Insights

The ‘Goldilocks’ Board Member: Getting Board Roles and Responsibilities Just Right

February 10, 2016

Management Liability/D&O

Some executives complain that their board members are an unnecessary expense: asleep at the switch and just collecting their fees. Others wish that their board members were asleep, because instead, they are overly involved.

In these situations, questions coming from the board can feel intrusive and irritating to management, often making officers feel that the board doesn’t trust their decisions.

But what does the just-right “Goldilocks” board member look like—one who knows when to be engaged and when to leave something to management?

 

Asian Businesswoman Leading Meeting At Boardroom Table

The Board-Management Relationship

Although the relationship dynamics between the board and management can seem chaotic at times, there’s actually order in chaos when we focus on the star of the show: the shareholders.

Board directors are elected by and accountable to their shareholders. In a nutshell, the board director’s job is to faithfully represent the interests of shareholders. The board, in turn, selects the corporation’s officers and monitors their performance.

Part of this job, bluntly, is to ensure that the officers don’t succumb to the temptation of maximizing their own wealth at the expense of shareholder returns.

The board’s job, however, isn’t limited to stopping management from committing embezzlement or fraud. Collecting an overly-large paycheck and doing a middling job is also a way for management to enrich itself at the expense of shareholders.

The board’s primary job is to make sure that management is, in fact, maximizing return for shareholders.

In order to carry out its obligations to oversee the company’s officers, the board needs access to sufficient information—including from sources independent of management—and the authority to direct action as needed.

Indeed, avoiding the unhappy circumstance of being a “knowledge-captured board” is a critical imperative; you are not an independent board member if you are unable to gather enough information to form an independent judgement.

A board’s job is not, however, mere compliance. In performing its role as the representative of shareholders, the board helps set corporate strategy, which in turn defines the operational activities of the company.

Officers should then be empowered to act as the agents of the corporation, and must have the freedom to carry out their management obligations.

Fiduciary Duties of Board Members

The directors are supposed to monitor management, but who monitors the directors? The answer is their boss, the shareholders.

However, because most shareholders are unable to directly monitor the board of directors, corporate law gives us the guiding principles of fiduciary duties.

Board members have two primary fiduciary duties:

  1. The duty of care
  2. The duty of loyalty

Duty of Care

The duty of care obligates board members to pursue the economic interests of shareholders. This translates to things like:

  • Establishing the overall business policy
  • Asking probing questions
  • Setting up reporting systems and internal controls
  • Paying strict attention to issues and problems

Duty of Loyalty

The duty of loyalty obligates board members to act independently and to avoid self-dealing. This means a director should act upon sound business principles and not be motivated by things like personal relationships.

This also means that even if there’s a chance that something could be considered self-interested, the director should fully disclose relevant facts and excuses him or herself from the decision-making process.

Good faith: Under corporate law, the duty of loyalty contains within it the duty of good faith. The duty of good faith requires that board members take action when faced with a red flag. When acting in good faith, board members cannot ignore inappropriate activities.

Consider, for example, a situation in which a board member suspects that the CEO of a company is embezzling funds. That board member has a duty to investigate and ultimately stop the CEO’s wrongdoings.

Disclosure: Also implicated by the duty of loyalty is the concept of good disclosure. For example, directors have a duty to disclose conflicts and potential conflicts of interest to fellow board members. They also have a duty to provide their shareholders with good disclosure, particularly if they are asking shareholders to take an action like approving a major acquisition.

Disclosure must be complete and timely. Federal securities laws also require that the board ensure that the company is providing its shareholders with complete and timely disclosure.

The 7 Key Areas of Corporate Director Responsibility

Fiduciary duties are important … but perhaps less theoretical and more actionable is the list of key areas of board responsibility that are derived from a board’s fiduciary duties.

There are seven key areas that fall clearly within the board’s ambit of responsibility. These seven areas can be organized under the two main roles of a board:

  1. Overseeing strategy that increases shareholder wealth
  2. Monitoring executive officers and functions of the company

Corporate Strategy

Four of the seven areas of director responsibility include:

  1. Succession
  2. Compensation
  3. Mergers and acquisitions
  4. Business direction and focus

1. Succession strategy: The board is responsible for managing succession not only for the company’s CEO, but also its own board members.

This includes:

  • Hiring and potentially firing the company’s CEO
  • Handling normal succession events like CEO retirement or unexpected death
  • Considering the need for and identifying new candidates for the board

2. Compensation strategy: The board should set a compensation strategy for both the CEO and the board.

This includes:

  • Structuring the CEO’s overall compensation package with appropriate incentives for the CEO to act in a way that is consistent with the goals of shareholders
  • Working with the CEO to build the broad outline for how the rest of the company’s employees will be compensated

Many corporate boards delegate the task of reviewing compensation to a compensation committee that does the heavy lifting.

3. Mergers and acquisitions: Deciding whether a company undertakes or passes on significant M&A activity, including the sale of the company, is another critical board activity. Fiduciary duties of care and loyalty are directly implicated in these activities, as is the need for accurate and timely disclosure to shareholders.

For more on D&O duties and risks when it comes to M&A, see this earlier blog post.

4. Business direction and focus: A company’s strategic direction and focus, of course, is crucial to how it creates value for shareholders. For this reason, the board is part of the strategy-setting process.

A common process goes something like this:

  1. The CEO formulates the strategy and comes to the board for input and feedback
  2. The CEO and board identify risks and obstacles to the success of the strategy
  3. After the strategy is set, the board holds the CEO responsible for meeting the goals and milestones that flow out of the strategy
  4. To ensure that the CEO is focused, the board aligns CEO compensation to the identified goals and milestones

Monitoring

Three of the seven key areas of responsibility for a board of directors can be filed under “monitoring.” Specifically, it falls to the board to monitor:

  1. Company performance
  2. Financial statement integrity
  3. Capital structure

5. Regulating company performance: As the representative of the shareholders, the board is obligated to hold the CEO accountable for company performance.

To gauge performance:

  • The CEO and the board need to determine key performance metrics
  • The board should review these metrics and understand, where relevant, why the company is either exceeding them or underperforming
  • The board should ensure that the company is achieving its goals in a legal and ethical way
  • The board should have access to professional advisors who are not engaged by management and who can offer outside perspective

6. Financial statement integrity: Shareholders rely on financial statements and expect them to be accurate. The board plays an important role in safeguarding statements by ensuring the company has solid internal controls in place.

The second line of financial statement integrity is the meeting that boards or their audit committees hold regularly with the company auditors without management present.

This gives directors a chance to learn more about the auditors’ opinion on the integrity of the financial statements and internal controls.

7. Capital structure: The board ensures that management does not take actions that dilute shareholder ownership inappropriately.

It’s the role of the board to:

  • Decide whether to issue new shares and at what price
  • Determine whether to repurchase a company’s shares, issue warrants and grant stock options
  • Ensure that any dividends issued are done properly

When it comes down to it, no clear-thinking board member wants to micromanage corporate officers, but they also can’t leave management to their own devices, either – especially in today’s regulatory environment.

Goldilocks board members—those who demonstrate the “just right” balance of when to be engaged and when to leave something to management—are board members who understand:

  • Why shareholders have hired them
  • Their fiduciary duties
  • The seven key areas of board member responsibility

When management shares this understanding, you have the formula for a productive relationship between the board and management.

 

The views expressed in this blog are solely those of the author. This blog should not be taken as insurance or legal advice for your particular situation. Questions? Comments? Concerns? Email: phuskins@woodruffsawyer.com.

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All views expressed in this article are the author’s own and do not necessarily represent the position of Woodruff-Sawyer & Co.

Priya Cherian Huskins

Senior Vice President, Management Liability

Editor, Management Liability/D&O

Priya is a recognized expert and frequent speaker on D&O liability risk and its mitigation. In addition to consulting on D&O insurance, she counsels clients on corporate governance matters, including ways to reduce their exposure to shareholder lawsuits and regulatory investigations. Priya serves on the board of an S&P 500 public company and a large private company and has an impressive list of publications, speaking engagements, and awards for her influence and expertise in the industry. 

415.402.6527

LinkedIn

Priya Cherian Huskins

Senior Vice President, Management Liability

Editor, Management Liability/D&O

Priya is a recognized expert and frequent speaker on D&O liability risk and its mitigation. In addition to consulting on D&O insurance, she counsels clients on corporate governance matters, including ways to reduce their exposure to shareholder lawsuits and regulatory investigations. Priya serves on the board of an S&P 500 public company and a large private company and has an impressive list of publications, speaking engagements, and awards for her influence and expertise in the industry. 

415.402.6527

LinkedIn