If you ask an average investor what a board of directors is, then he will have an image of male and female people wearing expensive suits, with expensive watches and sitting at an expensive wooden table. Usually, this is how photos of the board of directors look in various corporate magazines and annual reports.
If you ask the same investor, why does a corporation need a board of directors, what are its functions, rights, duties, and what role does each director have in the board, then it is difficult for him to give correct answers.
The article discusses the basic principles of the corporate board of directors that every investor needs to know. This is useful when investing in stocks or bonds of any corporation. The analysis of the structure of the board of directors, the study of the biography and the achievements of individual directors of the board are an integral part of qualitative fundamental analysis.
The purpose of the board of directors
The Board of Directors is the highest mandatory body in the management structure of a public corporation. The main purpose of the board of directors is to work in the interests of the company, understood as the long-term interests of shareholders.
The board of directors is obliged primarily to protect the assets of the corporation and to ensure a good return on assets by all legal means. This duty is enshrined in corporate law, called the fiduciary duty.
The responsibilities of the board of directors include the following items:
- Appointment of the chief executive officer (CEO);
- Approval of wages and compensation for top management;
- A decision on whether or not to pay dividends to shareholders;
- The decision on mergers and acquisitions or tough opposition to them;
- The decision to repurchase shares;
- The decision to split the shares;
- Approval of financial statements.
At the same time, directors should take into account the interests of other stakeholders. These include:
- Suppliers and partners;
- The local population, where the corporation operates;
- Environmental organizations;
A company that takes into account the long-term interests of shareholders along with the interests of stakeholders minimizes the risk of discontent or confrontation on their part, especially from the state. Such a company is attractive for investors, because it is more stable and safe for its development.
In some countries of Europe and Asia, the board of directors puts the interests of the workforce in first place, and the interests of shareholders in second place. Most often, these are corporations where the controlling stake belongs to the state. Investors should consider whether to invest in such corporations, where the interests of corporate employees and other stakeholders are at the forefront, to the detriment of the interests of shareholders. This line of conduct of the board of directors is unfriendly to shareholders.
The structure of the board of directors
The board of directors consists of people of any gender who are selected and approved by the shareholders of the corporation. Consequently, the board of directors is trusted by the shareholders, otherwise it will not be able to effectively perform its duties.
Directors, as a rule, are selected for long-term periods and their number in corporations may vary. Many corporations at a meeting of shareholders choose only part of the board of directors, following the principle of gradual rotation. This makes it difficult to dislodge the entire board of directors for one meeting of shareholders in a hostile takeover.
Directors, as a rule, correspond to the following types:
- Affiliate director – personally interested in the company, possessing a certain package of stocks or options;
- Executive director (insider) – works in the top management of the company, possessing secret corporate information;
- Independent director (outsider) – a person independent of the company, possessing high business skills and impeccable reputation.
If two corporations cooperate mutually, or hold each other’s stakes, then a high-ranking employee of one corporation may be on the second board of directors and vice versa. In this way, communications and business relationships between corporations are enhanced.
Violations of corporate ethics and laws lead violators to expulsion from the board of directors. Some reasons that could trigger an expulsion:
- Abuse of authority, resulting in financial and reputational losses of a corporation;
- Using insider information for personal gain or for the purpose of harming a corporation;
- Bribery of other members of the board or shareholders in order to influence the outcome of voting at a meeting of the board of directors or shareholders;
- Making decisions that lead to conflicts of interest.
Committees under the board of directors
After the election, the board of directors forms certain committees from at least three directors. The number of committees may vary, but the most important are the following 4 committees:
- Executive Committee is a small group of directors with the authority to act on behalf of the board of directors. Usually consists of a chairman, vice-chairman, treasurer and secretary. May be collected at any time when solving emergency problems. It is desirable that independent directors be present on the committee;
- Audit Committee is responsible for working with independent auditors and consulting firms so that financial statements and other books are correct and that there is no conflict of interest between auditors and other consulting companies hired by the corporation. As a rule, a person licensed by a certified public accountant (CPA) is appointed as chairman of the audit committee. The committee should consist of independent directors in order to avoid conflicts of interest and meet at least 4 times a year;
- Compensation Committee is responsible for setting wages and other remuneration of top management. The chief executive officer and other people with a conflict of interest should not be members of the compensation committee. It’s funny, but many companies admit this when the CEO or COO is on the compensation committee. The committee should consist of independent directors in order to avoid conflicts of interest and meet at least 2 times a year;
- Nomination Committee is responsible for studying the skills, characteristics and assessment of candidates to the board of directors. Determines suitable candidates for specific positions of directors. Usually consists of the chairman of the board, deputy chairman and chief executive officer.
Controlling shareholder and the board of directors
The corporate board of directors and its effectiveness are affected by the company’s ownership structure. If there is a controlling shareholder, then he fully controls the organization, including the board of directors. When individual directors have any questions or problems, they turn to the controlling shareholder for help.
In companies where there is no controlling shareholder, the board of directors is still obliged to act in the interests of this non-existent imaginary shareholder. Even if it will have to cancel any management decision, dismiss the CEO or use other tough and unpopular decisions.
In some companies, the controlling shareholder also holds the position of chairman of the board of directors or chief executive officer. In this case, any director is in the immediate field of view of the controlling shareholder.