Which of the following is a major function of the board of directors of a company?

What Is Board of Directors (B of D)?

A board of directors (B of D) is the governing body of a company, elected by shareholders in the case of public companies to set strategy and oversee management. The board typically meets at regular intervals. Every public company must have a board of directors. Some private companies and nonprofit organizations also a board of directors.

Key Takeaways

• The board of directors of a public company is elected by shareholders.
• The board makes key decisions on issues such as mergers and dividends, hires senior managers, and sets their pay.
• Board of directors candidates can be nominated by the company's nominations committee or by outsiders seeking change.
• The New York Stock Exchange and the Nasdaq require listed companies to have a majority of outside, or independent, directors on their board.

The Board of Directors

How a Board of Directors (B of D) Works

In general, the board makes decisions as a fiduciary on behalf of the company and its shareholders. Issues that fall under a board's purview include the hiring and firing of senior executives and their compensation, dividends, major investments, and mergers and acquisitions.

In addition, a board of directors is responsible for helping a corporation set broad goals, supporting senior management in pursuit of those goals, and ensuring the company has adequate, well-managed resources at its disposal.

The board of directors typically includes the chief executive officer and sometimes other senior managers, alongside board members not otherwise affiliated with the company.

An inside director is most commonly defined as a company employee, though the category sometimes also covers significant shareholders.

Independent, or outside, directors are only involved with the company through their board membership. Independent directors face fewer conflicts of interest than company insiders in discharging their fiduciary obligations.

The New York Stock Exchange and the Nasdaq require listed companies to have boards with a majority of independent directors, and to include independent directors on key board committees such as the audit committee.

The structure and powers of a board are determined by a company's articles of incorporation and its corporate bylaws. Bylaws can set the number of board members, how the board is elected (e.g., by a shareholder vote at an annual meeting), and how often the board meets.

While there is no set number of members for a corporate board, many pursuing diversity as well as cohesion settle on a range of 8 to 12 directors.

Every public company listed on the New York Stock Exchange and the Nasdaq is required to have a majority of independent directors on its board.

Election and Removal of Board Members

For publicly listed companies in the U.S., members of the board of directors are elected by shareholders. Board candidates can be nominated by the board's nomination committee, or by investors seeking to change a board's membership and policies.

Directors may be removed in elections or otherwise in instances of fiduciary duty violations. In addition, some corporate boards have fitness-to-serve protocols.

Special Considerations

Corporate governance can differ in international settings. In some countries powers are split between an executive board and a supervisory board. The executive board is composed of insiders elected by employees and shareholders, is headed by the CEO or managing officer, and is in charge of daily business operations.

The supervisory board is chaired by someone other than the chief executive officer and fills a role similar to that of a board of directors in the United States.

What Does a Board of Directors Do?

In general, the board sets broad policies and makes important decisions as a fiduciary on behalf of the company and its shareholders. Issues that fall under a board's purview include mergers and acquisitions, dividends and major investments, as well as the hiring and firing of senior executives and their compensation.

Who Makes Up a Board of Directors?

Usually, the board of directors includes at least one company insider such as a chief executive officer, along with a majority of outside, or independent, directors with relevant expertise. Outside directors don't face the same conflicts of interest as the company insiders on a board.

Are Board Directors Paid?

Insider directors are not typically compensated for board duties since they're most often company employees. Outside directors are paid.

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We continue in this issue the discussion of the proper role of outside directors in determining the strategy of a company and in evaluating capital investments in its future. William Wommack recommends that corporate objectives or a strategy committee should become the usual structural means for reviewing management’s recommendation for investments. The author argues that management must organize well to relate to such a committee and that someone should be clearly designated the chief strategic officer (if not the CEO, then not the chief operating officer). He outlines the processes leading to management-board involvement in funding strategies (not projects) and in determining direction.

The board of directors’ most important function is to approve or send back for amendment management’s recommendations about the future direction of the corporation. This function usually receives minimal attention. Two reasons explain this irony. First, management is often not organized or required to deal with strategic choices within its own ranks—and even less under the questioning of a board of directors. Second, the board of directors is not usually organized or able to shoulder its responsibility.

The Securities and Exchange Commission, prolific in recent announcements, has said nothing about the board’s responsibility for its company’s strategy. The Commission officially, or its chairman personally, has settled on the virtues of having at least a majority of outside directors (or even no insiders except the CEO), an audit committee made up entirely of outside directors, a nominating committee to recommend new directors, a chairman who is not the CEO, and other suggestions substantive and cosmetic.

All of the foregoing pronouncements seem designed to check management power; they are negative in nature. Little has been said to suggest that boards of directors should be organized to perform a positive role in examining the objectives and the progress of the company in achieving what it has set out to do.

Organizing the Board for Examining Strategy

Most effective boards get their work done through committees that report to the full board. Setting up a small group of directors chosen for their relevant expertise has proven to be an effective way to examine complex issues. Audit, compensation, and nominating committees—in order of their recent rise to prominence—overshadow the older executive committee whose function tended to become that of the entire board. None of these newer committees is designed to examine resource allocation. This activity is the very essence of control over the company’s future.

The formation of a corporate objectives or strategy committee of the board is an important first move to involve the board in the strategy (program for the future) of the company. Such a committee usually functions best if its members are outside, independent directors, and thus free of the emotional commitments which competing claimants for scarce resources inevitably develop.

Organizing Management for Relating to the Board

If a board sets up a strategy committee, management quickly feels the need to organize itself to relate to it. The following two steps seem very important to me:

1. A company must have a set of objectives. What I am referring to here are the broad objectives of the company that really relate to compounding cash at a satisfactory rate. For example, the set objective for a return on shareholders’ equity might be 17% (at today’s inflation rate).

Thus I believe that the underlying general objective of any corporation must be to create value for both society and the corporation. For the corporation, it must compound cash at a rate that satisfies the expectation of the stakeholders. Numbers must be assigned to objectives, if the latter are to mean anything. Because of inflation, absolute numbers are deceptive. It becomes important to set goals also in terms of industry rankings and return on equity after inflation. And, of course, my premise here is that the CEO should set these objectives.

2. A company needs to develop a strategic philosophy. The philosophical belief, in short, reflects a set of theories which a company believes will result, if applied correctly, in meeting the objectives. One such general guide could be: “Businesses that generate neither cash today nor credible promise of more cash tomorrow are worthless.” Another could be: “All our businesses will be the cost-effective leaders in their market segment; otherwise they will be managed for cash today.”

In a multiple product company, a philosophical belief has to be set forth so all the individual strategic business units have a common basis to which they can relate. For instance, if all the businesses become the cost-effective leaders, the sum of the results of the individual units will satisfy the corporate objective of 17%. Whereas the CEO without exception, as noted, always does the first step, a chief strategic officer should be identified, even if it is the CEO, to do the second step.

The strategic philosophy is developed out of identifying market opportunity, applying corporate resources to this opportunity, and determining product/market strategies that spell out what product or services are to be provided to clearly defined market segments. A diversified company will organize its activities into strategic business units and develop mission statements that recognize the power of grouping corporate strengths to attack a specific set of product, market, financial, and organization goals.

If a company lacks a strategy expressed in part in philosophical terms, its projection of the business’s future is not a strategic plan; rather, it is only a financial forecast which probably will not come true. A planning system will then produce a lot of paperwork but very little strategic guidance for the business. The allocation of capital comes to be seen by managers as a corporate expression of confidence, affection, or love.

The responsibility for developing a strategically rational philosophy should fall to a chief strategic officer. But who is the CSO?

Ideally, the CEO should clearly be designated the chief strategic officer. This responsible individual sets the strategic plans of the corporation and submits them to the board committee for discussion, debate, approval, or modification.

Although we often assume that the CEO is indeed the chief strategic officer, he is hardly ever identified as such—in the way that the chief operating officer or chief financial officer is usually identified. The function often falls between designated responsibilities; strategic issues are not addressed.

Although the CEO is the most natural choice because of the importance of the job and the power it requires, he must make the conscious decision that he himself will be the chief strategic officer and make that clear to the management and the board.

In making that decision, I would encourage him to consider the following points:

• This job is not the kind that can be entrusted to the consensus process that in most organizations has determined the current state of their businesses. If strategic change is desired, organizational consensus will never bring it about. Group decisions on strategy tend to be comfortable compromises developed by the same people who must implement them.

• Success in effecting strategic change occurs probably in inverse proportion to the number of other duties handled by the same person. Strategy formulation is tough, demanding, and often unpopular work. If the executive has other demands and duties, he will naturally spend his time on the more popular work and lower-risk tasks.

• The chief strategic officer needs to make direct contact with each organizational level where strategic choices are being considered. The idea that an organization will present strategic choices for selection is fiction. If alternatives are ever generated, they are consciously or unconsciously eliminated as they move through the organization.

(To prevent such suppression, the strategic officer must work directly at the level where alternatives are first considered so that he can understand the situational analysis and identify the choices that he would like to see survive long enough to be dispassionately studied.)

It is for these reasons that I say the CEO must make a very deliberate decision that he can and will devote the necessary time and discipline to be truly the chief strategic officer. This decision requires of him an involvement at lower organizational levels (especially in a large diversified company) than is customary in his other supervisory responsibilities. If his other work and management style do not match these requirements, he should delegate the duties, title, and power to another officer.

The best alternative to the CEO’s assuming this clearly identified role is to appoint a separate chief strategic officer. This individual should be at least equal in organizational responsibility to the chief operating officer. We know that delegating title and duties like these to a staff function without power will not work. It is essential also that the chief strategic officer have control over the resources required to effect change. Most often, but not exclusively, the critical resource is capital funding.

It is of course true that the chief operating officer often by default falls heir to responsibility for strategy when the CEO finds himself too busy to devote the necessary time to it. It is an easy delegation, because it takes advantage of organizational lines to ensure lack of conflict between strategy and execution.

The disadvantages, however, are massive. First, the need to be selective in denying some applications for resources and persistently seeking out others presents a conflict in management style in situations where the need is that the chief operating officer be supportive. Second, a fundamental conflict between what is easy to execute and what is right to execute often leads the chief operating officer away from the tougher decision.

The Work of the Board’s Corporate Objectives Committee

Sooner or later the chief strategic officer, whoever he may be, must submit the proposed strategic philosophy (or corporate strategy) to the corporate objectives committee of the board for discussion, debate, modification, and, ultimately, approval. If the two steps I have recommended are carried out, the board committee should be able to arrive at a reasonably clear idea about the broad objectives of the company and the philosophical framework for evaluating a succession of much more specific strategic decisions.

To develop more specific business strategies for board consideration and, even more important, to make the strategic process work within the company, the chief strategic officer proposes to the committee the strategic guidelines for each business unit and thereafter makes them clear to the strategic business unit (SBU) management. The following guidelines to me are the most important:

• The growth rate expected of the strategic business unit. Knowledge of the market growth rate, assessment of the company’s current position vis-à-vis the competition, and where the chief strategic officer wants the SBU to be at the end of the long-range plan will set the growth rate of the unit. This objective can usually be translated into an asset growth rate.

• The long-term return expected of the SBU. There are several techniques to arrive at this figure—some quite sophisticated. A simple way that will approximate the answer the chief strategic officer might expect, for example, from the PIMS-PAR model, would be to examine the 10-Ks and annual reports of the competition, if these are public companies. A tremendous amount of information is exposed in these two documents.

(By accumulating this information from most competitors, the chief strategic officer can get a quite accurate idea of the range of returns within the industry being examined. Then the officer picks where he or she should be in that range, depending on the relative cost effectiveness.)

• The ratio of cash usage to generation must be determined. Any strategic officer who has undergone the discipline of determining a corporate strategy should have a good idea whether the business should use or throw off cash, remembering that compounding cash is the name of the game. As a matter of fact, if the system is designed correctly, the chief strategic officer can derive this figure mathematically once the asset-growth rate and the return on net assets are known.

From an organizational point of view, the importance of these strategic parameters is that they give the business units an understanding of their mission and make it possible for them to be more efficient in developing their long-range plans in a manner that will be acceptable to the executive management. Most senior managers too many times have had the experience of receiving a long-range plan from a strategic business unit that is unbelievable, unacceptable, or unfundable. Often the time cycle is so short before the plan must be wrapped up that there is no chance to return to the business unit for correction. The end result is usually a plan which goes into the bottom drawer to gather dust.

The importance of this process to those directors who are or are imagining themselves to be on a board objectives or strategy committee is that now they have some basic information to which they can relate management recommendations for capital investment. I am myself half-amused and half-dismayed to see boards of directors approve capital expenditures using only project information like years’ payback, return on net assets, or discounted cash flow. At best such figures are guesses and at worst lies. A board cannot meaningfully relate to either.

However, if the board committee has been exposed to a clear statement of the mission of the business and the strategic parameters that will guide action to carry out that mission established for the next five years, the committee can with some intelligence make the judgment that a capital allocation is moving the company in the predetermined direction or that it is not. Simply said: “Fund strategies—not projects.”

A format similar to that shown in Exhibit I can be developed for each strategic business unit. The board committee can have before it a single page, like that illustrated for a plastic products division, for reference each time a capital allocation is proposed for any division.

Exhibit I Statement of an SBU’s Mission and Strategic Parameters (Plastic Products Division)

Exhibit I indicates how this essential information was developed for polyvinyl chloride shrink wrap, part of the XYZ Company’s Plastic Products Division. The actual format of such summaries should vary with the nature of the company, product, and market.

I suggest this example to indicate how succinctly strategic information can be summarized for consideration by a board of directors. One piece of paper kept in a permanent book for each committee member, to be available for reference each time an issue or performance review is to be presented, makes manageable in reduced form the background information essential for the kind of judgment that an effective board of directors is called on to make.

The process of strategic planning with board involvement continues with the line management developing a strategic plan to satisfy the guidelines. (The submission of alternative plans is not precluded.) The chief strategic officer reviews these submissions. The chief operating officer attends the review conducted by the chief strategic officer in order to understand the strategy and to assent that it is operationally doable. The chief operating officer then sets one-year guidelines consistent with the strategy.

The line management next develops operational plans. These plans are submitted back to the chief operating officer with the chief strategic officer checking for strategic consistency. This process will result in a combined strategic and operational plan which will be reviewed and approved by the CEO and submitted for discussion and information to the corporate objectives committee of the board.

Exhibit II summarizes the development and convergence of the three processes described: (1) setting strategic direction, (2) strategic planning, and (3) operational planning. The specific elements of these processes and the particular techniques that can be applied for dealing with detail will vary with the goals and culture of individual companies.

Exhibit II Development and Convergence of Strategic Planning Processes with Board Involvement

But after all is said the specific techniques are not important. What is important is to consider bringing management and the board together in the proper relationship in the processes that determine the future of the company. The legitimacy of corporate power is being questioned today as it has never been questioned before. The foundation of the legitimacy of the corporation is the creation of value for the broad society in which it lives.

For management to decide in its own interests how the capital of the company will be invested in its future with the board as uninvolved bystanders is, in the current climate of public expectations of corporate performance, unacceptable. If management and the board of directors do not attempt to devise some process for the interdependent involvement of both groups in corporate strategy, then they can be charged with gross neglect of the central shared responsibility of the management and the board for determining the future of the company.

In short, the responsible exercise of free choice means doing everything we can to see that the interests of management, stockholders, and society interact to produce the best possible outcome.

A version of this article appeared in the September 1979 issue of Harvard Business Review.

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