Profit Through Ethics on Board effectiveness

Has your business adopted appropriate policies and practices to ensure that its board is effective?

Not applicable 2 minute read

While founded in 2003, for all intents and purposes Profit Through Ethics Ltd (‘PTE’) remains a start-up. The founder, Michael Solomon, is currently the sole director and we consider the company not to have a board, and thus answer NOT APPLICABLE to this question.

As sole director, Michael has been responsible for all aspects of the business and its operations to date, including for its values and culture. To ensure that the company is effective, Michael takes third party advice from professionals although decision-making remains, as it must, his sole responsibility. One of the company's key advisers, Malcolm Bacchus, a chartered accountant, assists Michael with various matters; operational and financial issues in particular. The company also calls on legal, branding, marketing and other advisers as required.

We keep under review the need to create a Board and appoint members, as the company moves into profitability. If this is the case, members will be chosen to augment Michael’s skills and experiences.  
As a start-up, we aim to disrupt markets with new products and services and to scale rapidly. Despite the considerable difficulty of creating and launching a transparency and accountability initiative for business, PTE continues to attract clients, partners and investors and, as a result, develop and improve Responsible 100 (‘R100’). We are accountable to these key stakeholders in particular.

PTE holds strong views on the values, roles and purposes of business, which have shaped the creation, management and development of R100. They also shape our approach to company governance.

We believe that, in an increasingly volatile and uncertain world, it is essential that businesses understand, manifest, and clearly articulate their values. To be effective over the long term, the leadership of a business must deliver financial sustainability and ideally achieve growth; it must also define and inculcate its culture and values. Never before have businesses needed to assure their stakeholders what it is they stand for and what it is people can expect of them in challenging times. Businesses cannot do this without the necessary belief and conviction of everyone in the organisation nor without leadership, vision and courage from the top. Strong culture and effective management go hand in hand.

R100 enables businesses to set out their values and demonstrate how they are manifest in the policies and practices they pursue. For example, PTE uses its profile page on R100 to set out its core values: openness, honesty, accountability, fairness, innovation and contribution. We also set out one of our objectives to help create a ‘race to the top’, where businesses are able to compete on the ambition and impact of their social and environmental innovations as well as on the price and quality of their products and services.

The recurrence of major business scandals contributed to or caused by a failure of governance suggests that establishing and maintaining effective boards remains a challenging issue for businesses and organisations. The collapse of Enron (2001) and Lehman Brothers (2008) are oft cited examples, as are the collapse of Northern Rock plc, the near collapse of HBOS, RBS, and the Co-op Bank and, more recently the VW’s vehicle emissions scandal which may cost VW in excess of US$50 billion to resolve. Finally, the recent various FIFA scandals also provide clear reminders that governance failures can contribute to massive losses for shareholders and stakeholders, and give rise to fundamental questions on the license to operate and the validity of the business model. A weak or dysfunctional board poses a significant threat to the ongoing success of a business and no business is likely to succeed or thrive for any length of time without an effective board.

Sound corporate governance, the systems and processes by which a business is managed, controlled and led, is critical to achieving and maintaining success, commercial or otherwise.

Corporate governance is concerned with although not limited to:

  • business values and culture
  • business strategy
  • risk management, internal controls and their oversight
  • board training and evaluation
  • effective leadership including effective delegation and accountability
  • director selection, appointment and succession planning
  • changes in control and adequate protection for shareholders
  • separation of key executive powers
  • scenario planning and disaster recovery
  • communication and engagement with shareholders and stakeholders
  • access to and constructive use of the AGM
  • auditor relationship, independence and appointment
  • consistency of approach, over time and between different jurisdictions
  • executive compensation and use of remuneration consultants

The hallmarks of good governance have expanded as the scope of the world's leading governance code has broadened. The checklist provided by the UK Corporate Governance Code (2014) or other codes such as South Africa's King Code 111 of Corporate Governance Principles (2009) are comprehensive and give a useful governance agenda for companies. The leading codes are revised periodically to ensure they remain fit for purpose and reflect developments in the real world, for example the 2014 revision of the UK Corporate Governance Code gave greater prominence to risk management and risk reporting.

The implementation of codes has to be driven by a combination of each company having the resolve to do so, because it makes good business sense, and shareholders performing a stewardship role to hold the company and its directors to account. This is entrenched in the approach of "comply and explain", which reflects that the codes are not a rigid set of rules but principles which should be applied unless the company explains to shareholders the rationale grounds for not doing so.

Given the long list of corporate and organisational failures, investors, analysts and stakeholders understandably seek assurance that boards have the internal processes required to enable them to ensure that the correct matters are reserved for the board and that the board is appropriately engaged to ensure that those matters are addressed at the right time, with the right information, by the right people. One element of this is ensuring that the composition of the board enables it to avoid "groupthink" and to bring informed insights and challenge to all issues before it.

Effective boards are effective for myriad reasons, most of which are of equal weight. The list is lengthy but includes:

  • clear division of responsibilities at the head of the company between the running of the board and executive responsibilities for running the company
  • a chairman who leads the board and ensures its effectiveness
  • non-executive directors on the board constructively challenging and helping to develop strategy and thereafter assessing its execution
  • the board and its committees having an appropriate balance of skills, experience, independence and knowledge
  • a formal, rigorous and transparent procedure for appointment of new directors
  • directors having sufficient time
  • directors receiving an appropriate tailored induction and thereafter regular updates to refresh skills and knowledge
  • being supplied in a timely manner with information in a form and of a quality which enables them to carry out their duties
  • directors submitting for re-election at regular intervals subject to satisfactory performance formal and rigorous annual evaluation of performance
  • presenting a fair, balanced and understandable assessment of company's position and prospects
  • determining the nature and extent of risks it is willing to take and maintain a sound risk management and internal controls systems
  • remuneration that was designed to promote long term success of the company
  • satisfactory dialogue with shareholders

Boards can be ineffective because of weak leadership by the Chairman/Chairperson ("Chair"). A high-performing board requires a chair to set the tone of governance at the board and across the organisation. This will include setting the board's agenda and ensuring appropriate time is allocated to strategic issues, allowing a culture of openness, meaningful debate, effective contribution from directors and constructive relationships between executives and non-executives. Importantly the chair must ensure that directors receive accurate, timely and clear information. In many of these activities the chair will be assisted by a competent company secretary.

It is also important that the board include an appropriate combination of executive and non-executive directors, with sufficient independent directors who are selected with due regard to the benefits of diversity in combating the chilling impact of group think. Directors must possess an ability to deal with difficult issues, to get to the heart of matters and to communicate with clarity and without rancor. Effective boards are likely to be directly engaged in what happens within the company, how staff are treated and motivated, and what the customer is experiencing at all company touch points, asking the hard questions, challenging assumptions and orthodoxies, and even expressing strong and dissenting views are all appropriate and welcome elements of board member engagement. Frequently, key decisions on issues such as ethics, sustainability and long term risk are taken inside board committees, which in turn need appropriate remits and governance.

The Board

The 'board' is a body of appointed members (directors) who collectively oversee the activities of a company or organisation. The members are usually elected by the shareholders of the company at an annual meeting. The board has the ultimate decision-making authority within the business, apart from powers which are reserved for shareholders such as approval of dividends, annual reports and accounts, political donations and others. Board members usually include the most senior company executives ('executive directors') as well as non-executive directors who may be independent and amongst them will possess complementary skills and experience required by the company. Therefore, not all board members will be directly engaged in the day-to-day operations of the business but the entire board is held liable (under the doctrine of collective responsibility) for the consequences of the company's policies and actions.

An effective board

'Effective' means able to accomplish a purpose, to achieve or produce the intended or expected results through appropriate means consistent with the company's values. Thus an 'effective board' will ensure that governance structures, policies and culture consistently deliver both the short and long-term objectives of the business model.

Corporate governance

'Corporate governance', as defined by the 1992 Cadbury Committee "is the system by which companies are directed and controlled. Boards of directors are responsible for the governance of their companies. The shareholders' role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place. The responsibilities of the board include setting the company's strategic aims, providing the leadership to put them into effect, supervising the management of the business and reporting to shareholders on their stewardship. The board's actions are subject to laws, regulations and the shareholders in general meeting."

Business culture

'Business culture' can be defined as an organisation's values, vision, working style, beliefs and habits. It is a key component in any organisation, impacting the strategic direction of a business and influencing decisions, management and all business functions. It is often characterised as 'the way we do things around here'.

Groupthink

'Groupthink' is a psychological phenomenon that occurs within a group of people in which the desire for harmony or conformity in the group results in an irrational or dysfunctional decision-making outcome.

Answering YES

Small and medium-sized businesses (SMEs) MUST

Describe the policies and practices they pursue to identify and address the risks to board effectiveness

Reveal that at least two members of the board (excluding the Chair) are non-executive independent directors, or explain why this is not the case

Describe the review process for the board

State the aims and/or purpose of the business and describe how the board’s activities support their realisation

Small and medium-sized businesses (SMEs) MAY

State any beliefs or values which influence their approach to corporate governance and culture

Explain how a supportive, inclusive culture is promoted both within the Boardroom and across the company

Explain any further relevant information

Large and Multinational Corporations (MNCs) MUST

Describe the policies and practices they pursue to identify and address the risks to board effectiveness

Explain how and how often a board effectiveness review is carried out by an independent, external consultancy, and to what extent its findings are published or shared, or explain why this is not done

State purpose of the business and describe how the board’s activities support its realisation

Large and Multinational Corporations (MNCs) MAY

State the values, principles and ethics which influence their approach to corporate governance of the board and the company

Explain how a supportive, inclusive culture is promoted both within the Boardroom and across the company

Explain what policies and practices they have in place to facilitate members of their board being able to fully contribute and engage in open, constructive debate, on strategic, risk and other difficult issues

Describe how relevant responsibilities and duties are explained to board members i.e. describe the induction process

Identify the different roles within the board, the chairs and committees, and explain any policies and practices on separating powers

Explain how the company identifies the skills, experience, knowledge and other characteristics for board membership which it deems necessary and how this exercise is applied in relation to recruitment of board members and the chair

Describe how diversity is promoted and groupthink avoided

Explain how members of board committees are appraised to possess appropriate skills and knowledge

Explain what training and development is undertaken by board members

Explain the evaluation process as applied to the board collectively, directors individually and to committee members

Describe information sharing practices and whether board members are able to access independent information

Describe any term limits that may be in place for members and chair positions

Explain any further relevant information

Answering NO

All Businesses MUST

Explain why they do not or cannot answer YES to this question and list any mitigating circumstances or any other reasons that apply

All Businesses MAY

List any practices that are relevant, but not sufficient to answer YES, such as sourcing some goods and services locally, but not as a matter of policy

Mention any future intentions regarding this issue

Explain any further relevant information

Answering NOT APPLICABLE

All Businesses MUST

Confirm that they do not have a company board and explain why not

All Businesses MAY

Disclose according to the guidelines for answering YES, or as close as possible, or otherwise demonstrate equivalent

Mention any future intentions regarding this issue

Explain any further relevant information

DON'T KNOW is not a permissible answer to this question

Version 2

This question has multiple scorecards.

Small and medium-sized enterprises (SMEs)

To receive a score of 'Excellent'

Establishing and maintaining an effective board is a core issue, demonstrated through the adoption of various best practices

Examples of policy and practice which may support the EXCELLENT statement:

  1. Actively builds and supports an ‘open board’ culture
  2. Actively builds and supports mutual respect between directors
  3. Regularly reviews past decisions, particularly those with poor outcomes
  4. Clearly outlines the board-level decision making process and allocation of authority
  5. Explains how an appropriate and healthy balance of executive and non-executive directors on the board is struck
  6. Complies with Section B of UK Corporate Governance Code where applicable and relevant
  7. Promotes importance of diversity of thought across the board
To receive a score of 'Good'

Commitment to the effectiveness of the board is clear and many best practices are successfully pursued

Examples of policy and practice which may support the GOOD statement:

  1. Undertakes appropriate succession planning
  2. Complies with Section B of UK Corporate Governance Code where applicable and relevant
  3. Ensures Directors have sufficient time to undertake their duties
  4. Actively considers the size, style and skills of the board
To receive a score of 'Okay'

The importance of board effectiveness is recognised, as demonstrated through the adoption of some appropriate policies and practices, albeit adopted in an-hoc fashion; OR board effectiveness is irrelevant to business

Examples of policy and practice which may support the OKAY statement:

  1. Describes one or more practices which promote effectiveness of board
  2. Recognises the validity and desirability of the UK Corporate Governance Code
  3. Explains factors which may constrain efforts to improve board effectiveness
  4. Explains why board effectiveness is not relevant to the business
To receive a score of 'Poor'

No compliance with practices associated with board effectiveness and minimal recognition of board effectiveness as a salient issue, OR business acknowledges its performance is below expectations

Examples of policy and practice which may support the POOR statement:

  1. Provides no evidence that board effectiveness is viewed as an important issue
  2. No meaningful statement of future intent
  3. Sub-par performance is recognised

Large and Multinational Corporations (MNCs)

To receive a score of 'Excellent'

A clear commitment to maximising the effectiveness of the board is evident, demonstrated through various examples of innovative practices designed to pursue and improve on transparency, communication and effective decision-making. Recognition that striving for board effectiveness is an ongoing pursuit with NEDs and all other relevant stakeholders fully involved.

Examples of policy and practice which may support the EXCELLENT statement:

  1. Actively builds and supports an ‘open board’ culture
  2. Actively builds and supports mutual respect between Executive Directors and NEDs
  3. Demonstrates that the board listens to and engages with stakeholders
  4. Has a ‘code of practice’ to ensure a minimum standard of external board review is met and potential conflicts of interest are addressed
  5. Meets an appropriate level of transparency in review methodology, recognising that sensitivity around some issues may prevent full public disclosure.
  6. Full cooperation apparent between the company and independent evaluator/reviewer to ensure integrity of review process
  7. Regularly reviews past decisions, particularly those with poor outcomes
  8. Clearly outlines the board-level decision making process and allocation of authority
  9. Ensures at least 50% of the board (not including the Chair) are NEDs
  10. Ensures risk is seen as a key aspect of the decision making process, not just as a standalone compliance issue
  11. Complies fully with Section B of the UK Corporate Governance Code
  12. Facilitates the attendance of external board reviewers at board/committee meetings
  13. Facilitates meetings between the executive committee and external board reviewers
  14. Actively measures progress of action plan following external board reviews
  15. Actively recognises/commentates on board effectiveness (e.g. through the Chairman’s statement in the annual report)
To receive a score of 'Good'

Committed to ensuring effectiveness of the board, as demonstrated through examples of good policies and practices, which are implemented in a considered, strategic manner

Examples of policy and practice which may support the GOOD statement:

  1. Justifies the non-attendance of external board reviewers at board/committee meetings
  2. Justifies rejection of recommendations made by external board reviewers
  3. Develops an appropriate research methodology for external board reviews
  4. Develops an action plan based on recommendations of external board review
  5. Complies with most Section B provisions in the UK Corporate Governance Code
  6. Undertakes appropriate succession planning
To receive a score of 'Okay'

Policies and practices to establish effectiveness of the board pursued on an ad hoc basis; company meets and occasionally surpasses legal minimum requirements; OR board effectiveness is not relevant to the business

Examples of policy and practice which may support the OKAY statement:

  1. Complies with some Section B provisions in the UK Corporate Governance Code
  2. Strategic report contains material which is not obviously relevant or material to shareholders and other stakeholders
  3. Facilitates external board reviews though without a clear strategy for recommendation implementation
  4. Does not have a detailed vision of how risk or profound changes to circumstances are approached
  5. Ensures Directors have sufficient time to undertake their duties
  6. Statements of future intent in regards improving practices
  7. Explains that the company does not have a board and why this is justifiable
To receive a score of 'Poor'

Little to no compliance with best practices, no apparent commitment to board effectiveness OR company admits its performance falls below expectations

Examples of policy and practice which may support the POOR statement:

  1. Provides no evidence that board effectiveness is viewed as an important issue
  2. Sub-par performance is recognised
  3. No statement of future intent in regards improving practices

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