Many businesses, from single-owner retail stores to Fortune 500 companies, are organized as corporations.
Corporations are owned by shareholders, and the shareholders elect a board of directors to govern most of the company’s business decisions. It is then the board of directors that selects and hires the CEO, CFO and other officers of the company.
The board makes significant business decisions such as corporate asset acquisitions, or selling off divisions of the company.
When electing directors, the shareholders are often faced with questions by prospective board members about what it means to serve on a board, as well as questions from other shareholders about the qualifications and background of the director candidates.
1. Boards serve at the mercy of the shareholders. The right to elect a director to serve on a corporation’s board is tied to the voting power of the shares owned by a shareholder.
The directors elected by any shareholder or group of shareholders are often expected to represent the objectives of their electing shareholders, and share their sensibilities.
If a director is not performing up to the expectations of the shareholders who elected them, the director can be removed from office. A corporation’s strength and viability are often measured by the strength and qualifications of its board of directors.
2. Directors are protected from liability for bad decisions.
Directors of a corporation owe a fiduciary duty to the shareholders of the corporation, which means that the directors must act with the best interest of the shareholders in mind.
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The duties of the directors are outlined specifically within the corporation’s bylaws, but in most cases, the purpose of a corporation and the objective of its directors is to increase the corporation’s value for the benefit of the shareholders.
Director’s decisions are supposed to be made in an attempt to accomplish the goal of increasing shareholder value. But sometimes director’s decisions are wrong, and the corporation can end up losing money, or even going out of business, because of the decisions of the directors.
As long as the director’s actions were taken in a good faith effort to accomplish their duties according to the corporation’s bylaws, directors are shielded from liability for their choices.
Directors may exercise their best good-faith business judgment, and even if that judgment is wrong and the corporation loses money, the directors cannot be sued or held financially liable for those mistakes. This protection is called the business judgment rule.
3. Not all boards of directors are treated equally. Sometimes a limited liability company (LLC) will have a board of directors.
Limited liability companies are very flexible business entities, and as a result of that flexibility, LLCs can operate under any fashion of management structure that the LLC’s members want.
The rules for each LLC’s activities are customized in a document called an operating agreement. Operating agreements of LLCs serve much the same function as bylaws of a corporation.
However, only directors of corporations will automatically benefit from the basic liability protection of the business judgment rule.