Chapter 1 Understanding Boards – Get on Board

CHAPTER 1

Understanding Boards

The board of directors, whether for-profit or nonprofit, oversees the activities of a company and represents its shareholders. The board is directly accountable to the shareholders. Each year the company will hold an annual general meeting (AGM) where the directors report to shareholders on the performance of the company, its future, and its strategies; they may also submit themselves for reelection to the board at the AGM.

Public companies must have a board of directors. Private companies are not required to have boards, although many of them do.

The board of directors’ key purpose is to ensure the company’s long-term prosperity. Oversight of management, including the hiring, evaluation, and dismissal of the chief executive officer (CEO), is seen as one of the most important duties of a fiduciary board. The board directs the company’s affairs by representing the appropriate interests of its shareholders and stakeholders. In addition to business and financial issues, boards deal with numerous other issues such as corporate governance, corporate social responsibility, and corporate ethics.

Boards are an incredibly complex facet of corporate culture. Before pursuing board service, which is a sizable commitment, it is helpful to have a foundational understanding of boards. For example, this chapter discusses what boards do, who appoints directors, time commitments for board service, how much directors get paid, and the factors that influence corporate board composition. It then delves into the board structure, committees, and the role of the chair. Finally, it discusses how to assess your qualifications, how directors stay effective, and whether board placement service is right for you.

What Do the Boards Do?

The board of directors is composed of the key people who make decisions about important issues, hire the CEO, and perform other roles and responsibilities. They are the governing body of a company.

For example, hiring a CEO, making any major acquisition, selling the company, and numerous other key events all require the board’s approval. Because the board determines the overall strategy of the company, its members must be engaged, diligent, responsible, and have a high degree of integrity.

The prime function of every director is to help in the effective functioning of the organization, while ensuring no interruptions in the output. Some of the core responsibilities of a director include the following:

  • Guide the CEO and monitor management

    The core function of a director is to work with the CEO of the company. The board selects the CEO; the board also has the power to remove the CEO. The board evaluates the work of the CEO. The members of the board encourage the CEO to handle situations effectively, aiding him or her to make better decisions. The board assists the CEO and other members of the leadership team. They make key decisions, facilitating introductions, oversight, and inquiries.

    In sum, the board recruits, retains, supervises, compensates, and evaluates the CEO. This is the most prominent function of a board of directors. It is the main reason that only skilled, experienced, and capable candidates are considered to join a board.

    The board also monitors the performance of the management. They keenly observe the activities and the policies followed.

  • Determine company strategy

    Directors must keep raising questions about the overall strategy that the organization follows. They focus on their advantages and disadvantages. This includes taking care of the company’s financial stability, selecting its target market, and designing the present and future of the company. The board is also responsible for creating the organization’s vision and goals.

  • Safeguard the values of the organization

    The board ensures that the company progresses responsibly and effectively. They ensure that all the activities that are taking place in the organization are conducted ethically and legally.

    Boards have numerous other responsibilities:

    • Controlling and monitoring various functions of the board. For example, the board is responsible for monitoring the auditing process. The board hires auditors.
    • Maximizing long-term shareholder returns and protecting the company’s assets and investments. This responsibility applies to the boards of most for-profit companies.
    • Monitoring internal controls and policies. The board determines company policies and ensures that internal controls are effective.
    • Planning. The board reviews and evaluates present and future opportunities and risks. They consider the geopolitical environment, industry trends, and economic cycles.
    • Collaborating with the senior management. The board communicates with the senior management. It must also monitor and evaluate that the management implements policies, strategies, and business plans. It must delegate authority to the management.
    • Staying accountable to shareholders. The board exercises accountability to shareholders and ensures that communications both to and from shareholders are effective. They promote the goodwill and support of shareholders and relevant stakeholders.
    • Acting in good faith. In the event of a conflict of interest between the company’s interests and their own, the directors must disclose and always favor the company. They must act with due skill and care.

Who Appoints Directors?

Shareholders ultimately determine the composition of the board. They may appoint or dismiss directors. The shareholders may also fix the minimum and maximum number of directors, and the size and length of the term. In some circumstances, the board can appoint (but usually not dismiss) a director, as well.

Often, a majority of shareholders may dismiss a director from office; they may need to follow special procedures for this purpose. The procedure is complex, and legal advice will always be required.

Who Is an Independent Director?

An independent director, or outside (nonexecutive) director, is a member of a board who does not work for the company. In contrast, inside directors are members of the corporation, usually part of the corporation’s management team.

For example, New York Stock Exchange (NYSE) requires listed companies to “have a majority of independent directors.” NYSE listing requirements define outside directors as having no “material relationship” to the company. NYSE listing requirements further explain: “Effective boards of directors exercise independent judgment in carrying out their responsibilities. Requiring a majority of independent directors will increase the quality of board oversight and lessen the possibility of damaging conflicts of interest.”

Outside directors contribute to the organization by advising the management on strategy and operations, drawing on their professional experience. They also ensure that executives act in the interest of shareholders.

Independent directors bring diverse backgrounds to decision making. They are also unbiased regarding company decisions.

What Are the Time Commitments to Serve on a Board?

Serving on a board offers many opportunities and responsibilities. However, directors must invest significant time to fulfill their responsibilities. They must prepare and attend board meetings, provide guidance, understand and analyze financial strategy, serve on committees, and fulfill numerous other obligations.

The role of the directors is substantially more complex and often time-consuming. Most boards meet at least four times a year. In some companies, the board meets more often. The board will almost always meet more often if circumstances warrant, such as when a merger or acquisition occurs, or when the board needs to deal with a crisis management event such as a CEO’s unexpected departure or news putting the company’s reputation at risk. The board survey reports indicate a director must commit a minimum of 60 hours per quarter for public board service, which does not include travel time.

Key time commitments outside of the actual board meeting itself include the following:

  • Considering strategies for the development of business
  • Monitoring competitors to understand the marketplace
  • Keeping an eye on industry trends, the development of the business, and any applicable laws
  • Providing guidance to the chairperson, company leadership, and the management team
  • Meeting with the professional and financial advisors of the company
  • Serving on board committees
  • Visiting company facilities
  • Understanding company culture
  • Attending governance and board training events
  • Traveling for formal and informal events

There are numerous other responsibilities a director may have, which can vary based on the organization and board type. If you are joining a board it is important to discuss the time commitments and expectations first. You must make sure that you are ready to meet the expectations and obligations that may come with the job.

How Much Does a Director Get Paid?

The compensation of directors varies depending on industry, experience, company size, and geographies. The number of meetings required and whether the company is public or private often play a role. Compensation also varies across different types of boards—advisory boards, private boards, public boards, nonprofit boards, startup boards, family boards, and others.

Director pay is set up differently in different companies. Most directors receive an annual retainer fee for board meetings. They may also be paid an additional retainer or fee for committee work, and a chair or lead director is usually paid an additional fee. Due to increased risks for director liabilities and the time required for board service, corporations often continue boosting director pay, year after year, often faster than they do for their regular employees.

  • Public boards

    On public boards, director compensation is generally divided between stock and cash. Compensation is public knowledge and can be found in SEC reports. Most directors receive an allocation of shares from the stock of the company. The trend over the last decade has been away from stock options and toward restricted stock, deferred stock, and outright stock. Only on rare occasions are directors paid by the hour. Per board meeting fees continue to decline as the preferred compensation method with only about 10 percent of the S&P 500 paying meeting attendance fees in 2018 compared to 45 percent a decade ago.

    Most companies require directors to hold the stock grants for a certain number of years. The total compensation for each individual member depends on different factors, such as how long they have been involved with the company, their specific skills or knowledge, whether they have a high public profile, and many other factors.

    Pay increases with company size, averaging at $298,981 in 2018 for directors of the S&P 500 with 56 percent of their pay in stock grants, according to the Spencer Stuart Board Index. A study released in 2017, by Arthur J. Gallagher & Co., showed the total pay for Russell 3000 companies at $191,043 made up of 58 percent equity. According to some calculations, the median pay for a board seat at a micro-cap company (one with less than $500 million in revenues) was a little over $100,000.

    In general, public company boards in the UK and EU pay less than similar size U.S. public company boards and provide more of their compensation in cash. Most corporate codes in Europe recommend against granting nonexecutive directors stock options or similar stock performance-related incentive.

  • Private boards

    There is a lot of variance in compensation for different types of private boards. The 2019 Private Company Board Comp Survey by Lodestone Global reported that the median total compensation (across 32 countries and 33 industries, with 50 percent family-owned companies) was $41,500 with a $30,000 retainer. A well-established large private board generally offers higher compensation to its prospective directors, as it competes with public boards for qualified directors. It is not unusual for a medium-sized private company to offer prospective directors somewhere between $15,000 and $40,000 per year. Some private companies offer compensation like that offered by micro-cap public companies, especially if they have $200 to $500 million in revenue. This comes to around $100,000.

    Family-owned companies often pay outside directors, as other private companies pay their directors, with cash and little to no equity.

    Outside directors of a Private Equity (PE)-owned company are often introduced by the private equity firm that owns the portfolio company. These outside directors are generally paid by the PE fund owner and their compensation is similar to public company board members.

  • Startup boards

    If you are wondering how startup directors get paid, well, here is the theory behind it. Directors receive compensation for their roles in a startup, but there are unique factors that influence the total compensation package. These are normally related to time commitment, expertise, experience, knowledge, and other factors.

    It is not unusual for a startup to manage money carefully. So they are often not able to throw a cash compensation at a prospective director! As a result, startup directors are more likely rewarded in the form of equity.

    At the early stage, prospective directors may be looking at up to 1 percent equity, based on time commitment, expertise, experience, knowledge, and other factors. As the company grows and becomes financially stable, equity compensation rates drop and are replaced by cash. So over time as the startup matures, the cash portion of the package increases, and the equity portion diminishes. Even startups that have raised plenty of money often offer an equity-based compensation of around 0.25 to 0.75 percent.

    Another major factor affecting the compensation of a startup director is how involved they are with the company. There are three different levels: high, medium, and low engagement levels. Highly engaged members are more involved. They should expect the highest pay among the three categories. Medium engagement-level members lie somewhere between active and semi-active. Their compensation is also moderate. Finally, the lowest compensated are members who are less engaged. They are present and accountable for board meetings and often communicate through calls. They are not less important than the other directors, but their compensation is lower compared to the other two categories.

    Although equity and engagement are the two main factors that determine the compensation of a startup director, their compensation also depends on their experience, expertise, and knowledge. Popularity and notoriety of the prospective director in the business world may also affect their compensation.

  • Advisory boards

    Compensation for advisory board member varies dramatically. It is not unusual for an advisory board member not be compensated or to receive only an equity grant, especially at startups. Some companies pay between $250 and $1,500 for each meeting attended, give stock in the company, or pay members to participate in the annual strategic session for about $5,000. But this is not true for all startups. Therefore, before joining an advisory board it is extremely important to have a very honest discussion about your time commitments and expected compensation.

  • Nonprofit boards

    Serving on a nonprofit board is typically a volunteer activity. Usually, nonprofit boards do not compensate their directors. Only a small number of nonprofit organizations pay their members. In fact, many nonprofits expect their directors to make a sizable annual donation or be heavily involved in fundraising efforts. Therefore, before joining a nonprofit board, consider having a very honest discussion about your time commitments and obligations.

How to Assess Qualifications to Serve on the Board?

Professionals who are asked to serve on a board often have significant executive experience or other equivalent professional experience. Here are some questions that you need to ask yourself in order to check whether you are qualified for board service.

  • Am I passionate about this company?

    This is very important! You need to ask yourself whether you are passionate about helping the company get to its desired heights. Are you interested in the vision and mission of the company? If the answer is “no,” you probably do not need to ask any more questions.

  • Am I knowledgeable enough?

    As a prospective board director, you must be knowledgeable in various aspects of your discipline, industry, and the company. This does not mean that directors are not prone to mistakes or that they know everything. A certain level of knowledge is required to be a qualified candidate.

  • Am I yearning to learn?

    Serving on a board means you must be open-minded, ask good questions, know how to work with experts, and stay on top of the industry. This means that you must have the mindset to challenge yourself and to learn new concepts and ideas.

  • How do I relate with others?

    A board comprises more than one director. Each director has valuable knowledge, life experiences, and industry expertise. Can you respectively interact and constructively disagree with them while maintaining good professional relationships? There will be times when you are likely to experience disagreements, whether it be tactical or philosophical ones. How do you handle such situations? How would you influence the outcome you want to see? Some ask bluntly, “Can you ‘check’ your ego at the door?” and “Do you have a sense of humor?”

  • Can I serve?

    Being a director places you in a position where you are serving the company. After all, your goal is to maximize long-term return for the company’s shareholders. You need to know whether you can withstand the challenges of the role and serve the company well. This involves time commitment, willingness to learn, and an uncompromising dedication to realizing the company’s goals.

The Board Profile and Competency Matrix worksheet in Appendix B can help you to identify the experience, knowledge, and skills that you can leverage for board service.

What Factors Generally Influence Board Composition?

Board composition is typically closely related to issues of board independence and the various experiences of outside directors. Companies must balance these competing interests and related trade-offs when they assemble their boards:

  • Status quo vs. new perspective: a very sophisticated balancing act

    Against the foundation of historic worldwide financial downturns, companies often want to enlist directors with new perspectives who also possess the experience and skills appropriate to address current challenges. There is also a developing appreciation for diverse boards, which are more likely to pose essential inquiries instead of surrendering to “general thinking.”

    Boards also need to stay productive and focused, as well as protect and use their current institutional information and connections. They need to have a long-term vision and create a sense of stability for all major stakeholders such as employees, investors, the leadership, the management, the community, and regulators.

  • Structure vs. diversity: trade-offs to consider

    The boards, especially at more established organizations, have frequently set a standard for choosing directors who can fit effortlessly into existing board culture and will work well with current company directors and the senior leadership. Therefore, CEOs, executives, and directors often rely on their professional or social networks to recruit directors. This tendency often increases board composition homogeneity. Homogeneous boards may be weak and insufficient to meet the needs and wants of diverse clients, partners, employees, suppliers, investors, and other key stakeholders. They may hinder the company’s success in an increasingly global economy, shifting political climate, and increasing pace of innovation.

  • Granular proficiency vs. long-term oversight

    A corporate board oversees its company’s direction to maximize the company’s long-term returns to its shareholders. They normally do not manage day-to-day operations. However, it is a significant asset for a director to understand the company, its industry, and its historic evolution. In fact, many suggest that it is paramount to the success of a corporate director. Some boards put less emphasis on recruiting directors with specific capabilities related to the company or industry.

How Are the Boards Structured?

Board meetings are held periodically, usually at least quarterly, so that the directors can discharge their responsibility to control the company’s overall situation, strategy, and policy, and to monitor the exercise of any delegated authority. There the individual directors can report on their areas of responsibility including the work that they do in the committees.

Normally, there are four primary board committees: executive, audit, compensation, and nominating.

  • The executive committee tends to be a smaller group that might meet when the full board is not available.
  • The audit committee reviews the financial statements with internal auditors and outside audit companies. It is often made up of independent directors.
  • The compensation committee determines the salaries and bonuses of top executives, including the board itself. It is often made up of independent directors.
  • The nominations and governance committees decide the slate of directors for the shareholders to vote their approval and provide general oversight of governance of the corporation and board.

Technology, risk, and compliance committees are additional committees that are becoming more prevalent. There may be others, depending on corporate philosophy, culture, history, special circumstances, or a company’s line of business.

What Is the Audit Committee? Who Is Qualified to Serve?

The audit committee is an operating committee of the board that supervises the financial reporting and disclosure process of a company. The audit committee members are chosen from the board often by the chairperson of the company.

It is one of the most important committees. It is required for many companies, especially public. For example, a qualifying audit committee is required for a U.S. publicly traded company to be listed on a stock exchange. Thus, it is often made up of independent directors.

While there is some diversity in the way the audit committee functions internationally, the directors that serve on the audit committee oversee the financial reporting process, selection of the independent auditor, and receipt of audit results. They typically assist the board with governance and oversee financial reporting, internal control, and the risk a management system.

The audit committee normally works with many inside and outside experts. It is often empowered to hire outside resources and expertise to perform their responsibilities.

Primary Purpose

The primary purpose of the audit committee is to review and recommend approval by the full board of the financial reports prepared by management. To do so, they hold regularly scheduled meetings and maintain a connection between the board, the financial management of the company, internal auditors, and independent auditors.

While the audit committee has various responsibilities and powers, it is not the duty of the audit committee to plan or generate financial statements. This is the responsibility of the management team and independent auditors.

Role of the Audit Committee

All U.S. publicly traded companies must maintain a qualified audit committee to be listed on a stock exchange. The necessity of the audit committee can fluctuate from country to country depending on the law.

There are many responsibilities of the audit committee, including the following:

  • Supervising financial reports
  • Monitoring the choice of accounting policies
  • Discussing risk management policies
  • Overseeing the performance of the internal audit committee
  • Supervising ethics (e.g., review of whistleblower calls)
  • Monitoring the internal control process
  • Hiring and overseeing external auditors

These responsibilities of the audit committee are assigned by a committee charter. Among other things, NYSE and Nasdaq Stock Market require that each company appoint at least three directors, all of whom must be independent, to an audit committee.

Essential Qualifications

At a minimum, each member of the audit committee must be financially literate. Accounting or financial management experience is important, if not required. One member of the committee must be a designated “audit committee financial expert,” as required by the U.S. Securities and Exchange Commission (SEC). The audit committee members and the chairperson of the audit committee typically must be nominated and elected by the board itself.

What Is a Nomination and Governance (“nom/gov”) Committee? Who Is Qualified to Serve?

This nomination and governance committee is a subset of the full board directors that has the power and responsibility to ensure that the board of directors is properly aligned to effectively address the strategic challenges of the company. The chair of the committee leads the process and reports results of decisions and recommendations to the full board.

It is the duty of the committee to have a succession plan for the board that ensures that the skills and characteristics of prospective directors have been properly evaluated and investigated. For a public company, it recommends to the board the proposed candidate(s) for nomination for election to the board at the next annual meeting of the shareholders.

It may also review and recommend changes to the full board of corporate governance policies and determine whether the board complies with its governance policies.

You are expected to not disclose the nomination committee’s discussions or decisions outside the board. You need to be comfortable with being even more discreet than other directors.

You must understand how to clearly interpret issues that relate to the board, company governance, and the company’s long-term strategic vision. You must know what is expected of every director at different times and what each director brings to the table. Such judgments must not only be unbiased but must also reflect the aims and objectives of the company.

The Board Profile and Competency Matrix worksheet in Appendix B can help you to identify the experience, knowledge, and skills that you can leverage for board service.

You will be trusted to carry out duties with utmost integrity. This means that members of the committee are expected to sustain the values of the company through a high level of integrity that will reflect whenever they are carrying out their duties. For instance, potential nominees of the committee are expected to be given purely objective considerations that take the company’s strategic long-term goals and vision into account.

You must possess diverse experiences and sound knowledge about various fields. This will help you clearly and accurately evaluate candidates from various fields and backgrounds.

What Is the Compensation Committee? Who Is Qualified to Serve?

The committee, a subset of the full board independent members, oversees the compensation packages for the CEO and management. Some committees also focus on management development and succession planning.

In a public company, the responsibilities of the committee have increased significantly with the “Say on Pay” mandated votes by shareholders as required by reform legislation in 2010.

With increasing complexity of executive compensation and competition for the key talent needed by the company, you will need significant training and study of regulations and market conditions, so that you can have an excellent understanding of how compensation plans impact the company’s goals and culture. The use of professional compensation consultants assigned to assist the committee is widely accepted. Having a member who has experience in human resources is becoming more common.

What Is the Role of the Board Chair? Who Is Qualified to Be a Board Chair?

The board chair is often seen as the spokesperson for the board and the company.

The articles of incorporation often provide for the election of a chair of the board. They may permit the directors to appoint one of their own numbers as chair and to determine the period for which the chair holds office. In many companies, CEOs also serve as chair; in other companies the role is separated.

The chair manages the board’s business and acts as its facilitator and guide. This can include the following:

  • Clarifying board and management responsibilities
  • Planning board and board committee meetings
  • Managing board composition and organization
  • Developing the effectiveness and credibility of the board

Every board meeting must have a chair. He or she ensures that the meeting is conducted in an orderly manner, is properly attended, that all those entitled to may express their views, and that the decisions adequately reflect the views of the meeting. The chair often decides the agenda and might sign off the minutes on his or her own authority.

Typically, if no chair is elected, or the elected chair is not present within 5 minutes of the time fixed for the meeting or is unwilling to preside, those directors in attendance will usually elect one of their members as the chair of the meeting.

Often there is no special procedure for resignation. As for removal, articles of incorporation may permit the board to remove the chair from office at any time.

What Is the Role of the Lead Director? Who Is Qualified to Be a Lead Director?

Until recently, many firms combined the CEO and board chair position in one person. Today there is increasing discussion of the benefits of splitting these into two people. After Sarbanes–Oxley was passed in 2002, the SEC requires listed companies with nonindependent chairs to have a lead director.

A lead director is an independent board member who is usually elected by the independent directors. The lead director works with the board chair to ensure that the board carries out its responsibilities and is increasingly undertaking a wide variety of tasks.

How Does a Board Stay Effective?

A great board is always very diverse in perspectives, background, thought, and representation. After all, the board of directors must make important decisions for the company to assure its long-term prosperity. For example, the board may fire or hire a CEO or other members of the executive staff. And the board is ultimately accountable to the shareholders of the company.

While good governance is necessary for a functioning board, these practices can also help boards be more effective in balancing its numerous, and sometimes competing, priorities and goals:

  • Regular attendance at corporate board meetings

    Attending regular board meetings is the hallmark of an attentive and responsible director. All directors must prioritize regularly attending meetings. Studies have demonstrated that regular attendance can truly impact the success of a company and its directors. Attending board meetings is a way to make important decisions; bond with other members; and share experience, knowledge, skills, and strategies. Board attendance records of each director must be reported to the SEC for public company boards.

  • Diversity of skills and experiences

    To run a board successfully, each director must bring strategic and valuable experiences, insights, knowledge, and expertise. Their complementary skills and attributes can benefit the company and may even increase the company’s revenue. It is important to have well-qualified, skilled, and collaborative directors.

  • Diversity of thought

    On average, diverse directors make better decisions than homogeneous corporate directors. In addition to diversity of skills and experiences, it is a good idea to make sure that a board of directors also exhibits diversity in other categories such as gender, age, race, sexual orientation, national origin, and thought as they bring different perspectives of customers and stakeholders into the discussions.

  • Maintaining a clear and distinct role

    One of the biggest wellsprings of contention may arise when the directors endeavor to overstep their roles from oversight to management. Directors are occasionally unclear about their roles. It is critical for the board to discuss important issues and oversee problems without managing.

  • Moral ownership

    The directors are the moral owners of the company. It is important that they are people of high integrity with long records of flawless judgment. This way, their actions and words can inspire a company and its leadership to stay on course.

  • Implementing key policies

    Among the greatest difficulties for organizations is having a clearly articulated mission and purpose. Companies can frequently lose all sense of direction in hectic administrations. Generating a clear idea of where the company is endeavoring to go or whether it has been successful should be the primary focus of boards.

  • Well-planned board of directors and committee meetings

    It is critical for a successful board to have a general meeting plan that spans the entire year, with a set agenda before each meeting. This way, the directors will plan, meet regularly to discuss issues in a timely manner, and make sure that their meetings are productive.

  • Self-improvement responsibility

    Each director is responsible for his or her own competency. Therefore, it should regularly inquire about the skills and experiences each director is bringing, the gaps that need to be filled, and the time frame for filling any gaps.