This would raise challenges that are common to all small businesses as they expand: issues of power, control and transparency as well as problems of cash flow – a perceived lack of legitimacy and a short track record.
A closer examination of governance includes an outline of the roles of the board members, board composition and an explanation of important issues of trust and conflicts of interest.
Governance is a system of checks and balances whereby a board is established to supervise and guide the managers. Governance is sometimes conceived as a virtuous circle that links the shareholder to the board, to the management, to the staff, to the customer and to the community at large. Boards review, confirm and approve the plans and performance of the senior management. The board needs to know what the vision is and then ensure that it is maintained. Management, on the other hand, is involved in the daily operations of putting the vision into action.
Fundamental to good governance is the ability of individual directors to work in partnership to accomplish an effective balance between strategic and operational responsibilities.
Effective governance occurs when the board is able to provide guidance to management in strategic issues and is effective in overseeing management carry out the agreed upon strategic plan. Management in turn assumes operational authority and ensures that the institution’s program of activities responds to the direction jointly agreed upon with the board.
The interplay between board and management centres on the relationship between strategy and operation, with the board basing its discourse on the strategy it has jointly defined with management ensuring that the operations are deployed effectively.
The challenge of governance is to employ the perspectives and experiences of the board and management to maximize their overall contribution to the institution’s performance.
Code of Conduct of the Board of Directors
Duties of the board fall within three categories: Duty of care, duty of loyalty and duty of obedience.
i) Duty of care
The duty of care calls on a director to participate in the decisions of the board and to be informed on the data relevant to such decisions. A common statement of the duty of care asks a director to be:
i) reasonably informed
ii) participate in decisions and
iii) to do so in good faith and with the care of an ordinarily prudent person in similar circumstances.
To discharge the Duty of care efficiently and effectively, directors must attend meetings, exercise independent judgment and ensure that they have an appropriate level of understanding of the issues critical to the institution.
ii) Duty of Loyalty
The duty of loyalty requires directors to exercise their powers in the interest of the corporation and not in their own interest or in the interest of another entity or person. By assuming a board position, directors acknowledge that for any corporate activity, the best interests of the corporation must prevail over their individual interests or the particular interests of the constituency that selected them.
The duties of loyalty primarily relate to conflicts of interest, corporate opportunity and confidentiality.
Conflict of interest should be disclosed by the director for board’s interpretation of the issue to determine if it is a proper or improper transaction.
Corporate opportunity requires that a director, before engaging in a transaction which she/he knows can be of interest to the corporation must inform the board of directors in sufficient time and in detail to allow it to act or decline to act to a director’s possible involvement in that transaction.
iii) Duty of Obedience
The duty of obedience requires board members to be faithful to the institution’s mission. Although board members have the authority to determine how the institution is to best meet its mission, they are prohibited from behaving in the manner inconsistent with the basic institutional objectives. The duty of obedience grows, in part, out of organizations heavy reliance on the public’s trust when soliciting donations and grants. In turn the public has the right to be assured that such funds will be used for the purpose for which they are given.
Continuum OF Board Involvement
The continuum of a board’s involvement in the governance of the institution are:
i) rubber stamp board, which exercise too little oversight of management
ii) hands-on board, which can play an effective governance function
iii) representational board, which, although less involved than the hands-on board, contributes to the institution in establishing key linkages with the business, banking and government sectors.
iv) Multi-type board. The challenge facing a microfinance institution is to achieve the type of board, which here is termed multi-type, in which board actively provide guidance in strategic issues and assist the institution in establishing the key linkages outlined above.
Rubber Stamp Board
A board of directors that is generally reactive in its relationship with management is called a rubber stamp board. Management tends to present strategic thinking as well as plans and decisions to the board merely for its official approval. Directors may be poorly prepared for meetings and may know very little about the Microfinance operations and activities.
Although such an arrangement may expedite the decision-making process for management, it negates the fundamental reason for a board’s existence and in the long term severely diminishes the institution’s overall effectiveness. A rubber stamp board is likely to create one or more of the following situations:
(i) Te board brings no additionality to the institution and is thus amenable to whatever strategy or program is submitted for its approval.
(ii) The institution is denied the benefit of varied thoughtful voices and experiences that are essential for its proper functioning and growth.
(iii) Enormous responsibility and power are placed in the hands of the top executive or on one board member. Such a situation is likely either to drive away a good executive who demands effective governance or to concentrate authority unduly in one person.
(iv) In the worst case, rubber stamp boards, which do not act as a check and balance, leave the institution vulnerable to mismanagement and fraud.
Hands-on Board
A hands-on board of directors consists of members who offer strong expertise and are actively involved in defining and monitoring the activities of the institution. Directors are kept informed of the ongoing operations and issues of the institution, are well prepared for meetings, and play a proactive role in overseeing the management of the institution. An effective board of directors that is well versed in the needs of the institution and able to utilize its collective experiences, skills, and contacts will consistently exhibits the following characteristics:
(i) Will raise issues that are at the core of the proper functioning of the institution and will not be distracted by peripheral or semi-peripheral concerns;
(ii) Will engage in more constructive and challenging discourse with management and provide the type of useful analysis that enables management to pursue increasingly higher levels of performance;
(iii) Accompanies good management and, if necessary, takes the lead in defining the overall strategy of the institution and works closely with management in overseeing its implementation;
(iv) Understands the difference between its strategic-based role and the operational responsibilities of management; and
(iv) Is more likely to identify quickly and effectively shortcomings in the board’s functioning and seek to address them.
Ironically, a hands-on board that loses sight of its primary strategic function is likely to cross the line into micromanaging the operation and thereby may become more harmful to the institution than the other board types.
Representational Board
A representational board includes influential and well-respected persons who provide important visibility for the institution and give it a level of credibility it would not otherwise have. This board type depends heavily on management to play a key role in strategic and operational decisions, but board members remain informed of the institution’s operations.
Members of such a board are often short of time and are more likely to provide a more distant level of oversight. When deploying their responsibilities effectively, members of this board type are likely to accomplish the following:
(i) Open doors for the institution that would otherwise remain closed or hard to open. A representational board member might improve the institution’s ability to establish key linkages with the government, business, or banking sectors, allowing it to more effectively achieve its institutional mission;
(ii) Increase the institution’s access to information outside its direct area of operations and enhance its national and international exposure; and
(iii) Maintain necessary oversight in part to ensure that their names and reputations are not damaged by their association with a poorly performing institution.
Multi-Type Board
A multi-type board includes members who play a representational role and those who are well informed about the operations of the institution and have solid expertise, here termed hands-on. The former provides the role of visibility and stature, whereas the latter provides useful input to strategic decisions facing the institution and, to some extent, specific operational issues. The multi-type board combines the representational and hands-on boards described above and extracts from each its comparative advantage on behalf of the institution. This board would be able to make well-informed, timely, and efficient decisions because it has the elements at hand to do so.
Clearly, a board that fits into the rubber stamp category is not executing its role effectively.
Similarly, boards in which all directors fit into one of the other two types—hands-on or representational—will also demonstrate limitations in their capacity to govern effectively. A mix of directors who together can effectively address the governing needs of the institution is the preferred option for quality governance.
Role and Responsibilities of Boards of Directors
The basic responsibilities of the board comprise of the following roles: fiduciary, strategic, supervisory and management development.
Fiduciary
The board has the responsibility to safeguard the interests of all the institution’s stakeholders. As such, the board serves as a check and balance to provide confidence to the company’s investors, staff, customers, and other key stakeholders that the managers will operate in the best interests of the institution.
Strategic Responsibility
The board participates in the organisation’s long-term strategy by critically considering the principal risks to which the organization is exposed, and approving the plans presented by the management. The board does not generate corporate strategy, but instead reviews management’s business plans in the light of the institution’s mission, and approves them accordingly.
Supervisory Responsibilities
The board delegates the authority for operations to the management through the Chief Executive Officer. The board supervises management in the execution of the approved strategic plan and evaluates the performance of management in the context of the goals and time frame outlined in the plan.
Management Development Responsibilities
The board supervises the selection, evaluation and compensation of the senior management team. This includes succession planning for the CEO. Governance should move an institution beyond dependency on the visionary.
Legal Obligations of the Board
As a fiduciary, the board of directors has several legal obligations. First, the board must ensure that the institution complies with its articles of incorporation, bylaws, and internal policies and procedures. Further, the board must ensure that the institution maintains its legal status. The board must also ensure that the institution complies with government rules and regulations, which will vary with the institution’s corporate structure. For example, as a microfinance institution becomes regulated, it will be subject to a new set of regulatory requirements that the board must understand. A final element of the board’s legal obligations is the level of personal liability of individual directors for the institution’s activities.
Relationship Between Board and Executive
Although the relationship between a board and the executive director or CEO is dynamic, it must be grounded in a clear understanding of the roles each serves. Effective governance strikes the appropriate balance in the relationship between a board of directors and in their combined efforts to move the institution forward. Each brings unique skills to this joint effort and views the institution from a different lens. Together they add value precisely because they are complementary.
Effective boards carry out their responsibilities by (1) maintaining operational distance from the institution, (2) drawing on the institutional memory of the directors, and (3) making binding decisions as a group. Board decisions are based on the voice of the majority.
Arriving at a consensus may be time-consuming and decrease the board’s operating expediency, but the process is essential to a well-functioning board.
These three factors empower the board and add significant value to the management of the institution.
Management, in contrast, is intimately involved in daily operations, has an up-to-date and in-depth understanding of the immediate challenges and opportunities facing the institution, and the flexibility to react quickly.
Effective governance requires boards to focus on three major areas of responsibility:
(1) management accountability,
(2) strategic planning and policy-making, and
(3) self-regulation.
Management Accountability
To ensure that management is held accountable for the activities of the organization, a board must first focus on the process and mechanisms it uses to identify a competent executive.
Second, it must set clear and measurable goals. Third, a board must monitor the performance of the executive. Finally, it must be able to identify managerial weaknesses and confront them when these adversely affect the institution. If necessary, the board must be prepared to remove the CEO.
Install Management Capacity. Hiring a strong, competent CEO is one of the primary functions of a board of directors. This individual, as the operational leader for the institution and the representative of the entire staff to the board, plays a key role in the long-term success of the institution and in the realization of effective governance. A board can only be as effective as the CEO it appoints, and therefore it must consider this a core responsibility.
Strategic Planning and Policy Setting
The second major area of board responsibility is strategic planning and policy making. However, although effective governance assumes that the strategic planning process involves the board in a significant way, the board should include and expect strategic thinking to be part of the leadership qualities that the top executive brings to the institution. The distance and diversity of experiences of board directors enables them to bring a perspective to the institution unique from that of management. If the board does not add significant value to the institution’s strategic plan, it is not performing its duty. The board should provide guidance and input in three distinct areas: charting the institution’s strategic course, setting broad operational policies for the institution, and resolving strategic issues as they arise.
Providing Direction. It is not uncommon for daily operational priorities to overtake the more thoughtful process of strategic planning. Effective governance requires that the board raise strategic issues that may not otherwise be addressed and, thus, significantly contribute to identifying and setting long-terms goals for the institution.
Setting Institutional Policy. A central feature of board leadership is to define and clarify, with management, general institutional policies. On a practical level and with few exceptions, the board role in setting policy should differ from that of management not by topic but by levels within topics. For example, it is typical for management to bring to the board general policies on compensation. In this matter, the board might decide that the institution should compensate its staff with packages that are competitive with other institutions of the same size and scope. The actual wage and salary administration plan is then left up to management. Or a board might be involved in setting a policy on the characteristics of the neighborhoods in which it wants to establish additional branch offices, and management is left to determine the specific locations.
A policy-centered approach allows a board to effect the most change and to place all operational and administrative activities of the institution within the framework of defined policies. This approach also encourages the recruitment of individual directors with general strategic management skills who are more likely to keep the board focused on its governing mandate.
Developing and Mobilizing Solutions. Boards that go beyond the above-mentioned elements—providing key input in charting a strategic direction and in defining general policies—assist the institution in identifying tactics and solutions for reaching its goals. In this sense, the board provides governance plus guidance.
Board Self-Assessment
A final area of effective governance involves the board’s assessment of itself as a body of individuals and as a permanent entity. Three areas constitute the core of any assessment that the board conducts on itself: continuity, renewal, and evaluation.
Continuity. Of great value to management is that the board and its individual directors possess an institutional perspective. The board must therefore be responsible for maintaining this continuity by ensuring that even with natural attrition; the board’s “institutional memory” is preserved. The design of board terms and succession policies, as well as a corporate binder, are the mechanisms used to ensure continuity.
Renewal. Having stated the need for continuity, so too is there a need for an infusion of new directors who bring fresh perspectives, talents, and expertise. Working with management, board members can fundamentally shape effective governance by identifying new directors who could enhance the board operation. Ideally, board composition is a balance of the old and new.
Evaluation.
As discussed earlier, given the contradictory frames of reference of boards and management, by definition board performance is vulnerable to being undermined by a set of complex dynamics. An effective board recognizes its own weaknesses and has in place mechanisms for self-evaluation. Board performance can be assessed under three categories:
the role, the working style, and the directors themselves. Though still an infrequent part of board processes, self-evaluation should be embraced.
Conclusion
This review of Governance in Microfinance in Uganda would raise more questions than it would answer. Indeed there are no easy answers, particularly in a struggling industry that has yet to establish governance guidelines. Future steps to address could include: training board members about the hybrid objectives of micro-finance, preparing guidelines about the appropriate role of board members to avoid conflicts of interest.
The writer is Advisor Microfinance, Ministry of Finance, Planning and Economic Development, Republic of Uganda.
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