Ethics and BP: Corporate Governance - Part 1

As an investor, it is important to understand the type of Corporate Governance framework established within the corporation before handing over your hard earned saving to the family broker. Corporate Governance, in its simplest form, can be described as the relationship between shareholders and management. When Corporate Governance goes bad, this relationship spoils and all stakeholders can be hurt in the process. For example, BP America (BP) has taken a massive reputational hit due to the April 20th explosion of the deep sea drilling platform, Deepwater Horizon, which killed 11 employees while spilling untold amounts of oil into the Gulf of Mexico (Casselman, 2010). Investigations into the explosions may not be finalized at the moment, however, we can take a look at this event and similar past incidents to reveal a pattern that can lead a prudent person to wonder if BP’s Corporate Governance is effective enough to mitigate risks and prevent other disasters from occurring in the future.

Introducing a new model for board effectiveness, Leblanc and Gillies (2003) established a model that attempts to measure the effectiveness of the Board of Directors. Their research points out that the majority of previous works use the “board structure” approach to corporate governance reform. What this correlates to is that board effectiveness is measured based off the corporation’s board structure. Leblanc and Gillies’ model indicates that the most important element is “board process,” which is the ability of Boards to come together and make decisions, and not “board structure,” which many are currently using for reform. The underlying foundation of the model has two types of effectiveness built into it: Board Effectiveness (BE) and Director Effectiveness (DE). I will attempt to use the model proposed by Leblanc and Gillies to further analyze BP America and their Corporate Governance Framework.

Board Effectiveness

To achieve board effectiveness, within the framework of this model, three elements are required: (i) board structure (BS), (ii) board membership (BM), and (iii) board process (BPr) (this was shortened to BP in the actual model; however BP is the corporation in this writing). Each element should be measured then added together to form a final tally showing the overall board effectiveness.

Board Structure

There are three separate items to consider when analyzing “board structure:” (i) leadership, (ii) composition, and (iii) size. With board structure being the basis for many debates concerning board effectiveness, it is important to understand what makes a board effective.

Leadership

Leadership is described as having either a non executive chair or the same person occupies the posts of Chairman of the Board (COB) and Chief Executive Officer (CEO), or what is known as CEO and COB Duality. Concerns over the effectiveness of CEO duality and its ability to create change within the firm are seen within two separate theories: agency theory and stewardship theory (Dickins, 2010).

Dickins (2010) describes agency theory as “emphasiz[ing] the importance of monitoring manageragents who seek to maximize their personal utility by maximizing their pay, or reducing their workload (shrinking).” Within the confines of agency theory the separation of CEO from the COB allow for better monitoring which decreases management’s ability to act in their own interests over that of shareholders.

Stewardship theory “emphasizes accountability and the importance of minimizing information-sharing costs.” This theory merges the two roles to make it easier to assign responsibility and minimizes the cost of sharing information.

Both, Leblanc and Gillies (2003) and Dicken (2010), suggest that there is inconsistent evidence to indicate which of the two theories are most effective. So, which theory does BP fall into? At a glance one could easily say that BP falls into the first theory, agency theory. A conclusion of this sort would be derived from the appearance of having both a CEO, Tony Hayward and a COB, Carl-Henric Svenberg. This separation of duty would allow for an increase of oversight of management by the COB.

However, upon further inspection of BP’s Corporate Governance framework we see evidence that the COB relinquishes his duty as the “overseer of management” to the CEO. BP’s Board Governance Principals state, “The Board believes that the governance of BP is best achieved by the delegation of its authority for the executive management of BP to the Group Chief Executive (GCE) subject to defined limits and monitoring by the Board (BP p.l.c.).” Using what looks to be a hybrid of theories it appears that BP has the best of both worlds; the appearance of agency theory by having both a CEO and COB but with governance being created by the CEO which is a concept of stewardship theory.

Composition and Size

Composition can be seen as the number of outside directors vs. the number of insider directors that make up the board members. According to Leblanc and Gillies (2003) the greatest concern associated with board structure has been the “independence” of directors. They further conclude that the evidence linking board structure and independence shows that 20 years of research find little evidence to its effectiveness. This does not mean that board independence is ineffective; it just means we need to develop more efficient tools to track the effectiveness of board structures. BP’s board composition can be seen in section 3.4 of BP’s Board Governance Principles (BP p.l.c.), Composition, Size, Independence and Tenure. BP maintains, “Over half of the directors, excluding the Chairman, will comprise Non-Executive directors who are determined by the Board to be independent in character and judgment and free from any business or other relationship which could materially interfere with the exercise of their judgment.” Non executive directors will occupy over half of the board seats which will not normally exceed sixteen. With the board holding sixteen seats, “Size,” should not create an issue.

Board Membership

Board membership analyzes the processes that determine how a corporation recruits its members for their board. According to Leblanc and Gillies (2003), “[b]oard membership includes the full panoply and balancing of all director competencies in matching the strategic needs of the company.” The board members need to be balanced in order to be effective as a group. BP’s board members are expected to have:

(a) Experience in dealing with strategic issues and long-term perspectives;

(b) Leadership experience, a supervisor knowledge of business principles and capacity for independent thought;

(c) An ability to participate constructively in deliberations; and

(d) A willingness to exercise authority in a collective manner.

The Nomination committee will oversee the mix of skills required for board members and make the appropriate recommendations (BP p.l.c.).

Board Process

The day-to-day operations of a corporation are carried out by management. As management styles differ from corporation to corporation and on an individual basis, a framework needs to exist to ensure management acts with the corporation’s best interests in mind. The unethical acts of management can be detrimental to the corporation and their stakeholders, which bring up the issue, as to, what are the corporation’s obligations to its stakeholders? Can we truly determine if a corporation is acting in an ethical manner?

A study, conducted by Management & Excellence (2008), lists BP as number three of the world’s most sustainable and ethical oil companies of 2008. The criteria for rating each oil company looks to be based substantially off board structure and the policies & procedures governing the corporation. However, the ratings do not take into account the ethical actions taken by the management team. How the Board of Directors oversees these ethical actions and creates corporate strategies for management to carryout is the basis of board process.

Board of Directors and Board Process

The ability of the Board of Directors to oversee management is a key goal in corporate governance. Shareholders rely on this oversight to ensure management acts appropriately. According to Vallabhaneni (2008), the Board of Directors is responsible for setting ethical standards as well as overseeing their compliance. Each board may look at corporate governance differently and have separate business views on how to govern.

One newly emerging business view that is on the rise is taking place globally. This view incorporates a set of core values that include: human rights; environmental protection; anti-corruption measures; board oversight; relationships with management, and accountability to share-owners (UN Global Compact, 2009). Central to this view, in accomplishing these objectives, is the Board of Directors that governs corporations. Two leading initiatives are trying to change the way we think about boards and their responsibilities. These two initiatives are the Organisation for Economic Co-Operation and Development’s (OECD) Principles of Corporate Governance and the United Nations Global Compact (global framework). The underlying framework, of these two emerging think-tanks, build upon research that shows responsible corporate governance creates a business ethos and environment capable of building integrity and trust within society and to share-owners. Focusing on board responsibilities, the global framework includes three fundamental strategies for boards and their directors: (i) Protecting Stakeholder rights and interests; (ii) Managing Risk; and (iii) Creating long-term business value.

As directors, fiduciary duties are imposed “on them to act in good faith, with reasonable care, and in the best interest of the corporation and its shareholders (Senate, 2002).” An investigative committee for the U.S. Senate (2002) named three broad fiduciary duties that corporate directors operate under: obedience, loyalty, and due care. Operating under this umbrella of trust, the board must balance their delegation of power with the right about of oversight.

By: Joseph Dustin
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