Under Delaware law, 'The business and affairs of every corporation . . . shall be managed by or under the direction of a board of directors'. The corporation law of all other US states similarly assigns corporate managerial power to the board of directors.i Board structure and practices
Boards of directors customarily organise committees to carry out specific functions without the presence of the entire board. State law generally permits most of the functions of the board of directors to be delegated to committees, and generally permits directors to rely on information, opinions, reports or statements presented to the board by its committees. Boards are specifically required by federal securities law to have an audit committee with certain prescribed functions relating to the retention, compensation and oversight of the company's independent auditor. Federal securities law and NYSE and NASDAQ listing rules also require listed companies to maintain compensation and nominating or corporate governance committees. Boards will often voluntarily establish additional committees: for example, a company in the technology sector might establish a technology committee comprising directors with the most applicable expertise to stay abreast of technological developments, and a company that has important relationships with labour unions might choose to establish a labour relations committee. By custom, many companies have established a risk committee (actually required of certain financial institutions by the Dodd-Frank Act), an executive committee, a finance committee, a public policy committee, or some subset thereof. Boards may also establish ad hoc committees in response to discrete or emergent developments.
A panoply of regulations and disclosure requirements affect the composition of boards of directors. Federal securities laws require all directors who serve on audit, compensation and nominating committees to be independent from the management of the company, and NYSE and NASDAQ listing rules require a majority of the board of directors to be independent. In addition, in 2018 California passed a law mandating female representation on the boards of publicly held companies based in the state. Companies are required by federal securities laws to disclose the experience, qualifications or skills of each director nominee that led the board to nominate that person to serve as a director. A company must also disclose whether and how its nominating committee considers diversity in identifying director nominees, and must make extensive disclosure about the nominating committee and how it functions.
Just under half of large corporations in the United States have a common CEO and chair of the board of directors. Companies that have one person serving as both chair and CEO typically have a lead director with additional rights, responsibilities and compensation. In 2018, about 52 per cent of companies listed on the S&P 500 Index had separate chairs and CEOs, up from 29 per cent in 2005. ISS generally recommends a vote in favour of shareholder proposals requiring an independent chair, taking into consideration the company's current board leadership structure (including whether the company maintains a strong lead director position), governance structure and practices (including overall board independence) and the company's performance. In 2018, shareholders brought proposals at 48 companies to require an independent chair. These proposals enjoyed an average level of support of 32 per cent. Companies are also required to describe in their annual meeting proxy statements the leadership structure of their board of directors, such as whether the same person serves as chair and CEO, and to explain why the company has determined that its leadership structure is appropriate. To date, the governance trend is towards ensuring an independent board leadership structure through a lead independent director, as opposed to separating the CEO and chair functions in all companies.
Corporations are generally permitted by state corporate law to have classified, or staggered, boards of directors, in which roughly one-third of the directors are elected each year for three-year terms; however, classified boards have become substantially less common in recent years. With a classified board, shareholders can replace a majority of the directors only in two election cycles, so a classified board can promote the continuity and stability of a corporation's long-term strategy, reduce a corporation's vulnerability to abusive takeover tactics, and ensure that the institutional experience of the board of directors will not be swept away in a single lopsided election. On the other hand, classified boards historically have not halted well-priced, all-cash takeover bids. The percentage of S&P 500 companies with staggered boards has declined, to approximately 11 per cent in 2018, down from approximately 57 per cent in 2003. Shareholder proposals to declassify boards of directors enjoy strong support from shareholders: shareholders voted on such proposals at seven companies in 2018, and the proposals averaged approximately 86 per cent shareholder support. (Shareholders voted on 46 management-initiated proposals to declassify boards in 2018, and these averaged 99 per cent shareholder support.) However, corporations are more likely to implement a classified board in connection with an initial public offering (IPO). Despite an ISS policy of recommending a withhold vote for directors at the first public company annual meeting of a corporation that implements a classified board in connection with an IPO, in recent years more than half of IPO corporations implemented a classified board in connection with the offering, although some companies provide that the classified board will be declassified within several years of the IPO. Notwithstanding the trend towards removing classified boards, a 2013 empirical study confirmed that classified boards can enhance shareholder value.
Delaware law currently permits corporations to choose whether and how to afford insurgent director nominees access to a company's proxy statement, but rules implemented by the SEC enhance the ability of shareholders to propose providing groups of shareholders without control intent to nominate up to a certain portion (typically 25 per cent) of the company's entire board, known as proxy access. The interest in proxy access as a democratisation of corporate governance and voting has garnered increased strength. In late 2014, a group of pension funds announced a broad campaign to install proxy access at over 75 US publicly traded companies of diverse market capitalisations and across a variety of industry sectors. In 2018, shareholders at 41 companies voted on shareholder-initiated proposals to grant shareholders proxy access, and the proposals averaged 32 per cent support. These shareholder proxy access proposals typically seek to permit shareholders to nominate between 20 and 25 per cent of a company's entire board. Many companies are also either proactively revising by-laws to permit proxy access or submitting management-initiated proxy access proposals for shareholder consideration. Although shareholder proxy access is becoming more prevalent, it remains to be seen to what extent shareholders will seek to exercise proxy access rights.
Historically, brokers holding stock of a corporation on behalf of clients have voted that stock at their discretion when their clients do not provide specific voting instructions. However, the NYSE listing rules now prohibit broker discretionary voting for listed companies on certain topics including governance-related proposals, and the Dodd-Frank Act eliminated broker discretionary voting in elections related to the election of directors, executive compensation and any other significant matter as determined by the SEC. As a result, directors in uncontested elections have more difficulty achieving majority votes. Lack of broker discretionary voting also increases the influence of activist shareholders and the power of proxy advisory firms such as ISS. Further concentrating voting power in the hands of activists is the problem of empty voting, in which an activist uses derivatives and similar arrangements to purchase voting power without taking on commensurate economic exposure to the corporation's stock – for example, by simultaneously purchasing and short-selling a stock, resulting in no net economic exposure or investment costs aside from transaction fees.
In uncontested elections, directors were historically selected by plurality vote, but in recent years, majority voting policies have been adopted by approximately 90 per cent of companies included in the S&P 500 Index. Under a majority voting policy, directors in uncontested elections must receive a majority of the votes cast, rather than the plurality required by Delaware law, and if they do not must tender their resignation, although Delaware courts will generally defer to a board's business judgement on whether to accept or reject a resignation from a director in such circumstances. Because directors must win a plurality of votes regardless of a corporation's majority voting policies, these policies have relatively less effect in the context of contested elections; their primary effect is to increase the power of withhold recommendations from ISS against incumbent directors running in uncontested elections.ii Directors
Directors' most basic and important responsibility is to exercise their business judgement in a manner they reasonably believe to be in the best interest of a corporation and its shareholders. In Delaware and 32 other states and the District of Columbia, where legislation approving a new corporate form – the benefit corporation – has been passed, directors of such corporations have an expanded fiduciary obligation to consider other stakeholders in addition to shareholders, including their overall impact on society, their workers, the communities in which they operate and the environment.
In most situations, directors do not and should not manage the day-to-day operations of the corporation, but instead exercise oversight in reasonable reliance on the advice of management, outside consultants hired by the corporation and their own understanding of the corporation's business. The courts will generally defer to decisions that boards make, granting them the 'presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company' – a presumption referred to as the business judgement rule. The business judgement rule applies to most decisions that a board of directors makes. When a shareholder challenges a board's business judgement, 'the court merely looks to see whether the business decision made was rational in the sense of being one logical approach to advancing the corporation's objectives'. To obtain the protection of the business judgement rule, directors must satisfy their duty of care, which entails reviewing the available material facts, and their duty of loyalty, which requires the disinterest and independence of the directors. In practice, the business judgement rule will protect directors when the corporate records reflect that they reviewed and considered the facts available to them and the advice of their advisers and when the directors did not have a conflict of interest in the decision.
The board of directors should work with management to set an appropriate 'tone at the top' of the corporation to encourage conscientiousness, transparency, ethical behaviour and cooperation throughout the organisation. It should approve the company's annual operating plan and guide its long-term strategy, and should monitor and periodically assess the corporation's performance in terms of these goals. The board should monitor and evaluate its own performance as well, noting any deficiencies in its expertise and composition with an eye towards rectifying them with future director nominations. It should monitor the organisation's risk management practices, as well as compliance with applicable law and best practices, set standards for corporate social responsibility, and oversee relations with regulators and the corporation's various constituencies, which increasingly includes engaging directly in director-level dialogue with shareholders. It should evaluate the corporation's CEO and senior management, and ensure that a succession plan is in place for the CEO and senior management, an issue that has received heightened focus in light of increased turnover rates and visible succession crises. When a company receives a proposal for a large transaction that creates a conflict – or the appearance of a conflict – between the interests of the corporation's shareholders and its management, the board should take care to place itself at the centre of the transaction, and should consider the merits of a special committee of independent directors to oversee the company's response to the proposal.
Directors enjoy substantial protection against personal liability for failures of board oversight. Under Delaware law, directors can be held personally liable for a failure to monitor only where there is 'sustained or systemic failure of the board to exercise oversight – such as an utter failure to attempt to assure a reasonable information and reporting system exists', which is a 'demanding test'. Delaware courts have repeatedly emphasised that they will not impose liability under this standard unless directors have intentionally failed to implement any reporting system or controls or, having implemented such a system, intentionally refused to monitor the system or ignored any red flags that it raised. Proxy advisory firms and institutional investors have also been increasingly willing to wield the threat of withhold vote recommendations in response to perceived risk oversight failures or missteps.