Volume 19, Issue 4, October–December 2016, Pages 246-260
https://doi.org/10.1016/j.brq.2016.06.001Get rights and content
Who calls the shots at a public company?
CEOs run businesses on a day-to-day basis and are often in the limelight. But there’s a group of people, you may not know about, who have the ultimate authority—the board of directors.
Chosen by shareholders, the primary job of a public company’s board of directors is to look out for the shareholders’ interests. In fact, directors are legally required to put shareholders’ interests ahead of their own. The board plays a supervisory role, overseeing corporate activities and assessing performance. Directors are responsible for hiring and firing top managers, and for setting their compensation.
Generally, “the role of the board is to oversee the affairs of a company from 50,000 feet, to ensure the long-term sustainability of the company,” said Henry Stoever, chief marketing officer of the National Association of Corporate Directors (NACD). Activist investor board members, though, may take on a more involved role.
“They are there to hire and fire management—and monitor them in between,” added Charles Elson, the director of the John L. Weinberg Center for Corporate Governance at the University of Delaware.
Corporate board requirements are largely governed by the state or country in which a company is incorporated, but boards are also increasingly subject to federal legislation and stock exchange listing standards.
Directors’ actions can have a critical impact on a company’s profitability. As such, it’s important for investors to understand the role of corporate boards—and their role in electing them.
What Are Some Of The Key Duties Of Directors?
Directors weigh in on such matters as strategic planning, mergers and acquisitions, share repurchase programs, declaring dividends and nominating future board members.
Boards are organized around committees that focus on special tasks. For instance, the audit committee works with a company’s auditors, while the compensation committee determines executive pay.
Some types of board committees are required for public companies, and must meet certain standards for independence, while others are up to the discretion of the company. It’s not uncommon for working groups to pop up from time-to-time to address special issues as needed.
What’s The Difference Between An Inside Director, An Outside Director And An Independent Director?
Inside directors are company executives, while outside directors are non-employees. Outside directors, and sometimes inside directors, get paid for their services, sometimes in the form of stock in the company.
An independent director must meet an even higher standard. On top of being an outsider, he or she must have “no material ties” to the company. For instance, a close relative of a high-ranking executive, or an individual with substantial financial dealings with a company, would be seen as having “material ties.”
In the wake of the Enron Corp. accounting scandal of 2001, and the recent financial crisis, institutional investors, regulators, lawmakers and stock exchanges have pressed for stronger corporate governance and for more independent boards. As a result, in recent years, public companies have moved to increase their ranks of independent directors.
Since the early 2000s, “a considerable number of substantive governance and related disclosure requirements have been imposed on boards and board committees through federal legislation, implementing rules and stock exchange listing standards,” the law firm Weil, Gotshal & Manges wrote in a 2015 report.
In 2003, the Securities and Exchange Commission approved listing standards related to corporate boards, proposed by New York Stock Exchange and the Nasdaq. The rules mandate that that the majority of board members of companies listed on the exchanges be independent.
Even so, critics have questioned whether directors labeled independent actually fit that description.
“In a perfect world we would hope that independent managers are truly independent from management,” Elson said. “It’s not always the case.”
Who Typically Serves On Boards And For How Long?
Outside directors, “typically have strong corporate experience, often as CEOs of their own company, or, occasionally, have experience as politicians or college presidents,” said Erik Gordon, a professor at the Ross School of Business at the University of Michigan.
A recent survey conducted by the Wall Street Journal found that at 24 percent of the country’s largest companies, a majority of the board had been in place for at least ten years.
On one hand, longtime directors can offer deep insight into a company, the Journal noted. On the other, longtime board members might become too close with management, critics say.
Should Ceos Also Serve As Chairmen Of The Board?
In recent years, there has been considerable pressure from activist investors and corporate governance experts to split the two roles. Critics see an inherent conflict of interest when the person who runs the company day-to-day also heads the board tasked with supervising the company.
Even so, many CEOs still wear both hats. About 56 percent of S&P 500 companies have a combined chairman and CEO, roughly the same percentage as in 2012, according to an analysis by Mercer.
Companies where the CEO and chairman are one and the same, have increasingly added another role, “lead director,” to monitor such issues as CEO performance.
How Often Do Shareholders Vote On Directors And What Should They Do To Make A Wise Decision?
Once a year, during proxy season, shareholders have an opportunity to vote on at least some members of the board of a public company. This is your chance to have a say over who leads the company.
You’ll want to scrutinize the proxy materials. Take a close look who has been nominated to serve on the board and ask questions before you make your decision.
“Does this person have skills that would be accretive to the future of company?” Stoever said.
“How independent do they appear to be from management?” said Elson. “Do they have integrity?”
For more information on proxy season, read our primer on proxy statements and shareholder meetings.
The average shareholder, who is typically not involved in the day-to-day operations of the company, relies on several parties to protect and further his or her interests. These parties include the company's employees, executives, and board of directors. However, each one of these parties has its own interests, which may conflict with those of the shareholder.
The board of directors is elected by the shareholders of a corporation to oversee and govern the management and to make corporate decisions on their behalf. As a result, the board is directly responsible for protecting and managing shareholders' interests in the company.
Regulators, such as the U.S. Securities and Exchange Commission (SEC) also protect shareholders by helping to facilitate the smooth functioning of the financial markets. The SEC requires publicly-traded corporations to disclose their financial statements periodically throughout the year. As a result, investors and shareholders can access a company's SEC filings, which might include news of mergers, acquisitions, and financial information pertinent to shareholders' interests.
The structure of a company's board helps to protect shareholders by having checks and balances in place and ensuring there aren't any conflicts of interest between the board members and management of the company.
The board of directors structure is made up of several representatives, including individuals chosen from within the company, called inside directors, as well as those chosen from outside the company called outside directors. The inside director could be an executive within the company or a major shareholder. The goal of the outside director is to provide an objective point of view and help with settling any disputes within the company.
The board of directors typically elects a chair, who is responsible for ensuring the board runs effectively. The chair also ensures that the corporation and its management team are acting responsibly. The board chair represents a public face for the company on behalf of the management team to the shareholders.
All publicly-traded companies in the United States must have a board of directors comprised of both inside and outside representatives. The role of the board of directors is to act as an advocate for shareholders and monitor the corporation's management team to ensure that they are promoting and maximizing the shareholders' interest.
A board chair is typically a different person than the chief executive officer (CEO), who is responsible for running the company's operation. The CEO's job is to execute the strategy laid out by the board, the management team, and it ensure that shareholders interests are met. Some corporations have the same individual occupy both the CEO and board chair position. However, many companies opt to have the position occupied by two individuals to help prevent conflicts of interest and protect shareholders.
A board of directors needs to be objective and proactive in its policies and dealings with management in order to be truly effective. This helps to ensure that management is maximizing shareholder value. A more objective board of directors, or one that is separate from a company's management, is more likely to promote or protect the interests of the company's shareholders.
For example, a board of directors made up entirely or primarily of management would clearly be hampered by conflicts of interest, and the preservation of shareholder value might not be a priority.
Compensation has an impact on the effectiveness of a board of directors. It's important to note the members of the board of directors can have an ownership interest in the company by owning stock. Compensating board members for their work is one way to ensure that they will make every effort to promote and protect investor interests. The members of a board of directors can be paid in cash and stock. Likewise, management and employees also need to be aligned with investors, and this can be achieved through the compensation that both groups receive. This may include making both parties owners (investors) in the company.
When management and employees are also shareholders, they are typically more motivated to protect shareholder interests as their own. This helps to protect a company from mismanagement and weak employee productivity. Also, a bonus targeting system can be used in which employees and managers receive bonuses when certain goals are met. Such strategies help to align the interests of employees and management with those of investors.
If these groups are not aligned with the interests of investors, major problems can arise and destroy shareholder value. Although the average shareholder does not have control over the board of directors or the day-to-day operations of the company, the ultimate responsibility for the protection of shareholder value lies with each individual investor. The investor is ultimately responsible for reviewing corporate policy and governance as well as for the compensation of managers. Investors who feel that a company does not show an adequate level of commitment to shareholders can always sell their investment.