Who guards the guards?

There has been much discussion lately of the role of government in ensuring companies, and particularly financial organisations, are properly regulated. But where does the responsibility for corporate governance really start? Is it with the government or the company itself?

A recent legal case in Australia against some of the board members of James Hardie Industries Ltd (a blue chip building products company started by a Scottish immigrant in 1888) has raised the issue of the role of directors. James Hardie manufactured asbestos. When it was found how dangerous the substance was, Hardies set up a compensation trust (through a separate company) to compensate employees and former employees who had been adversely affected.

That seemed morally and ethically appropriate. However, it has been alleged that when in 2001, the financial forecasts suggested the trust would run out of money before all were compensated, the directors decided not to meet the shortfall. They argued that they had no legal obligation to do so (because the trust was a separate company) and that it was their duty to protect the interests of the shareholders.

As one press report commented, this one action by the directors of a once-proud company, "ensured James Hardie became a byword for corporate immorality". Meanwhile, the Australian Securities and Investments Commission is pursuing the directors through the courts for their 2001 decision.

Does this theme sound familiar? Think Enron, WorldCom, Adelphia, Tyco, Enron, Arthur Andersen and more recently Freddie Mac, and Fannie May. In fact some of the directors of these two are now also said to be under investigation - by the FBI.

But why has this board "brain snapping" happened so frequently over the last decade? I would suggest there are at least two reasons; a lack of balance in managing the needs and expectation of all stakeholders, and a blurring of role and responsibility between board and management.

Organisations that are successful over a long period have one thing in common. They know who their stakeholders are and how to manage the expectations of these stakeholders successfully.

Take McDonalds as an example. They actively have policies to manage the expectations of the six stakeholder groups; their customers, suppliers, owners, staff, industry and the community. Granted they have had disagreements with some stakeholders from time to time (some even got to the legal dispute stage). However, at no time has the needs of one stakeholder and the expectations of one stakeholder group, overtaken or overridden any other.

Compare this with some of the recent financial institutions that have crashed. It seems that the needs of the investors (who invariably include directors and senior management), have been almost sacrosanct.

Has there been anything done to arrest this trend?

In the US the Sarbanes-Oxley legislation enacted in 2002, was supposed to usher in the greatest corporate governance improvements in history. Unfortunately, this legislation (which was mirrored elsewhere in the world), only looked at financial accounting issues, not corporate structures. Nor did it look at the total issue of corporate governance.

Corporate structures too remained unchanged. Boards, because of their over dependence on the development of shareholder wealth have lost site of the divide between leadership and management. They should be showing leadership and leaving the CEO and his/her team to get on with managing the organisation. However, to make it easier to deal with the staff member stakeholder, they have paid CEOs and senior management exorbitant salaries – and in many cases given them positions on the board.

Immediately, this raises the issue of the blurred roles of management (through the CEO) and leadership through the directors.

For example, in the US it is possible to be both a director and an employee. In some European countries, (e.g. Germany), there is a legal requirement in companies over a certain size, to have a staff member (in addition to the CEO) as a Director. In other countries, CEO's may not be permitted to be full board members, yet creative boards have overcome this however, by making the CEO, and even other senior management, "Executive Directors".

Thus in the western world, management and staff become part of the "Board Team" and there is a diffusion of roles. Not only is there a diffusion of roles, but people who sit side by side on the Board are unlikely to vote against motions that might affect their own remuneration and shareholding.

The company board should have only two responsibilities: to ensure the needs and expectations of all stakeholder groups are managed appropriately and to appoint the CEO. The CEO should be responsible for implementing and managing board policy and the directors should be the guardians of all stakeholder needs. By ensuring all stakeholder group needs are effectively managed, the board can provide the corporate ethics and morality so often missing today.

In "A Board Culture of Corporate Governance," business author Gabrielle O'Donovan defines corporate governance as: "an internal system encompassing policies, processes and people, which serves the needs of shareholders and other stakeholders, by directing and controlling management activities with good business savvy, objectivity and integrity. Sound corporate governance is reliant on external marketplace commitment and legislation, plus a healthy board culture which safeguards policies and processes".

There are many, many companies that are well run by effective boards that demonstrate admirable corporate stewardship. However, recent events would suggest that there are a sufficient number of company boards who don't.

Perhaps it's time that these boards are told. Told how to balance the needs and expectation of all stakeholders, and how to distinguish the roles and responsibilities of board and management through both legislation and training.