What Is a Board of Directors?
Every public company in the United States must have a board of directors. Stockholders elect board members, and they work for stockholders, voting on decisions to protect their interests – whether the company should merge with another company, for example. The board of directors plays an instrumental role in how a company is ultimately managed, and it must act as a fiduciary in representing shareholders.
For shareholders, the board of directors is a direct line to the company they hold equity in. This is why companies hold an annual general meeting: to bring shareholders and board members together. In the meantime, throughout the rest of the year, the board of directors maintains oversight duties that keep the organization on its path to profitability. It’s a complex and all-important role in the governance of any public company.
What Does the Board of Directors Do?
While not active in the day-to-day operations of a company, the board is responsible for appointing the executives who are. The primary roles of the board are to oversee the hiring and firing of company executives and to create the standards of accountability they’re held to. This ensures that leadership acts with the best interests of the company (and its shareholders) in mind.
The board of directors is also responsible for determining executive compensation. The board votes on everything from stock awards and vesting schedules to the annual salary of new executives. Its goal is to balance incentives for executive performance, without burdening the company or cutting away from shareholder value.
Finally, the board also votes on important company policies and actions that affect shareholders, such as the decision to issue, raise or cancel a dividend. Other duties of a company’s board include…
- Approving the company’s annual budget
- Establishing strategic company objective;
- Presenting the company’s annual report
- Selecting legal representation for the company.
Above all, the board of directors has the last word on high-level decision making. A strong board will make decisions that bring value to shareholders and growth to the company; a weak board can hinder a company’s prospects and stunt its ability to generate returns for shareholders.
Who Serves on a Board of Directors?
Anyone can serve on a board of directors. That said, it’s in the best interests of both shareholders and executives to appoint highly qualified directors. This means executives from within the company, knowledgeable outside consultants, industry thought leaders, corporate shareholders and the like. Given the purpose of a board, it’s best to have a competent, capable and experienced group of directors with a mixed background.
Types of Directors
- Director. The broad term for anyone serving on a board of directors.
- Outside director. A person from outside a company who was selected to serve on its board.
- Inside director. A person serving on a company’s board with meaningful ties to its organization.
- Executive director. An inside director who is also a member of the company’s C-suite.
- Shadow director. An unofficial board member who has influence on board decisions.
- Nominee director. Someone appointed to a board by a shareholder group.
Board Member Election and Removal
There are several ways members can become elected to serve on a board. The mode of selection tends to indicate whether an individual is an inside or outside director. Ultimately, shareholders vote on directors; however, nominations can come from different interest groups.
For example, a board member nominated by a company’s C-suite is more likely to be an inside director and represent the needs of administrators. Conversely, an activist group of shareholders may nominate an outside board member to represent shareholder interest – or shareholder malcontent. Finally, in other cases, board membership may be contingent on investment agreements, which is often the case for startups and new public companies.
Board members serve the term they’re elected to and can run for reelection – unless they’re removed. Board member removal can happen for a number of reasons:
- Abuse of directorial power for self-gain
- Gross misrepresentation of shareholders
- Manipulation of the board through clandestine deals
- Undisclosed conflicts of personal interest
- Conduct unbecoming of a board member.
The board can oust members or ask them to vacate their seat in the event they fail in their fiduciary duties to shareholders. The removal of a board member is a significant event in a company’s timeline. Their spot is usually filled by an interim board member or is left unfilled if an election cycle is upcoming. Depending on their inside or outside status, the new board member could change the dynamic of the company’s governance.
How Often Does the Board of Directors Meet?
There is no set standard for the frequency of board meetings. Many companies choose to host closed-door board meetings quarterly. Other companies convene the board once a year, exclusively for the annual general meeting. States have differing laws about how frequently a company’s board needs to convene. In any case, a board must notify shareholders of upcoming meetings and follow due process in documenting each meeting.
A company’s board will also meet as needed in the event of monumental company developments. For example, if there’s an action to remove the CEO or if the board needs to vote on whether to approve an acquisition, it will meet. These events may also require a vote by proxy from shareholders, which would also trigger a board meeting. Regardless of the reason, directors need a quorum to legitimize the meeting.
An Experienced Board Is an Asset to a Company
A well-appointed board of directors can significantly boost a company’s prospects. Likewise, an inexperienced or mismanaged board can stagnate an organization. Before investing in a company, investors need to consider that company’s board of directors and its track record of governance. When it comes to important tasks like approving budgets and appointing executive leadership, there’s no substitute for the actions of an engaged, capable board of directors. If you have confidence in a company’s board, you’re more likely to have confidence in your investment. To learn more about making smart investments to take your portfolio to the next level, sign up for the Liberty Through Wealth e-letter below. In fact, you can learn how to build a life of financial independence by making better investment decisions.