Corporate Governance vs. Management – Who is Keeping Score?

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Annual board of directors meeting season is just beginning for companies on a calendar year basis.  Some companies took the opportunity to look at how they do business.  Many small companies have what is referred to as their OPERATIONAL PLANS.  As it definition states, this is how they “operate” their daily business working IN their company as a W-2 employee. Congratulations, that is a good start but it is not a good finish unless you just wanted to create a job for yourself and others? If not then you need to work ON your company.  In fact, working ON your business is just as important because you want more than income, you also want profit and equity [“ROE”] which are the results of ownership work – not just employee work.

The biggest mistake you will make this year is equating working IN your company with working ON your company, according to the well-known author Michael Gerber of the book The E-Myth Revisited.  He states that P&Ls and tax data are static because they look backwards – not forward. Ownership work gets beyond Income only and into Profit and Equity [ROE] strategy. And isn’t that why you went into business in the first place – to go beyond income?  You simply can’t be effective long-term until you integrate what you do IN with what you do ON your company. So stepping back and doing some critical decision-making is the key. But that raises the question of who does it and how to do it?

So let’s answer the first question of who is responsible for governance?  In a corporation the board of directors sole job is to “govern” the company.  So HOW does a board “govern”?  The answer lies first in defining the difference between management and governance.  Most people have a good idea of what management is so I will restrict my remarks to governance issues.  Some top 10 good governance director practices are the following:

1.            Strategic Planning addressing sustainability, competitive advantage, etc.

2.            Corporate performance and valuation planning

3.            Risk and Crisis Oversight [e.g. data security]

4.            Oversight of company core principles, ethics and culture

5.            Oversight of human resources [e.g. management] and recruitment of directors

6.            Financial Oversight [e.g. review of P&L, Balance Sheet and Budgets]

7.            Oversight of sustainability matters and stakeholder relations

8.            Create/approve company-wide policies and procedures.

9.            Manage Board of Directors education, meeting processes, committees, etc.

10.             Oversight of corporate social responsibility

I recommend that these key governance issues be addressed by your directors.  (See also NACD Directorship Board Intelligence, survey report dtd 1/2011, p. 40).  Managers manage the company.  Directors govern [direct] managers. They are both important but very different.  The Massachusetts Business Corporation Act [“MBCA”], Section 8.30(a) defines the standard a director must comply with.  It states, in pertinent part, that a director must, generally speaking, act (i) in good faith, (ii) with the care that a person in a like position would reasonably believe appropriate under similar circumstances; and (iii) in a manner the director reasonably believes to be in the best interest of the corporation.

So how does a director comply with this legal standard?  The comment section to Section 8.3 provides advice by stating: “The process by which a director informs himself will vary but the duty of care requires every director to take steps to become informed about the background facts and circumstances before taking action on the matter at hand.   [However], a director may rely on information, opinions, reports, and statements prepared or presented by others as set forth in Section 8.30(b).”

So who are these “others” referred to?  Section 8.30(b) lists the individuals and groups (the “others”) that a director may rely on.  Generally speaking, they are as follows: (i) corporate officers or employees whom the director reasonably believes to be reliable and competent with respect to the information, opinions, reports or statements presented, (ii) professional advisors as to matters within their professional competence, and (iii) a committee of the board, where the director is not a member, if the director reasonably believes the committee merits confidence.

But there are two major caveats.  The first is that “a director so relying must be without knowledge concerning the matter in question that would cause his reliance to be unwarranted”.  The second is that “. . . in order to rely on a report, statement, opinion, or other matter, the director must have read the report or statement in question, or have taken other steps to become familiar with its contents.”

In summation, directors must become actively engaged in the governance of the company or else they should resign.  So take a look at the recommendations above and ask yourself “is your board living up to the legal standards of the laws in your state”?  If not, your company is at increased risk.  Haven’t started yet to address the governance issues of your company? I suggest you do so before a third-party discovers you are running a high risk business – and that high risk is your decision-making – or lack thereof!

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