What Is a Board of Directors and What Is Their Purpose?
Changes to an executive board of directors are big news. Depending on the change, the news has the potential to send a stock screaming for the top or spiraling downward.
That’s because members of the board handle some of the most important decision making for companies. That’s why struggling publicly traded companies tend to rocket when an activist investor like Carl Icahn or Bill Ackman can take a seat on their boards. Investors know that these Wall Street gurus have the chops to help turn these companies around.
Learn more about what boards of directors do and why you need to know about them as an investor.
What Is a Board of Directors?
A company’s board of directors is a group of people that acts as that company’s governing body. All public companies and most nonprofit organizations have a board. Although less common, some private companies also operate under the guidance of a board.
You own shares of Apple, Amazon, Tesla. Why not Banksy or Andy Warhol? Their works’ value doesn’t rise and fall with the stock market. And they’re a lot cooler than Jeff Bezos.
Get Priority Access
A company’s board acts as a fiduciary in the best interests of the company and its stakeholders. This is important because the company’s and stakeholders’ interests may not align with those of their management teams.
For example, the Chief Executive Officer (CEO) of a publicly traded company may decide their annual salary of $5 million dollars isn’t enough. Without a board of directors, CEOs could raise their salaries at will.
With board oversight, it’s not that easy. When the CEO of a company with a board of directors wants a raise, they must bring a motion to the board for the raise. The chief executive must explain why they deserve a raise, how much is reasonable, and that the raise won’t have a negative impact on the company or its stakeholders. From there, it’s up to the company’s board — and often a board-appointed compensation committee — to determine whether the CEO gets a raise and how much.
What a Board of Directors Does
A company’s corporate board of directors is in charge of corporate governance, which is just a fancy way to say it does the high-level decision making. Some of the most pressing decisions made by a board of directors include:
- Mergers and Acquisitions. The board typically votes on any merger or acquisition transaction before bringing the opportunity to investors. For example, you may read a press release about an acquisition that says the deal is subject to regulatory and shareholder approval, and it typically also says the transaction has been approved already by both boards of directors.
- Annual Budget. Companies must operate on strict annual budgets to hit their earnings and profit margin targets. The board is typically charged with determining a reasonable annual budget for each department of the company.
- Fundraising. It takes money to make money, and public companies raise funds often, such as by issuing new shares of common stock or by selling corporate bonds. The boards of these companies play crucial roles in deciding how to raise funds with a goal of minimizing the impact on the company and its stakeholders.
- Partnerships. A company’s board votes before it decides to enter into any partnership with another company.
- Senior Executives. The board typically nominates candidates for senior executive roles, although voting shareholders usually have the final say in who holds senior management positions.
- Operation Plans. The board also oversees the development of operational plans and helps to optimize the company’s operations considering productivity and cost. For example, a company’s board may present a plan to increase research and development spending significantly in an effort to develop new products.
The bottom line is that a company’s board does quite a bit.
Especially with large companies, sometimes a board’s duties entail more than a single small group of people can handle. A board of directors may also build and oversee board committees to help provide guidance on key decisions.
Some of the most common committees include:
- Compensation Committee. A compensation committee oversees any executive salary or bonus increases. Their job is to ensure every pay increase is earned, is reasonable, and doesn’t have a negative impact on the company or its stakeholders.
- Audit Committee. An audit committee is essentially there to ensure the company’s finances are always accurate. This committee ensures proper financial reporting to shareholders, the Internal Revenue Service (IRS), and regulatory agencies.
- Nominating Committee. Nominating committees are usually appointed by the board to help determine the best candidates for executive positions and for open seats on the board itself.
- Development Committee. A development committee is charged with making important decisions associated with the continued development of the company. They help set goals and deadlines as well as create processes and procedures to meet those goals. For example, a traditional car manufacturer’s development committee may develop a plan for converting to all-electric production by 2035.
Board of Directors Structure
All board members fall into one of two categories:
- Inside Directors. Inside directors are members of the board who are also employees or large shareholders of the company. These members typically hold a minority of the board to avoid any conflicts of interest.
- Independent Directors. The majority of board members are typically independent directors, or outside directors. These directors have no affiliation with the company other than their positions as board members.
Major stock exchanges, such as the New York Stock Exchange (NYSE) and Nasdaq, require companies to have boards made up primarily of independent directors, although it’s common that a company’s CEO will also be its chairperson. Both inside and outside directors can hold any position on the board.
The structure of a company’s board of directors varies from one company to another. You can find the details of its structure in the company’s articles of incorporation and corporate bylaws. There are several roles that are typically included in any board:
- Board Chair. The board chair, chairperson, or board director, is the head of the board of directors. The chair serves as a point of contact for all board members, sets goals for the board, and works to ensure its goals are met.
- Board President. The president of the board is charged with ensuring the members act in accordance with the board’s policies. The president also typically sets the agenda for board meetings.
- Board Vice President. The board vice president assists the board president with any duties they need help with.
- Board Secretary. The board secretary’s tasks are primarily clerical, such as organizing meetings and events, managing schedules, and maintaining records.
- Board Treasurer. The board treasurer is responsible for creating, implementing, and maintaining corporate financial policies. The treasurer plays a key role in the development of budgets and creating financial policies to boost or maintain profit margins.
- Board Members. Some board members are simply board members. They take part in board meetings and assist in the development of concepts and procedures for growing the company.
- Executive Director. The executive director of the board is typically appointed by the board of directors to assist in the company’s day-to-day operations. The executive director is responsible for ensuring all policies and procedures are followed on the ground level of the company.
Why Investors Should Care About Boards of Directors
As an investor, a company’s board of directors has a fiduciary duty to you and the company. The role of the board is to assist in making corporate decisions that are in the best interest of the company and its stockholders — including you!
These are the members that make the important decisions for the companies you invest in, which determine the future growth of your investments (or lack thereof). You don’t want an underperformer with no experience making big decisions with your money.
Before you invest in a company, follow these steps to look into who’s running it:
- Look Up a List of Board Members. All you should need to do to find a list of a public company’s board members is to type “XYZ company board members” into your favorite search engine.
- Look Up Each Name. Type each of the names of the company’s board members into Google. Read the results, specifically looking for each board member’s work history, history with other publicly traded companies, and potential investor complaints about the board member. Continue your research until you feel comfortable with each member on your list.
- Check LinkedIn. Most people in a professional career are searchable on LinkedIn. Use the social network to your advantage. Search LinkedIn for the names on your list to learn more about the people at the helm of the company.
If you’re confident the team is one you can stand behind, feel free to make an investment.
Don’t lose sight of the board or its members as the roster changes over time. Keep tabs on the policies and decisions the board is making so you have a full understanding of how the company is being operated.
Board of Directors FAQs
Board members make some of the most significant decisions in publicly traded companies. Having questions about the people who make crucial decisions with your money is normal. You’ll find answers to some of the most commonly asked questions about boards of directors below.
How Are Board Members Elected?
New potential board members are typically nominated by current members of the board or a nominating committee. Once a new board member is nominated, the decision to accept or reject the nomination falls on the shareholders’ shoulders.
In most cases, the company announces a shareholder vote in a press release or direct message to shareholders. The announcement will outline the various provisions the company may be voting on at the time and give you a deadline for your vote to be submitted.
Once all shareholders have voted or the deadline is reached, votes are counted. If more than 50% of shareholders vote in favor of the new board member being appointed, the decision to add the member is finalized.
How Are Board Members Removed?
This depends on the company’s articles of incorporation and bylaws. In some cases, a board member can be removed by a majority vote among other board members. In other cases, board members can only be removed as the result of a majority vote by the company’s shareholders.
Are Board Members Paid?
Some members of a company’s board are paid and others are not. Payment depends on the type of member you’re talking about:
- Independent Members. Independent members don’t work for the companies they serve. Instead, they’re paid for their time and providing unbiased opinions at board meetings.
- Inside Members. Inside members are typically paid for their duties as employees of the company but are not paid for their board duties.
Can Board Members Invest in the Company?
In most cases, board members are free to invest in the companies they serve. In fact, shares of the company are often part of the compensation plans offered to independent board members.
Although independent directors may be paid in stock and invest their own capital, their positions must remain relatively small to maintain their role as independent directors. Typically, any investor with a 10% or larger stake in a company — board member or otherwise — is considered an insider.
Investments in the company made by board members, regardless of whether they’re inside or outside directors, are considered insider investments and subject to lockup periods.
The board of directors is a crucial part of any publicly traded company. Although most professionals in leadership roles at publicly traded companies are reasonable, it’s easy for them to fall under the belief that what’s best for them is best for you as an investor, even if that’s not truly the case.
Boards of directors carry out a fiduciary responsibility to stakeholders by ensuring executive management teams make decisions in the best interests of the shareholders they serve.
If you’ve been investing without looking into the team on the board, it’s time to add a new level to your investment research.