; instead, it monitors the performance of the body's organs. If an organ encounters issues, such as impaired vision, the brain does not intervene directly and performs the eyes’ job but instead determines that the body should seek professional help, such as visiting an optometrist.
In a business context, the board serves as the brain of the company, positioned at the top of the hierarchy to receive information, directors meet together to deliberate and scrutinize, and then make decisions that are to be executed by the company organs. Like the human brain, the company brain (the board) holds ultimate authority, with the power to request and access any data or information needed. The board is responsible for directing the company, setting its strategy, providing stewardship, oversight, and control, ensuring proper transparency and disclosure, and safeguarding shareholder rights. Hence the board is fundamental in overseeing the other five attributes of governance mentioned above, it plays a principal role in governing the company and impacting its performance, exactly mimicking the human brain that governs the functions of the body.
The board plays the medium conduit between shareholders and management. At the top of any corporate structure, the efficacy of the board is critical in ensuring that good corporate governance practices are in place, its primary obligation is to provide strategic direction while overseeing management performance.
Investors are more drawn to organizations that prioritize corporate governance and embrace best practices that surpass legal and regulatory requirements. Corporate boards wield the authority to make key decisions, and from an econometric standpoint, they alone can function as an effectual measure of good governance. More specifically, the independence of the board serves as a strong indicator of the overall quality of governance owing to the board’s roles in stewardship and oversight. Corporate governance became indispensable for amplifying corporate performance, especially as companies expand and confront increasing complexity. Elevated standards of corporate governance empower boards of directors to optimize company operations and compete on a global scale. Companies with feeble compliance and incompetent boards have encountered substantial challenges, often resulting in their collapse. A well-structured and proficient board of directors is pivotal for ameliorating company performance, it functions as a mechanism to harmonize shareholder interests with those of the organization.
By: Dr. Yehia El Husseiny , Assistant Professor, Free-lance Corporate Governance and Compliance Adviser & Coach
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