Major corporate scandals during the beginning of the century, such as those involving Enron, WorldCom and Tyco, have sparked reactions from lawmakers and regulators around the world. In addition to profound regulatory changes, such as the ones introduced by the Sarbanes-Oxley Act in the US, several other initiatives have broadened the responsibilities of boards of directors to ensure their independence and strengthen their role as a direct oversight body.
In Brazil, new regulatory structures and initiatives introduced since the early 2000s were an objective echo of this movement. Among them are the revisions of Law 6.404/76, the creation of the Novo Mercado segment by the Stock Exchange, the Brazilian Institute of Corporate Governance (IBGC) and the Capital Market Investors Association (AMEC), in addition to the enactment of the Anti-Corruption Law (12.846/2013). Even so, the new national regulatory and governance framework, including the apparently reinvigorated boards of directors, has not been able to prevent countless corporate and corruption scandals involving some of the country’s largest public and privately held companies.
Why is our corporate governance system so weak? What are the implications for the boards of directors? How can boards of directors evolve to fulfill their responsibilities in a scenario with increasingly strict regulations, innovation, and constant scrutiny by media and activist investors?
The relationship between the board of directors and the CEO is one of the most important and decisive elements for a company’s success. To construct a successful relationship, both the board of directors and the CEO must have a clear joint understanding of their roles, requirements and limitations. These shared responsibilities will only be successful if the CEO and the board of directors share the same goals. Both parties must understand and agree on priorities, with the board of directors being responsible for setting strategic guidelines and the CEO responsible for their execution.
In addition, modern board of directors need to be prepared to closely supervise corporate activities, ensuring compliance with increasingly strict regulatory guidelines and identifying the risks imposed by frequent changes in the business environment. To achieve this, an appropriate and qualified board of directors is a key aspect. The days in which board members held conventional meetings every three months for updates on general business matters are over. Acting on current events only is no longer enough. Boards need to act closely, ask the right questions and enforce debates from a broad global prospective, deepening discussions to anticipate risks and foresee opportunities. Therefore, it is imperative that board members have extensive business knowledge and the ability to communicate clearly and effectively to foster and stimulate relevant discussions.
Another essential quality for modern board of directors is to anticipate complex situations or situations that can create potential conflict of interest for management. Merger and acquisition transactions are relevant examples for this type of situation. Obviously, not every merger and acquisition transaction deserves special treatment by the board, but situations involving companies with diluted ownership or relevant shareholders sitting on both sides of the table are typically more complex and sensitive. Additionally, transactions involving relevant divestments or transformational actions deserve greater scrutiny and require special treatment by boards of directors.
In any of these situations, the use of fairness opinions, a document issued by an independent and conflict-free adviser, can be an important resource for boards of directors and can be engaged by the company’s management upon the board’s request. In practical terms, the fairness opinion assesses whether a given merger, sale or acquisition transaction unintentionally proposed to the board of directors by management, or received from a third party, is “financially fair for the target company’s shareholders”.
Although a specific regulation does not determine when fairness opinions should be requested in Brazil, they have been increasingly and commonly used by local boards to ensure they are acting in a diligent and responsible manner, always looking out for the best interests of all shareholders involved. In Brazil, boards of directors of companies such as Petrobras, Taesa and Eneva routinely use fairness opinions in the execution of their strategic initiatives, serving as an important example to be followed.
Another recent and important transformation in the Brazilian business environment is the growth in the number of companies with diluted ownership in the capital market. In such cases, when no single shareholder or a small group of controlling shareholders exist, boards of directors are responsible for appropriately identifying and responding to any attempts by third parties to acquire controlling stakes that may be considered “hostile” and detrimental to the best interest of the shareholders.
Defense mechanisms against such “hostile takeovers”, known as “poison pills”, may be designed in many forms to inhibit the possibility of such events, or may be implemented whenever a hostile takeover offer is effectively announced. One of the most frequently used mechanisms of this type in Brazil is a statutory clause that demands any acquirer accumulating an equity stake higher than a predetermined percentage (typically between 20% and 30%) to carry out a public tender offer to acquire the company’s outstanding shares.
However, the application of poison pills still lacks more relevant examples in Brazil. Moreover, most of these mechanisms can only be directly implemented (or removed) from corporate bylaws by the shareholders themselves, which relevantly restricts the actions of local boards of directors. In any case, it is important that boards of directors of companies with diluted share capital remain alert to this type of situation and guide their shareholders, acting diligently and objectively and basing their conclusions on financial and legal studies prepared by their own independent advisors.