
The Role of a Board: Appoint, Approve, Audit and Advise
Over the years I have served on a number of boards for public companies, private companies and non-profit organizations. I have asked myself, what role should a board serve? This question can be asked from different points of view: the shareholders, the CEO and the directors. Interestingly, I have found that those viewpoints sometimes diverge. In this article I offer a classification of four roles of the board. In keeping with the provocative nature of these articles, I end with some positions that might be counter to other people’s points of views. To make it more meaningful to our audience, I will highlight items that are more relevant to private, public or non-profit organizations.
Let's start by getting clear on the board's responsibility. The board is a governance body, not an operating body. Management, led by the CEO, is the operating body. The job of a board is to keep bad things from happening. Management is responsible for making sure good things happen. This division of labor is much like the distinction between a President and Prime Minister in parliamentary systems of government. Directors that become zealous on what needs to be done cross the line from governing to operating. Now onto the roles.
1. Appoint
The first and most important job of a board is to appoint the CEO. This is particularly important in public companies and non-profit organizations. In smaller and private companies, the CEO might well be the majority owner and makes this duty of the board perfunctory. The board also appoints all the officers, including the Chairman and the Secretary. In private companies this responsibility of the board might not have any bearing unless the company finds itself in legal issues.
2. Approve
The board must approve three things:
- The guiding documents for operating the company, including the annual operating plan, the long-term strategic plan, the risk management plan, cash investment plan and other guiding documents.
- All “substantial” changes to the balance sheet, where substantial refers to both the magnitude and length of time of commitments.
- All changes to the capital structure of the company, including debt, equity and disbursement of dividends.
To cite examples for illustration, the board should approve the compensation philosophy of the company, large capital expenditures, long lease contracts, all loans and any receipt or disbursement of capital. Note that approval of these items is not with an intent to serve in an operating role, but rather to keep management from doing something that might harm the balance sheet.
3. Audit
Clearly, the board is responsible for auditing the financial accounts or ensuring that qualified experts are appointed to audit the accounts. The board indicates its fulfillment of that duty by approving the financial statements that are released to the shareholders. In public and non-profit organizations, appointing certified auditors discharges this duty. In smaller companies with concentrated ownership, management might choose to conduct this activity internally and provide that information to the board. In such cases, the board has a responsibility to ensure that adequate oversight of the reported financials is exercised.
Of particular note, specifically in private companies, is the audit of the cash accounts to ensure that the liquidity of the company is within the guidelines established by the board. The board does not audit just the financial statements. The board also audits whether management is operating within the parameters of the guiding documents. As such, the board reviews management’s performance against their operating plan and the strategic plan. This audit function is a significant piece of the board’s role. This is where the board upholds its governance.
4. Advise
This is a broad catchall category. Whereas the management has to abide by the board’s instructions in the three other roles described above, this role is distinguished by the caveat that management can take the board’s advice as just that – advice. The value of this role is significantly impacted by the relationship between the CEO and the board, as well as the experience and background of the directors. A well-functioning board with a tight relationship with the CEO can have a significant impact here.
Now to the pitfalls. Many directors want to contribute to the development of the strategy of the company. There is no problem with that as long as the contribution is merely advice. But when it becomes a directive, the board has stepped into an operating role. Development of the organic strategy of the company is the responsibility of management. However, the board does have a role in strategy as described in our September 2008 Food for Thought (Should the Board Get Involved in Strategic Planning?).
Directors often rely solely on the input provided by the CEO. Other executives do provide reports during the board meetings. But they are likely scrutinized by the CEO. In our June 2007 article (Three’s a Crowd: When CEOs Need to Bow out of a Conversation), we point out the value of directors having direct contact with the executives.
Finally, to whom does the board answer? This question is ever more present in public companies, where the shareholders have little say in nominating directors in the proxy. In our July 2009 article (Dissatisfied Shareholders – What Recourse Do They Have?) we offer a provocative idea of ensuring contested elections for public company boards. Both private and public company boards suffer the problem of becoming complacent and accepting of management’s performance. To keep the board’s feet to the fire we offer an idea in our May 2008 article (Can Your Board Face Warren Buffet?) that might give pause to some directors.
Private companies with concentrated ownership often operate without a board. Is that prudent? If there is a single owner, the company can be viewed as a sole proprietorship for all but legal purposes. However, if there are multiple owners, you are always well advised to have a formal board. That could well be the topic of a future article.
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