Question

a. An employee, Fred, working in the accounts office of a medium-sized company listed on the Nairobi Stock Exchange, was working late one evening during the week. He realized he had left his pen in the boardroom at an earlier meeting and, given its value, went upstairs to look for it. As he approached the door he heard the following discussion:
‘Chief Executive: I am deeply concerned that if this fall in profit figures is disclosed in the next annual report, there will be sorts of problems with the shareholders. We may even lose a number of big investors.
Non-executive director (also the cousin of the Chief Executive): (large sign) well, I suppose we could always find a way of making them look better.
Chief Executive: How? I can’t see it at all.
Non-executive director: Well, we could make them just slightly higher than last year’s figures by including the proceeds of sales of our toothbrush division.
Chief Executive: But the sale doesn’t go through until October.
Non executive director: No, but it will…….and it doesn’t make much difference we need the money on the books now.
Chief Executive: But when the accounts are signed off, won’t that be fraudulent?
Non-Executive director: Not really ……. I don’t see why ….. It’s just a manipulation of timing rather than numbers.
Chief Executive: Ok. That sounds good to me. Let’s sort it out now.’
Fred heard one of them move towards the door, and quickly slipped back to the stairs. He left work and spent the evening worrying about what he should do, if anything. He decided he would anonymously ask the Company Secretary how he could deal with this situation, and bring the issue out into the open.
As Company Secretary you receive a report from the employee about the overheard conversation. Write a brief summary for board members of the corporate governance problems raised by this employee, and the weakness in the company’s corporate governance which are evident from the conversation which was overheard.
b. Outline the main features of a two-tier board structure.

c. Advise the board on how these challenges can be addressed to improve board performance.

Answer 1

Answer A

Brief Summary for Board Members of the corporate governance problems raised by anonymous employee and the weakness in the company's corporate governance :

For the attention of all Board Members -
This is to highlight one of the corporate governance issue raised by one of our employees (Indentity is not disclosed), who heard off Chief executive and Non executive Director (who is also the cousin of Chief Executive) converstaion over manipulating accounts. Chief executive was concerned of fall in profit figures which is to be disclosed in next annual report, since it may lead to sorts of problems with the shareholders and company may even lose a number of big investors.Non executive Director suggested to increase profit figures just slightly higher than last year's profit figures by including the proceeds of sales of company's toothbrush division which doesn't go through untill october, he called this a manipulation of timing rather than numbers and Chief executive gave his consent for the same. It is completely evident through this overheard conversation that there is weakness in the company's corporate governance, problems like conflict of interest, oversight issues, accountability issue, transparency and Ethics violation.

Answer B

Main features of a two-tier board structure :
Composition and Supervision - In this structure, one board is appointed to oversee routine managerial tasks and transactions while a separate, independent board handles the long-term strategic planning and decision-making. The latter, the “supervisory board”, oversees the former, the “management board”.
The supervisory board—often appointed by shareholders—is commonly made of experts working outside of the company it serves. In some cases, a few employee representatives are appointed to the board to improve communications between tiers and provide insider insights. The management or “executive” board is commonly comprised of the company’s senior-level employees—often appointed by the supervisory board. Under a two-tiered structure, the CEO typically chairs of the management board, but is prohibited from serving on the supervisory board.

Cooperation and effective Communication - The Management board has to closely cooperate with the Supervisory board to develop the business strategy, this is done by creating a steady flow of information between the two. The information flow would include risk management, business development and any differences of the development of the business compared to the initial plan. Open discussions between members of the boards are also key to the functionality of the business under a Dual Board management system, because these must exchange information frequently.

Segregation of Roles - In a one-tier or unitary board of management there is no clear separation of duties as both the executive and non-executive directors sit on the same board. While in a two-tier board, two different boards are present, with one clearly responsible for undertaking management roles and the other for the purposes of check and balance and policy making.

Decision Making - The process of decision-making in a unitary board is faster because all the decisions are made and approved by a single board. Whereas, decisions made by the management board in a two-tier system have to be approved by the supervisory board for implementation which, therefore, can take time. This delay can prolong if the management and supervisory board disagree on a certain agenda.

Stakeholder Indulgence - The composition of unitary board of directors does not allow for different kinds of stakeholder representation. This is because a single board cannot accommodate a large number of directors and therefore non-executive directors are the only independent input in a unitary board. However, in a two-tier system, as the management board and supervisory boards are different, it provides a chance to add representatives of more stakeholders especially representatives of employees.

Answer C

Advising the board on improving board performance -
1. Implementing two-tier board structure - As evident from answer 2

2. Increase Diversity - Corporate boards suffer from a serious lack of diversity. In 2008, the board composition of Fortune 100 companies was approximately 71 percent white men and 29 percent women and minorities. Women make up only 16 percent of the directors of the Fortune 500 companies. This lack of diversity has been pervasive even though there are many studies which show that diversity in the boardroom improves company performance.

3. Appoint Competent Board Members - The Nominating Committee should devote adequate time to identify board members who have the skills and industry knowledge to assist the board. That does not mean that there is only one type of board member who would qualify. There should be a balance between those board members who know the organization, those board members who have a helpful expertise and those that offer a fresh perspective. What is important for a board is that it has a good understanding of what skills it has and those skills it requires. A board candidate should also be evaluated on his or her interpersonal skills since board interactions and relationships will be important to overall board performance. (In this incident Non executive director was cousin of Chief executive was also one of the problem in board constitution)

4. Ensure timely information - Timely information results in better decision-making. Senior management has to provide timely information to ensure proper board supervision and direction. Board members, however, should not be overwhelmed with information. There is a balance which needs to be achieved between necessary information and irrelevant information. Interactions between senior managers and the board are critical to ensuring that adequate information is provided to the board. If a board member requests information, senior managers must respond promptly to the request.

6. Evaluate Board performance - Boards must be willing to examine their own strengths and weaknesses. On a regular basis, the board should conduct a self-evaluation process, including the performance of individual directors. The evaluation process should be used to identify weaknesses in board performance, and adopt reforms needed to improve board performance. The evaluation should be broad, cut across all issues and personnel and include senior management interactions with board members.