A board of directors has many duties, but its first is to protect shareholder assets. Its primary goal is to ensure that shareholders receive a decent return on their investments. You should know the details about what a corporate board does if you're thinking about putting money in a company, either by buying shares of stock or bonds.
The Purpose of the Board
The board is the highest authority within the structure of a corporation or a publicly traded business. It owes the shareholders the highest financial duty under U.S. law, known as a fiduciary duty.
It's the board's job to select and approve the right level of pay for the chief executive officer (CEO). It gauges the appeal of and pays dividends. It recommends stock splits. The board oversees share repurchase programs and approves the financial statements. It recommends or strongly discourages acquisitions and mergers.
This concept differs in some countries where many boards feel that their foremost goal is to protect the workers first and the shareholders second. In that case, corporate profitability takes a back seat to the needs of the workers.
The Structure and Makeup of the Board
The board is made up of persons (the "directors") who are elected by the shareholders for multi-year terms. Many companies work on a rotating system so only a fraction of these people are up for election each year. They do this because it makes it harder for a complete board change to take place due to a hostile takeover.
Directors have a vested interest in the company in most cases. They work in upper management. They're referred to as "executive directors." They might not have any ties to the company, but they're known for their business abilities.
Directors are often tied to major vendors to strengthen key relationships. You might expect to see a high-ranking employee of The Coca Cola Company on the board at McDonald's Corporation, or vice versa. They have a mutually beneficial relationship.
The number of people on a board can vary a great deal. It can range from three to 30.
Most board directors must meet certain rules of "independence" in the U.S. They aren't linked with or employed by the company. This means that in theory, at least, they won't be subject to pressure. They're more likely to act in the shareholders' best interests when those interests run counter to the goals of entrenched management.
How Committees Work
Setting up audit and compensation committees is also the duty of the board. The audit committee makes sure that all financial statements and reports are correct. They use fair estimates. The board members select, hire, and work with an outside firm that does the auditing.
The compensation committee sets base pay, stock option awards, and incentive bonuses for the company's executives, including the CEO. Many boards came under fire in 2020 for letting these salaries reach very high levels.
How Board Members Are Paid
Directors are paid a yearly salary. They receive extra pay for each meeting they attend and for stock options, as well as other benefits in exchange for their services. The total amount of fees can vary.
The compensation, along with any other benefits, can be found in a special issue known as the proxy statement. This statement also includes a short bio, age, and their level of ownership in the business.
It's often a good sign to have directors with large ownership stakes. This implies that they truly walk in the shoes of the outside shareholders.
Structure and Its Impact
The ownership structure of a firm has a huge impact on the effectiveness of the board. An entity or investor could more or less control the corporation if just one large shareholder existed. The director can appeal to the controlling shareholder in this case.
The directors often act as if a controlling shareholder does indeed exist when, in fact, there isn't one. They 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.
The controlling shareholder can also sometimes serve as the CEO and/or chairman of the board. A director is at the will of the owner in this case. They have no real way to override their decisions.
Frequently Asked Questions (FAQs)
Who elects the board of directors?
The election process for a company's board of directors is outlined in a company's bylaws. However, publicly traded companies are typically required to allow shareholders to vote on board members.
How often does a board of directors meet?
State laws usually dictate the frequency of required board meetings. They're typically required once a year, though it's sometimes more often.
When does a corporation need a board of directors?
As soon as a company is publicly traded, it is legally required to have a board of directors. Private companies may also choose to have a board to protect the financial interests of the owners, as well.