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Board of Directors

Introduction

Most of us have seen or heard a TV show, series, or movie with a Board of Directors, or "Board" for short, that made important decisions which affected the outcome of a business. Think of Tommy Boy starring Chris Farley and David Spade. Tommy Callahan Jr, "Tommy Boy" (played by Chris Farley), had to sell a certain amount of brake pads for his dad’s auto company or the Board of Directors would have sold the company. So, Tommy Boy went out to do the impossible – he sold half a million brake pads in a short amount of time, and saved the company from being sold by the Board of Directors.

In Tommy Boy, the auto company was a corporation called Callahan Auto. In corporations like Callahan Auto, a Board of Directors is accountable to the shareholders of the corporation. The shareholders are the actual owners of the corporation and vote for the individual directors that make up the Board of Directors. In turn, those individual directors must act in the best interests of the shareholders. If the directors on the Board fail to act in the best interests of their shareholders, directors on the Board can be held liable for civil and even criminal damages.

But if someone simply mentions the term "Board of Directors," you’ll likely need more information. That’s because there are Boards of Directors for all kinds of different companies and organizations, including: (i) public corporations, (ii) private corporations, (iii) government agencies, (iv) universities, (v) non-profit organizations, and (vi) other businesses or organizations.

In this article, we’ll focus on Boards of Directors on corporations (but many of the same principles apply to Boards of Directors on other organizations or agencies). We’ll explore what you’re likely see in a Board meeting, how Boards function, how Boards are elected, some modern legal doctrines that are supposed to govern Boards’ operations, and the faces behind the decisions of some of the most well-know public corporations.

Next, we’ll go over where a director fits in the corporate structure.

The Directors on the Board

It’s important to understand where the Board of Directors fits in a corporation’s structure. In a corporation there are generally 3 types of individuals:

Shareholders

owners of the corporation

Directors (what this article is about)

sit on the Board of Directors and make the big policy decisions of the corporation
generally elected by the shareholders

Officers

managers of the corporation
run the day-to-day operations
generally elected by the Board of Directors

The shareholders are the owners of the corporation and they elect directors to the Board of Directors to act on behalf of them and the corporation. In turn, the directors generally elect officers to carry out the day-to-day decisions of the corporation. That’s why officers, like a Chief Executive Officer (CEO), reports to the Board. So, the order of power goes from the shareholders, to the directors (on the Board of Directors), to the officers of the corporation.

Only individuals can be directors on the Board. In other words, other businesses cannot be directors on the board. This is an important concept, because shareholders can be businesses or individuals. But directors must be individuals. Also, serving as a director is generally a temporary job, not a career, and may not even be a paying job.

Many times the directors on the Board are also shareholders and/or officers. In other words, one individual can actually be a shareholder, director, and officer for the same corporation. Individuals that do this wear multiple "legal hats" - i.e. they carry out more than one legal role for the corporation. Let’s go over a brief example to clarify this concept (which is important to understand and often one of confusion for many people).

Example of "Multiple Legal Hats"

Assume Ron is a shareholder and director of ABC, Inc. As such, Ron has 2 different legal roles, i.e. he wears 2 different legal "hats."

As a director, Ron must act in the best interests of the corporation. However, as a shareholder Ron is free to act in the best interests for himself. But Ron must be careful not to act like a shareholder when he is acting in the capacity as a director. For example, when Ron meets at a Board meeting, he is acting as a director and must act strictly for the benefit of the corporation. However, when Ron votes as a shareholder he can vote in the best interests for himself. Ron therefore wears 2 different "legal hats" for ABC, Inc.

Next, we’ll go over some of the differences between Board of Directors in public and private corporations.

Public vs. Private Corporations

A Board of Directors can generally fall into two broad categories: (i) stock corporations, and (ii) non-stock corporations or organizations, like universities and non-profit organizations. Here, we’re focusing on how the Board of Directors operates in stock corporations (but many of the same principles will apply to non-stock corporations).

Within stock corporations there are basically 2 types of corporations: (i) public, and (ii) private, or closely-held. Public corporations are the ones we generally hear on the news, like Microsoft Corporation, GE, Ford, Google, etc. Public corporations are traded on a national trade exchanges like the New York Stock Exchange. In order for a corporation to "go public," that corporation must meet many stringent requirements and generate a great amount of revenue (in the multi-million dollar range).

In contrast, private corporations are "private" because they are not traded on a national trade exchange. Instead, private corporations are generally smaller than public corporations and often have less formal rules to follow. For example, in public corporations directors generally cannot agree to vote a particular way on business issues before the issue is presented to the Board. However, the Board of Directors on private corporations can generally agree to create contracts or vote a particular way, as long as there is no harm to: (i) the general public, (ii) creditors of the corporation, or (iii) minority shareholders, i.e. shareholders with a small amount of interest in the corporation.

With that said, many of the same general rules apply to Boards of Directors in public and private corporations. For example, the duties of directors, how directors are elected, and how directors’ meetings are conducted tend to follow a similar format.

Next, we’ll take a look at directors’ duties for the corporations they represent.

Board of Directors’ Duties

The Board’s duties are generally set forth in the corporation’s bylaws, which usually indicate the number of members on the Board, how meetings should be conducted, how to fill in vacancies on the Board, etc. In addition, a Board of Directors has fiduciary duties to the shareholders of the corporation, which include the duties of care and loyalty. In other words, if a director on the Board does not act in good faith or with a certain standard of care in making his or her decisions, that director can be held civilly or criminally liable.

Overall, the Board makes the top-level policy decisions. The Board then usually elects officers to run and implement the day-to-day operations of the corporation. With that said, let’s take a look at some of the Board’s main duties.

The duties of the Board of Directors generally include:

Setting the main policies for a company

E.g. Approving budgets

Maintaining accountability to the shareholders

E.g. giving reports on the success and/or failures of the corporation

Hiring, firing, promoting, and setting the compensation structures for the officers of the corporation
Monitoring the progress of the corporation

NOTE: A board of directors is not an advisory board. Advisory boards are often hired by corporations for advice on certain matters. However, advisory boards do not have any authority to make the final decision or vote on corporate matters.

Next, we’ll take a look at how the Board of Directors’ elections work.

Board of Directors’ Elections

Directors are elected by the corporation’s shareholders. In public and private corporations, the directors may also be the shareholders. So, how does this work?

Well, shareholders vote for the directors and the shareholders with the highest percentage ownership interests in the corporation usually votes for themselves. As such, those shareholders essentially elect themselves to the Board. Let’s go over an example to clarify.

Assume ABC, Inc. is a private closely-held corporation with 10 shareholders. Five of the shareholders own 15% each of the corporation and the other 5 shareholders own 5% each. If you’re doing the math, 15% x 5 = 75% and 5% x 5 = 25% (75% + 25% = 100%).

Now, assume that the bylaws of ABC, Inc. only allow for 5 directors to sit on the Board. Who do you think will be elected to the Board? Most likely, the 5 shareholders that each own 15% in the corporation because they’ll all vote for themselves. But that may not be the case, depending on how they really vote and the type of voting system that the corporation uses.

There are 2 main voting methods used with corporations, which include (i) straight voting, or (ii) cumulative voting. Straight voting is by far the most common and the default method for voting. With straight voting a shareholder must vote for every open seat, and can only vote up to his or her total share for each open seat. In contrast, with cumulative voting a shareholder can consolidate all of his or her votes for one candidate. Let’s go over an example to clarify.

Under the straight voting system, if Bill has 100 shares of ABC, Inc. he can vote up to 100 times for each of the 5 directors’ seats. So, Bill has 500 votes to use, but he can only cast 100 votes for each seat. In other words, Bill would vote 100 times for Seat 1, 100 times for Seat 2, etc. However, under cumulative voting, if Bill was voting for 5 different directors, he could take all his 500 votes and vote for 1 person. This is called consolidating his voting power. As you can see, with cumulative voting a person with less shares has a better chance of being elected to a director’s seat.

NOTE: Voting for directors takes place through (i) classified elections – where every director’s seat is voted upon (usually on an annual basis), or by (ii) staggered elections – where a few directors’ seats are voted on each voting cycle. Think of classified elections like the U.S. House of the Representatives where every member runs for election every 2 years. Think of staggered elections like the U.S. Senate where only 1/3 of the senators run for election every 2 years.

Next, let’s take a look at how the Board of Directors’ meeting run.

Board of Directors’ Meetings

A Board of Directors generally must conduct a Board meeting to make company decisions. There generally must be a quorum for a Board of Director’s meeting. A quorum represents the minimum amount of directors that must be present to conduct business. For example, if the Board is comprised of 9 directors, the bylaws of the corporation might require a quorum of 7 directors before business can be conducted. So, if only 6 directors show up, nothing can be voted on.

There are also essentially 2 types of directors’ meetings: (i) special, and (ii) scheduled. A special meeting is one called by a majority of the director for a particular purpose or purposes. A scheduled meeting is generally set forth in the corporation’s Bylaws or Articles of Incorporation. The Bylaws usually require a certain amount of meeting per year at certain times to deal with the particular issues of the corporation like monitoring the budget, electing new officers, etc..

The Bylaws or the Board of Directors may give the officers of the corporation, like the Chief Executive Officer (CEO), Chief Financial Officer (CFO), or other officers certain powers to act on behalf of the corporation. Some of these powers might include the power to sign contracts, deposit checks, etc. In return, the officers often have to report and give updates to the Board. The Board holds the officers accountable for their particular jobs and usually has the authority to hire, fire, and/or promote the officers.

The Board may also hire advisory boards that brief the Board of Directors on particular topics, such as how to efficiently cut costs, buy another business, enter a different market, etc. But as previously mentioned, advisory boards hold no power over the corporation. Advisory boards merely act as advisors for the Board of Directors. It is therefore the Board of Directors that holds responsibility for the overall success and failure of the corporation.

Next, let’s briefly take a look at some well-known public corporations’ Boards of Directors.

Board of Directors on Some Well-Known Public Corporations

The men and women who sit on the Boards of Directors of public corporations make the big policy decisions that affect how they operate and function. From the big oil companies, to the leaders in technology, pharmaceuticals, and retail, all the big corporations have a Board of Directors.

It’s fairly easy to find Boards of Directors on public corporations (while private corporations tend to refrain from releasing their Boards of Directors).

To see the faces on the Board of Directors behind some of the world’s most renowned corporations, take a look below:

Wal-Mart Stores, Inc.
Notice the Waltons who sit on the Board (related to the founder Sam Walton).

Dell, Inc.
Notice Michael Dell, the founder of Dell, Inc., sits on the Board as the Chairman and acts as the Chief Executive Officer. In other words, he wears 2 legal hats.

Microsoft Corporation
Notice the founder, Bill Gates, acts as the Chairman of the Board.

Exxon Mobile
These are the individuals who direct one of the largest oil companies in the world.

Google, Inc.
This link will show you the Board of Directors and top-level officers at Google, Inc., including the positions of Sergey Brin and Larry Page (the creators of Google).

Apple, Inc.
Notice the position Steve Jobs, the founder of Apple, holds. Also, Al Gore is a current member of the Board (last checked on 08/21/09).

Pfizer
These individuals direct one of the largest pharmaceutical companies in the world.

Well, now you should have a slightly better idea of the faces that make the big policy decisions for some of the most well-known public corporations.

Finally, let’s wrap up this article with some main thoughts to keep in mind.

Conclusion

In this article, we covered a number of topics concerning how a Board of Directors functions. We focused on Board of Directors in corporations, but Boards sit on all kinds of other organizations, agencies, etc.

With a good understanding of the Board of Directors you might want to explore the functions and role of the Chairman of the Board - perhaps one of the most prestigious positions in the corporate world. The Chairman of the Board is the leader of the Board of Directors and must attend and preside over the Board’s meetings.

Next time someone talks about a Board of Directors you should have a much better understanding about how they operate. And remember, it is the Board of Directors that makes the policy decisions that sets the direction of the corporation (or other organizations).

At the very least, the next time you watch Tommy Boy, you’ll know the functions and responsibilities of the Board of Directors at Callahan Auto.