When you form a corporation, you must appoint a board of directors. Though their size and makeup differ from company to company, every corporation has must have one. Unfortunately, there are no hard and fast rules about structuring a board of directors, a fact that leaves many new business owners uncertain about exactly how to organize their upper management.
Understanding the purpose of your board and the roles for directors and officer will help you effectively hit the ground running after incorporation.
Public vs Private
Private corporations have great leeway in how they organize management. In very small companies, a single individual can serve as the sole director and fulfill the roles of all corporate officers, something clearly not possible in a large corporation.
While this article focuses primarily upon public corporate structure, it should be noted that in recent decades, rules for public companies have been adopted by and helped shape the composition of private corporations.
Shareholders, Directors and Officers: Who's Who?
When it comes to the management of your corporation, there are three distinct categories of stakeholders:
- Shareholders: owners of the company who have exchanged assets for shares of stock
- Directors: appointed by shareholders to oversee the management of the corporation
- Officers: appointed by directors to manage day-to-day activities of the company
In many companies, these three roles intersect so that you may have a Chief Executive Officer who also has a seat on the board of directors and owns shares of the company stock.
Who's on the Board?
A board of directors can range in size anywhere from three to thirty or more members (or as few as one in a privately held company). A GMI Ratings study prepared for the Wall Street Journal in 2014 found that the average board size was 11.2 members. The study also found that smaller boards tended to outperform larger ones.
There are three distinct types of directors:
- Chairman of the Board: the leader of the board whose job is to effectively oversee the other directors and work in conjunction with the CEO and other corporate officers to formulate and implement business strategies
- Inside Directors: directors elected from within the company who have either a direct stake in the success of the business or who work in the daily operations and can offer insider perspectives
- Outside Directors: directors elected from outside the company who have no stake in the success of the business and who are brought in to provide unbiased and impartial perspectives
In 2002, the US Congress passed the Sarbanes-Oxley Act, which required public companies regulated by the Securities Exchange Commission (SEC) to include outside directors on their boards, specifically on their Audit Committees.
Directors of public companies are invested with fiduciary responsibilities. They must manage in good faith and make decisions that are beneficial to stockholders. For this reason, outside directors are highly valued for their impartiality.
Roles of Corporate Officers
Corporate officers are elected by the board of directors. Their job is to manage the daily activities of the corporation. Officers can sit on the board of directors. In fact, it is common for the CEO to also be a director.
There are three significant officer roles:
- Chief Executive Officer (CEO): the highest-ranking executive of the corporation responsible for the corporation's operations at every level, the CEO reports directly to the Chairman of the Board.
- Chief Operations Officer (COO): second in command, the COO oversees the daily business operations and reports directly to the CEO.
- Chief Financial Officer (CFO): top executive in charge of the corporation's finances, the CFO calculates financial risks, plans financial strategies, prepares and oversees company audits and handles financial record keeping.
Because the CEO answers directly to the Chairman of the Board, it is usually seen as a conflict of interest for the same individual to hold both positions.
While your board of directors will have regular meetings, it is also comprised of smaller committees. There are four significant committees found on most boards.
The Executive Committee (EC) should be a small group of directors capable of convening easily, quickly and often. An EC is often tasked with making urgent executive decisions during periods when a normal board meeting isn't scheduled. Where full board meetings are infrequent, many ECs meet regularly to handle routine business.
The Audit Committee (AC) works with the corporation's auditors to ensure that the company's financial records and tax reports are accurate and complete. Your AC should meet at least four times a year to review the most recent quarterly audit.
The Compensation Committee (CC) sets pay for top executives. Clearly, the CEO and other officers with direct conflicts of interest should not be members of the CC. Your CC should meet at least twice a year. Holding only a single meeting each year will give the impression that the CC is merely signing off on a compensation package instead of holding rigorous debate.
The purpose of the Nominating Committee (NC) is to nominate people to the board of directors. An NC must design and oversee a nomination process.
When structuring your board of directors and upper management, be sure to consider not only the various strengths and weaknesses each member brings to the table, but also the way in which personalities interact. Strong corporate management comes from a board that is neither too divided nor too lock-step.
Every director and officer should, ideally, be dedicated to the success of the company. It is not easy managing even a small corporation, and individuals who are lackluster in their commitment will likely find their talents better served elsewhere.