Board of Directors
A Board of Directors is a recognized group of people who jointly oversee the activities of an organization, which can be either a for-profit business, a nonprofit organization, or a government agency. Such a board's powers, duties, and responsibilities are determined by government regulations (including the jurisdiction's corporation law) and the organization's own constitution and bylaws. These authorities may specify the number of members of the board, how they are to be chosen, and how often they are to meet.
Board of Directors - How it Works and Why it Matters
Directors attend board meetings, evaluate management performance, tend to major decisions (such as making acquisitions or selling the company), declare dividends, create stock-option policies (including approving grants to key managers), and establish executive compensation packages. Boards of directors often have several committees dedicated to specific decision-making processes. For example, the compensation committee constructs the executive compensation packages and brings them before the full board for a vote; the audit committee evaluates and hires the company's auditors after bringing its research and judgment before the full board, and the finance committee evaluates the merger bids or potential sources of capital. Directors are elected by the shareholders usually once a year and usually at the annual shareholders' meeting. In most cases, directors have staggered terms, meaning that they will not all be up for re-election in the same year. Quite often, the CEO of the company is on the board, and the CFO or even the COO might hold board seats. Most shareholders agree that management's presence on the board brings detailed expertise to the board's decision-making processes, but this can also create conflicts between acting in management's best interests and the shareholders' best interests. Independent directors (also called non-executive directors) are directors who don't work for the company. Non-executive directors are compensated with cash for their directorships; quite often they also receive stock options or stock grants. The Sarbanes-Oxley Act of 2002 introduced new standards for board conduct to ensure that directors are aware of and accountable for the financial condition of the companies they manage. These new standards include holding the board responsible for the integrity of the company's internal controls, but higher accountability is even more evident in the act's requirement that the board of directors of most public companies has an audit committee. This committee must appoint, inspect, regulate, and control the actions of the company's auditing firm. The auditors in turn report directly to the audit committee. Committee members cannot be employees of the company, and companies are required to disclose which members meet the definition of "financial expert." The audit committee must be prepared to address complaints and confidential or anonymous submissions about the company's accounting practices. In most cases, directors are covered by directors' and officers' insurance ("D&O insurance") in order to protect the company against judgments caused by board misconduct.
The purpose of the board of directors is to make sure management is acting in the best interests of the shareholders. This is why the board of directors lays at the heart of the notion of Corporate Governance -- it has a fiduciary duty to the shareholders, and only to the shareholders. This can be difficult, especially when the vast majority of information that boards receive about corporate performance comes from management. Board members also aren't "there" every day and thus generally don't know their companies, as well as the managers, do. In addition, there is often pressure to agree with executive directors given their day-to-day knowledge of the company. But ultimately, if the shareholders don't think the board is representing their interests well, the shareholders simply elect different directors.
The Job of the Board of Directors
There are three key components to the board’s job. In order to be accountable for the organization’s performance to the shareholders or “owners,” a board must:
- Maintain an ongoing connection with the shareholders or owners in order to understand their values and perspectives. Otherwise, how can the board effectively govern on their behalf? This is often called “ownership linkage.”
- Develop policies that address all areas of the board’s own job and of the operations of the organization, at the broadest levels. There are four categories of policies, that when developed well, adequately address everything about the organization.
- Monitor to assure that whatever has been delegated is being performed, consistently with the expectations of the board’s policies.
There are some “optional” jobs that boards may choose to add to the three above, but only those three are necessary in order to govern well. Some boards choose to take on direct accountability for fundraising, or for maintaining an active connection with political decision-makers that have a major impact on their organizations. However, these extra tasks should never be taken on unless the board is confident that it is able and has time to do the first three well. Contrary to popular opinion and common practice, it is NOT the board’s job to be the “advisor” to the CEO.
Types of Boards
There are several common types of boards each having distinguishing characteristics:
- Collective: A collective is a group of people with a shared focus or purpose. They make decisions collectively and each individual represents themselves and their interests.
- Governing Boards: The board leads the organization using authority to direct and control provided by the owners and the legal act of formation. They set initial direction and have the full authority to act in the owners’ best interests. Governing boards function at arm’s length from the operational organization. They focus on the big picture, are future-oriented, and act as a single entity.
- Working Boards: The board leads the organization but also does double duty as the staff. These are common in very small organizations and community-based organizations that do not have the resources to hire employees. Working boards often get caught up in project management and set aside the governing function.
- Advisory Boards: The board serves to provide insight and perspective to any decision maker including boards. An advisory board typically does not have the authority of its own but works to educate some person or body.
- Managing Boards/Executive Boards: A group of people who actually manage the operations as a collective group (instead of a single CEO). They are not the same as a governing board but may work under one. They make the day-to-day decisions of what gets done and the long-term decisions about how to organize operations to achieve the organization’s purpose.
- Fund Raising Boards: The board is often only a “board” in name alone. Its real purpose is to use its members’ connections and influence to solicit resources for the organization.
- Policy Board: This is actually more about how the board does its work than a type of board but since you often hear the name we wanted to describe it. A policy board is any board, typically a governing board, that directs operations by developing policies that guide operational decisions rather than making the actual yes or no decision themselves. The CEO is then expected to carry out all policies.
Types of Directors
In law, there is no real distinction between the different categories of directors. Thus, for purposes of the law, all directors are required to comply with the relevant provisions and meet the required standard of conduct when performing their functions and duties. It is an established practice, however, to classify directors according to their different roles on the board. The classification of directors becomes particularly important when determining the appropriate membership of specialist board committees, and when making disclosures of the directors’ remuneration in the company’s annual report.
- Executive Director
Involvement in the day-to-day management of the company or being in the full-time salaried employment of the company (or its subsidiary) or both, defines the director as an executive. An executive director, through his or her privileged position, has an intimate knowledge of the workings of the company. There can, therefore, be an imbalance in the amount and quality of information regarding the company’s affairs possessed by an executive and non-executive director. Executive directors carry an added responsibility. They are entrusted with ensuring that the information laid before the board by management is an accurate reflection of their understanding of the affairs of the company. Executive directors need to strike a balance between their management of the company, their fiduciary duties, and the concomitant independent state of mind required when serving on the board. The executive director needs to ask himself “Is this right for the company?”, and not “Is this right for the management of the company?”
- Non-Executive Director
The non-executive director plays an important role in providing objective judgment independent of management on issues facing the company. Not being involved in the management of the company defines the director as non-executive. Non-executive directors are independent of management on all issues including strategy, performance, sustainability, resources, transformation, diversity, employment equity, standards of conduct, and evaluation of performance. The non-executive directors should meet from time to time without the executive directors to consider the performance and actions of executive management. An individual in full-time employment of the holding company is also considered a non-executive director of a subsidiary company unless the individual, by conduct or executive authority, is involved in the day-to-day management of the subsidiary.
- Independent Director
In essence, an independent director is a non-executive director who: • is not a representative of a shareholder who has the ability to control or significantly influence management or the board • does not have a direct or indirect interest in the company (including any parent or subsidiary in a consoli¬dated group with the company) which exceeds 5% of the group’s total number of shares in issue • does not have a direct or indirect interest in the company which is less than 5% of the group’s total number of shares in issue, but is material to his or her personal wealth • has not been employed by the company or the group of which it currently forms part in any executive capacity, or appointed as the designated auditor or partner in the group’s external audit firm, or senior legal adviser for the preceding three financial years • is not a member of the immediate family of an individual who is, or has during the preceding three financial years, been employed by the company or the group in an executive capacity • is not a professional adviser to the company or the group, other than as a director • is free from any business or other relationship (contractual or statutory) which could be seen by an objective outsider to interfere materially with the individual’s capacity to act in an independent manner, such as being a director of a material customer of or supplier to the company, or • does not receive remuneration contingent upon the performance of the company.
In many countries, boards must have a specific proportion of independent directors. Boards of directors can be either one-tier or two-tier.
- A one-tier, or unitary, board delegates day-to-day business to the CEO, management team, or executive committee, and is composed of both executive and non-executive members. This structure is most often found in countries with a common law tradition, such as the United States, the United Kingdom, and the Commonwealth countries.
- A two-tier, or dual, board divides supervisory and management duties into two separate bodies. The supervisory board oversees the management board, which handles day-to-day operations. This structure is common in countries with civil law traditions, primarily in Germany, but also in some companies in France and in many Eastern European countries.
Board Governance Models
Governance is an amalgamation of policies, systems, and structures, along with a strategic, operational framework that aligns organizational Nonprofit boards keep the organization’s mission at the forefront when directing the affairs of the organization. Incoming funds are used to support the organization’s work. Most board members for nonprofit organizations serve on the board because of their passion and commitment to a cause. While serving on a nonprofit board carries a certain level of honor and prestige, board members need to take an active approach to overseeing the organization to prevent problems and legal issues. Nonprofit boards hold responsibility for fiduciary matters, as well as matters that have been delegated to others. There are five common board models for nonprofit boards:
1. Advisory Board Governance Model: A CEO who founds an organization will soon find that he needs help in running the organization. An advisory board serves as the primary resource for the CEO to turn to for help and advice. Members of an advisory board are trusted advisors who offer professional skills and talents at no cost to the organization. Advisory boards may also be formed in addition to an organization’s board to help and advise the board, as a whole. Advisory board members typically have established expertise or credentials in the nonprofit’s field. An organization that is visibly connected to an advisory board’s name, can increase the organization’s credibility, fundraising efforts, or public relations efforts.
2. Patron Governance Model: The Patron Model is similar to the Advisory Board Model. The main difference between the two models is that the primary purpose of the board members under the Patron Model is to perform duties related to fundraising. Patron Model boards are typically comprised of board members who have personal wealth or influence within the field. The primary role of board members under the Patron Model is to contribute their own funds to the organization and to use their network to gain outside contributions for the organization. Under this model, the board members have less influence over the CEO or organization’s board than in the Advisory Board Model.
3. Cooperative Governance Model: A board that operates without a CEO uses a Cooperative Model. The board makes consensual decisions as a group of peers, making it the most democratic governance model. There is no hierarchy and no one individual has power over another. The board exists only because the law requires its formation. This model requires that each member be equally committed to the organization and willing to take responsibility for the actions of the whole board.
4. Management Team Model: The most popular governance model for nonprofit organizations is the Management Team Model. This model is similar to how an organization administers its duties. Rather than hiring paid employees to be responsible for human resources, fund-raising, finance, planning, and programs, the board forms committees to perform those duties.
5. Policy Board Model: John Carver, author of “Boards that Make a Difference,” developed the Policy Board Model, which quickly became a staple platform for nonprofits. The board gives a high level of trust and confidence to the CEO. The board has regular meetings with the CEO to get updates on the organization’s activities. Under this model, there are few standing committees. Board members should have a demonstrated commitment to the organization and be willing to grow in their knowledge and abilities regarding the organization. Many nonprofit organizations will adopt one main model, such as Carver’s Policy Board Model, and add one or more boards to round out the needs of the organization. For example, a health organization may form an advisory board to advise them and a charity board to work on fundraising. Religious organizations operate under different rules than other non-profits. Churches, faith missions, and other religious organizations may add a religious board, so that they may be better stewards of their organization’s assets.
*Corporate Governance Models
Adopting an appropriate governance model is only one step in setting the stage for good governance. Organizations need to establish guiding principles and policies for the organization, delegate responsibility and authority to individuals for enacting principles and policies, and identify a path for accountability. There are five notable corporate governance models in today’s business establishments:
1. Traditional Model: The Traditional Model is the oldest model for corporate governance. It’s a bit outdated by today’s standards, but it includes a useful template that continues to be used for establishing articles of incorporation. The Traditional Model gives legal responsibility to the collective board and the board speaks as one voice on all matters. The model identifies the structures, but the board outlines the processes as stated in the bylaws.
2. Carver Board Governance Model: As noted in the section on nonprofit models, the Carver Model works for nonprofit and for-profit organizations. The Carver Model places its focus on the “ends” of the organization’s purpose. This means the organization actively works towards what it needs to achieve or what it needs to do to put itself out of business. Within defined limits, the board gives the CEO the bulk of the responsibility for using the means to get to the ends.
3. Cortex Board Governance Model: The Cortex Model is a model that focuses on the value that the organization brings to the community. The board defines the standards, expectations, and performance outcomes according to the aspiration of the organization. Clarifying and setting outcomes to achieve success become the primary duties of the board under this model.
4. Consensus Board Governance Model: The Consensus, or Process Model, is a form of the Cooperative Model that nonprofit organizations use. It gives all board members an equal vote, equal responsibility, and equal liability. The Consensus Model is appropriate for corporations without major shareholders.
5. Competency Board Governance Model: A corporate board that is interested in developing the knowledge and skills of the board members will benefit from the Competency Model, a model that focuses on communication, trust, and relationships to improve overall board performance. The organization’s bylaws do the work of outlining practices and strategies.
While many board governance models can be used for either nonprofit or for-profit entities, depending upon the needs of the organization, certain types of models may be amenable to nonprofit organizations, while other models are more amenable to for-profit organizations. It’s common for boards to adopt a combination of board governance models that cater to the features of the organization and the composition of the board.