INTRODUCTION

The standard view among governance experts is that board independence is a

necessary condition for effective governance. The boards effectiveness in monitoring
management is a function of the mix of insiders and outsiders who serve on the
board.1 Consistent with this view, Weisbach reported a higher correlation between
CEO turnover and company performance for companies in which outsiders
predominated on the board of directors than for companies in which insiders
predominated.2 It was also found that addition of another outside director increased
firm value.3 All these findings are consistent with the premise that outside directors
represent shareholder interests. Thus considering such findings and premises, we shall
proceed to discuss the concept of board composition & structure in various
jurisdictions.
THE BEASLEY STUDY4
Beasley examined whether a larger proportion of outside members on the board of
directors and certain characteristics of outside directors affect the likelihood of
financial statement fraud. Using a logit-regression analysis of 75 fraud and 75 nofraud companies, he found that the inclusion of outside members on the board of
directors increases the boards effectiveness at monitoring management for the
prevention of financial statement fraud.
When a corporate fraud is uncovered, the company faces substantial costs while the
outside directors face reputational costs in the market. The percentage of outside
directors on the board of directors of fraud-companies is lower than that of no-fraudcompanies.

Hatice Uzun, Samuel H. Szewczyk, and Raj Varma, 2004, Board Composition and Corporate
Fraud, Financial Analysts Journal, Vol 60, No 3 (May-June), pp 33-43
2

Weisbach, M.S., 1988, Outside Directors and CEO Turnover, Journal of Financial Economics, Vol
20, Nos 1-2 (January March), pp 431-460
3

Rosenstein, Stuart, and Jeffrey G. Wyatt, 1990, Outside Directors, Board Independence, and
Shareholder Wealth, Journal of Financial Economics, Vol 26, No 2 (August), pp 175-192
4

Beasley, M.S., 1996, An Empirical Investigation of the Relation between Board of Director
Composition and Financial Statement Fraud, Accounting Review, Vol 71, No 4 (October), pp 443-460

Secondly, some so-called outside directors may have business (actual or potential) or
family ties to the management and are thus less likely to monitor the management.
The outside directors, therefore, have to be necessarily independent. Hence, the
percentage of independent directors on the board of directors of fraud-companies is
lower than that of no-fraud-companies.
BOARD COMPOSITION & STRUCTURE IN THE UK
Dahya and McConnell5 investigated the relationship between outside directors and
corporate performance based on the issuance of the Report of the Committee on the
Financial Aspects of Corporate Governance, commonly known as the Cadbury
Report, published in December 1992.
Regarding Board Composition, the Cadbury Report states that the board of a listed
company should include non-executive directors of sufficient caliber and number for
their views to carry significant weight in the boards decisions 6; and that a majority
of non-executives should be independent. In order to meet the latter
recommendation, together with another regarding audit committees, all boards should
have a minimum of three non-executive members, two of whom should be
independent. However the percentage of independent non-executives was smaller for
medium-sized and small listed companies.7
It was also recommended that:
a)There should be a clearly accepted division of responsibilities at the head of a
company, which will ensure a balance of power and authority, such that no one
individual has unfettered powers of decision
b)There should be an audit committee composed solely of non-executive directors
with a minimum of three members and a majority of independent members.
c)There should be a remuneration committee made up wholly or mainly of nonexecutive directors, and chaired by a non-executive.
5

Jay Dahya and John J. McConnell, Board Composition, Corporate Performance, and the Cadbury
Committee Recommendation, October 16, 2005
6

Cadbury Code, para 1.3. This is almost identical to para 4.5(a) of the ISCs Statement on Directors.

G.P. Stapledon, Institutional Shareholders and Corporate Governance, Oxford University Press,
Oxford, 1996, p.69

d)Non-executive directors should be selected through a formal selection process,

which should be a matter for the board as a whole (but the Committee regarded
it as good practice for there to be a nomination committee composed of a
majority of non-executive directors, and chaired by the chairman or a nonexecutive director, responsible for proposing new appointments to the board).
Recommendation

(c)

was

later

replaced

by

the

Greenbury

Committees

recommendation that all listed companies should have a remuneration committee

consisting exclusively of non-executive directors.8
The proportion of quoted UK industrial companies operating audit, remuneration, and
nomination committees rose markedly between 1988 and 1993: in the case of audit
committees, from 35% to 90%; in the case of remuneration committees, from 54% to
94%; and in the case of nomination committees, from 10% to 39%.9
As regards (a), about 57% of quoted UK industrial companies separated the roles of
chairman and chief executive in 1988, but some 77% did so in 1993. In most such
splits of roles due to the Cadbury Committee Report, the person previously occupying
the roles of chairman and chief executive remained as an executive chairman whilst a
new chief executive has been appointed.
However, the rationale behind having separate persons for these two jobs is that the
chairmans role is leader of the board of directors a primary function of which is to
monitor the executive management. The inherent problem with a combined
chairman/chief executive is that the chairman, who is supposed to lead the board in
ensuring the accountability of executive management, is a member of the executive
management. This problem does not disappear if there is an executive chairman and a
separate chief executive. In such cases, the reality is often that the executive chairman
is the top executive in the company (i.e. effectively the chief executive) and the chief
executive is effectively what is known in the US as a chief operating officer.10

See Study Group on Directors Remuneration (Greenbury Committee), Report (1995) para 4.2, 4.8.

M.J. Conyon, Corporate Governance Changes in UK Companies between 1988 and 1993 (1994) 2
Corp. Gov. :Inter. Rev. 97, at 103-5.
10

The executive chairman is commonly the highest-paid director. In a minority of cases the executive
chairman is second in command to the chief executive: Korn/Ferry International, Boards of Directors
Study UK (1993) 18

BOARD COMPOSITION & STRUCTURE IN AUSTRALIA

While UK-based institutions were a driving force behind movies for improvements in
board composition and structure in quoted UK companies, the institutions in Australia
were not key players in the development of the first Australian statement of best
practice in this area: the Bosch Committees Corporate Practices and Conduct.11 After
the Australian Investment Managers Association (AIMA) was formed in 1990, one of
the first things that they have done is to release a public statement supporting
Corporate Practices and Conduct and advising that AIMA members would give
preference in their investment decisions to those corporations which complied with
the principles in Corporate Practices and Conduct.12
In 1995 the AIMA Corporate Governance Guidelines were issued which
recommended that the board of directors of every listed company should be
constituted with a majority of individuals who qualify as independent [non-executive]
directors.13 Board composition has not been as big an issue in Australia as it has been
in the UK, but that was because the average board of large and medium-sized
Australian companies has for a long time had a majority of non-executive members.14
The AIMA Guidelines also recommended that:
a)The chairperson should be an independent director
b)That there should be an audit committee chaired by an independent nonexecutive director and composed entirely of non-executive directors
c)There should be a remuneration committee and a nomination committee, each
chaired by an independent executive director and made up of a majority, at least,
11

Working Group of the Business Council of Australia, et al. (Bosch Committee), Corporate
Practices and Conduct (1991).
12

H. Bosch, Corporate Practices and Conduct: Setting Standards for Corporate Governance in
Australia (1993) 1 Corp. Gov.: Intern. Rev. 196
13

Para 3.2

14

J.F. Corkery, Directors Powers and Duties (1987) 3, cites a study which found that the average
board size for the largest 500 listed companies (measured by market capitalization) in 1983 was seven
directors, with 30% being executive and 70% being non-executive. These proportions were about the
same in 1975. The Cooney Committee (n. 22 above), at 117, cited a study which showed that the
figures in 1988 were: 9.3 directors; 31% executive; 69% non-executive. At 1992, the figures were: 8
directors; 25% executive; 75% non-executive: Korn/Ferry International, Boards of Directors in
Australia: Twelfth Study (1993) 3.

of non-executive directors.
As for (a), 84% of a sample of listed and unlisted Australian companies in 1992 had a
non-executive chairman separate from the chief executive of managing director.
Regarding (b), 48% of a wide sample of listed companies in 1992 had an audit
committee, though the proportion amongst larger companies was 63%. It increased to
74% by 1994. In regard to (c), a survey in 1993 of the 100 largest listed Australian
companies found that 73% had a remuneration committee, but only 17% had a
nomination committee. But in the remuneration committee, 91% were non-executive
directors while the nomination committee had 100% non-executive directors.
CONCLUSIONS: UK & AUSTRALIAN SYSTEMS
The Cadbury Committee in the UK, and the Bosch Committee and the AIMA in
Australia, have dealt reasonably thoroughly with the issues of board structure and
composition. There are, however, some areas that could be improved.
First, given that executive domination (numbers) of the board is an impediment to the
effective monitoring by non-executives, serious consideration ought to be given to the
recommendation of AIMA that the board of every listed company should comprise
majority of independent non-executive directors.15
Secondly, proper accountability within the one-tier board sustem requires that the
chairman should be an independent part-time director. The growing UK practice of
having an executive chairman and a separate chief executive should be addressed.
Finally, the board nomination committees, preferably composed entirely of nonexecutive directors, should be a requirement for quoted companies.
CORPORATE LAWS IN INDIA
Clause 49-I(A) of the Listing Agreement stipulates that the board of directors of a
company shall have an optimum combination of Executive and non-Executive
directors. Not less than 50% of total number of directors on the board should
comprise of non-executive directors. The listing agreement also emphasizes on the
induction of independent directors on the boards. The Explanation to Clause 49-I(A)
15

Para 3.2 of AIMA Corporate Governance Guidelines. See also the proposed Fifth EC Directive on
harmonization of company law: 1983 OJ (C 240) 2, art. 21a (a majority of directors on a one-tier board
would have to be non-executives).

defines independent director as those directors which apart from receiving

directors remuneration, do no have any other material pecuniary relationship or
transactions with the company, its promoters, its management or its subsidiaries,
which in the judgment of the board may affect independence of judgment of the
director. The induction of independent directors not only adds value to the board but
results in more objective and fair decision making process; in the process, outsiders
also gain confidence in the functioning of the board.
The company should spell out the maximum size of the board. The age limit for
directors has to be prescribed and the board members should have leadership skills
and other specialist, technical or other expertise. The non-executive directors should
be persons drawn from amongst professionals having expertise in business, finance,
law etc.16
As far as the issue of independent directors goes, the Kumara Mangalam Birla
committee extensively debated and felt that the touchstone of the independence is the
material pecuniary relationships or transactions of the non-executive directors with
the company.17
Apart from the listing agreement, the Companies Act, 1956 provides for inclusion of
independent directors and lays down the requirements and procedure for appointment
of various directors. It is imperative and mandatory for companies to follow the
provisions of the Companies Act as well as the listing agreement.

CONCLUSION
The scandals at numerous high-profile companies have led to a public perception of a
crisis in corporate governance, to subsequent passage of Corporate Governance Acts
(such as the Sarbanes-Oxley Act in the US) and other enactments around the world,
and to the subsequent establishment of strengthened corporate governance
requirements in various jurisdictions, including oversight by independent company
directors.
16

Corporate Governance Reporting (Model formats) by ICSI p.25

17

N. Gopalsamy, A Guide to Corporate Governance, New Age International (P) Ltd., Publishers,
Delhi, 1st Edition, 2006

The above discussion leads to a conclusion that the board composition is significantly
related to the incidence of corporate fraud. The company laws in India as well as other
jurisdictions require companies to have independent directors so as to increase the
quality of the board.
At the same time, it is also recognized that even with the best structures and bestpractice board composition and structure, things can go wrong. But such a practice
ought to be followed and should not affect detrimentally the ability of the ability of
the executive management to drive the company forward, but should despite the
shortcomings with traditional non-executive directors increase the chances of
corrective action being taken if managements performance becomes unsatisfactory.
REFERENCES
1. G.P. Stapledon, Institutional Shareholders and Corporate Governance, Oxford
University Press, Oxford, 1996
2. N. Gopalsamy, A Guide to Corporate Governance, New Age International (P)
Ltd., Publishers, Delhi, 1st Edition, 2006