The obligation of the board to challenge management
I think we all know that the board is supposed to have a majority of independent directors (at least in public companies) and to challenge the executives running the organization. That is what “oversight” means.
But the board is also supposed to work with those same executives, sharing their insights and experience to complement that of the CEO and his team.
Often, and I have seen this many times, the board finds it difficult to exercise what one might call professional skepticism in listening to the management team. As they look at the CEO and CFO, they see people just like them – one of their class, just perhaps a little younger.
Yet, professional skepticism is needed – and it is their legal obligation.
Recently, a good friend mine, Diane Frankle of Kaye Scholer, touched on this as she analyzed a case involving Yahoo! and the compensation of an executive. The case was Amalgamated Bank vs. Yahoo! Inc and was heard in the Delaware Chancery Court.
There are two important elements in her piece that I want to highlight: the obligation of the management team to provide the board with all the information they need to provide oversight, and the obligation of the board members not to accept management representations uncritically.
Here are the relevant excerpts (although I recommend reading her entire piece):
- Officers have a risk of personal liability for a breach of the duty of care without exculpation. …………. Officers have a duty to comply with board directives and to provide the board with information they need to perform their fiduciary roles. This precept then argues for officers obtaining board authority for important decisions, after providing to the directors all relevant information reasonably available. Going it alone can create significant risk of liability for officers.
- Directors who accept management’s statements uncritically, particularly with respect to executive compensation or employment actions, risk scrutiny and possible liability. The court notes that here the involvement of the Committee and the Board on the hiring and firing of de Castro was “tangential and episodic.” The court explains that a board “cannot mindlessly swallow information, particularly in the area of executive compensation.” The board must exercise business judgment. Where there is a lot of money at stake, and the provisions are out of the norm, directors protect themselves by asking questions and understanding the provisions they are approving, rather than simply relying on management. In cases involving executive compensation, hiring and firing, a board or committee may need to exercise more scrutiny than usual about the decisions being made, given possible self-interest of the executives. Lack of curiosity on obvious points, such as a candidate’s identity and credentials, or the financial impact of a complex compensation scheme, gives rise to concerns that the directors simply abdicated their responsibilities in a critical area.
I have often been concerned about what amounts to redaction of the information that is provided to the board. It is generally colored by the CEO or other top executive – presented in a way that supports his/her position, rather than with the intent of providing the board members with all the information they need to make informed decisions.
Even the choice of the CEO as to who will be present or absent as information is presented and discussed can inappropriately bias a decision.
Of course, I am not at attorney (Diane is) and would not presume to make authoritative interpretations.
But, I can see how the risk to the board – and to management – may be more than they think.
Both need to be informed that there is personal as well as collective risk.
If others (such as the CAE or CRO) see officers or board members failing either to provide the board with all relevant information reasonably available, or failing to exercise professional skepticism when presented with information by the CEO/CFO, is there not a duty to ‘ring the bell’?
I welcome your thoughts and views.