Getting it right: directors' responsibilities

IT was the mid-1990s. I had spent my whole professional career as a university academic.

IT was the mid-1990s. I had spent my whole professional career as a university academic.

Even though I had been on a number of government boards, I had never given any thought to becoming a company director.

One of my university colleagues and I were invited to have lunch downtown with the chairman and managing director of a large listed company. Dressed in our best attire -- academics are not known for their sartorial elegance -- we had a very pleasant time, discussing economic and political events.

Standing outside the building after lunch, my colleague and I openly questioned what that had all been about. As it turned out, the chairman rang me several days later to invite me to join the board.

In typical academic fashion, I assembled every book and article I could lay my hands on, to understand more about the role of a company director. What are the duties? What are the responsibilities? What are the advantages? What are the disadvantages? What did I need to find out before I accepted?

This furious research may have done me some good, but as is the case with many things, nothing beats on-the-job experience. The view from the boardroom is never fully reflected in academic texts.

After many years now as a company director, I think I am well-placed to have a crack at answering the question: what do the boards of listed companies really do?

I know this may seem a strange question. Surely, the roles and responsibilities of directors of company boards are set out in company law and in the ASX listing rules.

Of course, directors do by and large meet their legal obligations, not least because they fear legal action if they do not. But I am posing a different question: about the modus operandi of company boards, how they operate as collectives and where they focus their efforts.

Rather than concentrate on the bad news stories about companies collapsing or directors failing in their duties, I want to highlight the much more common cases, where boards operate successfully and the directors fulfil their roles diligently and with due care, to the benefit of the company and the shareholders.

For avid readers of the business section of newspapers, it must be easy to develop a distorted view of boards and their workings, as bad news dominates the headlines and article upon article is written about HIH, James Hardie, Babcock & Brown, ABC Learning and the like.

Much less is written about successful boards and successful companies; not necessarily spectacularly successful companies -- many of those are the equivalent of shooting stars -- but boards of companies that deliver solid returns to their owners, the shareholders, over long periods of time.

The theory of company boards is reasonably straightforward: directors are agents for the shareholders -- the principals who own the company. It would not be practical for shareholders to make clear to management their preferences on every issue, so directors act as a go-between for the shareholders, on the one hand, and management, on the other.

Without a board of directors to appoint senior managers and then oversee their actions and behaviour more generally, the alignment of shareholders' interests with those of management would be left to chance. In many instances, managers would subordinate the interests of the shareholders, preferring to act in their own self-interest.

So what do company boards really do? A common view is that the most important single action of a board is to appoint the chief executive. There is certainly a very large element of truth to this view.

And by the same token, a board will terminate the services of a chief executive if it considers that in the best interests of the shareholders.

Boards are often criticised for their selection of chief executives, and then for sacking them.

From the outside, it may seem like an easy process, but in practice a board can only choose from the list of available candidates, which in turn is conditioned by the price the board is prepared to pay. And, yes, some potential candidates will not be considered because their price tag is just too high.

Until recently, it was relatively difficult to attract US-based executives because of the substantial sums that person would be leaving on the table in share options.

Even by following agreed procedures and using the nomination committee to establish essential and desirable criteria for a new chief executive, mismatching can occur.

The real suitability and fit of a candidate can never be completely established ex ante.

This is why directors place a great deal of weight on their role in overseeing succession planning within the company; to require that there be suitable replacements for the chief executive and other senior managers.

Depending on the circumstances of the company, many directors will prefer to appoint an internal candidate to the role of chief executive. Not only can the board be confident of the suitability of the appointment, but much less time is wasted because the new chief executive does not need to come up to speed in the way an external appointee does.

The chief executive and his or her (but let's face it, it is generally his) senior management team have chief responsibility for the strategic direction of the company; of establishing business plans consistent with that direction; and of carrying out the actions required to meet the objectives laid out in the plans.

This is not meant to imply that boards are passive in this process. Indeed, off-site strategic discussions involving directors and senior managers are common. The chief executive will be guided by these discussions, as well as ongoing debate and examination of strategic matters that occur during more routine board meetings. It is then the role of the board to sign off on the strategic direction, as fleshed out by the chief executive and senior management, as well as confirm business plans and annual budgets.

By and large, this process is an interactive one. Questions are posed, answers given, revisions are often made. It is often useful for one director to play the devil's advocate by pointing out the pitfalls of the proposed strategy and asking a number of what-if questions.

In this way, management can be truly challenged and be required to articulate convincingly the rationale behind the proposed strategy and specific actions, including capital expenditure and possible transactions. Sensitivity analysis is essential. The outcomes for the company need to be modelled using various assumptions about the key parameters.

Even so, results are not always as anticipated because many aspects of business are inherently risky. The presumed context may not pan out; the anticipated behaviour of competitors may not meet expectations; the customers may be underwhelmed; the credit cycle may turn; a volcano may blow up. Any number of events can conspire to render the predicted outcomes unachieved and unachievable.

This is not necessarily a criticism of the board, but it is where its important role in risk management comes in. If there is one question that all directors must be able to answer about their companies, it is this: what are the three main risks this company faces and what actions are being taken to mitigate those risks?

By and large, board processes are informal. Rather than mimicking outmoded meeting procedures -- motions being put, seconded, formal voting and the like -- board meetings are typically free-flowing, albeit subject to the discipline of the agenda and expected outcomes.

What if there is a seemingly intractable disagreement among board members? In my experience, this type of situation is typically managed in a consensual way.

Take the case of one director who cannot agree with others on a particular proposal. The director will typically disclose the strength of his or her opposition -- whether or not it is a die-in-a-ditch matter.

Where it is of very considerable importance to the director, it is not uncommon for the proposal to be dropped because board harmony is more valuable than acceptance of a proposal without unanimous support.

If the director is happy to let the resolution pass, notwithstanding some reservations, the principle of cabinet solidarity is invoked and the proposal receives full board support from that moment.

A high-functioning board is one that both welcomes dissent, as well as working towards resolution in a constructive way. Of course, sweetness and light does not always prevail. A forceful and charismatic chief executive can create problems, making it difficult for directors to stand their ground.

That is why the personality traits of directors, including the chairman, are important. Intelligent, independent, courageous, considerate and collegial -- these are very important characteristics of good directors.

In the first of a five-part series, academic and company director Judith Sloan provides a personal insight into the role of non-executive directors and company boards.

ON MONDAY: What makes a great company director?

Judith Sloan is an economist and company director. In 1994, she was appointed to the board of Santos and has sat on a number of company boards since then. She currently sits on the board of Westfield Group. She has also sat on a number of government boards, including the Australian Broadcasting Corporation. She has been a member of the Productivity Commission and the Australian Fair Pay Commission.