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The Role of Boards and Officers in the Corporate Model of the United States
John P. Beavers The corporate method of doing business in the United States has become the dominant model for doing business throughout the world. The United States corporate model is being copied not only in Europe, but also in the Pacific Rim, Africa, former Communist countries, and the rest of the Americas. It is also being copied by other forms of entities in the United States, such as board-managed limited liability companies.
Three Major Characteristics
The United States corporate model reflects America’s penchant for both capitalism and democracy, as well as its desire for accountability. Three major characteristics of the United States corporate form are: Ownership that is separate from management, which reflects America’s penchant toward capitalism;
Management that is led by representatives elected by the owners, reflecting America’s penchant toward democracy; and
Management that is headed by a chief executive officer, who is subject to the direction and oversight of the elected representatives, which reflects America’s desire for accountability.
The Legal Framework
Generally under most states’ laws, all of a corporation’s power and authority are vested in its board of directors, except to the extent otherwise reserved to or vested in stockholders1. Corporate law recognizes that a board does not directly exercise all of that power and authority, but it is exercised “under the direction” of the board2. In reality, the board exercises the authority under its direction by delegating to others, such as: Committees of the board3;
Officers or senior management4; or
Professionals or other experts, including legal counsel and public accountants.
Many states’ laws reflect this reality by entitling the board as well as individual directors to rely upon information, opinions, reports, or statements, including financial statements and other financial data, that are prepared or presented by those committees, officers or senior management, and professionals or other experts5.
Directors exercise their authority only as a board and not as individuals. Under most states’ laws, authority is exercised only by action of a majority of the directors present at a meeting at which a quorum is present, unless the act of a greater number is required by the articles, the regulations, or the bylaws6. For this purpose, a majority of the whole authorized number of directors is necessary to constitute a quorum for a meeting7.
Most corporate statutes provide little guidance as to the role of officers. As implied by the statutory scheme, the role of officers is to carry out the direction of the board and to manage, subject to oversight of the board, the business and affairs of the enterprise.
Finally, under most states’ statutes, there is a major difference between potential liability of directors and that of officers. Under most states’ corporate laws, directors are protected by a “business judgment” rule. The business judgment rule applies to any situation in which directors make a decision which, in retrospect, was or is argued to be a bad one. If the directors are thereafter sued because of that decision, a court applying the business judgment rule will not second guess the merits of the decision as long as the court finds all of the following to be true: The directors made a business decision (the rule does not apply to acts of directors which do not constitute business decisions);
The directors were disinterested (that is, they are not “on both sides of the transaction” and will not derive any personal benefit from their decision);
The directors exercised “due care” (this means acting like an ordinarily prudent person would act);
The directors acted in good faith; and
The directors did not abuse their discretion.
Most states’ corporate statutes do not extend the business judgment rule to officers, leaving officers as those ultimately responsible for decisions made by the enterprise, at least to the extent that the officers participated in those decisions.
Evolved Role of the Board
The role of the board has evolved from the legal framework and continues to evolve, especially to meet the needs of new economy companies.
Although a key function of the board is adopting the strategic direction of the enterprise, boards themselves often do not have the time to strategically plan the enterprise’s direction. Instead, the enterprise’s officers, who are familiar with all of the nuances of the business, the affairs of the enterprise and its competitive advantages and disadvantages, serve as the planning arm in proposing strategic direction for the board’s consideration.
Another chief task that has evolved from the board’s representative capacity is oversight. In addition to the owner and shareholders, lenders and other creditors often rely on the board to oversee the actions of the officers in management of the business and affairs of the enterprise. Typically, oversight is provided by requiring that reports of the enterprise’s operations and financial condition be given to the board.
A role that is evolving with new economy companies, that often have officers with less prior management experience, is mentoring. A director who has “been there and done it before” can often help guide a CEO or management team that has not. The result is what Peter Larson, former CEO and chairman of Brunswick Corporation, refers to as the “expertised” board. That is, a board composed of directors having competencies or experience not possessed among the officers or management team of the enterprise.
Evolved Role of the CEO
In an attempt to have greater accountability to the board as the elected representatives of the owners or shareholders, the role of the CEO has evolved so that he or she has full authority to hire, fire, and compensate every other officer and employee. The reasons for this evolution are twofold. First, the board can establish levels of compensation and employment responsibilities for the entire enterprise by having the board set those of the CEO and allowing the CEO to set those of the rest of the enterprise. This assumes that the CEO, taking into account his or her level of compensation and responsibilities, will then set lower levels of compensation for everyone else. Second, a board can, if it wants, replace the entire management team by replacing the CEO with a successor who can then hire and fire everyone else.
Recent Trends in the Continued Evolution
Led by new economy boards that have fewer than ten members, the size of boards is getting smaller. Board members are increasingly being chosen for their competence or experience and less for their familiarity with the CEO and management. More and more, boards are made up of outside and independent membership with fewer officers and other insiders being retained. Audit and compensation committees, with at least a majority of their membership being independent members, are overseeing the financial reporting and compensation planning of the enterprise. Fewer, but lengthier, meetings of the board are becoming more common, typically lasting for a full day, four or six times per year, rather than for several hours monthly.
As accountability through a CEO increases, a greater proportion of key management’s compensation, especially of the CEO, is becoming incentive based, and a lesser portion is fixed or based upon salary. The portion of a CEO’s incentive compensation based upon the financial results of the enterprise is increasing while the portion based upon individual performance is decreasing.
When a strategic direction of the enterprise is finding an event of liquidity for the owners or shareholders, more of that liquidity is being shared with key management through carried interest, co-ownership, and similar plans.
Conclusion
Unless the worldwide trend toward capitalism and democracy reverses itself, the United States corporate method for doing business will likely continue to be the model to emulate. Perhaps better than any other form of organization, the United States corporate model reflects the American ideals of capitalism, democracy and accountability by providing ownership separate from management, direction by elected representatives of the owners, and management headed by a CEO.
Footnotes 1. See 8 Delaware Laws Annotated §141(a) which provides that “The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation. See also, Ohio Revised Code §1701.59(A) which provides that “Except where the law, the articles, or the regulations require action to be authorized or taken by shareholders, all of the authority of a corporation shall be exercised by or under the direction of its directors.”
2. See 8 Delaware Laws Annotated §141(a) which provides that “The business and affairs of every corporation . . . shall be managed by or under the direction of a board of directors.” (Emphasis added.) See Ohio Revised Code §1701.59(A) which provides that “the authority of a corporation shall be exercised by or under the direction of its directors.” (Emphasis added.)
3. See 8 Delaware Laws Annotated §140(c) which provides that the board “may designate 1 or more committees . . . [that] to the extent provided in the resolution of the board of directors, or in the bylaws of the corporation, shall have and may exercise all the powers and authority of the board of directors in the management of the business and affairs of the corporation.” See also, Ohio Revised Code §1701.63(A) which provides that a board may create “an executive committee or any other committee of the directors, to consist of one or more directors, and may authorize the delegation to any such committee of any of the authority of the directors. . . . ."
4. See 8 Delaware Laws Annotated §142(a) which provides that a corporation “shall have such officers with such titles and duties as shall be stated in the bylaws or in a resolution of the board of directors which is not inconsistent with the bylaws.” See also, Ohio Revised Code §1701.64 which requires each Ohio corporation to have “officers” consisting of at least a president, secretary and treasurer having, respectively, “such authority and perform such duties as are determined by the directors. . . . "
5. See 8 Delaware Laws Annotated §142(e) which provides that “A member of the board... or a member of any committee... shall, in the performance of such member's duties, be fully protected in relying in good faith upon the records of the corporation and upon such information, opinions, reports, or statements presented to the corporation by any of the corporation's officers or employees, or committees of the board of directors, or by any other person as to matters the member reasonably believes are within such other person's professional or expert competence and who has been selected with reasonable care by or on behalf of the corporation.” See also, Ohio Revised Code §1701.59(B) which provides “In performing his duties, a director is entitled to rely on information, opinions, reports, or statements, including financial statements and other financial data, that are prepared or presented by: One or more directors, officers, or employees of the corporation who the director reasonably believes are reliable and competent in the matters prepared or presented;
Counsel, public accountants, or other persons as to matters that the director reasonably believes are within the person's professional or expert competence;
A committee of the directors upon which he does not serve, duly established in accordance with a provision of the articles or the regulations, as to matters within its designated authority, which committee the director reasonably believes to merit confidence.”
6. See 8 Delaware Laws Annotated §141(b) which provides that “The vote of the majority of the directors present at a meeting at which a quorum is present shall be the act of the board of directors unless the certificate of incorporation or the bylaws shall require a vote of a greater number.” See also, Ohio Revised Code §1701.62 which provides that “The act of a majority of the directors present at a meeting at which a quorum is present is the act of the board, unless the act of a greater number is required by the articles, the regulations, or the bylaws.”
7. See 8 Delaware Laws Annotated §141(b) which provides that “A majority of the total number of directors shall constitute a quorum for the transaction of business unless the certificate of incorporation or the bylaws require a greater number.” See also, Ohio Revised Code §1701.62 which provides that “Unless the articles or the regulations otherwise provide, and subject to the exceptions, applicable during an emergency, . . . a majority of the whole authorized number of directors is necessary to constitute a quorum for a meeting of the directors, except that a majority of the directors in office constitutes a quorum for filling a vacancy in the board.”
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