Aug 132008

Dr. Earl R. Smith II

When a company is launched the founder’s focus on the board of directors is usually an afterthought – a response to a legal requirement which is highlighted by the lawyer who is assisting them in setting up the corporation. But, as a company moves out of the start-up phase, issues that surround the board of directors, its operation, composition and management become more important.

First – It’s a Matter of Law: A corporation, whether for-profit or nonprofit, must by law have a governing board of directors. A company operates as a separate legal entity, much like a person in that it can own bank accounts, enter into contracts, etc. But, the laws governing corporations require that a company be ultimately accountable to its owners (stockholders in the case of for-profits and the stakeholders with nonprofits). The mechanism for assuring that accountability is a board of directors which represents either the stockholders or the stakeholders. The intention of the law is that the board of directors serves as the fiduciary representatives of either the shareholders or the stakeholders.

Second – Board Members Have Fiduciary Obligations: Members of a board have certain fiduciary obligations which are rather precisely defined by law. Dereliction of these duties can result in serious legal and financial liabilities.

Third – Boards Are Governed by both Statutes and the Bylaws of the Company: The phrase ‘board operations’ refers to the activities conducted between and among board members. They can include development and enactment of additional bylaws and other policies, recruitment of board members, training and orientation of board members, organizing board committees, conducting board meetings, conducting board evaluations, etc. The boards authority to operate arises out of the corporate documents – including its charter, bylaws and other agreements with the shareholders.

Fourth – The Principal Role of the Board is Governance: The phrase ‘governance’ refers to the board’s activities to oversee the purpose, plans and policies of the overall organization. These include establishing those overall plans and policies, supervision of the CEO, ensuring sufficient resources for the organization, ensuring compliance to rules and regulations, representing the organization to external stakeholders, etc. The nature of board operations and governance depends on a variety of factors, including explicit or implicit use of any particular board model, the desired degree of formality among board members and the life-stage of the board and organization.

Fifth – There Are a Range of Models: Governing boards can operate under a variety of models (configurations and ways of working). For example, ‘working boards’ (hands-on, or administrative, where board members might be heavily involved in strategic planning and other high-level issues), ‘collective boards’ (where board members and others in the organization usually do the same types of work), ‘policy boards’ (where members attend mostly to top-level policies but have limited executive authority), ‘governance boards’ (where there are very clear lines of authority and areas of prerogatives between board and the CEO), etc. All of these models are types of governing boards.

Sixth – Boards Can Play a Wide Range of Roles: Boards can have a broad range of ‘prerogatives and authority’. Boards of large for-profit and nonprofit corporations are generally formalized with strong attention to appropriate procedures. They will have highly structured operations. In contrast, boards of small nonprofit or for-profit corporations will be much more informal in nature.

Seventh – Board Need to Evolve as the Company Expands: Most boards start out as ‘in-house’ arrangements. This means that they are populated by founders and their friends, subject to the management team (mostly because the founders own the bulk of the outstanding shares) and operate as a rubber-stamp for management decisions. As a company grows, its board can enter an ‘insurgent’ phase – one during which the initial outside directors begin to attempt to establish board prerogatives and counterbalance the tendencies of management. Finally, if the insurgency prevails a ‘collaborative’ board may emerge.

The principal driver of board evolution is the rise of a significantly more diversified shareholder or stakeholder community. Minority shareholders and stakeholders are protected by law – their interests preserved against the tendency of the majority to overrun them. As the shareholder or stakeholder base expands and becomes more diversified, it is likely that an insurgency will arise to challenge the prerogatives of management and the majority shareholders. Insurgencies are appropriate when such an expansion occurs. The resolution of the insurgency – either in favor of the outside directors and minority shareholders or the founders – often determines the future of the company.

The victory of the insurgency generally results in the establishment the type of relationship between the board and management which is envisioned under the law. The division of responsibility which is embedded in corporate law anticipates that the board will represent all the shareholders while management works under the close supervision and with the approval of the board.

© Dr. Earl R. Smith II


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