How do boards of directors work

Most boards of directors and most individual directors are intensely reluctant to face the unpleasant conclusion that the president of the company must be replaced. While sometimes the unpleasantness is avoided by hiring outside consultants or by resigning from the board, there are some situations in which board members who have procrastinated in taking any action find themselves obligated to face the task of asking the president to resign.

These situations are relatively rare. For the most part, the outside directors remained on the board and devoted more than casual amounts of time to the company in distress. Many directors expressed regret for not having responded to the symptoms of weakness they had seen earlier, now more recognizable than before. They gave more of their time to the affairs of the ailing company, and they acted as responsible corporate citizens by assuming for the interim the de facto powers of control held previously by the president.

The business literature describing the classic functions of boards of directors typically includes three important roles: a establishing basic objectives, corporate strategies, and broad policies; b asking discerning questions; and c selecting the president.

In this section of the article, I shall discuss the evidence that I collected during my interviews on each of these generally accepted roles. Boards of directors of most large and mediumsized companies do not establish objectives, strategies, and policies, however defined. These roles are performed by company managements. Presidents and outside directors generally are agreed that only management can, and should have, these responsibilities.

We decide what course we are going to paddle our canoe in. We tell our directors the direction of the company and the reasons for it. Theoretically, the board has a right of veto, but they never exercise it. Naturally, we consult with them if we are making a major change in direction.

We communicate with them. But they are in no position to challenge what we propose to do. And the market, for more and more companies, includes opportunities abroad, thus adding another complicating dimension of analysis. The typical outside director does not have time to make the kinds of studies needed to establish company objectives and strategies. At most, he can approve positions taken by management—and this approval is based on scanty facts, not on time-consuming analysis.

Giving operational meaning to a set of defined corporate objectives is generally achieved by allocating or reallocating corporate capital resources.

The managements of a few companies, I found, do not accept the idea that boards can, or should be, involved in the process of capital appropriations, even in an advisory capacity. Accordingly, their studies and approvals of capital appropriations are made at management levels and not at the level of the board of directors.

In most companies, the allocation of capital resources, including the acquisition of other enterprises, is accomplished through a management process of analysis resulting in recommendations to the board and in requests for approval by the board. The minimum dollar amounts which require board approval and the quantity of analytical supporting data accompanying such requests vary among companies. Approval by boards in most companies is perfunctory, automatic, and routine. Presidents and their subordinates, deeply involved in analysis and decision making prior to presentation to the board, believe in the correctness of their recommendations, and—almost without exception—these go unchallenged by members of the board.

Rarely do boards go contrary to the wishes of the president. In a few instances, boards of directors do establish objectives, strategies, and major policies, but these are exceptions. Here, the president wants the involvement of the directors, and he not only allows for, but insists on, full discussion, exploration of the issues, agreement, and decisions by the board along with himself.

A second classic role ascribed to boards of directors is that of asking discerning questions—inside and outside the board meetings. Again, I found that directors do not in fact do this. Board meetings are not regarded as proper forums for discussions arising out of questions asked by board members; the president and directors alike feel that such meetings are not intended as debating societies.

In one situation, for example, an outside director, who was concerned about steadily declining earnings and who perceived no apparent management program to reverse the trend, asked the chairman and the president what was being done to correct the situation.

The other outside directors also expressed their concern, and the president, obviously embarrassed, responded with unpersuasive and unimpressive replies. After the meeting, the chairman asked the initial questioner to stop by his office before leaving, and there he explained:.

You must remember that you are challenging the president in the presence of his subordinates, some of who are insiders on the board.

If you have questions about what is being done to reverse the trend, the proper way is to make a date to confer with the president privately. Presidents generally do not want to be challenged by the questions of directors, especially if subordinates of the president are on the board or in attendance at the meeting. Despite the fact that most presidents profess that they want questions to be asked by interested members of the board, I have concluded that, while they may say this, and may even go to some trouble to make directors feel that they are free to question, actually the presidents do not want discerning questions or comments.

The unsophisticated director may learn from experiencing rebuffs that the president does not want penetrating and issue-provoking questions, but only those which are gentle and supportive and an affirmation that the board approves of him. Many presidents stated that board members should manifest by their queries, if any, that they approve of the management.

If a director feels that he has any basis for doubt and disapproval, most of the presidents interviewed believe that he should resign. The lack of active discussion of major issues at typical board meetings and the absence of discerning questions by board members result in most board meetings resembling the performance of traditional and well-established, almost religious, rituals.

In most companies, it would be possible to write the minutes of a board meeting in advance. The format is always the same, and the behavior and involvement of directors are completely predictable—only the financial figures are different.

My research disclosed few exceptions to this routine. In a handful of instances, presidents said that they do in fact want discerning, challenging questions and active discussions of important issues at their board meetings. There are also a few directors who do in fact ask discerning questions, the desires of the president notwithstanding. Typical garden-variety outside directors, selected by the president and generally members of a peer group, do not ask questions inside or outside board meetings.

However, directors who serve on corporate boards of companies because they own or represent the ownership of substantial shares of stock generally do in fact ask discerning questions.

Their willingness to query presidents is, in part, a manifestation of the split in the de facto powers of control of those companies. The large stockholder-directors are not usually on the board because the president wants them there, but because through cumulative voting procedures they can force their way onto the board.

Directors, as described in the literature, represent the stockholders. Yet, typically, they are actually selected by the president and not by the stockholders. Accordingly, the directors are on the board because the president wants them there. Implicitly, and frequently explicitly, the directors in point of fact represent the president.

But a large stockholder-director is not selected by the president and does not therefore represent the president; rather, he represents himself and an interest more likely to be consistent with that of the other stockholders. These differing attitudes with regard to stock ownership often are manifested in the extent to which discerning questions are asked of the president by the directors.

A third classic role usually regarded as a responsibility of the board of directors is the selection of the president. Yet I found that in most companies directors do not in fact select the president, except under the two crisis situations cited earlier.

The board does not select the management; the management selects the board. In some situations, formal or informal committees of outside members of boards are charged with the responsibility of evaluating candidates inside the management for the presidency.

But, generally, these committees have no more control over the naming of the president than do similar committees charged with identifying and recommending the names of candidates for board membership. In both committee situations, the president with de facto powers of control essentially makes the decisions.

The administrative use by the president of board committees to evaluate candidates for his successor in the presidency gives the selection process an appearance of careful evaluation and objectivity. But in most cases the decision as to who should succeed the president is made by the president himself. Certainly, the president knows the key members of his organization better than anyone else. He has worked with them closely and, typically, over a considerable period of time.

Board members with relatively brief exposure to company executives—whether on the board or not—base their appraisals necessarily on very inadequate evidence. When insiders appear before the board for presentations of their divisional operations, for example, or to explain a request for a large capital appropriation, the setting is artificial and synthetic.

Executives, aware that the process of evaluation is going on, rehearse their appearances to communicate to the board that they have the capacities and skills needed for the presidency.

Boards of directors, I found, do serve in an advisory role in the selection of a new president—in their capacity as a sort of corporate conscience. The process of electing a new president requires a vote by the board, and the president generally observes the amenities of corporate good manners by discussing his choice with individual members prior to the meeting.

Rarely does a board of directors reject a candidate for the presidency who is recommended by the president. In the small family company, the ownership of the stock and the management are identical.

In an earlier study, I found that the powers of control are in the family owners, and what the board of directors does is determined by the owners. The owner-managers of some small companies add outside directors to multiply the inputs to policy making, policy implementation, and day-to-day operating problems.

The primary function of the outside directors is to provide a source of advice and counsel to the family owner-managers, and they do not serve in a decision-making role, except in the case of the unforeseen death of the dominant family owner-manager. They have the authority to manage the enterprise, and the board is at most a legally required body which can be used for advice and counsel on management or family problems. The family owners determine what the board does or does not do.

At the opposite end of the spectrum is the large, widely held corporation in which typically the president and members of the board own little stock. Here, the de jure powers of control are dispersed among thousands of stockholders who are generally both unorganized as owners and essentially unorganizable. With this absence of control or influence by the corporate owners, the president typically does have the de facto powers to control the enterprise, and with these powers of control it is the president who, like the family owner-managers in the small company, determines in large part what the board of directors does or does not do.

Between the two corporate situations just cited, there are many variations and combinations of centers of control, or ownership influences on control, of the company. The supervisory board is chaired by someone other than the presiding executive officer and addresses similar concerns as a board of directors in the United States. In addition to those duties, a board of directors is responsible for helping a corporation set broad goals, supporting executive duties, and ensuring the company has adequate, well-managed resources at its disposal.

Essentially, B of D is responsible for oversight of management's actions to ensure that the company's vision is being adhered to. Usually, the B of D includes a mix of company insiders and qualified outsiders with expertise in associated fields.

An inside director is a member who has the interest of major shareholders, officers, and employees in mind and whose experience within the company adds value. Outside directors, while not involved in the daily operations, should bring an objective, independent view to goal-setting and settling any company disputes. Striking a balance between the two is critical to the success of the board.

Outside directors are paid. Aside from attending board meetings, outsiders are often chosen for their expertise in associated fields that can add value in fostering a healthy business structure. Compensation can vary depending on the company's size. Securities and Exchange Commission. Financial Statements. Business Essentials.

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I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. Business Business Leaders. Table of Contents Expand. What Is Board of Directors? How a Board of Directors Works. Election and Removal Methods. Special Considerations. Internal board members are not usually monetarily compensated for their work, but outside board members are paid.

The board makes decisions concerning the hiring and firing of personnel, dividend policies and payouts, and executive compensation. A board member is likely to be removed if they break foundational rules, for example, engaging in a transaction that is a conflict of interest or striking a deal with a third party to influence a board vote.

It is a good practice to have directors require that management produce regular updates on progress, especially in the early years. For startups a weekly reporting system is not uncommon. In the case of young companies, directors often become quite involved in day to day matters and sometimes they assume a part-time management role as well.

Directors work with management to approve budgets, business plans, senior job descriptions, compensation, policies, and financial statements. With respect to job descriptions, it is advisable to draw up some "terms of reference" for a board which clearly articulate not only legal duties and responsibilities but also any other expectations. In situations where you are a substantial shareholder in a company, it makes sense for you to be a director.

What is substantial? The owners and founders of a company usually comprise its first board of directors. It would be very unusual for a key person not to be a director. If asked to be a director of a company, you have to weigh the pros and cons very carefully.

You should first ask why you are being nominated. Is it because of your reputation or because of certain skills and contacts you may have? What potential risks and liabilities are you assuming by agreeing to serve on the board? To what extent can the company indemnify its directors against claims? What is your reward for taking such a risk?

In this regard, stock option plans, or even better - stock purchase or ownership plans - are very attractive inducements and can be very effective, especially in cases where one has been invited to serve on behalf of other shareholders without necessarily having a personal equity stake.

Directors are often paid a fee in addition to any stock appreciation compensation they may have. Some companies pay a fixed amount per board meeting, others pay a monthly or annual retainer. A retainer, regardless of amount, is likely the best because, in principle, directorship is a full-time, 7x24, job.

A potentially problematic situation may occur if you are asked by a shareholder to serve on a board on that shareholder's behalf. For example, if you are an employee of a shareholder, i. Although liability insurance may reduce the potential liability, it will not eliminate it. If you are asked to serve as a director for a company with which you or your employer have some other relationship with that company, e.

When you agree to become a director of a company, you may be precluded from having any involvement with other companies due to non-competition or conflict of interest concerns.

Because such restrictions may be imposed, not to mention the liability issues, directors must be appropriately compensated. Far too many people think they are doing a favor for a friend or business associate by serving as a director for them without any compensation. That's bad business - for both parties! Being asked to serve on a major corporate board such as IBM is a lot different than being asked to serve on the board of Fly-By-Night Enterprises.

Many people view serving on high-profile prestigious boards as a valuable asset in their own career development - not to mention the perks they might enjoy such as free first-class air travel if they are on the board of an airline. Being a director of a public company is an order of magnitude more onerous than being a director of a private company. In a private company, it is possible to learn about directors' responsibilities on-the-fly.

This is not advisable for directors of public companies. Directors of public companies must familiarize themselves with the very extensive matters of corporate governance relating to the regulatory environment and the applicable securities legislation e. Securities Act that regulates all companies. There is so much that must be learned that special educational programs are being offered to executives. Simon Fraser University, for example, in cooperation with the stock exchanges and regulatory bodies, offers a special three-day course on corporate governance.

Of particular concern are such activities as insider trading, corporate filings, investor relations and public disclosure issues. It is very easy for a director of a public company to make an innocent mistake through ignorance. You can rest assured - the law courts and the news media won't look it it in the same way! Are you a board member or just plain bored? Aside from everything else, being a board member should be fun and interesting. Don't join a board until you've met other board members.

Consider a trial period - i. Know something about the dynamics of the board first. Does the CEO listen to his board? Some board meetings can become exercises in showmanship or stress control while others are little more than fan clubs.

If you choose to accept a directorship, you will find that there are many resources available to you to help you become an effective director. There used to be no special qualification such as a certificate, diploma or belonging to a professional association in order to be a director. While this is still the case, some regulators do require or suggest that directors meet certain standards.

We are likely to see more of this in the public arena. Regardless, there are organizations such as the Institute of Corporate Directors www. In Canada, companies are either provincially or federally incorporated with provincial incorporations being the most common. Each jurisdiction has a corporate registry office which maintains corporate information on all incorporated companies - public and private.

Anyone can access this information, sometimes for a small fee, to determine a company's status, legal address, as well as the names and addresses of its directors. This is how potential litigants can easily track down the directors. It may not be sufficient for a director to submit his or her resignation to the company.

The company, or its legal counsel, must execute the appropriate filing with the Registrar of Companies. I know an ex-director who was once served by the U.

Directors must meet certain qualifications before they can act as such. For example, directors must be at least 18 years of age. Persons who are undischarged bankrupts or who have been convicted of a criminal act or a securities violation may not be allowed to serve as directors. Directors owe a fiduciary duty to both the company and all shareholders and as such must act in the interests of all shareholders.

A director may be held liable by others if he or she acts in such a manner as to be detrimental to their interests. Great care has to be taken to declare any possible conflicts of interest and to avoid deriving any personal benefits in preference to the company for example diverting business away from the company. Directors must act in accordance with any applicable legislation, notably the Company Act and the Securities Act. Other Acts e. Employment Standards, Social Services Tax Act, Worker's Compensation, etc pertaining to corporate management may also give rise to personal liability.

Not knowing the laws does not absolve a director from any responsibility and liability. Directors may even be liable under the Criminal Code where a company has committed a crime e. Companies may endeavor to indemnify directors against any liabilities that may arise.