Board of Directors

Related Terms: Sarbanes-Oxley

A corporation is a legal entity created ("chartered") either under federal or state law. The corporation is an artificial "person" distinct from the individuals who own it. This prompted a jurist once to remark that a corporation has "neither a soul to damn nor a body to kick" (as recalled by Barron's Dictionary of Finance and Investment Terms.) This legal person is nevertheless entitled to own property, borrow money, bring law suits, and to have its communications protected under the First Amendment. The charter of this institution is its "constitution," the shareholders are its "people," the management is its "executive," and the board of directors is its "legislature." In theory stockholders elect board members and board members elect the chief executive. Thus a "board of directors" is associated with companies organized as corporations. Partnerships and sole proprietorships do not have boards. The minimum and maximum number of board members is usually specified by state law; three is a typical minimum membership; the maximum may not exceed the number of shareholders. The board's duties are defined by the corporate charter which, in turn, is structured by state and/or federal law.

HISTORICAL PERSPECTIVE

In discussing boards generally, it is important at the outset to note that all boards are different. Despite major trends over time, specific boards have exhibited every variety of function associated with such bodies, often in defiance of prevailing custom.

By historic origin, boards initially were the investors—the three or four wealthy people who funded an energetic entrepreneur. The distinction between investors and boards developed over time as the number of investors grew large and, in more modern times, enormous; boards then took on the role of bodies representing stockholders. The presence on the board of major stockholders, however, in person or by proxy, has never disappeared. Through much of the sustained growth period that followed World War II, boards retained their governance functions but often exercised them weakly ("rubber stamp boards"), especially in successful, growing corporations led by dominant executives. In the opening years of the 21st century, in response to major corporate scandals, a strong role for boards has reemerged, mandated by federal law. But these changes are strictly speaking specific only to publicly traded companies. The role of boards in privately held corporations continues to be shaped by other factors, most prominently by the degree to which major stockholders alone or in groups wish to be involved. Private boards may be quite active in some companies and may exercise supervisory powers; in others board members are chiefly used as resources and as ambassadors to other interests; in yet others boards are a mere formality required by law.

BOARDS AND THEIR ORGANIZATION

Corporate boards have members, usually called "directors," who are elected by the stockholders. In the ordinary course of events, a privately held corporation has board members selected by the consensus of the company's founders without a formal election. When the company goes public and stockholder numbers increase substantially, the company prepares slates of board candidates and submits these to stockholders for a vote. The stockholder may accept the recommended slate, choose one of the alternatives, name others who do not appear on the list, or give his or her vote ("proxy") to the company itself to exercise.

Board members are called inside directors if they are members of the management or outside directors if they have no direct role in the company itself. Outside directors are typically well-known figures in the business community recruited for service on the board to provide valuable advice and counsel; they may not be executives of competitors or sit on competitors' boards. Outside directors may also be drawn from community organizations sometimes representing academia, law, labor, or other large constituencies or interests. Outside directors are also called independent directors because they are not under the influence of the chief executive of the corporation. In publicly held companies directors receive compensation for their services. Compensation may also be paid in privately held organizations.

Under the rules of the Securities and Exchange Commission (SEC), directors of either category are held to be "insiders" and therefore prohibited from trading stock based on "inside knowledge."

In large corporations the board is frequently subdivided into committees with functional roles such as Executive, Finance, Compensation, Strategy, Audit, etc. Board members are assigned to committees and these, in turn, develop positions on issues pertinent to the functional matter assigned to the committee. They make recommendations to the full board. Under legislation passed in 2002, audit committees are mandatory and their functions and membership are precisely defined.

Boards set their own rules of operation. If the corporation's bylaws or charter specify that Robert's Rules of Order will be followed, procedures may take the parliamentary form—or do so if conflicts arise.

In large corporations the board—and its committees—will have full-time staffs engaged in preparatory and administrative work related to board activities. Employees of such staffs are also considered to be insiders because of their unique access to sensitive data.

THE EVOLUTION OF A BOARD

In a small privately held corporation the board will typically be a so-called "working board," with its members all engaged in the business. In addition one or two additional family members may be on the board but inactive in operations. Board meetings tend to be rather informal in such situations because operational and board decisions coincide. The paper-work connected with the board activity—recording legally mandated board meetings, for instance—will be seen as rather a nuisance. If and when the business begins to grow, the board will tend to evolve.

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