Corporate Governance Primer: Authority of the Board

As the ultimate repository of management authority, the board of directors is spared the often laborious process by which matters are presented to it for its determination. By necessity boards must, and are entitled to, rely on corporate officers and advisers to select, refine, and present crisply for resolution the issues that come before it. The cost of such efficiency is the risk that board meetings become formulaic, board action becomes automatous, and board members fail to learn the alternatives, procedural or substantive, that might be available. This article is intended as a corporate governance primer, identifying the toggles, levers, and switches the board can set, pull, push, in the cab of the corporate crane.

In general, management of a corporation is divided between the board of directors and officers. Officers are directly responsible for a corporation's day-to-day operations, whereas the board's role, generally, is supervisory. Therefore, the board need expressly authorize only those transactions that are material or otherwise outside the corporation's ordinary course of business. Examples of such transactions include issuances of securities, declarations of dividends, bank borrowings, mergers, business acquisitions, appointment of officers and setting their compensation, and authorization of significant contracts, including officer employment contracts and employee benefit plans. In addition, the Sarbanes-Oxley Act of 2002 requires the audit committee of public companies to have direct responsibility for the outside audit function.

Procedural Authority

Meetings. Generally, a corporation's bylaws determine how board meetings can be called. Bylaws that do not authorize members of the board to call a meeting can be amended to do so, if the board so desires.

Agenda; Appointment of Chairman. Boards have authority to fix the agendas of their meetings or to require management to address particular matters. A board can elect a chairman from among its members to administer board functions and operations. The chairman need not be the CEO or other member of management.

Board Compensation. Boards have authority to fix the compensation of directors for their services as such, including for committee memberships, or in any other capacity. Compensation, in any case, must be reasonable. Services by a director to a corporation in any capacity other than board or committee membership may affect the director's independent status.

Number and Election of Directors. Generally, the number of directors may be fixed by the board, often within a range stated in the certificate of incorporation or bylaws. Although directors are elected (or re-elected) at the annual stockholders meetings, boards have authority to fill vacancies occurring between meetings. This authority includes authority to increase the number of directors and elect directors to fill the newly created positions.

Access to Information. A director is entitled to examine any of the books and records of the corporation, and should be permitted to communicate or meet with any company employee the director wishes, for a proper corporate purpose. Some jurisdictions consider the director's right of inspection to be “absolute.”

Access to Independent Counsel and Other Advisers. Generally, directors would not seek advice directly from independent counsel or other advisers, except in special circumstances, such as takeovers or investigations into wrongdoing. Compensation committees commonly engage compensation consultants, however. Under the Sarbanes-Oxley Act (the Act) and proposed stock market rules, independent directors may rely more frequently on independent counsel, accountants, or other advisers at the company's expense. For example, under the Act, audit committees have been given express authority to engage independent counsel and other advisers in carrying out their duties.

Removal of Directors. In general, stockholders may remove a director for cause, but their right to remove a director without cause is more restricted. In some states, directors may be authorized to remove another director for cause.

Removal of Officers. Corporation officers serve at the pleasure of the board. Even if the board's removing an officer would breach an employment contract, the officer cannot prevent his or her removal on this basis.

Functions of Board Committees

In general, boards are empowered to establish committees with almost any authority that the board itself possesses. Such broad powers are sometimes vested in an “executive” committee.

Committees formed for narrower purposes may be authorized to exercise all of the power of the board with respect to specified matters or only to investigate or make recommendations for board action. Boards may establish standing committees or special committees in particular circumstances. The functions of the most common standing committees are described below.

Audit Committee. The audit committee's traditional role has been to oversee the corporation's accounting functions, including its financial reporting processes, its internal controls, and the independence of its external auditors. Public companies with securities trading in a stock market are required by its rules to adopt a charter for its audit committee, setting forth the outside auditor's ultimate accountability to the committee and the board of directors; the committee's specific duties, including particular subject matter that the committee is required to review with the auditors and management; and qualifications for committee membership, including independence and financial sophistication. A report of the audit committee regarding the prior year's audit is required to be included in the company's proxy statement.

The Act imposes the following additional requirements:

• The audit committee is directly responsible for appointing, setting the compensation for, and overseeing the work of the company's auditors, who must report directly to the audit committee;
• The audit committee must disagreements between management and the auditors over financial reporting;
• The audit committee must consist solely of independent directors;
• The audit committee must establish procedures to receive and handle complaints regarding accounting, internal accounting controls, or auditing matters and for anonymous, confidential submissions by employees regarding such matters; and
• The audit committee must have authority and funding to hire independent counsel and other advisers in carrying out its duties.

The Act also requires disclosure of any “financial experts” on the committee or reasons for lack of any. The qualifications of a “financial expert” are more stringent than rules regarding financial sophistication;

Compensation Committee. The compensation committee recommends or approves the compensation for officers and senior management and executive compensation programs. SEC rules and the Internal Revenue Code dictate the creation of a compensation or equivalent committee comprised of independent directors. The committee is delegated authority to make stock option and other equity awards, to qualify for exemptions from the short-swing trading provisions (Section 16(b)) of the Securities Exchange Act of 1934 or incentive stock option treatment for stock options. The Internal Revenue Code also requires the compensation committee to establish, and certify compliance with, performance criteria as a condition to the deductibility of executive officer compensation exceeding $1 million per year.

Each company's proxy statement must contain a report of the compensation committee setting forth the bases for executive officers' compensation for the prior fiscal year.

Nominating and Corporate Governance Committees. The chief traditional responsibility of the nominating committee is to identify, vet, and recommend candidates for board membership. Frequently assigned corporate governance supervision as well, the committee may recommend board committee assignments or board compensation; oversee executive officer succession matters; assess board, board member, or executive officer performance; or evaluate management organizational structure, among other functions.

Although not mandated by rules or listing requirements, in the current climate, establishment of a committee with such functions is recommended. Ideally, committee members should all be independent, but senior management should have a role in finding and recruiting director candidates. The committee should maintain a record of considering the performance of incumbent directors in determining whether to recommend their nomination for re-election.

Special Committees. Boards can form standing special committees, in addition to audit, compensation, or nominating/corporate governance committees, as well as from time to time handling non-recurring matters. For example, boards will often form a special litigation committee composed of disinterested directors to handle derivative actions or investigations of insider misconduct. Boards will often also form special committees of independent directors to consider mergers involving interested directors and officers.

As the ultimate repository of management authority, the board of directors is spared the often laborious process by which matters are presented to it for its determination. By necessity boards must, and are entitled to, rely on corporate officers and advisers to select, refine, and present crisply for resolution the issues that come before it. The cost of such efficiency is the risk that board meetings become formulaic, board action becomes automatous, and board members fail to learn the alternatives, procedural or substantive, that might be available. This article is intended as a corporate governance primer, identifying the toggles, levers, and switches the board can set, pull, push, in the cab of the corporate crane.

In general, management of a corporation is divided between the board of directors and officers. Officers are directly responsible for a corporation's day-to-day operations, whereas the board's role, generally, is supervisory. Therefore, the board need expressly authorize only those transactions that are material or otherwise outside the corporation's ordinary course of business. Examples of such transactions include issuances of securities, declarations of dividends, bank borrowings, mergers, business acquisitions, appointment of officers and setting their compensation, and authorization of significant contracts, including officer employment contracts and employee benefit plans. In addition, the Sarbanes-Oxley Act of 2002 requires the audit committee of public companies to have direct responsibility for the outside audit function.

Procedural Authority

Meetings. Generally, a corporation's bylaws determine how board meetings can be called. Bylaws that do not authorize members of the board to call a meeting can be amended to do so, if the board so desires.

Agenda; Appointment of Chairman. Boards have authority to fix the agendas of their meetings or to require management to address particular matters. A board can elect a chairman from among its members to administer board functions and operations. The chairman need not be the CEO or other member of management.

Board Compensation. Boards have authority to fix the compensation of directors for their services as such, including for committee memberships, or in any other capacity. Compensation, in any case, must be reasonable. Services by a director to a corporation in any capacity other than board or committee membership may affect the director's independent status.

Number and Election of Directors. Generally, the number of directors may be fixed by the board, often within a range stated in the certificate of incorporation or bylaws. Although directors are elected (or re-elected) at the annual stockholders meetings, boards have authority to fill vacancies occurring between meetings. This authority includes authority to increase the number of directors and elect directors to fill the newly created positions.

Access to Information. A director is entitled to examine any of the books and records of the corporation, and should be permitted to communicate or meet with any company employee the director wishes, for a proper corporate purpose. Some jurisdictions consider the director's right of inspection to be “absolute.”

Access to Independent Counsel and Other Advisers. Generally, directors would not seek advice directly from independent counsel or other advisers, except in special circumstances, such as takeovers or investigations into wrongdoing. Compensation committees commonly engage compensation consultants, however. Under the Sarbanes-Oxley Act (the Act) and proposed stock market rules, independent directors may rely more frequently on independent counsel, accountants, or other advisers at the company's expense. For example, under the Act, audit committees have been given express authority to engage independent counsel and other advisers in carrying out their duties.

Removal of Directors. In general, stockholders may remove a director for cause, but their right to remove a director without cause is more restricted. In some states, directors may be authorized to remove another director for cause.

Removal of Officers. Corporation officers serve at the pleasure of the board. Even if the board's removing an officer would breach an employment contract, the officer cannot prevent his or her removal on this basis.

Functions of Board Committees

In general, boards are empowered to establish committees with almost any authority that the board itself possesses. Such broad powers are sometimes vested in an “executive” committee.

Committees formed for narrower purposes may be authorized to exercise all of the power of the board with respect to specified matters or only to investigate or make recommendations for board action. Boards may establish standing committees or special committees in particular circumstances. The functions of the most common standing committees are described below.

Audit Committee. The audit committee's traditional role has been to oversee the corporation's accounting functions, including its financial reporting processes, its internal controls, and the independence of its external auditors. Public companies with securities trading in a stock market are required by its rules to adopt a charter for its audit committee, setting forth the outside auditor's ultimate accountability to the committee and the board of directors; the committee's specific duties, including particular subject matter that the committee is required to review with the auditors and management; and qualifications for committee membership, including independence and financial sophistication. A report of the audit committee regarding the prior year's audit is required to be included in the company's proxy statement.

The Act imposes the following additional requirements:

• The audit committee is directly responsible for appointing, setting the compensation for, and overseeing the work of the company's auditors, who must report directly to the audit committee;
• The audit committee must disagreements between management and the auditors over financial reporting;
• The audit committee must consist solely of independent directors;
• The audit committee must establish procedures to receive and handle complaints regarding accounting, internal accounting controls, or auditing matters and for anonymous, confidential submissions by employees regarding such matters; and
• The audit committee must have authority and funding to hire independent counsel and other advisers in carrying out its duties.

The Act also requires disclosure of any “financial experts” on the committee or reasons for lack of any. The qualifications of a “financial expert” are more stringent than rules regarding financial sophistication;

Compensation Committee. The compensation committee recommends or approves the compensation for officers and senior management and executive compensation programs. SEC rules and the Internal Revenue Code dictate the creation of a compensation or equivalent committee comprised of independent directors. The committee is delegated authority to make stock option and other equity awards, to qualify for exemptions from the short-swing trading provisions (Section 16(b)) of the Securities Exchange Act of 1934 or incentive stock option treatment for stock options. The Internal Revenue Code also requires the compensation committee to establish, and certify compliance with, performance criteria as a condition to the deductibility of executive officer compensation exceeding $1 million per year.

Each company's proxy statement must contain a report of the compensation committee setting forth the bases for executive officers' compensation for the prior fiscal year.

Nominating and Corporate Governance Committees. The chief traditional responsibility of the nominating committee is to identify, vet, and recommend candidates for board membership. Frequently assigned corporate governance supervision as well, the committee may recommend board committee assignments or board compensation; oversee executive officer succession matters; assess board, board member, or executive officer performance; or evaluate management organizational structure, among other functions.

Although not mandated by rules or listing requirements, in the current climate, establishment of a committee with such functions is recommended. Ideally, committee members should all be independent, but senior management should have a role in finding and recruiting director candidates. The committee should maintain a record of considering the performance of incumbent directors in determining whether to recommend their nomination for re-election.

Special Committees. Boards can form standing special committees, in addition to audit, compensation, or nominating/corporate governance committees, as well as from time to time handling non-recurring matters. For example, boards will often form a special litigation committee composed of disinterested directors to handle derivative actions or investigations of insider misconduct. Boards will often also form special committees of independent directors to consider mergers involving interested directors and officers.