7.1 Introduction

The board of directors is a group of individuals elected by shareholders to provide oversight and advisory help to management and to represent shareholder interests in a company. Because the board of directors represent the shareholders, the most important thing board members can do is act as if the resources of the company were their own and protect the shareholders' interests as if they were their own. Every decision a board member makes must be made with the shareholders in mind. As discussed in a previous chapter, directors are elected or removed through a shareholder vote in a general meeting or through a proxy solicitation process. The directors of publicly traded companies in the United States are largely selected for nomination by either the board as a whole or a nominating/governance committee of the board. The need for a board of directors arises as a result of information asymmetry and the principle-agent problem discussed in an earlier chapter. As you previously learned, information asymmetry occurs when one party in a transactional relationship has more or superior information than another. This creates an opportunity for one party—management in this case—to use its superior knowledge to take advantage of the other party—in this case, the shareholders. When a corporate shareholder both owns and manages a company, no such problem exists because the owner is involved and knows the business well. In this situation, the agent or management is able to make decisions that impact the principal. Sometimes there may be an incentive for the agent to act in his or her own interests rather than those of the principal. As an example consider the following:

Dennis Kozlowski, the CEO of Tyco, was convicted of embezzling millions of dollars of company (shareholders') funds to support his expensive habits, including the purchase of a $6,000 shower curtain, a $15,000 umbrella stand, a $6,300 sewing basket end table, a $l7,000 toiletries case, and a $2,900 waster paper basket. He even used over a million dollars of company funds to hold an expensive birthday party for his wife on the island of Sardinia in the Mediterranean Sea.

In this case, Dennis Kozlowski, the company's CEO, was an agent who was supposed to be managing the resources of the company for the shareholders (principals). Unfortunately, he perceived an opportunity to further his self-interests and use company funds and did exactly that. Until he was caught, the shareholders, with their inferior company information, did not know the CEO was not acting in their best interests.

Board of Director Meetings: Members of the board of directors usually meet in person at least quarterly (from 4 to 8 hours) (If there is a crisis or major decision to make, they often meet much more often than quarterly). Board meetings are generally a series of sequential snapshots of the company punctuated by moments of drama and occasional crises. Because members of boards of directors are usually well educated, familiar with the industry and have experience in managing organizations, attending a board of directors meeting is like being in a very engaging MBA class with really smart people. The major difference is that instead of talking theoretically about various business topics, boards of directors authorize the use of company resources to buy companies, pay dividends, buy back company stock, make capital expenditures and compensate management. They also make strategic decisions that determine the direction the company will go and authorize borrowing or issuing of stock when additional resources are needed or desired. While management makes proposals concerning each of these issues, in the end, it is the board of directors that must approve these decisions and authorize major expenditures or shifts in company strategy.

In addition to in-person meetings, boards of directors also participate in conference telephone calls between meetings to handle urgent issues, review financial and other disclosures by the company and to receive updates from members of management. When authorization for a transaction is needed between meetings and telephone calls, unanimous written consents (UWCs) are distributed to and signed and returned by board members. Regardless of whether it is an in-person meeting, a telephone call or a UWC, the board of directors must approve major transactions and actions of the company.

Board of director meetings are run by the chairman of the board. In many cases, that is the CEO of the corporation. In other cases, there is a board chairman who is different than the CEO. (Activist investors and shareholder advocacy firms are pushing for all companies to have a chairman of the board who is separate from the CEO.) In cases where the CEO is also the chair, boards must have an independent lead director who can conduct executive sessions of the board without the CEO.