Two-tier Supervision Helps the 'Anxious Vigilance' of Corporate Management

Aug 28 , 2021
By Yehualashet Tamiru Tegegn

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Ethiopia’s previous Commercial Code recognised a purely one-tier board structure, where both managerial and supervisory responsibilities are placed on the board of directors. The revised Commercial Code commendably allows a two-tier structure where there is the option of forming a supervisory board, writes Yehualashet Tamiru Tegegn (yehuala5779@gmail.com), adjunct lecturer at Addis Abeba University and an associate at MTA.

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Corporate governance, as a system by which companies are controlled and directed, has been a critical area of concern for as long as corporations have existed. The size, characteristics, composition, and interaction of the corporate actors will greatly affect and determine the effectiveness of the overall governance structure and its performance. Any corporate governance seeks to balance a competing interest of innovation with predictability in the company.

One of the most recurring problems in contemporary corporate governance is the issue of agency – the principal relationship between shareholders as real owners of the company and the board of directors as a representative of shareholders. This agency problem may arise in three different instances. It could be between the management and the shareholders, or majority and minority shareholders. A third one is between the controllers of the company, either managers or majority shareholders of the company, and non-shareholder stakeholders, such as employees and debenture holders.

Adam Smith, the founder of modern economics, indicated that the directors of a company, being the managers rather of other people’s money than of their own, cannot be expected to watch over a company with the same anxious vigilance as that of partners in a private company. He is not wrong, which is why there have been corporate management mechanisms set in place to address this gap.

In the separation of ownership and management, the most prominent structural characteristic of the board of directors is whether it is a one-tier or two-tier institution. Ethiopia’s previous Commercial Code did not even recognise the latter. Thus, the board structure adopted was purely one-tier – both managerial and supervisory responsibilities were placed on the board of directors. This form of board structure has its advantages, allowing a superior flow of information and securing faster decision-making.

But unlike the one-tier board structure, in two-tier boards, executive directors, the management board, are responsible for the daily operations of the company while non-executive directors, the supervisory board, are responsible for the supervision and monitoring of executive directors.

The revised Commercial Code gives discretionary power to companies to adopt a voluntary two-tier board structure during their memorandum of association. By introducing this option, policymakers have conceded that shareholders choose the structure of the company that best suits them.

Unlike the sizable number of members of the board of directors, the general meeting of shareholders can appoint not less than three but not more than five members of the supervisory board. The revised Commercial Code takes a commendable step in limiting their number to a maximum of five members since a smaller board will be more likely to have effective discussions to reach a consensus and arrive at sound decisions from their deliberations.

If a company opts to form a two-tier board structure, there will be complete separation between its supervisory board and its management board with no overlapping membership between them. Only shareholders of the company shall be appointed as supervisors, unlike members of the board of directors. The supervisory board will participate neither in management affairs nor in the board of directors.

The supervisory board has two main roles in corporate governance: monitoring and evaluating functions in filling the gap between the unaware shareholders and the well-informed executive managers.

The supervisory board governs and monitors the activities of the board of directors. In this respect, under the revised Commercial Code, supervisory boards are mandated, among other things, to undertake supervision to ensure that directors and other members of the management are discharging their responsibilities properly. When it has been ascertained that they have committed an act that jeopardises the interests of the company, they can demand corrective measures be taken. They also have the power to recommend, as appropriate, to the board of directors or general meeting of the company, for the removal of those who have failed to discharge their responsibilities properly and as well as initiate the examination of the financial affairs of the company.

The supervisory board is also actively engaged in the evaluation or ratification of some of the activities of the board of directors. Here, the revised Commercial Code mandates the supervisory board, among others, to institute proceedings when it knows or has reason to suspect that an act that injures the company has been committed.

For this service and onerous obligations, members of supervisory boards are entitled to have remuneration, the amount of which is determined by the general meeting. However, the supervisors are jointly liable for damages that may be caused to the company, shareholders, or third parties as a result of failure to discharge their responsibility.

The updated Commercial Code has come at a time when the country is seeing its economy open up. Allowing a two-tier board structure is one among many efforts that will help corporations become more accountable and effective if the private sector is going to take the upper hand in steering the economy. With the presence of a supervisory board, the option to oversee the activities of the board of directors and make them accountable for shareholders is now widening.

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PUBLISHED ON Aug 28,2021 [ VOL 22 , NO 1113]

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