Page 127 - Introduction to Business

CHAPTER 3 Business Governance, Ethics, and Social Responsibility 101

LEARNING OBJECTIVE 2
Explain the basic roles of corporate boards of directors and officers.

Boards of Directors. The legal governing body of all corporations is its board board of directors The governing board
of directors. State incorporation laws generally require that there be at least three of a corporation, which generally must
have at least three members
members of the board and that it meet at least once a year. In practice, most large
corporations have a larger board of directors (20 or so members is not uncommon),
with board meetings scheduled quarterly or more. Boards of directors are respon-
sible for all major policy decisions of the corporation, including the hiring (and
sometimes firing!) of corporate officials.
Traditionally, boards of directors have had two general types of members—
inside directors and outside directors. Inside directors are individuals from inside inside directors Corporate board of
the corporation, such as its chief executive officer (CEO) and other top officers, that directors members employed full-time
by the company, for example, the CEO or
sit on the board. Outside directors are individuals who are not employed as officers
other corporate officers
of the company and are thus outside of the firm. Outside directors are typically
outside directors Corporate board of
prestigious individuals such as university presidents, CEOs of other corporations, directors members not employed full-
attorneys, accountants, and so on, who are named to help run the corporation. time by the company
At times, though, the distinction between inside and outside directors is
blurred, for example, in the case of former employees still sitting on the board.
Because of this, the New York Stock Exchange and other entities have begun distin-
guishing between independent outside directors and those outside directors not independent outside directors Outside
deemed to be independent. For example, an attorney whose law firm has as a major directors who do not have any financial
or other relationship with the corpora-
client the company on whose board of directors the attorney is sitting would not be
tion beyond their service as a director
viewed as an independent outside director. Similarly, an outside director who in
addition to her or his director’s fee also is employed by the company as a $200,000
per year marketing consultant would not be truly independent of the company.
General Electric (GE) has recently adopted very stringent requirements in this
regard, stating that its goal is to have two-thirds of its board of directors be truly
independent outside directors. GE has defined independence to mean that the out-
side director and any other entities he or she is involved with cannot have any
meaningful ties to the company beyond the given directorship service. GE will con-
sider as meaningful in the case of directors who are executives of other companies
the fact that either sells to or purchases from GE total of 1 percent or more of the
revenues of the companies where the individuals are executive officers. Put another
way, executives at companies that do a lot of business with General Electric will not
be regarded as independent outside directors by GE. 9
Boards of directors of all corporations (as well as corporate officers) operate
under a legal doctrine known as the business judgment rule. This essentially business judgment rule The
means that directors in carrying out their duties must act in good faith and exercise requirement that corporate directors
and officers act in good faith and
at least the level of care that an ordinary prudent person would exercise in similar
exercise at least an ordinary prudent
circumstances. In short, they must give their work as a corporate director their best person’s judgment in making business
business judgment. This means directors cannot properly come to meetings drunk decisions
or take actions for which there was no rational basis. They must continually try to
fulfill their key role of aligning the interests of the corporation’s top management
and its shareholders.
It is very important, though, to note that the business judgment rule does not
require that corporate directors always make the “right” decisions. It is well under-
stood that corporate boards of directors are often faced with very complex
decisions in very complex business environments. Thus, shareholders, courts, gov-
ernment regulators, and so on are not allowed to second-guess, or “Monday morn-
ing quarterback,” corporate boards so long as the directors made their decisions in
good faith using their (at the given time) best judgment.

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