Board of directors

For other uses of "trustee", "trusty", and related terms, see Trustee (disambiguation).

"Board Room" redirects here. For the "Board Room" member lounge, see Alaska Airlines.

A board of directors is a body of elected or appointed members who jointly oversee the activities of a company or organization. Other names include board of governors, board of managers, board of regents, board of trustees, and board of visitors. It is often simply referred to as "the board".

A board's activities are determined by the powers, duties, and responsibilities delegated to it or conferred on it by an authority outside itself. These matters are typically detailed in the organization's bylaws. The bylaws commonly also specify the number of members of the board, how they are to be chosen, and when they are to meet.

In an organization with voting members, e.g., a professional society, the board acts on behalf of, and is subordinate to, the organization's full assembly, which usually chooses the members of the board. In a stock corporation, the board is elected by the stockholders and is the highest authority in the management of the corporation. In a non-stock corporation with no general voting membership, e.g., a university, the board is the supreme governing body of the institution; its members are sometimes chosen by the board itself.

Typical duties of boards of directors include:

• governing the organization by establishing broad policies and objectives;
• selecting, appointing, supporting and reviewing the performance of 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 and compensation of company management.

The legal responsibilities of boards and board members vary with the nature of the organization, and with the jurisdiction within which it operates. For public corporations, these responsibilities are typically much more rigorous and complex than for those of other types.

Typically the board chooses one of its members to be the chairman, who holds whatever title is specified in the bylaws.

Directors

The 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.

An inside director is a director who is also an employee, officer, 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 (CEO) who may also be Chairman of the Board
• Other executives of the organization, such as its Chief Financial Officer (CFO) or Executive Vice President
• Large shareholders (who may or may not also be employees or officers)
• Representatives of other stakeholders such as labor unions, major lenders, or members of the community in which the organization is located

An inside director who is employed as a manager or executive of the organization is sometimes referred to as an executive director (not to be confused with the title executive director sometimes used for the CEO position). Executive directors often have a specified area of responsibility in the organization, such as finance, marketing, human resources, or production.

An 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 bring outside experience and perspective to the board. They keep a watchful eye on the inside directors and on the way the organization is run. 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.

Recapping the terminology:

• director - any member of the board of directors
• 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 - a director who is not an executive with the organization

Individual directors often serve on more than one board. This practice results in an interlocking directorate, where a relatively small number of individuals have significant influence over a large number of important entities. This situation can have important corporate, social, economic, and legal consequences, and has been the subject of significant research.

Corporations

Theoretically, 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 (such as a finance director or a marketing director) 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. The shareholders tend to grant proxies to the directors and accept all recommendations of the board rather than try to get involved in management, since each shareholder's power is so small. Also, the large number of shareholders 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.

Conversely, though, boards of directors in large public companies tend to wield very little practical power, because they 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, as shareholders normally follow management recommendations when electing them.

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.

In most cases, serving on a board is not a career unto itself, but 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. 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.

Classification

The 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 (see types of business entity). For example, the nature of the business entity may be one that is traded on a public market (public company), not traded on a public market (a private, limited or closely held company), owned by family members (a family business), or exempt from income taxes (a non-profit, not for profit, or tax-exempt entity). 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.

History

The development of a separate board of directors to manage the 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 (of all shareholders) was the supreme organ of the company, and the board of directors was merely 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 v Cunningham [1906] 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 [1909] 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 Shaw & Sons (Salford) Ltd v Shaw [1935] 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 (as it was then) seemed to contradict this approach rather than to endorse it.

Election and removal

In 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 NYSE 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 (inside directors) 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" (independent directors with conflicts of interest) 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 (in some countries they may only do so "with cause"; in others the power is unrestricted).

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.

In a recent academic study that was published in the Journal of Finance, Drexel University’s LeBow College of Business professors Jie Cai, Jacqueline Garner, and Ralph Walkling examined how corporate shareholders voted in nearly 2,500 director elections in the United States. They found that directors received fewer votes from shareholders when their companies performed poorly, had excess CEO compensation, or had poor shareholder protection. They also found that directors received fewer votes when they did not regularly attend board meetings or received negative recommendations from RiskMetrics (a proxy advisory firm). This evidence suggests that some shareholders express their displeasure with a company by voting against its directors. The article 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.

Exercise of powers

The 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 (see also: the rule in Turquand's Case).

Duties

Main articles: Directors' duties and Fiduciary duties

Because directors exercise control and management over the organization, but organizations are (in theory) 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.

Acting bona fide

Directors must act honestly and bona fide ("in good faith"). The test is a subjective one, and directors must act in what they consider is in the interests of the company, not what a court might consider to be those interests. However, the directors may still be held to have failed in this duty where they fail to direct their minds to the question of whether a transaction was in the best interests of the company.

Difficult questions can arise when treating the company too much in the abstract. For example, it may be for the benefit of a corporate group as a whole for a company to guarantee the debts of a "sister" company, even though there is no ostensible "benefit" to the company giving the guarantee. Similarly, conceptually at least, there is no benefit to a company in returning profits to shareholders by way of dividend. However, the more pragmatic approach illustrated in the Australian case of Mills v Mills (1938) 60 CLR 150 normally prevails:

"[directors are] not required by the law to live in an unreal region of detached altruism and to act in the vague mood of ideal abstraction from obvious facts which must be present to the mind of any honest and intelligent person when they exercise their powers as a director."

"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 Privy Council decision of Howard Smith Ltd v Ampol Ltd [1974] AC 821. The case concerned the power of the directors to issue new shares. It was alleged that the directors had issued a large number of 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 (even if it was a desired consequence) 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 (although that may involve a breach by the company of the contract that the board previously approved).

"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 company

By definition, where a director enters into a transaction with a company, there is a conflict between the director's interest (to do well for himself out of the transaction) and his duty to the company (to ensure that the company gets as much as it can out of the transaction). 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 (1854) 1 Macq HL 461 Lord Cranworth stated in his judgment that:

"A corporate body can only act by agents, and it is, of course, the duty of those agents so to act as best to promote the interests of the corporation whose affairs they are conducting. Such agents have duties to discharge of a fiduciary nature towards their principal. And it is a rule of universal application that no one, having such duties to discharge, shall be allowed to enter into engagements in which he has, or can have, a personal interest conflicting or which possibly may conflict, with the interests of those whom he is bound to protect... So strictly is this principle adhered to that no question is allowed to be raised as to the fairness or unfairness of the contract entered into..." (emphasis added)

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 information

Directors 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 (Hastings) Ltd v Gulliver [1942] All ER 378 the House of Lords, in upholding what was regarded as a wholly unmeritorious claim by the shareholders, held that:

"(i) that what the directors did was so related to the affairs of the company that it can properly be said to have been done in the course of their management and in the utilisation of their opportunities and special knowledge as directors; and (ii) that what they did resulted in profit to themselves."

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 company

Directors 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 skill

Traditionally, 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 [1925] Ch 407, it was expressed in purely subjective terms, where the court held that:

"a director need not exhibit in the performance of his duties a greater degree of skill than may reasonably be expected from a person of his knowledge and experience." (emphasis added)

However, this decision was based firmly in the older notions (see above) 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 [1989] 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:

"such care as an ordinary man might be expected to take on his own behalf."

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 duty

In most jurisdictions, the law provides for a variety of remedies in the event of a breach by the directors of their duties:

1. injunction or declaration
2. damages or compensation
3. restoration of the company's property
4. rescission of the relevant contract
5. account of profits
6. summary dismissal

The future

Historically, directors' duties have been owed almost exclusively to the company and its members, and the board was expected to exercise its powers for the financial benefit of the company. However, more recently there have been attempts to "soften" the position, and provide for more scope for directors to act as good corporate citizens. For example, in the United Kingdom, the Companies Act 2006 requires directors of companies "to promote the success of the company for the benefit of its members as a whole" and sets out the following six factors regarding a director's duty to promote success:

• 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, and
• the need to act fairly as between members of a company

This represents a considerable departure from the traditional notion that directors' duties are owed only to the company. Previously in the United Kingdom, under the Companies Act 1985, protections for non-member stakeholders were considerably more limited (see for example, s.309 which permitted directors to take into account the interests of employees but which could only be enforced by the shareholders and not by the employees themselves). The changes have therefore been the subject of some criticism.

Sarbanes–Oxley Act

The Sarbanes–Oxley Act 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 an accounting expert.

Compensation

Directors of Fortune 500 companies received median pay of $234,000 in 2011. That was an increase of 10% from 2010.

Process

The 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 are the National Association of Corporate Directors, McKinsey Consulting and The Board Group.

Two-tier system

In some European Union and Asian countries, there are two separate boards, an executive board for day-to-day business and a supervisory board (elected by the shareholders) for supervising the executive board. In these countries, the CEO (chief executive or managing director) presides over the executive board and the chairman presides over the supervisory board, and these two roles will always be 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 (elected by the shareholders) is often equivalent to the supervisory board, while the executive board may often be known as the executive committee (operating committee or executive council), composed of the CEO and their direct reports (other C-level officers, division/subsidiary heads).

See also

• Agency cost
• Alternate director
• Board of governors
• Board of regents
• Celebrity board director
• Chairman
• Chief executive officer
• Company (law)
• Corporation
• Corporate governance
• Corporate titles
• Executive compensation
• Finance director
• Interlocking directorate
• Managing director
• Non-executive director
• Parliamentary procedure in the corporate world
• President
• Say on pay
• Supervisory board (in German: "Aufsichtsrat")
• Vorstand, German for "management board"

References

• P Blumberg, ‘Reflections on Proposals for Corporate Reform Through Change in the Composition of the Board of Directors: “Special Interest” or “Public” Directors’ (1973) 53 Boston University Law Review 547
• KJ Hopt, 'The German Two-Tier Board: Experience, Theories, Reforms' in KJ Hopt and others. (eds), Comparative Corporate Governance: The State of the Art and Emerging Research (Clarendon 1998)
• KJ Hopt and PC Leyens, 'Board Models in Europe – Recent Developments of Internal Corporate Governance Structures in Germany, the United Kingdom, France, and Italy' (2004) EGCI Working Paper

External links

• Web site of the Board of a large U.S. university, illustrating a typical board's composition, duties, concerns, etc.
• Guidance on director's duties (Lemon & Co)
• National Association of Corporate Directors
• European Directors and Board Members Association
• Corporate Governance Board Leadership Training, Global Corporate Governance Forum
• BoardofDirectors.com.au - Australia's leading Online Directorship Listing