Significance of the composition of a corporate board and its role

Mar 17, 2022

While it is next to impossible to define ‘corporate governance’ from a universal point of view, there is, however, a complete unanimity on the fact that the composition of the board of directors and its role are the key elements of corporate governance. As per 49.7 percent of the respondents participated in a survey held in Switzerland in the year of 2016, the board of directors, especially the process of its composition, has the colossal impact on the ultimate value creation of the company. The organizational structure (in particular the structure of the board of directors) and legal framework of corporate governance are varied. While one-tier organizational structure (meaning that the tasks of operations and supervision are managed by the same instance) is adopted by the companies in the US, Switzerland opts for a rather flexible slant that leaves companies with the options of one-tier and two-tier organizational structures (where two-tier organizational structure means the tasks of operations and supervision are managed by different instances). Differences as regards the legal framework of corporate governance between countries are also patent. The Swiss legal framework obliges the board of directors to act in the best interest of the company though the directors are elected by the shareholders (Forstmoser, 2005), on the other hand, the legal framework of the US sticks to the notion that the board of directors will only act in the best interest of the company’s shareholders (Millstein, Gregory, Altschuler and Di Guglielmo 2011). The positioning of the board of directors, which is in between shareholders and stakeholders of the company, is a crucial juncture. The board, being in its position, has to ensure a proper ‘checks and balances’ between the shareholders and stakeholders at all times. Research corroborates that the task of ensuring ‘checks and balances’ does sometimes become very difficult for the board that could either be for an inclination towards the shareholders or the stakeholders, where in either case, such inclination questions the integrity of the board directors. It is therefore imperative to underscore the process through which the board directors are elected and re-elected.

Pursuant to Article 710 of Part Five of the Swiss Code of Obligations, board directors are elected for a stint of three years, unless the articles of association of the company stipulate a tenure that does not exceed six years. What it means is that the stint of the office must not exceed six years. This provision also mentions about the possibility of re-election. Since 2014, subject to other additional provisions, each company board director in Switzerland, has to be individually elected on an annual basis. Though this requirement of annual election of the board directors seems to have made the AGM agendas significantly longer, however, research shows that the practice of annual election allows investors to have differing views on each board director which can benefit the company. It has also been found that the shareholders have appreciated the system of annual election. The discrepancy as regards board election approval has increased from 3.4 percentage points in 2010 to 6.5 percentage points in 2016 (Schneider, Wagner and Wenk 2016). An interesting nexus has also been encountered between total shareholder return and the board election outcomes, when shareholders lost wealth in the previous year, election yields approval rates one percentage lower on an average though the truth of the matter is that elections of the board members are barely contested (Wagner, Bernasconi 2016).

The current Swiss legal framework does not provide any rules on the composition and diversity of the board of directors. FINMA, however, has made many additional rules that are there to be followed by financial sector companies in Switzerland. The idea of setting up these additional rules is to ensure and uphold the independence of the board and committee and minimum availability of certain skills that the board directors ought to have. Financial sector companies are required to have a risk committee in addition to the audit and composition committee.

Two most striking issues found in the ongoing corporate governance practices in Switzerland are the independence of the board of directors and their availability (Wagner, Bernasconi 2016). These hindrances may put the board on the back foot by making the directors less ambitious and disengaging from the steps that would be beneficial for the company as a whole. Though no requirements in these regards exist for regular companies listed in Switzerland, guidelines entailing minimum requirements along with other important factors, have been set out for financial sector companies by FINMA. One of such minimum requirements is that at least one-third of all board members must be independent, members being independent refer to those a) who are not working or have not worked for at least two years in any function at the company, b) who have not been involved as lead auditor for the company, c) who do not have any substantial business relationship with the company.

Another concerning factor in the ongoing corporate governance practices in Switzerland is the less participation of female directors in the board. However, the good news is that a new provision (article 734f CO) as regards gender quota has been introduced. The implementation of this provision works on a comply-or-explain basis. Though the new provisions have already taken effect in Switzerland, however, they are still subject to long transition periods. As per this gender quota provision each gender must be represented on the board of directors at least by 30% starting from 2026, and by 20% in the executive management starting from 2031.

Though the role of the board of directors is intertwined with a lot of other important factors such as board directors’ knowledge about the industry environment, board directors’ homework and research before every meeting that they take part in, expectations of the shareholders and stakeholders from the board, nonetheless, the way the board of directors is composed has the greater impact on what its role would be and how integriously it would be managing and overseeing the operations of the company.

Mohammed Rakib-ul-Hassan
Legal Research Analyst
Zazoon AG

Please get in touch should you face corporate governance challenges info@zazoon.com

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