This article was first published in the May 2012 Malaysia edition of Accounting and Business magazine.
To help optimise board performance, the Audit Committee Institute (ACI) Malaysia developed The Directors’ Prism: Building Better Boards. This guide helps organisations to challenge the status quo and elevate board oversight and corporate governance.
ACI Malaysia, sponsored by KPMG, was set up to educate audit committee members and thereby promote effective audit committee processes.
Defining the prism
The Directors’ Prism is a diagrammatic expression of the board of directors and how it relates to other players in the corporate ecosystem. The board sits at the pinnacle of the prism, symbolising its oversight of the entire organisation. It is supported by the various board committees to which it cascades its responsibilities – audit, nomination, risk, and remuneration – at the centre of the prism.
Meanwhile, management and auditors form the base of the prism, denoting the board’s reliance on their services to execute its oversight
responsibilities. The collective stakeholders surround the prism, seeking assurance from the board that the company is being well-governed and will discharge its obligations.
To advance corporate governance, the Directors’ Prism advises companies to ask seven key questions. While these seven questions were compiled to help boards achieve successful oversight, they are not exhaustive; instead, they are a starting point for further assessment and incremental improvements by boards.
1 What makes up an ideal board?
Board quality depends on a diverse mix of factors such as the competence of the chairman, collective board expertise, and the perceived independence of non-executive directors. ‘The essential characteristics of a strong chairman are often personal attributes,’ namely, clarity of vision, strong leadership qualities, and the personal courage to manage tough issues.
Collectively, the board should demonstrate broad knowledge, sound judgement, unblemished integrity, and the courage and ability to challenge and probe into difficult issues. Individual directors should possess the expertise relevant to the company’s line of business.
‘It is important that the board is not reliant solely on management to provide it with such expertise,’ warns the guide. Meanwhile, audit committee members must be financially literate and at least one member of the audit committee must fulfil the financial literacy requisite under Bursa Malaysia’s listing requirements.
The senior independent non-executive director plays an important role in the board as the director to whom concerns may be conveyed, especially in a landscape where board independence may be compromised. ‘In Malaysia, it is common that the chairman of the board is the managing director or the CEO. Put simply, such a director embodies the exact reverse of an independent director.’
2 How can the board be sustained?
Assess director remuneration: compensation should be sufficient to compensate directors, while removing conflicts or biases due to excessive remuneration. Provide the board with sufficient resources to discharge its duties, including access to company secretarial services.
Directors should be provided with ongoing professional development training to enable them to discharge their fiduciary duties. Also recommended are formal induction programmes for new directors to familiarise them with their duties, current issues and the organisation.
Finally, boards should be cognisant of related party transactions involving directors, which can compromise board independence and corporate governance.
3 How can the board’s effectiveness be enhanced?
The guide recommends holding private or ‘in camera’ board meetings with only directors present prior to management joining in, as well as holding audit committee meetings ‘in camera’ with the external auditors.
It is also important to identify issues early and keep communications channels open with management and auditors in the run-up to the year-end board meeting. ‘Questions of substance should not be raised for the first time at the year-end board meeting.’
Boards should meet as frequently as company matters require, while allowing sufficient time in between meetings for work to be done. The board committees should submit reports of sufficient depth to the chairman to enable the board to fulfil its oversight duties.
Finally, boards should conduct self-evaluation to assess its performance and effectiveness, perhaps to the extent of requesting feedback from senior management.
4 Is the board cognisant of company strategy?
Are directors alert and sceptical regarding earnings management? ‘Directors need to know enough about the company to recognise when inappropriate earnings management practices are present.’
The guide warns boards that ‘specific areas of attention warrant special attention. They can be particularly vulnerable to interpretations that may obscure financial volatility and adversely affect the quality of reported earnings.’ These areas are revenue recognition, changing estimates, abuse of the materiality concept and capitalisation and deferral of expenses.
Boards should also take note that in Malaysia, the Companies Act 1965 states that the board, and not management, is responsible for the preparation of the company’s financial statements. The act makes no distinction between executive or non-executive directors – all are equally accountable, notes the guide. Thus, it is critical that the board keeps abreast of financial reporting developments to discharge its duties satisfactorily.
5 Is the board addressing the risks facing their organisation, especially financial risks?
‘Risk management should always be on the board agenda, demonstrating the board’s clear ownership of risk management oversight.’
Directors on the boards of owner-managed companies, the most common type of business in Malaysia, face a challenging set of risks, such as the lack of a formal management structure and established corporate governance programmes and dominant leadership which strains existing controls and may set the wrong tone at the top, notes the guide.
The board should also be alert to fraud risk facilitated by technological advances, and ensure that an effective whistleblowing mechanism is in place to protect employees who make disclosures in the public interest.
6 Is full use being made of external and internal auditors?
Since the external and internal auditors are key drivers in facilitating the board committee’s oversight duties, an efficient board makes full use of the two.
How can an effective relationship be established with the external auditor? The audit committee is advised to develop policies to appoint and remove the external auditor, to safeguard auditor independence, to understand the audit cycle and to assess its performance.
Since the listing requirements make it compulsory for listed companies to have internal auditors, the audit committee should determine that the internal and external audit functions complement and coordinate their audit efforts to optimise assurance and the control environment.
7 Can the board see the bigger picture?
Boards are advised to focus on current and emerging issues that may affect their organisations, such as regulatory developments and economic shifts. For example, the Malaysia Competition Act 2010 which took effect on 1 January 2012 features two major prohibitions – anti-competitive agreements and abuse of dominant positions – that could affect business as usual.
Boards should also watch out for round tripping – the act of artificially inflating volume and revenues, which in reality adds no profit – which is gaining keener scrutiny from regulators.
Boards should also be mindful of trends favouring corporate sustainability, government diversity policies to place more women on boards, and disgorgement, which is ‘the repayment of profits arising from irregularities in trading shares or other securities.’
Report summary by Nazatul Izma Abdullah, journalist