Key2 What is a board of directors and why do you need one?
Adam Smith was not only wrong about corporation, he was wrong about the ability of corporate boards to watch with anxious vigilance. His fear may have sprung from the idea that those minding the store might be tempted to slack off, or, even worse, dip into the till while on guard duty. Adam Smith underestimated the creativity and motivation of armies of business and legal minds who, over the years, have developed a variety of ways to curb dipping and slacking among managers.
When a corporation is created by its shareholder owners, it becomes what the law falteringly refers to as a “fictitious person.” Have nearly all the same rights that a natural, even shallow, person might have. Corporation can own property and enter into contracts, but they must pay taxes, too. Corporation cannot take the Fifth Amendment as a defense against releasing corporate documents, but they are entitled to all other rights and responsibilities under the law.
The truly tricky part of being a fictitious person with many rights is the inability to speak up. When a real person is being robbed, he tends to speak, rather loudly, about the theft of his property. A fictitious person is at the mercy of natural persons when it comes to being robbed. And real people gathered around the funds of a corporation might be tempted to divert them or use its resources to their own benefit at the expense of the shareholders. People in corporations who have not been adequately supervised can get away with murder. They have done everything from, the illegal---Michael Monus, for example, embezzled funds by keeping two sets of books at Phar-Mor, Inc.---to the outlandish, like purchasing a Boeing 737 jetliner for personal use--- witness the creative expense accounts if Bill Agee and Mary Cunningham at the Knudsen Corporation.
A corporation exists to increase the wealth of its shareholders, who need designated speakers to protect them by voicing concerns should the actual people running the corporation abuse the rights of their fictitious charge. That’s where directors come in.
Shareholders elect directors to be their voice and the voice of the corporation. Directors are accountable to them, monitor the corporation’s officers and employees, and speak for the corporation in everything from annual reports to securities filings to strategic initiatives. Directors elect the officers of the corporation to manager it on a day-to-day basis. Those officers handle everything from employee compensation to the cafeteria contracts.
All corporations---profit and non-profit, private and public---must gave a board to act as designated speaker on the corporation’s legal, financial and management issues. All states require a board of directors. But the number of directors required in each state varies. Under the Model Business Corporation Act, adopted in about one-third of the states, a corporation must have at least one board member. The structure and composition of the board are covered in Key 4.
In exchange for its legal existence and rights, a corporation has full liability for all of its contracts and actions. All corporate assets are on the line. But as long as the corporation operates properly with full regard for its rights as a fictitious person, its shareholders do not have to worry about personal liability for any of the corporation’s unpaid obligations.
This limited liability is in jeopardy if the shareholders fail to treat the property and funds of a corporation as separate and subject to formalities including everything from approval of transactions to the annual filing of reports. The duty of formality belongs to the board of directors and those to whom they delegate responsibility. In effect, the board holds the responsibility to speak for the corporate person on behalf of the shareholders who elected its members.
The success and efficiency of corporations comes from a simple structure: shareholders vote for a board of directors, which delegates authority for day-to-day operations to a group of managers called officers (see Key 17). The board sets the course for the company and guides the officers as they carry out the board-charted course. The owners of a corporation may be widely dispersed but they retain their power through the ballot box. At the annual meeting where directors are elected, shareholders have the ultimate power to control both their investment and their designated agents, the directors of the board.
Should the board and its hired officers veer off the shareholders’ desired course or continue along an ill-advised route, the shareholders have the power to replace the directors at the helm. Those new directors can then take the necessary steps to re-chart the course and, if necessary, use their power over officers to replace them. In short, shareholders---the ones with the money at risk---are supposed to rule.
How a board works and how well it speaks for its shareholders is a key component of a company’s performance and financial success. Good fences make good neighbors and good boards make good returns on investments.
