The Directors Manual> ROLE OF THE BOARD > FUNCTIONS OF THE BOARD > [¶1−210] Making appointments and

tments and reviewing 1

management

FUNCTIONS OF THE BOARD

[¶1−200] Introduction
Whilst it is suggested that the board should delegate much of its authority to management, it must carefully consider which
functions it reserves for itself. The overriding principle here (perhaps the first principle of corporate governance) is that there is
no single right answer. Companies and other organisations vary so much in size, ownership structure, complexity and tradition,
not to mention in the personalities involved, that there is no simple blueprint that applies in all cases. It is necessary to consider
carefully what will work best for the board in its own circumstances.
Every board has a charter that sets out its responsibilities. It is important for directors to recognise that the exercise of these
responsibilities is ongoing and continuous.
Generally speaking, the board should explicitly confirm its responsibility for the following core functions:
• the selection of the Chief Executive Officer (CEO) and management team and the ongoing monitoring and assessment of
the CEO, management team, the board, directors and committees;
• the setting of broad parameters within which the management team operates, including adopting a strategic planning
process, approval of strategic plans and monitoring performance against these plans;
• ensuring policies and processes are in place to identify business risks, to address which risks are acceptable to the
corporation and ensure that systems and actions are in place to monitor them;
• overseeing the policies and processes adopted to ensure the integrity of the company’s internal control and management
information systems; and
• providing assurance to shareholders and other stakeholders as to the integrity of the corporation’s reported financial
performance.

[¶1−210] Making appointments and reviewing management

Appointing the CEO
In the days when boards took their responsibilities less seriously it was common for Chief Executive Officers (CEOs) to select
their own successors and for the boards to rubber stamp them. As standards have risen it has become accepted that the board
must make the decision and the role of the outgoing CEO has now greatly diminished. Advice may be sought but the board
should make the decision. In listed companies the independent directors will probably take the principal role.
In many of the largest companies it would be accepted as good practice for the nomination committee of the board to draw up a
specification of the ideal candidate and have it ratified by the board as a whole. The committee would then brief the employment
agency, and interview their short list before referring the finalists to the board, which has the responsibility for being satisfied
that the best possible CEO has been selected. The outgoing CEO might not be consulted at all.

Appointing other executives

There are widely differing views as to whether the board should take a role in the appointment of other executives. There are
strong arguments for saying that if the board is to hold the CEO accountable for the performance of the company, he/she must be
allowed to take the key operating decisions, and that if the board’s intervention leads to the appointment of an executive who the
CEO would not have chosen, then accountability has been compromised. On the other hand, it can be argued that the quality of
the executives directly reporting to the CEO is of such importance to the company that the board must be satisfied that they will
perform adequately.
Practices in this area vary, in some cases appointments are left to the CEO, in others the board makes, or at least approves, the
final selection. It may be advisable for a second opinion to be available to the CEO, at least with the most important
appointments. Within a single company the practice may vary depending on the length of time the CEO has been in office and
the board’s confidence in his/her judgment.
Reviewing the performance of management
The board is also responsible for ensuring that management is managing properly and this requires the board to make inquiries
and to form a view of the CEO’s performance. Should the board lose confidence in the CEO to such an extent that it is felt that
counselling or training would be of no avail, the board must remove and replace him/her, however unpleasant the process may
be. This task is usually delegated to the chairperson. It is noteworthy that the average tenure of Australian CEOs has fallen

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The Directors Manual> ROLE OF THE BOARD > FUNCTIONS OF THE BOARD > [¶1−240] Monitoring performance and compliance 2

sharply in recent years and now stands at about four years.

Accountability is an integral component of corporate governance. The board should consider the following issues when
assessing the performance of management:
• how to monitor actual performance against plans and budgets;
• board analysis of information provided by external and internal auditors; and
• communication to the management team if corrective action is required, including a system to monitor the effectiveness
of corrective action taken.
The board should also have in place a process to review its performance in view of:
• its performance goals;
• directors’ (and management’s) compensation arrangements; and
• the need for any changes to the board or management team, particularly the processes required to facilitate such changes.

[¶1−220] Succession planning

The board’s responsibility for the ongoing prosperity of the company requires it to satisfy itself that there is an appropriate
succession plan in place to cover the CEO and other critical management positions. It is unlikely that the non−executive
directors would want, or be able, to nominate candidates for particular positions, but it is good practice for them to carry out an
annual review of management’s plan, to satisfy themselves that the matter has been considered by management and that proper
arrangements are in place.
Whilst strictly speaking the election of directors is a matter for shareholders, in practice the board must take the initiative, and
appointments are ratified at the next annual general meeting. It is therefore essential that the board continually review its own
composition and effectiveness. Many large companies choose to constitute a nomination committee for this purpose. In any case,
it is part of the chairperson’s role to ensure the continued review and consideration of a succession plan. Advice from external
sources may be useful both in reviewing the current board’s suitability, and in identifying potential candidates for appointment.

[¶1−230] Setting the goals of the company

It is important that clear goals for the company be set and that the board is satisfied that they are in line with the shareholders’
aspirations for the ongoing prosperity of the company, and any requirements of the constitution.
In order to discharge its duty to shareholders, the board must satisfy itself that there is an appropriate strategic plan in place
which is capable of achieving the goals which have been established and which will allow the board to assess the performance of
management.
These issues are considered in detail in the ‘‘Strategies and Processes’’, tab commencing at ¶4−000.

[¶1−240] Monitoring performance and compliance

The budget and the non−financial performance indicators
The budget is the primary measure of the company’s performance and it is essential that the board be satisfied that it is in line
with the plan and appropriate to the company’s circumstances. In addition to the budget a number of performance indicators,
both financial and non−financial, must be selected and agreed upon so that the board and management are able to monitor
progress and take corrective action when necessary. The board’s role in establishing these indicators can vary, but an effective
board will take a pro−active approach (see ¶4−400 and following for further discussion).

Compliance with the law

A company’s reputation is a valuable asset and its loss can be extremely damaging. Boards, therefore, have a responsibility to
see to it that a good reputation is earned and preserved. As a first step an effective board will require that the company obey all
relevant laws and the board should be aware of the requirements of specific legislation and common law that are of importance
to the company. In addition, appropriate policies should be established and monitored. Prudent directors will be familiar with the
Australian Standard on Compliance Programs: AS 3806−2006 which sets out procedures that companies can use to ensure
compliance with the law. In most companies the board will wish to allocate some time to satisfying itself that the management
understands the parts of the law applicable to the company, that satisfactory provisions have been made to ensure compliance,

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and it will monitor compliance to the extent necessary to satisfy itself that the company is obeying the law.

The board’s role

It is not only necessary for appropriate goals, plans, budgets, performance indicators, policies and codes to be put in place  the
company’s performance against them must be monitored. Although most of this work will be done by management, the board is
responsible to shareholders for ensuring that the goals are being achieved, the plans and budgets adhered to, and the policies and
codes implemented. An effective board will therefore agree with management how this is to be done; the methods of reporting
and the frequency with which individual matters are to be considered have to be laid down, and the agreed timetable must be
adhered to.
The company’s accounts and finances
Among the board’s most fundamental responsibilities are those of protecting the company’s assets, ensuring that its debts are
paid as they fall due and reporting the financial situation of the company to the shareholders through the annual, half−yearly, and
sometimes quarterly statements. The Corporations Act 2001 requirement that the directors make, and sign, a declaration that the
financial statements of the company comply with the relevant standards and regulations, and are true and fair, imposes a very
serious obligation, as do the requirements concerning insolvent trading. The court’s finding in Commonwealth Bank of Australia
v Freidrich and Ors (1991) 9 ACLC 946 (the National Safety Council case) that its chairperson, Mr Eise, was personally liable
for $97 million, drove home to all directors that their personal responsibility was real. In that case the judge said:
"... the stage has been reached when a director is expected to be capable of understanding his company’s affairs to the
extent of actually reaching a reasonably informed opinion of its financial capacity. Moreover, he is under a statutory
obligation to express such an opinion annually.
I think it follows that he is required to be capable of keeping abreast of the company’s affairs, and sufficiently abreast of
them to act appropriately if there are reasonable grounds to expect that the company will not be able to pay all its debts
in due course and he has reasonable cause to expect it."
Several other judgments have reinforced the need for directors to take adequate steps to satisfy themselves as to the accuracy of
the financial statements and records.
Aspects of financial reporting of which directors need to be aware in discharging their obligations are discussed in detail in Tab
6 "Financial Reporting", commencing at ¶6−000.

[¶1−250] Relations with auditors and shareholders

Relations with the auditors
The shareholders are responsible for appointing the external auditors, although in practice they will look to the board for a
recommendation if any change is necessary. While the auditor’s opinion on the financial statements does not reduce the
directors’ responsibility for them, it does provide a very valuable reassurance to the board, as well as to the shareholders, and it
is most important that the board satisfy itself that the scope of the audit is adequate and that the auditors are acting
independently. The issue of auditor independence is one of the main focuses of the amendments introduced by the Corporate
Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 (CLERP 9), and these are discussed further
at ¶6−860.
The spectacular company collapses in recent years should serve to remind directors that merely having an auditor is not enough;
they stand as a warning that the board must maintain a working relationship with the external auditors. It is usual for most of this
work to be delegated to the audit committee of the board (see ¶6−500) but it is good practice for the full board to meet the
external auditors annually and to satisfy itself that the "management letter" has been properly dealt with.
Over the last decade companies have made increasing use of internal auditors, which are sometimes in−house departments and
sometimes services outsourced from accounting firms. The scope of the internal audit function varies greatly according to the
needs of the company. The following are common areas covered by internal audit:
• the system of internal controls
• various operating procedures
• the efficiency with which management functions are carried out, and
• the systems by which risks are being mitigated.
An effective internal audit process can provide directors and senior management with considerable reassurance and the board
should pay close attention to the scope of the audit program and the degree of independence with which the internal auditors

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operate.

Relations with shareholders

Directors should never forget that they have been elected by the shareholders to watch over their interests and that they have an
obligation to communicate with them. Of necessity, the board has to delegate most of these functions to the chairperson or the
CEO, but it is important for the board to take a close interest in what is done in its name.
The board is likely to be particularly interested in matters concerned with:
• the annual and half−yearly reports (and quarterly reports if applicable)
• the AGM and any EGMs that may be required
• the annual report
• any prospectuses or other aspects of capital raising
• matters related to takeovers, and
• major announcements that may affect the share price.

[¶1−260] Reviewing board performance

Regular formal reviews of the performance of executives are generally recognised as a valuable way of improving their
effectiveness, and over the last decade there has been a growing recognition that similar reviews of boards are equally
worthwhile. The conduct of board reviews is discussed in the ‘‘Review of Board Performance’’ tab commencing at ¶8−000.
In deciding who is to do what, a useful rule of thumb is:
‘‘Management formulates,
The board ratifies,
Management implements,
The board monitors.’’
Over the last two decades, life in Australia’s boardrooms has changed dramatically. Directors now feel much more accountable,
both to the shareholders and to the law, and they are taking their responsibilities more seriously. The Korn Ferry surveys show
that, since the early 1980s, the amount of time the average director puts into his/her duties has approximately doubled, rising
from about 13 days to about 26 days per year  and the great increase in the number of committees means that time spent on
board duties is more productive. Boardroom discussions now tend to be more focused and the questioning of management more
serious. Perhaps more importantly, many new methods and procedures have been developed, which have increased the
effectiveness of directors, and board structures and composition are being approached more professionally.
Despite the great changes that have occurred the process of change is far from over. The law is still changing rapidly,
shareholder pressures are still increasing and a great deal of thought is being given to ways of improving board effectiveness.
While a broad consensus has been reached on many governance issues, there are others still under debate and yet others which
have hardly been considered at all. It can be expected that there will be a great deal more change in the boardroom in the next 10
years.
The expected pace of change reinforces the need for a board to review its own performance as well as the effectiveness of its
processes. In his report into the failure of HIH Insurance (Vol 1, pg 118), Owen J states:
‘‘In reviewing its own governance practices, a board should bear in mind that corporate governance is a means to an
end and not an end in itself.’’
This comment graphically illustrates the interrelationship between the principles of corporate governance and the company’s
performance, both financial and non−financial. Board review should be aimed at progressing towards the company’s goals.

[¶1−270] Risk management

Adventurous strategies may well lead to enhanced company performance but they are also likely to increase the risks associated
with business operations. Since the board is responsible for preserving and enhancing the investment entrusted to it in perpetuity,
it must also be responsible for the company’s risk profile, for seeing to it that the risks faced by the company have been
identified and quantified, and that the material risks are being properly managed. An effective board will consider the method
and extent of its own involvement, but at all times the directors should be satisfied that the risks that the company is running are
understood and are being properly managed.

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Principle 7 of the ASX Corporate Governance Principles and Recommendations requires the company to establish a sound
system of risk oversight and management and internal control. Recommendation 7.1 states:
"Companies should establish policies for the oversight and management of material business risks and disclose a
summary of those policies."
Recommendation 7.2 goes on to say:
"The board should require management to design and implement the risk management and internal control system to
manage the company’s material business risks and report to it on whether those risks are being managed effectively. The
board should disclose that management has reported to it as to the effectiveness of the company’s management of its
material business risks."
It is suggested that the appropriate policies should include internal compliance and control systems, and a mechanism for
assessing their effectiveness. As part of its oversight for the risk management and internal control system, the board should
review the effectiveness of the implementation of that system at least annually. The board retains responsibility for assessing the
effectiveness of the company’s systems for management of material business risks. In addition, a company is encouraged to
consider having an internal audit function, which should be independent of the external auditor and overseen by the audit
committee. A board committee is an efficient mechanism for focusing the company on appropriate risk oversight, risk
management and internal control. The appropriate committee may be the audit committee, a risk management committee or
another relevant committee. Ultimate responsibility for risk oversight and risk management rests with the full board, whether or
not a separate risk management committee exists. Management should establish and implement a system for identifying,
assessing, monitoring and managing material risk throughout the organisation. Frameworks for risk management include the
AS/NZS4360 (Standards Australia) and Risk Management within the Internal Audit Process (The Institute of Internal Auditors
Australia & Standards Australia, 2002).
Recommendation 7.3 states:
"The board should disclose whether it has received assurance from the chief executive officer (or equivalent) and the
chief financial officer (or equivalent) that the declaration provided in accordance with section 295A of the Corporations
Act is founded on a sound system of risk management and internal control and that the system is operating effectively in
all material respects in relation to financial reporting risks."
The integrity of the company’s financial reporting depends on the existence of a sound system of risk oversight, management
and internal control. This requirement is designed to encourage management accountability.
Recommendation 7.4 states:
‘‘Companies should provide the information indicated in the Guide to reporting on Principle 7.’’
The Guide to reporting on Principle 7 requires any departure from best practice recommendations 7.1, 7.2, 7.3, or 7.4 to be
included in the corporate governance section of the annual report. A summary of the company’s policies on risk oversight and
management of material business risks should be made publicly available, ideally by posting it on the company’s website, in a
clearly marked corporate governance section.

[¶1−280] Statement of matters reserved for the board

Once the board has decided what it will do itself and what will be delegated to management, the allocation of responsibilities
should be set out in writing and discussed with management to ensure that both the CEO and the board understand clearly the
limits of management’s authority. This includes which matters are to be referred to the board for information, and which matters
the board wants to decide.
It is sometimes argued that ‘‘everyone knows what a managing director’s job is’’ but companies vary so much in size,
complexity and other ways that the function is not always the same. Even in very similar companies, there is room for
differences about the matters in which the board wants to be involved. Perhaps the most simple and obvious is the limit to the
CEO’s authority on capital expenditure, but there are many other areas where boards hold different views. Moreover, it should
be open to a board to increase the amount delegated as they gain confidence in a new CEO. There have been serious
misunderstandings in the past that have led to substantial damage to the companies concerned, and sometimes to the hasty
departure of the CEO.
The contents of a statement of matters reserved for the board will vary from company to company. A statement of matters might
include the following:
Appointments
• Appointment of the CEO.

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• Appointment or removal of the secretary to the board.

• Senior management appointments.
• Membership and terms of reference of board committees.
Board and senior management
• Delegations of authority to the CEO (eg capital expenditure limits).
• Ratification of the organisation chart.
• Approval of remuneration and incentive policies.
• Approval of senior management remuneration.
• Management contracts.
• Overseas visit approvals.
• Approval of succession plans.
• Disclosure of conflicts of interest.
• Assessment of the organisation’s and CEO’s performance.
• Assessment of board performance.
• Matters concerning the governance of the organisation.
Relations with the members and stakeholders
• Arrangements for the Annual General Meeting, and other members’ meetings (if any).
• Matters relating to reports as required by the Corporations Act 2001.
• Suggestions for nomination of directors for election by the members.
Financial matters
• Approval of annual financial statements and directors’ reports.
• Approval of accounting policies.
• Approval of the internal audit plan.
• Any question of borrowing or giving security over assets.
• Treasury policies including foreign currency and interest rates.
• Bank accounts and signatories.
• Acceptance of audit reports including management letters.
Business strategy and company performance
• Approval of company objectives.
• Approval of strategic plan.
• Approval of proposals for major expansion or closures.
• Approval of budgets.
• Approval of priorities and performance indicators.
Capital expenditures
• Approval of the capital expenditure budget and alterations to it.
• Approval of spending and project priorities.
• Approval of individual expenditure items above $...
Lease or purchase of buildings
Major transactions not included in the budget or outside the ordinary course of business
Actions or transactions which might involve questions of legality or propriety
Internal controls and reporting systems

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• Risk assessment and insurance.

• Risk management policies, eg hedging.
• Approval of company policies, including compliance with the law.
• Approval of reporting systems.
Use of the seal
Donations and sponsorships above approved limits
These headings should be amplified sufficiently so there is no doubt about the allocation of responsibilities. It may be useful for
some of the items to specify which matters are to be referred to the board for a decision and which are to be brought to the
board’s attention for information after management has taken the decision.
A board charter
The functions of the board, as well as its responsibilities, are sometimes incorporated into a formal board charter, which may
also deal with other aspects of the board’s operations and the rights and obligations of individual directors. Board charters are
usually not as detailed as statements of matters reserved for the board and some companies use both.

A statement of delegations
Another option is to set out the matters the board has delegated to management. This will probably be a longer statement than
the one that sets out the board’s functions because, in most cases, the day−to−day operational decisions which are delegated to
management are very numerous. A further difficulty of this approach is that residual or unspecified matters remain the
responsibility of the board and, should they crop up unexpectedly, there may be a damaging delay.

The CEO’s job description

It is good practice for the CEO to be given a job description and this can be used to define management’s role and, by
implication, that of the board. The main difficulty with this option is its inflexibility. A board may well wish to keep a closer
control of operations while it gains confidence in a new CEO, or in times of crisis, and since the job description will probably be
the basis for the CEO’s annual assessment and possibly remuneration, there may be good reason not to vary it unnecessarily.
There is no reason why a job description should not refer to a statement of matters referred to the board that could go into greater
detail.

The CEO’s letter of appointment

Similarly, the CEO’s letter of appointment may be used to define his/her role and that of the board but, again, this is a relatively
inflexible method and in most cases it will probably be wiser to refer in the letter to a more detailed statement of matters
reserved for the board.

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