Functions And Powers Of Directors

• Author: James D. Cox/Thomas Lee Hazen
• Profession: Professor of Law at Duke University/Professor of Law at the University of North Carolina, Chapel Hill
• Pages: 116-158

9.16 Limitations on Delegation of Board

Powers to Commit tee s

9.17 Responsibility of Noncommittee

Directors for Committee Actions

9.18 Management Agreements and Other

Corporate Contracts Delegating Control

9.20 Long-Term Employ ment Contracts

§ 9.1 The Traditional Pattern of

Corporate Governance

The traditional corporate pattern is triangu lar, with the shareholders at

the base. The shareholders, who are generally viewed as the ultimate or

residual owners of the business, select the personnel at the next level—

namely, the board of directors. According to accepted wisdom, t he

board of directors appoints the chief executive officer and other corpo-

rate officers, determines corporate policies, oversees the officers’ work,

and in general manages the corporation or supervises the management

of its affairs. The directors’ control of a corporation is limited by statu-

tory require ments that sha reholder approval b e obtained for fundamen-

tal corporate acts such as charter amendments, consolidations, mergers,

voluntary dissolution, and sale or lease of all or substantially all corpo-

rate assets.

The principal corporate officers, or executives, are at the top of the

corporate triangle. These off icers execute policies that supposedly have

been fixed by the board of directors. The corporation’s executives and

operating management are said to derive their authority and legitimacy

from the board.1

Directors are elected by shareholders. Election of directors t ra-

ditionally has been by a plura lity vote. However, in recent years, an

increasing number of corporations are requiring a majority of affirma-

tive votes to elect a director.2 In 2006, Delaware amended its corpo-

rate law to allow a shareholder-adopted bylaw (not subject to repeal or

amendment by the board) to proscribe the met hod of director selection.3

Other states also permit majority election requirements. Directors cus-

tomarily serve an nual terms, though modern statutes permit staggered

three-year terms.

116 | C  C G: C  L

cox85509_09_c09_p115-158.indd 116cox85509_09_c09_p115-158.indd 116 6/28/12 9:14 AM6/28/12 9:14 AM

In legal theory, the directors are supreme during their term of

office. As will be examined later in this chapter, many modern statutes

empower shareholders to remove directors at any time with or with-

out cause4 and, even in the absence of such a statute, removal power

may be conferred on the shareholders by the corporation’s charter or

bylaws. The power of the removal is not the only mechanism for assur-

ing accountability to t he company’s owners. Other forces at play here

are the demands of product markets, reputational considerations, a nd

changes in control either through a tender offer or proxy solicitation.

Majority rule is the traditional governing pr inciple, and the holders

of a majority of the voting shares cert ainly have the ulti mate power to

control the corporation.5 The holders of a majority of the voting shares

elect the di rectors, or most of them.6 A nd as can be expected, the board

of directors usual ly acts by majority vote of directors present and voting.

§ 9.2 Continuing Efforts to Strengthen

the Monitoring Role of the

Board of Directors

How and why corporate governance has evolved for the public cor-

poration in the United States are best illustrated by the contrasting

approaches in two leading decisions in Delaware. I n a 1963 decision, t he

Delaware Supreme Court in Graham v. Allis- Chalmers Manufacturing

Co.,7 dismissed a derivative action against t he directors of a large pub-

licly held corporation that sought to recover from the directors losses

the corporation suffered as a consequence of illegal price fixing by sub-

ordinates in one of the numerous divisions within the highly decen-

tralized ma nagement structure of the large public corporation. The

plaintiff arg ued the directors were remiss in not installing surveilla nce

and compliance programs t hat would have prevented the antitrust viola-

tion. The court dismissed the action, reasoning that “absent cause for

suspicion there is no duty upon the directors to install and operate a

corporate system of espionage to ferret out wrongdoing which t hey have

no reason to suspect exists.”8

Ten years later, in Stone v. Ritter, the Delaware Supreme Court

expressly approved the standard ar ticulated by the Court of Chancer y in

an earlier decision.9 Under Delaware law, directors incur personal l iabil-

ity for failing to d ischarge their oversight responsibilities if they utterly

Functions an d Powers of Directors | 117

cox85509_09_c09_p115-158.indd 117cox85509_09_c09_p115-158.indd 117 6/28/12 9:14 AM6/28/12 9:14 AM

failed to implement any reporting information system or controls, or if

they implemented a system but consciously failed to monitor or oversee

its operations.

The contrasting approaches illustrate the movement from the view

that the board of directors is a “super management” body that reviews

and approves corporate strategies to today’s widely held view that the

board’s essential function is to monitor the officer’s stewardship. That

movement did not occur without intense debate. It is a debate that con-

tinues to inform t he expectations, and hence, demands placed upon the

modern board of directors.

The heyday for calls for reform was the 1970s. Studies of the com-

position of boards and how directors disch arged their tasks documented

serious weaknesses in the operation of the board. Studies revealed that

in most public corporations the executive officers carried out most of

the funct ions that were commonly thought to be initiated by the board.

Officers set the cor poration’s goals , develop plans for their achievement,

allocate the company’s resources, and make important policy decisions,

including the selection of their successors and nominees to the board.

Between the 1960s and the mid-1980s, a tremendous change in

the composition of the America n boardroom occurred. W here in 1960

approximately 63 percent of the corporations could report that a majorit y

of their directors were outsiders, by 1989 the percentage had climbed to

86 percent. More generally, the trend that began three decades ago has

resulted in (1) boards of directors of publicly held corporations having a

higher percentage of independent outside directors; (2) independent out-

side directors now serve on key commit tees and on some committees, for

example audit and compensation committees, are a majority; (3) director

fees have generally increased over time; (4) outside directors are devoti ng

more time to corporate affai rs; (5) there is evidence that outside directors

are developing greater expertise in t he work of the committees on which

they serve; and (6) independent outside directors are more engaged in

determining polic y and monitoring the performance of executives.

Through most of the 1980s, the major forum, a nd even focal point, of

debate on corporate governance was not the epic tales that were to be told

in the heyday of takeover contests, but rather the A merican Law Insti-

tute’s Corporate Governance Project. Historically, the ALI produced

thoughtful rest atements of the law whose black letter law and supporting

commentary nurt ured efforts for g reater uniformity a mong the states,

118 | C  C G: C  L

cox85509_09_c09_p115-158.indd 118cox85509_09_c09_p115-158.indd 118 6/28/12 9:14 AM6/28/12 9:14 AM