Rational behind directors’ duties and effectiveness of their jobs

By | May 1, 2014

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1. Rational behind directors’ duties and effectiveness of their jobs

1.1 Basic concepts

1.1.1 Directors’ duties

Directors are required to exercise their power with competence (or skill) and diligence in the best interests of the corporation. They owe what is called a “fiduciary duty” to the corporation. The duty is a “fiduciary” duty because the obligation to act in the best interests of the corporation, at its core, is an obligation of loyalty, honesty and good faith. Modern corporations statutes governing business corporations provide a concise formulation of the fiduciary obligation owed by directors. Directors’ fiduciary duties can be divided into two main branches: a) the duty of care and b) the duty of loyalty (Robertson 2007).

1.1.2 Responsibility and accountability

According to John Carver and Caroline Oliver (2002, p. 48), responsibility refers to an individual’s or a group’s direct, hands-on obligation to produce something of value. Differently, accountability refers to an individual’s or a group’s obligation to either produce or see to the production of something of value. And the distinction between one’s direct responsibility and one’s responsibility for the achievements of subordinates is an important one in designing the board’s job or the job of any manager.

1.2 Rational behind directors’ duties

It is claimed that directors and officers are deemed to be fiduciaries of the corporation because their relationship with the corporation and its shareholder is one of the trust and confidence. As fiduciaries, directors and officers own ethical and legal duties to the corporation and the stakeholders as a whole (Miller, Cross & Jentz 2011, p. 278). And these fiduciary duties as said above include the duty of care and the duty of the loyalty. The duty of care refers to the responsibility to be a prudent board member. In other words, board members must pay attention to what’s going on and make decisions based on good information. And in term of the duty of loyalty, directors are required to subordinate their personal interest to the welfare of the company. Directors are precluded from competing with companies on whose board they serve. Their fiduciary duty requires them to fully disclose potential conflicts of interest that might arise from company transactions. In short, they can not exploit the company for personal gain (Burke, Guy & Tatum 2008, p. 209).

1.2.1 Ethical duties

The deontological theory states that people should adhere to their obligations and duties when analyzing an ethical dilemma. This means that a person will follow his or her obligations to another individual or society because upholding one’s duty is what is considered ethically correct. For instance, a deontologist will always keep his promises to a friend and will follow the law. A person who follows this theory will produce very consistent decisions since they will be based on the individual’s set duties (davidson.edu 2010). In term of the business practices, in many industries especially in the large corporations, companies usually have the so called “standards of ethical coding” approved by the board of directors to provide a code of conduct that forms the basis for ethical decision making. For example, in a typical ethical conduct, a company will be comply with all applicable regulations and expects its directors, officers and employees to conduct business in accordance with the letters spirit of all relevant laws, to refrain from any illegal, dishonest or unethical conduct, to act in a professional, businesslike manner, and to treat others with respect. Directors and officers should not use their positions to obtain unreasonable or excessive service or expertise from the company’s staffs (Axelrod 2010). Therefore we can see that even the company would have enacted policies and code of ethics to regular the behaviors of the employees and expect their directors to carry out the ethical duties as stated in the relevant policies and code of ethics. And according to Laurinda B. Harman (2005, p. 103), though these standards will not provide all the answers for those faced with an ethical decision, but ethics often transcend the normal legalistic view and often involve highly complex situations involving more than just translation of text into numbers according to some rules. But, it is the fact that these standards and coding can help recommend a course of action and facilitate the fulfillment of the directors’ duties.

1.2.2 Legal duties

1.2.2.1 The duty of care

Almost in all jurisdiction systems, such as the US legal systems, there is a distinction between delegation and abdication of responsibilities and duties. Abdication of duties is simply not permissible. Abdication can take one of two forms: the board or a director can affirmatively cede authority to someone else. For instance, if the board of directors tell the CEO to handle everything and no need to make any reporting, if the CEO commits any felonies it the board would be legally responsible for overlooking the behaviors, performance and decisions making of the CEO. And the second form of abdication rises through neglect (Siegel 2006, p. 82). Similar duties of care of the board of directors or a director could also be found in case of Australia legal systems in which the discussion of directors’ duties and liability could be adequately based on statutory provisions in the Australian Corporations Act 2001. In particular, the enforcement of the civil penalty provisions ensures the enforcement of directors’ duties and liability. For example, section 180s regulates that a director or other officer of a corporation must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise if they (a) were a director or office of a corporation in the corporation’s circumstances and (b) occupied the office held by, and had the same responsibilities within the company as director or officer. From the statement of this section in the Act, we can see that the judgment of the directors fulfillment of their duty in Australia is against the objective standards because the standards are made according to the practices of a reasonable person rather than subjective standards. In another world, directors could not excuse their lack of duty of care by saying that they do not have the relevant knowledge to make the relevant decisions or spot the wrongdoing.

1.2.2.2 The duty of loyalty

As mentioned above, in term of the duty of loyalty, directors are required to subordinate their personal interest to the welfare of the company. Directors are precluded from competing with companies on whose board they serve. Their fiduciary duty requires them to fully disclose potential conflicts of interest that might arise from company transactions. One of the most serious relevant scandals is the Enron Scandal which is considered to be one of the most notorious within American history. The scandal eventually led to the bankruptcy of the Enron Corporation, and the dissolution of Arthur Andersen, one of the five largest audit and accountancy partnerships in the world. In addition to the auditor’s failure Enron’s aggressive accounting practices were not hidden from the board of directors, as later learned by a Senate subcommittee. The board was informed on the rationale for using the Whitewing, LJM, and Raptor transactions, and after approving them, received status updates on the entities’ operations. Although not all of Enron’s widespread improper accounting practices were revealed to the board, the practices were dependent on board decisions (Robert 2003). Therefore, the fact that the Enron Board of Directors knowingly allowed Enron to engage in high risk accounting practices actually was not in accordance with the relevant legal compliance requirement in term of fulfilling the duty of royalty to the shareholders and also to the public interest.

1.3 Effectiveness of the directors’ duties

From the analysis above with reference with several cases and legal systems, we can see that the legal systems and also business ethics all have expectations that directors in organizations fulfill the duties, but based on the fact the many financial and accounting scandals were only reviewed to the public after they were becoming too big and too serious and can not be controlled and covered up any more, it is not safe for us to the come to the conclusion that the directors’ duties are well implemented with good effectiveness. But one thing that we can witness is that with the exposure of these scandals, they actually help companies and governments to better regulate the behaviors of the directors to ensure their duties are not only written well in paper but also carried out with firmed actions by improving the corporate governance structures and legal systems.