Understanding How a Board of Directors Works

The term “board of directors” often evokes visions of a large group of moguls put in place to drive multi-billion dollar corporations. In reality, most companies led by a board of directors are much smaller and made of people who are certainly not moguls.

A "mogul-ish" looking man.

When it functions well, a board of directors is a key asset for any organization. Businesses of any size and in any industry can assemble a board. However, before making any decisions, it helps to understand the purpose and functions of a board of directors.

What is a board of directors?

A board of directors is a group of individuals who provide oversight, direction, and advice. While publicly traded companies are mandated to have a board of directors, many private companies also opt to assemble a board. 

Not-for-profit organizations may also rely on a board of directors or governors to ensure proper oversight.

What does a board of directors do?

A board of directors provides advice to help the company achieve its goals. How it executes that function can vary widely. In some cases, the role of the board is strictly advisory. In others, the board must approve any major organizational or strategic changes. 

Power and responsibility may be divided between the board and executive leadership. Some organizations also select employees to sit on the board of directors.

In addition to providing advice and helping set strategy, boards are often responsible for the following:

• Establishing company culture
• Hiring and determining C-level compensation
• Defining organizational strategy
• Setting company-wide policy to deal with ethical concerns

Outside of publicly traded companies where the board of directors is obligated to act in the best interests of shareholders, businesses have some flexibility in how they use their board of directors.

Members of a board can often act as a mentor to executives in smaller companies.

When does a company need a board of directors?

A company needs a board of directors when it is publicly traded or when leadership determines that it will benefit the organization. Here are a few scenarios in which this may happen:

• Multiple stakeholders have different needs and expectations
• There are knowledge gaps within company leadership
• Objective insights are needed that existing management can’t provide
• Oversight is required for reputation management
• To create a balance of power
• For fiscal and leadership accountability
• To mediate conflicts

A board often provides an objective voice to issues when employees and leaders in the organization may have tunnel vision.

Rules about boards of directors

A board of directors may be subject to certain rules and regulations. This depends on the organizational structure, industry, and even the location of the business. 

These rules may limit who is allowed to sit on a board of directors, any disclosures that members must make, and how the board is elected or appointed. They also create and set limits on the amount of power a board has.

It may be helpful to create some rules and policies that define how its board of directors functions. These rules can reduce conflicts of interest and ensure the board adds value to the organization. 

For example, a business might establish that at least one employee is on the board and that immediate family members of executives cannot be appointed to the board.

The rules about a company’s board of directors will usually be articulated in its bylaws or constitution.

Who appoints the board?

When a company is publicly traded, the shareholders are responsible for electing the board of directors. In other organizations, that process may vary. Businesses may decide whether they want to appoint or elect a board and create a mechanism for doing that. 

With that being said, there are organizations, such as the National Association of Corporate Directors, that have best practice recommendations over issues like board tenure. 

For example, it may be better to hold staggered elections. This way, an entire board won’t be entirely vacated by a single election. To do this, elections may be held as frequently as every year but not for every position.

It’s also fairly common to set term limits for board members. This ensures new members can bring fresh ideas to the organization. It also helps to offset some ethical concerns that can come from keeping the same members on a board that can influence policy.

There are several options for appointing or electing a board. These include:

• Department heads and executives elect board members
• Executives appoint board members
• An open election is held to elect board members
• Some positions are elected by employees and others are placed by management

In some instances, there may be stakeholders outside of the organization who are given a voice in electing or appointing board members. 

Choosing a board and board structure

When it comes to who should be appointed to a board of directors, ideally, these should be people with the right combination of knowledge, understanding of the organization, and desire to contribute to the company’s success. The best-qualified people for board positions may vary depending on the company's growth stage, challenges, and goals.

There are a few board structures that may be the right fit for an organization. Here are a few examples of this.

Corporate board structure

Commonly, a corporate board is elected by shareholders. In turn, the board may appoint the chairman. It is fairly common for the CEO, founder, or recently retired top executive to serve as chair. There may also be a vice chair.

Board representation diversity

While the exact makeup of a board may vary, diversity is often a priority. This includes both inherent and acquired diversity. For example, a board of directors at a non-profit organization may include people with expertise in running charitable organizations. It may also include community members who may receive the organization’s services. 

In private organizations, potential board members may be recruited with the company's diversity, equity, and inclusion policies in mind. 

Skills representation

An effective board will have the right balance of skills and experience. To ensure this, companies can create a skills matrix to help define the characteristics needed among the board members. This will also help to assign various roles and responsibilities to board members.

Board Governance Model

This model determines how the board influences the policies and direction of the business. Here are a few of these:

• Patron: For non-profits and focused on fundraising initiatives
• Carver: For businesses and non-profits focused on completing the organization’s mission
• Traditional: Board operates as a monolith and has legal responsibilities
• Advisory: Unpaid board members offer expertise and advice
• Cooperative: Board members have equal votes and cooperating interests
• Management Team: For non-profits and forms committees to achieve goals
• Cortex: Board members ensure the company is accountable to the community

There may be cases where a company puts together more than one board to fulfill different responsibilities. Board members may also form committees or recruit people from the organization to serve on committees.

What happens when a board is dysfunctional?

Some levels of dysfunction can be dealt with through negotiations and by using conflict management techniques. A company can also create bylaws to call an election when dysfunction becomes unmanageable. 

This situation may happen more than many people imagine, as 48% of board directors believe at least one of their peers should be replaced.

However, when things are exceptionally bad, or there is some evidence of corruption, it may be necessary to dissolve all or part of a board. This can be done by shareholders or through a mechanism defined in a company’s bylaws.

Planning is key to board success

A board of directors can be an asset to any company. However, it’s imperative to plan carefully. Bylaws must define the board's structure, governance model, and role. Additionally, supporting documentation should map the roles and responsibilities of each board member to ensure that everyone makes a positive contribution.

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