The board of directors for a corporation has the responsibility to:
1. Institute corporate values and corporate governance mechanisms that will ensure business is conducted in a proficient, ethical, and fair manner.
2. Ensure that the firm meets and complies with all legal and regulatory requirements in a timely manner.
3. Create long-term strategic objectives for the company that are consistent with the shareholders' best interests.
4. Determine management's responsibilities and how managers will be held accountable. Performance should be measured in all areas of a company's operations.
5. Hire, appropriately compensate, and regularly evaluate the performance of the chief executive officer.
6. Require management to supply the board with complete and accurate information in order for the board to make decisions for which it is responsible and adequately monitor company management.
7. Meet regularly to conduct its normal business, and attend extraordinary sessions when necessary.
8. Ensure board members are adequately trained to perform board functions.
In order to determine the effectiveness of the board of directors, investors or investment analyst must assess:
1. The composition of the board of directors and whether or not directors are independent. In order to assure the directors are serving shareholders, global best practice recommends that at least three-quarters of board members should be independent.
2. Whether the board has an independent chairman. Many companies have a single individual serve the dual role of CEO and chairman of the board. Some arguments support the dual role as providing the board with in-depth knowledge and experience regarding company strategy and operations. However, others claim that having the CEO chairing board meetings allows the CEO to control the board's agenda and diminishes the role of independent board members, particularly when determining management compensation. For the exam, remember that having the CEO and Chairman as separate positions is considered a strong corporate governance practice.
3. Qualifications of directors. Corporate governance best practice is for board members to have the requisite industry, strategic planning, and risk management knowledge, not serve on more than two or three boards, and show a commitment to investor interests and ethical management and investing principles.
4. How the board is elected. Strong corporate governance practice says that staggered elections limits the power of shareholders and doesn't allow changes to the board composition to occur quickly. Annual elections force directors to make more careful decisions and be more attentive to shareholders because they can cast a vote to keep or eliminate a director each year.
5. Board self-assessment practices. Boards should evaluate and assess their effectiveness at least annually. The focus of the self assessment should be on member participation, committee activities, and future needs of the board.
6. Frequency of separate sessions for independent directors. Best practice requires independent board members to meet at least annually, preferably quarterly, in separate sessions without management in attendance.
7. Audit committee and audit oversight. Best practice mandates that the audit committee consists only of independent directors, has expertise in financial and accounting matters, has full access to and the cooperation of management, and meets with auditors at least once annually.
8. Nominating committee. The nominating committee is responsible for establishing criteria for identifying and evaluating candidates for the board of directors as well senior management. Corporate governance best practice requires that the nominating committee consist only of independent directors.
9. Compensation committee and the compensation awarded to management. A common industry practice that is considered poor corporate governance is to use the salary at other companies as a reference point rather than on company performance. Another poor practice is the repricing of stock options, which allows management to recoup losses after stock price decline. Best practice would have base salary and perquisites as a small percentage of compensation, with bonuses, stock options, and grants of restricted stock awarded for exceeding performance goals making up the majority of the senior manager's income.
10. Use of independent or expert legal counsel. A common practice is for internal corporate counsel to advise the board of directors, but this is considered weak governance, because of the potential for conflict of interest. Corporate governance best practice is for the board to use independent, outside counsel whenever legal counsel is required.
11. Statement of governance policies. Statements provided in shareholder materials about corporate governance policies, and how those policies change over time, can be a great tool for analysts and investors in evaluating a firm's corporate governance system.
12. Disclosure and transparency. In general, best practice supports the conclusion that more disclosure is better. The company should provide information about organization structure, corporate strategy, insider transactions, compensation policies, and changes to governance structures.
13. Insider or related party transactions. Best practice for any related party transaction is to have the transaction approved by the board of directors.
14. Responsiveness to shareholder proxy votes.