The ABCs of Corporate Boards: An Investor Walk-Through

You might own shares of a company with a rock-star CEO, a hot new product or service, a track record of solid growth and earnings performance, or a stock price that keeps making you happy—that’s all well and fine. But as a shareholder of this company, who’s really got your back? That’s the job of the corporate board of directors.

Who’s On Your Board?

Most U.S.-based, publicly traded corporations have a board of directors. This is an elected group of individuals, many from outside the company, who are broadly responsible for providing independent guidance and protecting the interests of a company’s shareholders. What exactly does a board of directors do? Do you know who’s on the board of directors of a company whose shares you own or are considering buying? For investors, these and other related questions are worth asking.

“The board of directors is a really important part of a public company structure,” said Viraj Desai, senior portfolio manager with TD Ameritrade Investment Management, LLC. “Boards are not there to run the company. They’re there to ensure shareholders’ interests are taken into consideration and to align shareholder interests to company management with a long-term focus.”

Corporate boards differ from company to company and have a number of important duties—such as setting executive compensation—that can affect investors, in positive and negative ways, depending on the circumstances. Here are some basics on corporate boards.

What Makes a “Good” Board of Directors?

Board members have a duty to make decisions based on what’s ultimately best for the long-term interests of the company and shareowners. To do so, a board needs a combination of four things, according to Desai, citing a report from the CFA Institute, an association of investment professionals:

• Independence. A board should be composed of at least a majority of independent board members with the autonomy to act independently from the management and other special interests. Rather than simply voting with management, board members “should bring with them a commitment to take an unbiased approach in making decisions that will benefit the company, shareowners, and stakeholders,” according to the CFA Institute.
• Experience. A well-functioning board requires appropriate experience, skills, and expertise relevant to the company’s business so it can evaluate what’s in the best interests of the company and its shareowners. Depending on the business, specialized expertise by at least some board members may be required—for example, an aerospace company board might be well-served by including engineers.
• Resources. A board should have mechanisms to support its independence, such as authority to hire an external auditor or other outside consultants without management’s intervention or approval. This mechanism enables the board to obtain expert help in specialized areas and circumvent potential areas of conflict with management, as well as “preserves the integrity of the board’s independent oversight function,” the CFA Institute stated.
• Accurate information. Board members must have access to complete and accurate information about the financial position of the company and its underlying value drivers to enable them to steer the company toward its best long-term interests.

What Makes a Board “Independent” and Why Is This Important for Investors?

Independence refers to the degree to which corporate board members are not biased or otherwise controlled by company management, other groups who exert control over management, or the shareholders.

A board that’s not predominantly independent “may be more likely than independent individuals to make decisions that unfairly or improperly benefit the interests of management, those who have influence over management, or groups of shareowners,” the CFA Institute said. “These decisions also may be detrimental to the long-term interests of the company.”

Generally, to be considered independent, a board member “must not have a material business or other relationship with the company or its subsidiaries or members of its group, including former employees and executives and their family members,” according to the CFA Institute.

How Can Investors Find Information About Corporate Boards?

Board members are often listed in the “investor relations” section of company websites or can be found in the company’s 10-K annual report filed with the U.S. Securities and Exchange Commission. The number of board members varies from company to company, from the low single digits to two dozen or more (some research suggests the ideal number of board members is seven to nine).

In most cases, board members probably aren’t considered public figures and rarely make the news, though some company boards include celebrity juice. The board of Apple, for example, includes former Vice President Al Gore. In other cases, activist shareholders may load up on a stock to accumulate enough to gain a seat on a company’s board and push for change (individual shareholders can still channel their inner “activist” and cast proxy votes on company matters).

Desai added that by studying a company’s board members, investors might be able spot potential red flags. Do the board members have a good professional track record? “Often, what you’re looking for are board members who aren’t spread too thin across different boards or other activities,” he said. “They can focus on the company in question.”

A good board of directors is part and parcel with good corporate governance, and the quality, independence, or effectiveness of a company’s board isn’t necessarily obvious in day-to-day financial media headlines or stock price gyrations. “During black swan events or other extreme circumstances, a good board might make the difference between a company’s survival or disintegration,” Desai explained. The 2008 financial crisis, for example, exposed banks with poor governance, and those with good corporate governance came out a lot better than those without.

“The point of having a good board and good corporate governance is to reduce the operational risks to the company,” Desai noted. “Companies with poor operational risk are more exposed to severe, catastrophic events. Ultimately, the boards are there to have the shareholders’ backs, and their responsibility is to protect and grow shareholder value.”