Corporate Governance and Board Effectiveness
Governance
Corporate Governance and Board Effectiveness
Syllabus tag: KASNEB CPA | Advanced Level | CA31 Leadership and Management | Topic 7 Corporate Governance and Board Effectiveness
Lesson objectives
By the end of this topic, you will be able to:
- Explain the agency problem and the governance response
- Describe board composition and the role of independent directors
- Explain the function of each principal board committee
- Compare rules-based and principles-based regulation
- Apply the Kenyan governance framework
Why this matters
CA21 covered directors' legal duties. Governance addresses the practical question those duties leave open: how does a board that meets a few times a year actually control a business it does not run?
The agency problem
Shareholders own the company; directors and managers run it. Their interests diverge:
- Managers may pursue growth or prestige rather than shareholder value
- They may take too little risk, protecting their positions, or too much, chasing a bonus
- They control the information shareholders rely on
Governance mechanisms respond: board oversight, independent directors, audit, disclosure, and remuneration linked to performance.
Note that each mechanism has a cost, and that the costs of governance — directors' time, audit fees, compliance — are borne by the shareholders it protects. Governance is a trade-off, not a free good.
Board composition
A board needs a balance of executive and non-executive directors, with the independent non-executives numerous enough that no individual or small group dominates.
Independence means free of any relationship that could materially interfere with judgement. Common threats: former employment, a material business relationship, a close family tie to management, cross-directorships, or very long tenure.
The roles of chair and chief executive should be separated. The chair runs the board; the chief executive runs the company. Combining them makes the person leading the board the person the board must hold to account.
A senior independent director provides a channel for shareholders where the normal route through the chair or chief executive is not appropriate.
Board committees
| Committee | Composition | Purpose |
|---|---|---|
| Audit | Independent non-executives | Financial reporting, internal control, external auditor relationship |
| Remuneration | Independent non-executives | Executive pay, so directors do not set their own |
| Nomination | Majority independent | Board appointments and succession |
| Risk | Often independent | Risk appetite and the risk framework |
The audit committee is the most examined. Its responsibilities include reviewing the financial statements, monitoring internal control and internal audit, recommending the appointment of the external auditor and reviewing their independence, approving non-audit services, and providing a route for whistleblowing.
Its independence is what makes it work. Internal audit reports to it precisely because a function reporting to the finance director cannot report adversely on the finance director — the same point made from the auditing side in CA24.
Succession planning is the nomination committee's least glamorous and most important function. A board that has not considered succession discovers the problem at the worst possible moment.
Rules and principles
Rules-based regulation — as under Sarbanes-Oxley — sets mandatory requirements with penalties. It is certain and enforceable, and it invites compliance with the letter while missing the intent.
Principles-based regulation — as in most Commonwealth codes — sets principles applied on a comply or explain basis. It is flexible and suits organisations of different sizes, and it depends on shareholders actually scrutinising the explanations.
The discipline in comply-or-explain comes from having to justify a departure publicly. Where shareholders are passive, that discipline weakens, which is the standard criticism of the approach.
:::checkpoint A listed company explains in its annual report that it has combined the roles of chair and chief executive "to provide clear leadership during a difficult period". Assess whether that is an adequate explanation and what a shareholder should ask. :::
The Kenyan framework
| Source | Application |
|---|---|
| Companies Act 2015 | Directors' duties and statutory requirements |
| Capital Markets Authority Code | Listed companies, on a comply or explain basis |
| Central Bank prudential guidelines | Banks |
| Insurance Regulatory Authority | Insurers |
| Mwongozo Code | State corporations |
| ICPAK and IESBA | Professional conduct |
Mwongozo is worth knowing by name. It applies to state corporations and addresses issues specific to them — the relationship with the parent ministry, the appointment of board members, and accountability for public resources.
Effectiveness
A board can be compliant and ineffective. What distinguishes an effective one:
- Information that is timely, accurate and sufficient — a board given three hundred pages the day before a meeting cannot govern
- Challenge, with non-executives willing to question the executive
- Time genuinely spent on the matters that carry the most risk
- Evaluation of the board's own performance, periodically and externally
- Diversity of background and thought, which improves the quality of challenge
The recurring failure is deference. Non-executives who do not challenge — because the chief executive is dominant, because the information is inadequate, or because challenge is treated as disloyalty — leave the board compliant on paper and absent in substance.
:::checkpoint A company has all the required committees, an independent chair and a full compliance statement, yet the board did not question a major acquisition that subsequently failed. Identify what may have gone wrong and what would improve it. :::