Boards of directors and conflicts of interest
Thursday, June 21 2012
A major risk that a public or private sector company faces is exposure to conflicts of interest. This is where persons acting for and on behalf of a company can obtain additional benefits for themselves. The risk is that the person may act with bias, seeking personal gain, possibly at the expense of the company. A person in a conflict of interest situation may not necessarily act to the detriment of the company that they represent, but best practice in governance seeks to avoid conflicts of interest or, if they cannot be avoided, to proceed in a transparent manner that is subject to review and accountability.
Since a company is an inanimate object, it cannot act for itself so it must act through people. The three main sets of actors in this regard are the shareholders, the directors and the management. In small companies, it is not unusual that all of these roles are combined. Separation of the roles is required primarily when the shareholders are not in a position to be directors or managers, so they delegate their powers. Examples of this are when the shares are owned by a large number of people, or by the State.
Shareholders appoint directors and delegate powers to them. In larger and state run organisations, directors are normally responsible for defining the companies’ strategies and major policies, and delegate the day to day running of the company to the management. In doing so, they may set limits to the managements’ authority beyond which the managers have to seek the approval of the board of directors.
Shareholders review the performance of the company based on reports prepared by management, who have an interest in showing performance that reflects positively on them. This creates a possible conflict of interest for managers: the shareholders’ need to have the facts versus the management’s desire to appear to have done their job properly.
Best practice over the years has shown that a corporate governance system based on directors who are independent of the management and the day-to-day activities of the company offers the best protection to shareholders and other key stakeholders, such as depositors and policyholders.
Current best practice has also been to move away from the appointment of executive chairmen, so as to keep the roles of policy formulation and execution separate.
The chairman of the board leads the board in its deliberations, and unless delegated with specific authority, does not make or carry out decisions independently from the board. One of the most important functions of the board is the selection of the CEO who leads the implementation of the policies that it has approved. The board then delegates some of its authority to the CEO who, depending on the size of the company, may further delegate authority to subordinate managers.
State-owned companies exist to implement areas of Government policy. Generally, the boards of state companies are comprised of non-executive directors who are responsible for seeing that the Government policy is properly implemented.
Good governance through transparency and accountability in the operations of state boards is even more important as the stakeholders are the national community. Accordingly, it is even more important that directors of state-owned companies avoid conflicts of interest that could lead to situations that put these wider interests at risk.
Non-executive directors should maintain their independence from the day-to-day management of their company.
When a non-executive director interferes in the routine running of a company, he runs the risk of placing himself in situations of conflict of interest, and losing the independence from the management function that he needs to discharge his monitoring responsibilities.
While the director’s actions may not necessarily involve corruption, they could compromise the company’s internal controls by disrupting authority and responsibility systems, thus increasing the susceptibility to corruption.
The governance system may also be disrupted, confidence in the CEO and management by the staff may be lost, and the chain of command broken. When an organisation is large and complex, this does severe damage to the management structure and systems.
Under this and previous administrations there have been reports about directors and chairmen in state corporations who either do not understand their roles, or refuse to accept the limitations of their roles.
The results in some cases are state companies that become dysfunctional, inefficient and do not meet the objectives for which they were established. Transparency International considers strong corporate governance systems a vital component of company efforts to reinforce the right incentives and practices and to address the corrupt practices they confront. As empirical evidence has shown, without good corporate governance systems in place, the overall impact of anti-corruption initiatives is reduced and the growth of companies (and the countries where they operate) is undermined.
This article was contributed by the Trinidad and Tobago Transparency Institute
The views expressed in this column are not necessarily those of Guardian Life of the Caribbean Limited