Businesses all around the world face enormous challenges due to pandemic. Good governance is in demand like never before. Both public and private companies have recognized that corporate governance affects directly their financial performance and long-term development. The governments have seen the value in well-governed companies too, and thus they cooperate with business in updating corporate governance codes and reforming corporate law.
Junior Associate at GOLAW
Following Ukrainian Code of Corporate Governance, Ukraine takes on overhauling its law on joint stock companies and on limited liability companies in the Bill No. 2493 (the “Bill”). One of the Bill’s major novelties is one-tier board structure. Thus, after the Bill will be adopted, Ukrainian companies will get a right to choose either one-tier or two-tier model and to switch from one to another.
The advantages of having a board in the company are obvious: it provides management with exclusive advice and protects shareholders by oversight of the management. The choice between the one-tier and two-tier model, however, is not straightforward. The shareholders establishing either type of board structure should consider the peculiarities of their business as well as the Ukrainian legal framework for corporate governance.
Ukrainian approach to one-tier board structure
One-tier or unitary board structure is innately a different mode of corporate governance of a company, which is widely accepted in the United Kingdom and United States of America. Unitary board substantially differs from two-tier or dual board structure in size, composition, and decision-making process.
In one-tier model, the managerial and supervisory powers are unified in single board of directors. Hence, decisions will be adopted and supervised by the same body. In the extant Ukrainian two-tier model, the management is separate from supervisory board. The supervisory board monitors the management severally, for example, by approving or consenting to its decisions.
The legal framework proposed in the Bill offers investors the opportunity to establish unitary boards measured up to the best international practices.
Composition as Distinct Feature
Board of directors is composed of executive and non-executive members. In practice, board of directors includes CEO, Chairman and Independent Directors. Nowadays most board of directors’ executives include only CEO, who represents other officers of the company. The CEO also can hold concurrently the office of the Chairman. Non-executive members are professionals, which could be either independent from a company – Independent Directors, or affiliated with it, for example, be former company’s executives, auditors, shareholders.
International experience shows that businesses choose unitary boards with majority of Independent Directors. For example, 90 % of directors on the boards of the Fortune 500 companies are independent directors. Independent directors usually are former CEOs and corporate executives from other companies or professionals from financial, legal and consultancy fields.
More is not always better than less
One-tier boards on average have fewer members than two-tier boards. Although the number of members on a board depends on the size of a company, the consensus is that it should not exceed eight members. The Bill proposes that board of directors of joint stock companies shall have at least three members to be legitimate.
Firms with smaller boards tend to outperform similar firms with larger boards. Smaller unitary boards provide for better interpersonal relationships between the members that facilitate resolution of conflict and speeds up decision-making. In turn, non-executive directors find understanding with the management easier and faster.
Rotation of Power
The general shareholders meeting of a company will elect members of the board of directors. The Bill proposes to elect the board members for three years unless otherwise prescribed by the articles of association. The members also may stand for reelection for unlimited times. The suggested default term for members’ tenure exceeds widely accepted standard of annual mandate. The annual rotation of members is better governance practice, because it incentivizes production of tangible results in a short term.
The Bill allows to dismiss board members without convening general shareholders meeting for breach of fiduciary duties by directors, for conflict of interest or other grounds specified in the articles of association. Other grounds may include, for instance, mandatory retirement ages and limitation on reelections. Such criteria ensure that a company receives fresh ideas and expertise.
Why to Choose One-Tier Board?
The one-tier board structure has several advantages due to its composition, size and mode of operation.
Several factors make board of directors predisposed to be better informed. Firstly, unitary board usually meets more often that allows receiving constant updates on company’s affairs. The Bill ensures that members have at least one mandatory meeting a month. Secondly, closer relationships with the management give non-executive directors access to the insider business knowledge. Therefore, it is easier to evaluate information and objectively advise management how to act. Finally, the management, being on the same board, will not be able to filter out the information supplied to non-executive directors. Thus, non-executives can supervise management more objectively in contrast to dual board structure. Two-tier board is provided with the information by the management, which could modify or withdraw it before board’s meetings. In addition, combination of frequent meetings and unitary structure contributes to better understanding and involvement of non-executive directors in the business.
Board of directors also is prone to make decisions faster. Management and supervising non-executive directors acting as one body will require only one set of procedures for making and approving a decision. Unlike in dual board model, the time gap between decision of the management and its approval by supervisors will not occur.
Benefits of Two-Tier Board Structure
Dual board model has merits of its own. The major strength of two-tier structure is independence of the supervisory function. The members of supervisory board have specific mandate: prior review of or approval and post monitoring of management’s decisions. In comparison, responsibilities of the non-executive directors in one-tier system may be blurred. In practice, it can be difficult to draw the distinction between member’s managerial and supervising responsibilities. Therefore, board members in two-tier structure avoid the conflict of simultaneously making and monitoring their own decision as in the unitary model.
Supervisory board also less likely to develop closer relationships with the management, because it does not meet with the management regularly and usually convenes less frequently. Hence, supervisory boards are likely to debate issues impartially and may adopt less biased decisions.
The larger business grows, or if company goes public, the more choice may shift to dual board structure, because of stronger demand for independence of board members. Extremely useful for such cases will be Bill’s provisions for choice of board structure and for transition from unitary to dual board model and vice versa after the registration of a company.
How to Take Advantage of New Modes of Corporate Governance
One-tier structure is an opportunity to have effective corporate governance due to smaller size of the board, its frequent meetings and deeper involvement into business. Unitary board structure offers streamlined and less time-consuming procedure for decision-making. At the same time, one-tier system presents certain challenges, such as separation of the board members’ supervision responsibilities, their liability for decision making, independence of non-executive directors from executives.
Nevertheless, most of the issues with unitary board structure could be overcome. The responsibilities and liability of non-executive directors can be specifically limited in the company’s articles of association, by-laws of the board and employment or service contracts with board members. Independence from executives could be secured by company’s policies for disclosure and conflict of interest.
The Bill’s proposal to introduce the one-tier structure in no way diminishes relevance of dual board. In big companies with many different interests of shareholders and creditors, the dual boards will be a better choice because of the prominent board members’ independence. Thus, companies may choose the unitary board first and with the growth of the business opt for two-tier structure. For such an instance, the Bill gives the right to switch from one structure to another after company’s registration.
The new proposals in the Bill No. 2493 will provide the opportunity for businesses to choose the mode of corporate governance that suits them better depending on company’s size, its ownership structure and required degree of independent oversight. New board structure and its operations at first may seem quite complicated, but with professional advice in corporate law and governance, the business owners will understand how each model works and easily choose the proper one for their company.