Does company board meet your expectations?

In corporate governance theory, the consensus is that it affects shareholder value. This means that shareholders in firms with efficient corporate governance systems should be happier than those without because their investments are protected against potential waste by management.

At the Nairobi Securities Exchange, there are corporate governance issues, the latest being the directorship and management issues at National Bank of Kenya. Corporate governance is about the law, rules, and procedures put in place to power a company’s operations and shape the decisions made by managers.

It aligns the interests of managers with those of shareholders. Corporate governance system attempts to provide incentives for taking the right actions, and punishments for taking the wrong actions - the carrot and the stick.

The news at the NSE suggests that while some board members are doing well, others are failing their shareholders. Poor corporate governance means poor protection of shareholders’ stake and interests such as employees, customers and suppliers.

Brigham, Ehrhardt and Fox tell us that at the centre of corporate governance are five key characteristics that ensure shareholders get good returns on their investment.

These characteristics can be indexed into a corporate governance score. Unfortunately, we are yet to reach this stage and uncertain about corporate governance scores at NSE.

The first and high ranked characteristic is monitoring and discipline by the board; followed by the rules and laws on hostile takeovers; third are compensation plans; fourth is capital structure choices; and fifth is the accounting control systems.

The effectiveness of the characteristics depends on the strength of the board. What board structure translates to effective corporate governance? The research results suggest key board characteristics summarised by Brigham, Ehrhardt and Fox: that the CEO is not the board chair and does not have undue influence over the nominating committee, and that the board has a majority of true outsiders who bring some type of business expertise to it.

The board is not interlocked and not too large; and that members are compensated fittingly, not too high, and some compensation is linked to company’s performance.

Disappoint shareholders

Boards devoid of these characteristics will disappoint shareholders. It is time regulators move to a higher level of disclosure that requires listed firms to report a board index score and corporate governance score. Such score will enable current and potential investors to rank companies in terms of board and corporate governance performance. Berk and DeMazro report that the proportion of outside directors, board independence, is foremost when firing CEOs and making disinvestment and acquisitions.

However, they point out that the link between company performance and board independence is not clear.

Some researchers conclude that board independence does not lead to better performance. However, this could be because it is difficult measuring board independence in a meaningful way to link it to company performance. It could also be explained in terms of tenuous characteristic inherent in an independent director associated with sitting on multiple boards.

The whole idea of independent directors is noble, but do they have time to prepare adequately for their advisory and monitoring roles? Do they come to add value to the company?

Less talked about is the capacity of a board to trade off her advisory role against monitoring or control role. Boards that over advice managements are not likely to be effective in controlling managers because it is difficult separating them from management. Compensation to the board of director and top management is becoming an issue at NSE.

The feeling is that top managements are ‘over compensated’. The premise is that incentive-based compensation encourage managers to take actions that add value to shareholders.

The rational practice would then to link pay to performance; which means adopting stock and option based compensation. However, it is up to the board to prove there is no overcompensation. The problem is how to determine the optimum stock and option based compensation that induces the desired managerial performance. This means more hard work on compensation.

-The writer teaches at the University of Nairobi