Board of directors
A board of directors is a group of people who jointly supervise the activities of an organization, which can be either a for-profit business, nonprofit organization, or a government agency. Such a board's powers, duties, and responsibilities are determined by government regulations and the organization's own constitution and bylaws. These authorities may specify the number of members of the board, how they are to be chosen, and how often they are to meet.
In an organization with voting members, the board is accountable to, and might be subordinate to, the organization's full membership, which usually vote for the members of the board. In a stock corporation, non-executive directors are voted for by the shareholders, with the board having ultimate responsibility for the management of the corporation. In nations with codetermination, the workers of a corporation elect a set fraction of the board's directors. The board of directors appoints the chief executive officer of the corporation and sets out the overall strategic direction. In corporations with dispersed ownership, the identification and nomination of directors are often done by the board itself, leading to a high degree of self-perpetuation. In a non-stock corporation with no general voting membership, the board is the supreme governing body of the institution, and its members are sometimes chosen by the board itself.
TerminologyOther names include board of directors and advisors, board of governors, board of managers, board of regents, board of trustees, or board of visitors. It may also be called "the executive board" and is often simply referred to as "the board".
RolesTypical duties of boards of directors include:
- governing the organization by establishing broad policies and setting out strategic objectives;
- selecting, appointing, supporting and reviewing the performance of the chief executive ;
- terminating the chief executive;
- ensuring the availability of adequate financial resources;
- approving annual budgets;
- accounting to the stakeholders for the organization's performance;
- setting the salaries, compensation and benefits of senior management;
Typically, the board chooses one of its members to be the chairman, who holds whatever title is specified in the by-laws or articles of association. However, in membership organizations, the members elect the president of the organization and the president becomes the board chair, unless the by-laws say otherwise.
DirectorsThe directors of an organization are the persons who are members of its board. Several specific terms categorize directors by the presence or absence of their other relationships to the organization.
Inside directorAn inside director is a director who is also an employee, officer, chief executive, major shareholder, or someone similarly connected to the organization. Inside directors represent the interests of the entity's stakeholders, and often have special knowledge of its inner workings, its financial or market position, and so on.
Typical inside directors are:
- A chief executive officer who may also be chairman of the board
- Other executives of the organization, such as its chief financial officer or executive vice president
- Large shareholders
- Representatives of other stakeholders such as labor unions, major lenders, or members of the community in which the organization is located
Outside directorAn outside director is a member of the board who is not otherwise employed by or engaged with the organization, and does not represent any of its stakeholders. A typical example is a director who is president of a firm in a different industry. Outside directors are not employees of the company or affiliated with it in any other way.
Outside directors bring outside experience and perspectives to the board. For example, for a company that serves a domestic market only, the presence of CEOs from global multinational corporations as outside directors can help to provide insights on export and import opportunities and international trade options. One of the arguments for having outside directors is that they can keep a watchful eye on the inside directors and on the way the organization is run. Outside directors are unlikely to tolerate "insider dealing" between inside directors, as outside directors do not benefit from the company or organization. Outside directors are often useful in handling disputes between inside directors, or between shareholders and the board. They are thought to be advantageous because they can be objective and present little risk of conflict of interest. On the other hand, they might lack familiarity with the specific issues connected to the organization's governance, and they might not know about the industry or sector in which the organization is operating.
- Director – a person appointed to serve on the board of an organization, such as an institution or business.
- Inside director – a director who, in addition to serving on the board, has a meaningful connection to the organization
- Outside director – a director who, other than serving on the board, has no meaningful connections to the organization
- Executive director – an inside director who is also an executive with the organization. The term is also used, in a completely different sense, to refer to a CEO
- Non-executive director – an inside director who is not an executive with the organization
- Shadow or de facto director – an individual who is not a named director but who nevertheless directs or controls the organization
- Nominee director – an individual who is appointed by a shareholder, creditor or interest group and who has a continuing loyalty to the appointor/s or other interest in the appointing company
Process and structureThe process for running a board, sometimes called the board process, includes the selection of board members, the setting of clear board objectives, the dissemination of documents or board package to the board members, the collaborative creation of an agenda for the meeting, the creation and follow-up of assigned action items, and the assessment of the board process through standardized assessments of board members, owners, and CEOs. The science of this process has been slow to develop due to the secretive nature of the way most companies run their boards, however some standardization is beginning to develop. Some who are pushing for this standardization in the USA are the National Association of Corporate Directors, McKinsey and The Board Group.
Board meetingsA board of directors conducts its meetings according to the rules and procedures contained in its governing documents. These procedures may allow the board to conduct its business by conference call or other electronic means. They may also specify how a quorum is to be determined.
Many organizations in the English-speaking world have adopted Robert's Rules of Order as a guide to supplement their own rules. In this book, the rules for conducting board meetings may be less formal if there is no more than about a dozen board members present. An example of the informality is that motions are not required if it's clear what is being discussed.
SizeHistorically, nonprofit boards have often had large boards with up to twenty-four members, but a modern trend is to have smaller boards as small as six or seven people. Studies suggest that after seven people, each additional person reduces the effectiveness of group decision-making.
Non-corporate boardsThe role and responsibilities of a board of directors vary depending on the nature and type of business entity and the laws applying to the entity. For example, the nature of the business entity may be one that is traded on a public market, not traded on a public market, owned by family members, or exempt from income taxes. There are numerous types of business entities available throughout the world such as a corporation, limited liability company, cooperative, business trust, partnership, private limited company, and public limited company.
Much of what has been written about boards of directors relates to boards of directors of business entities actively traded on public markets. More recently, however, material is becoming available for boards of private and closely held businesses including family businesses.
A board-only organization is one whose board is self-appointed, rather than being accountable to a base of members through elections; or in which the powers of the membership are extremely limited.
Membership organizationsIn membership organizations, such as a society made up of members of a certain profession or one advocating a certain cause, a board of directors may have the responsibility of running the organization in between meetings of the membership, especially if the membership meets infrequently, such as only at an annual general meeting. The amount of powers and authority delegated to the board depend on the bylaws and rules of the particular organization. Some organizations place matters exclusively in the board's control while in others, the general membership retains full power and the board can only make recommendations.
The setup of a board of directors vary widely across organizations and may include provisions that are applicable to corporations, in which the "shareholders" are the members of the organization. A difference may be that the membership elects the officers of the organization, such as the president and the secretary, and the officers become members of the board in addition to the directors and retain those duties on the board. The directors may also be classified as officers in this situation. There may also be ex-officio members of the board, or persons who are members due to another position that they hold. These ex-officio members have all the same rights as the other board members.
Members of the board may be removed before their term is complete. Details on how they can be removed are usually provided in the bylaws. If the bylaws do not contain such details, the section on disciplinary procedures in Robert's Rules of Order may be used.
CorporationsIn a publicly held company, directors are elected to represent and are legally obligated as fiduciaries to represent owners of the company—the shareholders/stockholders. In this capacity they establish policies and make decisions on issues such as whether there is dividend and how much it is, stock options distributed to employees, and the hiring/firing and compensation of upper management.
GovernanceTheoretically, the control of a company is divided between two bodies: the board of directors, and the shareholders in general meeting. In practice, the amount of power exercised by the board varies with the type of company. In small private companies, the directors and the shareholders are normally the same people, and thus there is no real division of power. In large public companies, the board tends to exercise more of a supervisory role, and individual responsibility and management tends to be delegated downward to individual professional executives who deal with particular areas of the company's affairs.
Another feature of boards of directors in large public companies is that the board tends to have more de facto power. Many shareholders grant proxies to the directors to vote their shares at general meetings and accept all recommendations of the board rather than try to get involved in management, since each shareholder's power, as well as interest and information is so small. Larger institutional investors also grant the board proxies. The large number of shareholders also makes it hard for them to organize. However, there have been moves recently to try to increase shareholder activism among both institutional investors and individuals with small shareholdings.
A contrasting view is that in large public companies it is upper management and not boards that wield practical power, because boards delegate nearly all of their power to the top executive employees, adopting their recommendations almost without fail. As a practical matter, executives even choose the directors, with shareholders normally following management recommendations and voting for them.
In most cases, serving on a board is not a career unto itself. For major corporations, the board members are usually professionals or leaders in their field. In the case of outside directors, they are often senior leaders of other organizations. Nevertheless, board members often receive remunerations amounting to hundreds of thousands of dollars per year since they often sit on the boards of several companies. Inside directors are usually not paid for sitting on a board, but the duty is instead considered part of their larger job description. Outside directors are usually paid for their services. These remunerations vary between corporations, but usually consist of a yearly or monthly salary, additional compensation for each meeting attended, stock options, and various other benefits. such as travel, hotel and meal expenses for the board meetings. Tiffany & Co., for example, pays directors an annual retainer of $46,500, an additional annual retainer of $2,500 if the director is also a chairperson of a committee, a per-meeting-attended fee of $2,000 for meetings attended in person, a $500 fee for each meeting attended via telephone, in addition to stock options and retirement benefits.
Two-tier systemIn some European and Asian countries, there are two separate boards, an executive board for day-to-day business and a supervisory board for supervising the executive board. In these countries, the chairman of the supervisory board is equivalent to the chairman of the board in a single-tier system, while the chairman of the management board is reckoned as the company's CEO or managing director. These two roles are always held by different people. This ensures a distinction between management by the executive board and governance by the supervisory board and allows for clear lines of authority. The aim is to prevent a conflict of interest and too much power being concentrated in the hands of one person. There is a strong parallel here with the structure of government, which tends to separate the political cabinet from the management civil service.
In the United States, the board of directors is often equivalent to the supervisory board, while the executive board may often be known as the executive committee, composed of the CEO and their direct reports.
HistoryThe board of directors, in its modern sense, was one of the 17th-century Dutch pioneering institutional innovations. In other words, modern-day boards of directors are all the descendants of the VOC model in many respects.
The development of a separate board of directors to manage/govern/oversee a company has occurred incrementally and indefinitely over legal history. Until the end of the 19th century, it seems to have been generally assumed that the general meeting was the supreme organ of a company, and that the board of directors merely acted as an agent of the company subject to the control of the shareholders in general meeting.
However, by 1906, the English Court of Appeal had made it clear in the decision of Automatic Self-Cleansing Filter Syndicate Co Ltd v Cuninghame 2 Ch 34 that the division of powers between the board and the shareholders in general meaning depended on the construction of the articles of association and that, where the powers of management were vested in the board, the general meeting could not interfere with their lawful exercise. The articles were held to constitute a contract by which the members had agreed that "the directors and the directors alone shall manage."
The new approach did not secure immediate approval, but it was endorsed by the House of Lords in Quin & Axtens v Salmon AC 442 and has since received general acceptance. Under English law, successive versions of Table A have reinforced the norm that, unless the directors are acting contrary to the law or the provisions of the Articles, the powers of conducting the management and affairs of the company are vested in them.
The modern doctrine was expressed in John Shaw & Sons Ltd v Shaw 2 KB 113 by Greer LJ as follows:
A company is an entity distinct alike from its shareholders and its directors. Some of its powers may, according to its articles, be exercised by directors, certain other powers may be reserved for the shareholders in general meeting. If powers of management are vested in the directors, they and they alone can exercise these powers. The only way in which the general body of shareholders can control the exercise of powers by the articles in the directors is by altering the articles, or, if opportunity arises under the articles, by refusing to re-elect the directors of whose actions they disapprove. They cannot themselves usurp the powers which by the articles are vested in the directors any more than the directors can usurp the powers vested by the articles in the general body of shareholders.
It has been remarked that this development in the law was somewhat surprising at the time, as the relevant provisions in Table A seemed to contradict this approach rather than to endorse it.
Election and removalIn most legal systems, the appointment and removal of directors is voted upon by the shareholders in general meeting or through a proxy statement. For publicly traded companies in the U.S., the directors which are available to vote on are largely selected by either the board as a whole or a nominating committee. Although in 2002 the New York Stock Exchange and the NASDAQ required that nominating committees consist of independent directors as a condition of listing, nomination committees have historically received input from management in their selections even when the CEO does not have a position on the board. Shareholder nominations can only occur at the general meeting itself or through the prohibitively expensive process of mailing out ballots separately; in May 2009 the SEC proposed a new rule allowing shareholders meeting certain criteria to add nominees to the proxy statement. In practice for publicly traded companies, the managers who are purportedly accountable to the board of directors have historically played a major role in selecting and nominating the directors who are voted on by the shareholders, in which case more "gray outsider directors" are nominated and elected.
Directors may also leave office by resignation or death. In some legal systems, directors may also be removed by a resolution of the remaining directors.
Some jurisdictions also permit the board of directors to appoint directors, either to fill a vacancy which arises on resignation or death, or as an addition to the existing directors.
In practice, it can be quite difficult to remove a director by a resolution in general meeting. In many legal systems, the director has a right to receive special notice of any resolution to remove him or her; the company must often supply a copy of the proposal to the director, who is usually entitled to be heard by the meeting. The director may require the company to circulate any representations that he wishes to make. Furthermore, the director's contract of service will usually entitle him to compensation if he is removed, and may often include a generous "golden parachute" which also acts as a deterrent to removal.
A recent study examines how corporate shareholders voted in director elections in the United States. It found that directors received fewer votes from shareholders when their companies performed poorly, had excess CEO compensation, or had poor shareholder protection. Also, directors received fewer votes when they did not regularly attend board meetings or received negative recommendations from a proxy advisory firm. The study also shows that companies often improve their corporate governance by removing poison pills or classified boards and by reducing excessive CEO pay after their directors receive low shareholder support.
Board accountability to shareholders is a recurring issue. In 2010, the New York Times noted that several directors who had overseen companies which had failed in the financial crisis of 2007–2010 had found new positions as directors. The SEC sometimes imposes a ban on serving on a board as part of its fraud cases, and one of these was upheld in 2013.
Exercise of powersThe exercise by the board of directors of its powers usually occurs in board meetings. Most legal systems require sufficient notice to be given to all directors of these meetings, and that a quorum must be present before any business may be conducted. Usually, a meeting which is held without notice having been given is still valid if all of the directors attend, but it has been held that a failure to give notice may negate resolutions passed at a meeting, because the persuasive oratory of a minority of directors might have persuaded the majority to change their minds and vote otherwise.
In most common law countries, the powers of the board are vested in the board as a whole, and not in the individual directors. However, in instances an individual director may still bind the company by his acts by virtue of his ostensible authority.
DutiesBecause directors exercise control and management over the organization, but organizations are run for the benefit of the shareholders, the law imposes strict duties on directors in relation to the exercise of their duties. The duties imposed on directors are fiduciary duties, similar to those that the law imposes on those in similar positions of trust: agents and trustees.
The duties apply to each director separately, while the powers apply to the board jointly. Also, the duties are owed to the company itself, and not to any other entity. This does not mean that directors can never stand in a fiduciary relationship to the individual shareholders; they may well have such a duty in certain circumstances.
"Proper purpose"Directors must exercise their powers for a proper purpose. While in many instances an improper purpose is readily evident, such as a director looking to feather his or her own nest or divert an investment opportunity to a relative, such breaches usually involve a breach of the director's duty to act in good faith. Greater difficulties arise where the director, while acting in good faith, is serving a purpose that is not regarded by the law as proper.
The seminal authority in relation to what amounts to a proper purpose is the Supreme Court decision in Eclairs Group Ltd v JKX Oil & Gas plc. The case concerned the powers of directors under the articles of association of the company to disenfranchise voting rights attached to shares for failure to properly comply with notice served on the shareholders. Prior to that case the leading authority was Howard Smith Ltd v Ampol Ltd AC 821. The case concerned the power of the directors to issue new shares. It was alleged that the directors had issued many new shares purely to deprive a particular shareholder of his voting majority. An argument that the power to issue shares could only be properly exercised to raise new capital was rejected as too narrow, and it was held that it would be a proper exercise of the director's powers to issue shares to a larger company to ensure the financial stability of the company, or as part of an agreement to exploit mineral rights owned by the company. If so, the mere fact that an incidental result was that a shareholder lost his majority, or a takeover bid was defeated, this would not itself make the share issue improper. But if the sole purpose was to destroy a voting majority, or block a takeover bid, that would be an improper purpose.
Not all jurisdictions recognised the "proper purpose" duty as separate from the "good faith" duty however.
"Unfettered discretion"Directors cannot, without the consent of the company, fetter their discretion in relation to the exercise of their powers, and cannot bind themselves to vote in a particular way at future board meetings. This is so even if there is no improper motive or purpose, and no personal advantage to the director.
This does not mean, however, that the board cannot agree to the company entering into a contract which binds the company to a certain course, even if certain actions in that course will require further board approval. The company remains bound, but the directors retain the discretion to vote against taking the future actions.
"Conflict of duty and interest"As fiduciaries, the directors may not put themselves in a position where their interests and duties conflict with the duties that they owe to the company. The law takes the view that good faith must not only be done, but must be manifestly seen to be done, and zealously patrols the conduct of directors in this regard; and will not allow directors to escape liability by asserting that his decision was in fact well founded. Traditionally, the law has divided conflicts of duty and interest into three sub-categories.
Transactions with the companyBy definition, where a director enters into a transaction with a company, there is a conflict between the director's interest and his duty to the company. This rule is so strictly enforced that, even where the conflict of interest or conflict of duty is purely hypothetical, the directors can be forced to disgorge all personal gains arising from it. In Aberdeen Ry v Blaikie 1 Macq HL 461 Lord Cranworth stated in his judgment that:
However, in many jurisdictions the members of the company are permitted to ratify transactions which would otherwise fall foul of this principle. It is also largely accepted in most jurisdictions that this principle can be overridden in the company's constitution.
In many countries, there is also a statutory duty to declare interests in relation to any transactions, and the director can be fined for failing to make disclosure.
Use of corporate property, opportunity, or informationDirectors must not, without the informed consent of the company, use for their own profit the company's assets, opportunities, or information. This prohibition is much less flexible than the prohibition against the transactions with the company, and attempts to circumvent it using provisions in the articles have met with limited success.
In Regal Ltd v Gulliver All ER 378 the House of Lords, in upholding what was regarded as a wholly unmeritorious claim by the shareholders, held that:
And accordingly, the directors were required to disgorge the profits that they made, and the shareholders received their windfall.
The decision has been followed in several subsequent cases, and is now regarded as settled law.
Competing with the companyDirectors cannot compete directly with the company without a conflict of interest arising. Similarly, they should not act as directors of competing companies, as their duties to each company would then conflict with each other.
Common law duties of care and skillTraditionally, the level of care and skill which has to be demonstrated by a director has been framed largely with reference to the non-executive director. In Re City Equitable Fire Insurance Co Ch 407, it was expressed in purely subjective terms, where the court held that:
However, this decision was based firmly in the older notions that prevailed at the time as to the mode of corporate decision making, and effective control residing in the shareholders; if they elected and put up with an incompetent decision maker, they should not have recourse to complain.
However, a more modern approach has since developed, and in Dorchester Finance Co Ltd v Stebbing BCLC 498 the court held that the rule in Equitable Fire related only to skill, and not to diligence. With respect to diligence, what was required was:
This was a dual subjective and objective test, and one deliberately pitched at a higher level.
More recently, it has been suggested that both the tests of skill and diligence should be assessed objectively and subjectively; in the United Kingdom, the statutory provisions relating to directors' duties in the new Companies Act 2006 have been codified on this basis.
Remedies for breach of dutyIn most jurisdictions, the law provides for a variety of remedies in the event of a breach by the directors of their duties:
- injunction or declaration
- damages or compensation
- restoration of the company's property
- rescission of the relevant contract
- account of profits
- summary dismissal
- the likely consequences of any decision in the long term
- the interests of the company's employees
- the need to foster the company's business relationships with suppliers, customers and others
- the impact of the company's operations on the community and the environment
- the desirability of the company maintaining a reputation for high standards of business conduct
- the need to act fairly as between members of a company
Board of Directors Technology
The adoption of technology that facilitates the meeting preparation and execution of directors continues to grow. Board directors are increasingly leveraging this technology to communicate and collaborate within a secure environment to access meeting materials, communicate with each other, and execute their governance responsibilities. This trend is particularly acute in the United States where a robust market of early adopters garnered acceptance of board software by organizations resulting in higher penetration of the board portal services in the region.
The Board and SocietyMost companies have weak mechanisms for bringing the voice of society into the board room. They rely on personalities who weren't appointed for their understanding of societal issues. Often they give limited focus to issues of corporate responsibility and sustainability. A Social Board has society designed into its structure. It elevates the voice of society through specialist appointments to the board and mechanisms that empower innovation from within the organisation. Social Boards align themselves with themes that are important to society. These may include measuring worker pay ratios, linking personal social and environmental objectives to remuneration, integrated reporting, fair tax and B-Corp Certification.
Social Boards recognise that they are part of society and that they require more than a licence to operate to succeed. They balance short-term shareholder pressure against long-term value creation, managing the business for a plurality of stakeholders including employees, shareholders, supply chains and civil society.
United StatesSarbanes–Oxley Act of 2002 has introduced new standards of accountability on boards of U.S. companies or companies listed on U.S. stock exchanges. Under the Act, directors risk large fines and prison sentences in the case of accounting crimes. Internal control is now the direct responsibility of directors. The vast majority of companies covered by the Act have hired internal auditors to ensure that the company adheres to required standards of internal control. The internal auditors are required by law to report directly to an audit board, consisting of directors more than half of whom are outside directors, one of whom is a "financial expert."
The law requires companies listed on the major stock exchanges to have a majority of independent directors—directors who are not otherwise employed by the firm or in a business relationship with it.
SizeAccording to the Corporate Library's study, the average size of publicly traded company's board is 9.2 members, and most boards range from 3 to 31 members. According to Investopedia, some analysts think the ideal size is seven. State law may specify a minimum number of directors, maximum number of directors, and qualifications for directors.
CommitteesWhile a board may have several committees, two—the compensation committee and audit committee—are critical and must be made up of at least three independent directors and no inside directors. Other common committees in boards are nominating and governance.
CompensationDirectors of Fortune 500 companies received median pay of $234,000 in 2011. Directorship is a part-time job. A recent National Association of Corporate Directors study found directors averaging just 4.3 hours a week on board work. Surveys indicate that about 20% of nonprofit foundations pay their board members, and 2% of American nonprofit organizations do. 80% of nonprofit organizations require board members to personally contribute to the organization, as BoardSource recommends. This percentage has increased in recent years.
CriticismAccording to John Gillespie, a former investment banker and co-author of a book critical of boards, "Far too much of their time has been for check-the-box and cover-your-behind activities rather than real monitoring of executives and providing strategic advice on behalf of shareholders". At the same time, scholars have found that individual directors have a large effect on major corporate initiatives such as mergers and acquisitions and cross-border investments.
The issue of gender representation on corporate boards of directors has been the subject of much criticism in recent years. Governments and corporations have responded with measures such as legislation mandating gender quotas and comply or explain systems to address the disproportionality of gender representation on corporate boards. A study of the French corporate elite has found that certain social classes are also disproportionately represented on boards, with those from the upper and, especially, upper-middle classes tending to dominate.