Many people in corporate America or the world of investing know that public companies usually have a governing board responsible for making decisions about their strategic goals and overall direction. For most companies in the U.S., the common corporate governance structure involves one board that handles these tasks.
In other jurisdictions, particularly in English-speaking countries outside of the U.S., a different board structure is also prevalent. Commonly known as the two-tier system, it involves governing with two separate boards, each with its own distinct function. Though it may not be the norm in a business’s country of origin, it’s important to understand, especially for corporations that expect to expand overseas in the future.
What Is the Two-Tier Board Structure?
The two-tier board structure seems simple in definition but is much more complex underneath the surface. As you might expect, it consists of two separate boards:
- A supervisory board
- A management board
Each board operates under a different hierarchy, with separate responsibilities. Understanding what each board is responsible for is key to seeing how they work in tandem to keep the company moving forward.
The Supervisory Board
The supervisory board is responsible for setting the long-term direction of the company and crafting the strategy to reach that goal.
Because they work in a two-tiered, hierarchical system, those on the supervisory board are also responsible for assessing the management board’s action and providing repudiation when necessary.
The supervisory board represents all stakeholders and ensures that things in the business work in their best interests. The board is typically comprised of non-executive directors (NEDs) who are not actively working within the company to avoid any conflict of interest.
While the board doesn’t generally play a part in the day-to-day operations of the company, it does ensure those operations meet legal and ethical standards set forth by regulatory agencies.
The Management Board
The management board lies on the opposite end of the spectrum. Unlike those on the supervisory board, management board members are active executive directors who concern themselves with daily business tasks, overseeing business operations and technical financial tasks.
The management board plays a large role in managing resources and overseeing the workforce. It receives strategic decisions from the supervisory board and manages their implementation. Although many may see the management board as a “junior” or “shadow” board, it offers valuable insight and feedback to the supervisory board about what is working well and what concerns are arising as they carry out the strategic plan.
Why Two-Tier Corporate Governance Works
Two-tier governance brings many benefits to the companies that use it.
In a two-tier system, everyone on the board maintains distinct roles. Since there’s very little crossover, everyone can focus on their own areas of expertise without worrying about usurping another’s authority.
Having two separate boards allows for the introduction of diverse thoughts and opinions. Because each board has a distinct purpose and experience, each group can challenge the other to think differently and independently about issues.
Because management boards are made up of executives who work at the company, the two-tier system allows for a greater level of employee engagement. While employees won’t necessarily determine the company’s direction or strategy, this does give them a larger voice.
Two-tier systems allow for larger boards. This is yet another aspect of the system that allows for more varied opinions and viewpoints, something that has long been touted as a feature of strong governance. This also allows more room for shareholders to get involved, which can reduce the tendency of shareholder activists to attempt hostile takeovers.
Many unitary boards have a hard time implementing DEI initiatives or creating space for gender and cultural diversity. Two-tier systems can sometimes offer a pathway to this goal due to the increased number of board members and the opportunity to have greater diversity among executives, even when NED boards struggle with this issue.
Within the two-tier system, any conflict can stay within one board rather than affecting the entire governance team. This often makes conflicts easier and quicker to resolve.
Making Better Decisions
A two-tier board means that each can have a system of checks and balances to increase the likelihood of making the best decision. Because the supervisory board signs off on the management board’s decisions, procedural mistakes can be kept to a minimum.
The Drawbacks of the Two-Tier Board
While two-tier governance systems can benefit companies in a plethora of ways, this model does have a few drawbacks:
- Performance Mindset: If independent NEDs benefit from a company’s stock, they may be inclined to focus only on what will drive up the stock price
- Increased Volume Without Results: Having more board members sometimes complicates issues while delivering no favorable results
- More Bureaucracy: Having two boards means that decisions take longer to be approved and implemented
- Multiple Priorities at Odds: The management and supervisory boards often have different priorities and must learn to manage opposing priorities while continuing to work toward a common goal
It’s important for both executives and NEDs to be aware of these potential issues so they can recognize and thwart them before they jeopardize either board’s ability to govern well.
Effective Governance Is Always the Goal
While the unitary board of directors may be the norm in the U.S., that simply isn’t the case throughout the rest of the world. Some jurisdictions prefer a two-tier system with a supervisory board to determine the company’s direction and strategy and a management board to oversee daily operations.
While neither model is necessarily better than the other, the two-tier model does offer a few advantages. For example, each board and member maintains distinct roles, a larger board allows for increased diversity, and having a management board can foster greater employee engagement.
Though this model may result in increased bureaucracy and requires juggling multiple priorities, these drawbacks don’t always mean that it can’t be done well. As long as board members are aware of potential issues, they can work together to resolve issues and keep moving toward the best solutions for all company stakeholders.
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