Normally a discussion of corporate boards and governance would focus mostly on structure and established responsibilities for general business oversight. However, the recent financial crisis, the emergence of transitioning countries and globalization of the business environment is generating discussion of corporate governance in terms of ethics. Talking about corporate governance models in Europe and the United States today is a bit like discussing a moving target because of the combination of significant changes going on in the business world. Despite the economic environment changes, there are issues so basic they remain important at any time. Business ethics is one of those, and it’s a topic of importance to both European and American boards.
Understanding Board Structures
In Europe, there are two basic board structures that are called unitary and two-tier. The unitary structure is found in common-law countries like the United Kingdom, Ireland, Spain and Greece. The two tiered structure is used in Germany and Austria. France has a legal board structure that is called “conseil de surveillance” or Supervisory Board. Some countries, including Portugal and Italy, can choose between unitary or two-tiered structures and may have executive and non-executive boards. American companies rely on a unitary structure and all corporate power rests with a single board.
Companies conducting global business need to understand the variations in board structures because corporate governance responsibilities can vary also based on the structure and the country’s laws. Internal governance refers to the Board of Directors and its committees, compensation programs and control systems. External governance refers to the laws, regulations, accounting rules and shareholders. The relationship of all these factors can be complex and ultimately impact corporate performance.
Generally speaking, Europe has been going through a process of deregulation to adapt to the globalization of capital markets. European boards have been moving away from behind-the-scenes governance to a system that is more transparent in order to increase accountability and standardization for the comfort of global investors. The increased transparency is also a product of the economic crisis. In the United States, expanding external governance is the trend as the government attempts to find ways to increase corporate transparency through stricter reporting requirements to prevent the kinds of problems experienced during the recession. These problems included risky investments by corporations that shareholders were not aware of, exorbitant compensation given to managers despite enormous company losses, and a number of ethical lapses such as managers using ‘insider information’ to make investment decisions for personal profit.
One of the main differences between European boards and American boards concerns who exactly the boards should protect. Some boards in Europe may actually include employee representation, work to balance minority shareholder interests against majority shareholder interests and govern issues concerning creditors. American boards are more focused on dealing with issues that arise between internal management and majority shareholders. Employees are not included on boards except in the case of where the Chief Executive Officer (CEO) is also elected Chairman of the Board.
Conflicts of Interest
A Board of Directors is accountable to shareholders under any structure. However, the structure of the boards can lead to conflicts of interest and mostly as related to the relationship between the board and the executive management, and the control of majority shareholders. In single board structures, like that in U.S. companies and the U.K., board members are free to determine management authority and compensation with no oversight, and are not required to include labor representation. In a two-tier system, like in Germany, where there is a Supervisory Board and a Management Board, the board powers are defined by law.
In the two-tier system, monitoring of business functions and business operations are separated. Using Germany as an example again, the Management Board is responsible for operations and the Supervisory Board is responsible for monitoring.
In the U.S., a single board has direct power or power through its control of management for both monitoring and operations. When majority shareholders then sit on the board, it is easy to understand how the misuse of power and control can lead to many of the ethical lapses discovered during the recent economic crisis.
Board Roles and Responsibilities
Though it’s important to recognize and understand the differences between boards when operating globally, there are certain responsibilities that every board assumes. They include defining the company vision, establishing strategic initiatives, ensuring the organizational structure supports the initiatives, delegating authority to management, establishing accountability to shareholders and stakeholders, establishing management compensation and exercising power in an ethical and responsible manner in the interests of the company. Board members are never supposed to act in their own interests and acting ethically means performing roles with integrity, monitoring the integrity of management, promoting company values and preventing corruption and fraud.
Price Waterhouse Coopers did a survey of the SPF 120 (the French stock market index) board directors in France and the directors of 650 top tier companies in 16 European nations. The results are interesting and informative. Approximately 59 percent of SBF 120 directors believed ethics and the financial crisis are linked; yet 46 percent of the directors believed that ethics is management’s responsibility. Thirty-five (35) percent of the SPF 120 directors believed ethics are the responsibility of the board, while 19.5 percent believed ethics are a shared responsibility between management and the board. Ninety-eight percent of the European chairmen and directors surveyed in 16 countries believe that business ethics are meaningful, while 72 percent believe management integrity is of prime importance.
Despite the variety of board structures, there is no perfect one that can prevent ethics violations or outright misuse of power or business assets. Since ethics refers to standards of behavior, there is always responsibility placed on each director, manager and employee to make the right decisions. There are some steps the board can take, though, to improve ethics oversight. First, the board should develop and promote a corporate culture based on core values that promote ethical behavior. The board should also monitor and review incidences of misconduct, fraud or corruption within the organization, and take steps to ensure that policy changes are instituted and enforced as necessary. As the monitoring group, it is the board’s duty to require management reporting on strategies taken to ensure compliance with regulatory guidelines and requirements. The board is also tasked with ensuring that transparency of financial matters and executive decision making is maintained.
The board of directors also has the power to ensure that management performance evaluations and compensation reflect ethical standards. This harkens back to the public and government outcry over CEO’s of large corporations earning multi-millions in compensation during the recession despite heading companies reporting losses. One approach board members have taken is creating a position like an ethics officer or a director who reports to the board as opposed to management - similar to an auditor position. Boards are also creating committees responsible for ethics monitoring.
Management Should Assist the Board
Management can assist the board with understanding their roles in promoting and monitoring business ethics. Regularly reporting to the board on ethics policies, implementation strategies and violations is recommended. Some corporations place ethics reporting on the board agenda once a year, which relegates the topic to an unimportant status. Management can also use a variety of resources to identify areas where ethics violations are most likely and include those areas in the report as a minimum to increase visibility. Strategies include ethical risk mapping and developing whistle blowing systems that protect employees from retribution when reporting ethics violations. It is also up to the manager to keep the board informed of changes needed to the code of ethics as the business expands, gets involved in new activities or changes the way it does business.
In the final analysis, ethics monitoring is a joint responsibility between the Board of Directors and management. Ethics violations and corruption harm corporate reputation, lead to a loss of business contracts, and distort the business operating environment and competitive market. Preventing and detecting ethics violations should be a priority in every business of every size because ethics violations have no limits in the damage it can do to a business.