Board of Directors

A corporation is a legal entity created ("chartered") either under federal or state law. The corporation is an artificial "person" distinct from the individuals who own it. This prompted a jurist once to remark that a corporation has "neither a soul to damn nor a body to kick" (as recalled by Barron's Dictionary of Finance and Investment Terms.) This legal person is nevertheless entitled to own property, borrow money, bring law suits, and to have its communications protected under the First Amendment. The charter of this institution is its "constitution," the shareholders are its "people," the management is its "executive," and the board of directors is its "legislature." In theory stockholders elect board members and board members elect the chief executive. Thus a "board of directors" is associated with companies organized as corporations. Partnerships and sole proprietorships do not have boards. The minimum and maximum number of board members is usually specified by state law; three is a typical minimum membership; the maximum may not exceed the number of shareholders. The board's duties are defined by the corporate charter which, in turn, is structured by state and/or federal law.

HISTORICAL PERSPECTIVE

In discussing boards generally, it is important at the outset to note that all boards are different. Despite major trends over time, specific boards have exhibited every variety of function associated with such bodies, often in defiance of prevailing custom.

By historic origin, boards initially were the investors—the three or four wealthy people who funded an energetic entrepreneur. The distinction between investors and boards developed over time as the number of investors grew large and, in more modern times, enormous; boards then took on the role of bodies representing stockholders. The presence on the board of major stockholders, however, in person or by proxy, has never disappeared. Through much of the sustained growth period that followed World War II, boards retained their governance functions but often exercised them weakly ("rubber stamp boards"), especially in successful, growing corporations led by dominant executives. In the opening years of the 21st century, in response to major corporate scandals, a strong role for boards has reemerged, mandated by federal law. But these changes are strictly speaking specific only to publicly traded companies. The role of boards in privately held corporations continues to be shaped by other factors, most prominently by the degree to which major stockholders alone or in groups wish to be involved. Private boards may be quite active in some companies and may exercise supervisory powers; in others board members are chiefly used as resources and as ambassadors to other interests; in yet others boards are a mere formality required by law.

BOARDS AND THEIR ORGANIZATION

Corporate boards have members, usually called "directors," who are elected by the stockholders. In the ordinary course of events, a privately held corporation has board members selected by the consensus of the company's founders without a formal election. When the company goes public and stockholder numbers increase substantially, the company prepares slates of board candidates and submits these to stockholders for a vote. The stockholder may accept the recommended slate, choose one of the alternatives, name others who do not appear on the list, or give his or her vote ("proxy") to the company itself to exercise.

Board members are called inside directors if they are members of the management or outside directors if they have no direct role in the company itself. Outside directors are typically well-known figures in the business community recruited for service on the board to provide valuable advice and counsel; they may not be executives of competitors or sit on competitors' boards. Outside directors may also be drawn from community organizations sometimes representing academia, law, labor, or other large constituencies or interests. Outside directors are also called independent directors because they are not under the influence of the chief executive of the corporation. In publicly held companies directors receive compensation for their services. Compensation may also be paid in privately held organizations.

Under the rules of the Securities and Exchange Commission (SEC), directors of either category are held to be "insiders" and therefore prohibited from trading stock based on "inside knowledge."

In large corporations the board is frequently subdivided into committees with functional roles such as Executive, Finance, Compensation, Strategy, Audit, etc. Board members are assigned to committees and these, in turn, develop positions on issues pertinent to the functional matter assigned to the committee. They make recommendations to the full board. Under legislation passed in 2002, audit committees are mandatory and their functions and membership are precisely defined.

Boards set their own rules of operation. If the corporation's bylaws or charter specify that Robert's Rules of Order will be followed, procedures may take the parliamentary form—or do so if conflicts arise.

In large corporations the board—and its committees—will have full-time staffs engaged in preparatory and administrative work related to board activities. Employees of such staffs are also considered to be insiders because of their unique access to sensitive data.

THE EVOLUTION OF A BOARD

In a small privately held corporation the board will typically be a so-called "working board," with its members all engaged in the business. In addition one or two additional family members may be on the board but inactive in operations. Board meetings tend to be rather informal in such situations because operational and board decisions coincide. The paper-work connected with the board activity—recording legally mandated board meetings, for instance—will be seen as rather a nuisance. If and when the business begins to grow, the board will tend to evolve.

A growing business tends to enlarge its board by inviting new investors to serve—or may have to welcome a new investor (or his or her representative) willingly or not. The owners also often see great benefit in drawing in people who can bring new points of view and important skills and knowledge in guiding the company as it expands, often into unfamiliar territories. An "advisory board" thus develops. Board meetings take on a real value at this stage. They serve to clarify directions and to gather information. Management learns to view itself more clearly and consciously by explaining the business to others at board meetings. Board members bring suggestions, make contacts, redirect efforts by good advice, identify opportunities, and otherwise participate in consulting capacities.

The board may finally develop into a "governing board" at the next stage when the company, seeking either to cash out its assets for the owners or to raise funds for the next stage of expansion, "goes public" and becomes a publicly traded entity. At that point the company comes under the regulatory aegis of the SEC. Its board members now are exposed to the colder and harsher winds of securities law. The character of the board will change automatically even if its inside management remains in control by retaining more than half the outstanding shares. The most important duties of a public board are the selection of senior executives, approving issuance of additional shares, declaring dividends, and overseeing financial activities through its auditing committee. Under securities laws, board members are held responsible for the lawful discharge of their duties; failing to do so may result in heavy fines and imprisonment.

PUBLIC COMPANIES AND SOX

The spectacular collapse of Enron Corporation, the energy trader, on December 1, 2001 added the largest bankruptcy ever in U.S. history to the national woes in a year of shock after the terrorist attack on 9/11 of that year. This bankruptcy, ultimately traced back to hidden and suspicious off-balance-sheet transactions, fraudulently overstated earnings, and failures in formal external audits brought into laser-like focus a long-building and widespread critique not only of top management but also of cozy boards of directors viewed as cheerleaders for flamboyant chief executives willing to approve actions without exercising due diligence. Long before Enron, pressure was building to enlist boards of directors into a fight for more disciplined and publicly responsible corporate behavior. Enron brought a very energetic legislative response in the form of the Sarbanes-Oxley Act of 2002, abbreviated as SOX. The subject is discussed in some detail elsewhere in this volume. Here it is only necessary to note that SOX overhauled financial reporting requirements, created a national Public Accounting Oversight Board to reform all auditing procedures, and criminalized a number of executive and director actions. An important provision of Sarbanes-Oxley was the requirement that every public board must have an audit committee made up exclusively of outside (independent) directors. Securities laws had always regulated insider trading activities, which affect directors. More regulations were introduced by SOX; the act unambiguously conveyed the sense of Congress that directors on boards are personally responsible for active supervision of the companies they serve.

see also Sarbanes-Oxley

BIBLIOGRAPHY

Hellriegel, Don, Susan E. Jackson, and John W. Slocum, Jr. Management: A Competency-Based Approach. Thomson South-Western, 2005.

Hitt, Michael A., R. Edward Freeman, and Jeffrey S. Harrison, eds. The Blackwell Handbook of Strategic Management. Blackwell Publishers, 2001.

Monks, A.G., and Neil Minow. Corporate Governance. Blackwell Publishing, 2004.

Robert III, Henry M. et al. Robert's Rules of Order Newly Revised, 10th Edition. Perseus Publishing, 2000.

Shultz, Susan F. The Board Book: Making your corporate board a strategic force in your company's success. AMACOM, 2001.

U.S. Congress. Sarbanes-Oxley Act of 2002. Available from http://www.law.uc.edu/CCL/SOact/soact.pdf. Retrieved on 20 April 2006.

                                             Darnay, ECDI

Board of Directors

What It Means

A board of directors (usually simply called a board) is a group of individuals who determine the general policies of a public company (a company owned by people, typically referred to as investors or stockholders, who have purchased shares in the company’s ownership). The members of a board are elected by the stockholders to represent their interests in shaping the company’s policies. Duties of a board include hiring and firing executive officers (individuals who oversee the operational management of the company), determining executive salaries, setting policies on dividends (money paid on a regular basis to stockholders; the amount depends on the performance of the company), and deciding on other policies regarding stocks (shares of ownership in a company). Typically a board of directors elects or appoints a chairperson to oversee board meetings.

When Did It Begin

The origin of the modern board of directors goes back to the early nineteenth century. As international trade (trade between different nations) expanded, public companies grew larger and attracted a larger and more diverse group of investors. As more investors became involved in the ownership of a corporation, it became impossible for all stockholders to play a direct role in the company’s governance. In order to allow the company to run efficiently, investors began electing boards of directors, who were entrusted with representing the investors’ interests in deciding corporate policy.

More Detailed Information

Although the board of directors of a corporation wields substantial power in determining corporate policy, they play almost no role in the company’s day-to-day operations. In choosing a company’s executive officers, the board delegates the management of the company to this team of officers. In this respect the board plays a predominantly advisory role in the overall management of a company’s affairs.

The chief executive officer, or CEO, is the highest-ranking member of a company’s management team and serves as the principal liaison between the company and the board. The second most critical member of the company’s executive team is the chief financial officer, or CFO. The CFO of a corporation is primarily responsible for managing the various financial operations of the company, including financial planning, overseeing accounting procedures, and generating reports on a company’s past performance and future prospects. At the same time the CFO is the executive officer responsible for assessing the financial risks involved with a company’s specific projects or goals. In most cases a CFO reports directly to the company’s CEO.

Boards monitor the affairs of a company by holding regular meetings, during which they discuss company affairs with the CEO and other executives. Ideally a company CEO will speak honestly with the board about company operations so that the board can make informed decisions about corporate policy. Although candor between the CEO and the board is a critical component in formulating sound policy, it also makes the CEO subject to greater scrutiny and allows him less independence in overseeing the company’s daily operations. In some companies the CEO also serves as the chair of the board, and the CFO may also be on the board.

Recent Trends

The late 1990s witnessed a general breakdown in the relationship between CEOs and their boards of directors. CEOs of a number of major corporations lied habitually to their boards, leading to a lack of oversight and to mismanagement and corruption. In the case of Enron Corporation (an energy company that traded on the stock market in fuels, electricity, and other forms of energy), fraudulent accounting practices (the recording and disclosure of a company’s financial dealings) resulted in the company’s bankruptcy in 2001. The bankruptcy shocked the business community because Enron’s CEO and board chairman Kenneth Lay (1942–2006) had previously asserted that the company’s health was strong. In the wake of this scandal and others, boards throughout the United States have become subject to intense scrutiny, with investors demanding that their directors exercise more rigorous oversight and control over corporate operations.

BOARD OF DIRECTORS

A group of people comprising the governing body of a corporation.

The shareholders of a corporation hold an election to choose people who have been nominated to direct or manage the corporation as a board. In the past nearly all states required that at least three directors run a corporation. The laws have changed, however, since many corporations have only one or two shareholders and therefore require only one or two directors to serve on the board.

Directors are elected at the first annual meeting of shareholders and at each successive annual meeting for one-year terms, unless they are divided into classes. In a corporation that divides its directors into classes, called a classified board, conditions are often imposed concerning the minimum size of the board, the minimum number of directors to be elected annually, and the maximum number of classes or maximum terms. The purpose of a classified board, which is expressly permitted by most statutes, is to make takeover attempts more difficult by staggering the terms of the directors.

Removal of a director during the course of his or her term may occur for cause by shareholders or by the board itself if there is a provision in the bylaws or articles of incorporation that confers such power upon them. The removal of a director for cause is reviewable by a court. Many jurisdictions have put into effect statutes that concern the removal of directors with or without cause.

The functions of directors involve a fiduciary duty to the corporation. Directors are in control of others' property and their powers are derived primarily from statute.

Directors are responsible for determining and executing corporate policy. For example, they make decisions regarding supervision of the entire enterprise and regarding products and services.

Liabilities of directors extend to both their individual and joint actions. A director who commits a tort against his or her corporation can be held personally liable.

Directors are bound by certain duties such as the duty to act within the scope of their authority and to exercise due care in the performance of their corporate tasks.