A board of directors is a group of people who govern a corporation. The shareholders elect the directors to the board and are empowered in some way (sometimes strong, sometimes inconsequential) to remove the directors later. The board is responsible for choosing the company's officers, who will run the company on a daily basis, for approving any non-routine transactions the company engages in, and for a handful of other tasks such as paying dividends to shareholders. The leader of the board of directors is called the chairman of the board.
Who is on the board
Historically, a board had to have at least three directors. This is still the rule in some places, but nowadays most places allow corporations with just one or two directors. Some jurisdictions hold, however, that one-person boards are only allowed for corporations with one shareholder. (Some jurisdictions also allow a corporation owned by one or two people to be governed directly by the shareholders, with none of this nonsense.) The number of directors can be even, although this can make it more difficult to get a majority vote. In larger corporations, there is usually an odd number of directors: seven, nine, and eleven are common figures.
When a corporation is formed, its initial directors are either named in the articles of incorporation, or selected by a shareholder meeting after the articles are filed. In every corporation, most, if not all, of the board is picked by the shareholders, at least in theory. In a small corporation owned by a handful of people, the board usually consists of the shareholders themselves. In bigger companies, key officers like the CEO, CFO, and general counsel often have seats. If someone gives a large loan to the corporation, they might also insist on a board seat in return, so they have some control over their investment.
Big public companies get directors from a variety of sources. The majority are independent directors, people with no real relation to the company: these roles are often filled by retired politicians, university presidents, and executives of other corporations (usually in different industries, although someone who retires from a company might later serve on the board of another company in that industry). In practice, the boards of most public corporations are run by the CEO. Independent directors usually have trouble keeping track of what's going on within the company and have to rely upon the CEO's expert opinions in making their decisions. (The audit committee, described below, helps in this.)
In public companies, the shareholders have little control over the board. Instead, the board essentially selects itself, and the shareholders approve it by proxy. A sufficiently large (i.e. wealthy) coalition of shareholders can theoretically force the board to resign at the annual meeting of shareholders, but this rarely happens. Instead, irate shareholders of public companies are far more likely to vote through their brokers by selling their stock. This drives down the value of the company if enough people do it, and that forces the board to either change their membership, change their ways, or look for new jobs.
How the board functions
The board exercises its powers through board meetings. Corporations have quite a bit of leeway in scheduling and structuring the board's activities through the articles of incorporation and the corporate bylaws, but there are some rules, and some defaults established by law for situations where the corporation hasn't established its own rule.
Every corporation has scheduled board meetings at fixed times during the year. The board can also call a special meeting when necessary, provided that all of the directors get notice in advance. Meetings can be held anywhere, not necessarily in the prototypical board room, although there has to be someone taking minutes.
The board makes its decisions by majority vote, and the vote is only valid if there is a quorum of directors present at the meeting (this varies from 1/3 to 2/3, and is usually a majority by default). Directors can participate in the meeting by telephone or other means of communication; the only requirement is that they have to be able to hear and be heard (unless they're deaf, in which case they should have an interpreter). They are not allowed to vote by proxy; if they cannot participate in the meeting live, they cannot participate at all.
Even when a meeting is impossible, there are other avenues for exercising board power. The board can make decisions by unanimous written and signed consent, for instance. Directors can also provide a written waiver in advance, which removes them from the total number of directors in computing the necessary quorum.
What directors are supposed to do
By law, directors have a "fiduciary duty" to the corporation. (Corporate officers have a similar duty, as do agents in general.) There are two components to this duty:
- A duty of care, to be reasonably careful, skillful, and prudent.
Directors get a bit of a reprieve from this duty through the "business judgment rule," which shields them from liability as long as they don't get too crazy. The definition of this rule varies greatly between jurisdictions and is worth several writeups in itself. Delaware, the gold standard for American corporate law, says that directors must be grossly negligent before they have breached the duty of care, and even then, they can justify their action by demonstrating the fairness of the transaction. Generally speaking, directors are supposed to make reasonably informed decisions in good faith and follow the rules of corporate governance, and as long as they do so they won't breach their duty of care.
There have been cases of directors being personally liable for their negligence in decision making. Most of the time, this happens when the director is completely oblivious to what's going on around them (see Francis v. United Jersey Bank), but some more controversial cases have indicated that directors need to take active measures to keep themselves informed, the most famous example being Smith v. Van Gorkom.
- A duty of loyalty, also known as a duty of "fair dealing." Directors are required to deal fairly in any transaction that creates a conflict of interest, such as when the corporation is dealing with the director himself, or another corporation upon whose board the director sits. Directors cannot take personal windfalls from corporate transactions, and if they run a business that competes with the corporation, they must do so in good faith. They cannot use corporate assets for their personal business.
Breaching these duties is grounds for what is known as a "derivative suit," in which one or more shareholders sue the errant director on the corporation's behalf. If the prospect of punitive damages isn't enough to scare directors, there's also criminal liability for some heinous conduct such as insider trading. If you get caught, go directly to jail. Do not pass GO.
If a director votes against a transaction approved by the majority, and they believe the transaction is illegal or violates their fiduciary duty, they can make a written dissent to escape personal liability.
Big corporations usually have a few committees underneath the board. In the US, three are required for companies that are publicly traded: the audit committee, nominating committee and compensation committee. The members of all three must be independent directors.
Audit committees choose an external auditing firm to double-check the corporation's accounting, communicate with the auditors about the corporation's finances, and review the statements the auditing firm sends back. Since independent directors often lack detailed information from inside the company, the audit committee provides a sort of back channel so that the entire board has an idea of what's going on.
Nominating commitees choose the slate of independent directors that will be sent to the shareholders for approval. Historically, the CEO was usually responsible for most of this; this helped keep CEOs dominant over their boards, so nominating commitees were required by the stock exchanges.
Compensation committees advise the board on how much the company's officers should be paid (generally ranging from "too much" to "far too much" all the way to "ludicrously much").
- Hamilton, The Law of Corporations In A Nutshell (5th ed., West 2000)
- Klein and Coffee, Business Organization and Finance (9th ed., Foundation 2004)