- CFA Exams
- Level I 2020
- Study Session 10. Corporate Finance (1)
- Reading 31. Introduction to Corporate Governance and Other ESG Considerations
- Subject 5. Board of Directors and Committees
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Subject 5. Board of Directors and Committees PDF Download
Composition of the Board of Directors
A board of directors is the central pillar of the governance structure, serves as the link between shareholders and managers, and acts as the shareholders' internal monitoring tool within the company.
The structure and composition of a board of directors vary across countries and companies. The number of directors may vary, and the board typically includes a mix of expertise levels, backgrounds, and competencies. Board members must have extensive experience in business, education, the professions and/or public service so they can make informed decisions about the company's future. If directors lack the skills, knowledge and expertise to conduct a meaningful review of the company's activities, and are unable to conduct in-depth evaluations of the issues affecting the company's business, they are more likely to defer to management when making decisions.
Executive (internal) directors are employed by the company and are typically members of senior management. Non-executive (external) directors have limited involvement in daily operations but serve an important oversight role.
In a classified or staggered board, directors are typically elected in two or more classes, serving terms greater than one year. Proponents argue that by staggering the election of directors, a certain level of continuity and skill is maintained. However, staggered terms make it more difficult for shareholders to make fundamental changes to the composition and behavior of the board and could result in a permanent impairment of long-term shareholder value.
Functions and Responsibilities of the Board
Two primary duties of a board of directors are duty of care and duty of loyalty. Among other responsibilities, the board is to:
- establish long-term strategic objectives for the company with a goal of ensuring that the best interests of shareholders come first and that the company's obligations to others are met in a timely and complete manner.
- establish clear lines of responsibility and a strong system of accountability and performance measurement in all phases of a company's operations.
- hire the chief executive officer, determine the compensation package, and periodically evaluate the officer's performance.
- ensure that management has supplied the board with sufficient information for it to be fully informed and prepared to make the decision that are its responsibility, and to be able to adequately monitor and oversee the company's management.
Board of Directors Committees
A company's board of directors typically has several committees that are responsible for specific functions and report to the board.
- The audit committee plays a critical role in ensuring the corporation's financial integrity and consideration of legal and compliance issues. The primary objective is to ensure that the financial information reported by the company to shareholders is complete, accurate, reliable, relevant, and timely.
- The governance committee tries to ensure that the company adopts good corporate governance practices.
- The remuneration (compensation) committee develops and implements executive compensation policies. Incentives should be provided for actions that boost long-term share profitability and value.
- The nomination committee searches for and nominates board director candidates, and establishes the nomination policies and procedures.
- Other common committees include those responsible for overseeing management's activities in certain areas, such as mergers and acquisitions, legal matters, and risk management.
Learning Outcome Statementsf. describe functions and responsibilities of a company's board of directors and its committees;
CFA® Level I Curriculum, 2020, Volume 4, Reading 31
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