Though they have many duties, the primary responsibility of corporate board of directors is to protect shareholder assets and ensure they receive a decent return on their investment. If you're investing in a company, either by purchasing shares of stock or buying bonds, It's wise for you to know the details about what a corporate board of directors does.
The Purpose of a Board of Directors
The board of directors is the highest governing authority within the management structure at a corporation or publicly traded business. The board owes a company's shareholders the highest financial duty under American law, known as a fiduciary duty.
It's the board's job to:
- Select, evaluate, and approve appropriate compensation for the company's chief executive officer (CEO)
- Evaluate the attractiveness of and pay dividends, recommend stock splits
- Oversee share repurchase programs
- Approve the company's financial statements
- Recommend or strongly discourage acquisitions and mergers
In some European countries, the sentiment is much different in that many directors there feel that it is their primary responsibility to protect the employees of a company first and the shareholders second. In these social and political climates, corporate profitability takes a back seat to the needs of workers.
The Structure and Makeup of the Board
The board is made up of individuals (the "directors") who are elected by the shareholders for multiple-year terms. Many companies operate on a rotating system so that only a fraction of the directors are up for election each year. They do this because it makes it much more difficult for a complete board change to take place due to a hostile takeover.
In most cases, directors:
- Have a vested interest in the company;
- Work in the upper management of the company (so-called "executive directors");
- Or are independent of the company but are known for their business abilities.
Directors are often tied to major vendors to strengthen important relationships. For example, you'd expect to see a high-ranking employee of The Coca-Cola Company on the board of directors at McDonald's Corporation, or vice versa, given their mutually beneficial relationship.
The number of people on a board of directors can vary substantially between companies and can range anywhere from 3 to 30.
In the United States, the majority of board directors must meet the requirements of "independence," meaning they are not associated with or employed by the company. In theory, independent directors will not be subject to pressure, and therefore are more likely to act in the shareholders' interests when those interests run counter to those of entrenched management.
How Committees Work
Another responsibility of the board of directors is establishing the audit and compensation committees.
The audit committee is responsible for ensuring that the company's financial statements and reports are accurate and use fair and reasonable estimates. The board members select, hire, and work with an outside auditing firm that does the auditing.
The compensation committee sets base compensation, stock option awards, and incentive bonuses for the company's executives, including the CEO. In recent years, many boards of directors have come under fire for allowing executive salaries to reach unjustifiably high levels.
Compensation for Board Members
In exchange for providing their services, corporate directors are paid a yearly salary, additional compensation for each meeting they attend, stock options, and various other benefits. The total amount of directorship fees vary from company to company.
The compensation directors receive, along with any other benefits, short biographical information, age, and level of existing ownership in the business is found in a special document known as the proxy statement.
Generally, it is considered a good sign to have directors with substantial ownership stakes in the business under their care because they truly walk in the shoes of the outside shareholders in many respects.
Ownership Structure and Its Impact on the Board
The particular ownership structure of a corporation has a huge impact on the effectiveness of the board of directors to govern. In a company where a large, single shareholder exists, that entity or individual investor can effectively control the corporation. If a director has a problem, he or she can appeal to the controlling shareholder.
In a company where no controlling shareholder exists, the directors typically act as if one did exist and attempt to protect this imaginary entity at all times (even if it means firing the CEO, making changes to the structure, or turning down acquisitions).
In a relatively few number of companies, the controlling shareholder also serves as the CEO and/or Chairman of the Board. In this case, a director is completely at the will of the owner and has no effective way to override their decisions.