Effective governance is critical to the success of any organization, regardless of its size, type, or mission. Today’s boards face an increasingly complex range of issues and challenges, from cybersecurity threats and global pandemics to societal and environmental pressures.
Despite the complexity and range of issues that today’s boards are facing, the basic principles of governance continue to provide the best guideposts:
- Engaged oversight
- Informed decision-making
- Conflict-free business judgments
- A balance of competing interests to promote the overall best interests of the organization and sustainable long-term growth in value
Let’s review the core responsibilities of directors and their directorial fiduciary duties.
Key responsibilities of boards of directors
Directors are responsible for acting in the best interests of the organization/corporation and its constituents/shareholders. To do so, directors must focus on delivering the mission to stakeholders while maximizing the corporation’s value for it’s shareholders’ benefit.
Directors fulfill this responsibility through two primary board functions: Decision-making and oversight. The board’s decision-making function generally involves considering and approving policy and strategic goals. They also take specific actions such as evaluating and selecting top management, approving major expenditures and transactions, and acquiring or disposing of material assets.
The board’s oversight function involves monitoring the organization’s business affairs, including financial performance, management performance, compliance with legal obligations and corporate policies, and evaluating and designing appropriate risk management structures.
Both functions require that directors understand the organization’s business and the environment in which it operates, including the risks and opportunities it faces and management’s capability to run the business while managing risks. While the board oversees corporate affairs, it delegates responsibility for day-to-day operations to management. Directors must oversee the organization’s activities effectively and make informed decisions without usurping management’s role. The phrase “nose in fingers out” applies here.
Three fiduciary duties of boards of directors
The board of directors has three primary fiduciary duties to shareholders and stakeholders: Duty of care, duty of loyalty, and duty of obedience.
These fiduciary duties apply to all types of organizations.
Duty of care
The duty of care is a core responsibility of the board of directors, requiring diligent oversight of the organization’s affairs. The director’s role is to take care of the organization by ensuring the prudent use of all assets, including facility, people, and goodwill.
Directors must carry out their responsibilities in good faith and in a manner they reasonably believe is in the organization’s best interests. They must act with the prudence and care that a reasonable person in like circumstances would.
Directors must do their homework, reviewing and understanding the information provided by management, outside experts, and other relevant parties. They must insist upon adequate information, be informed and prepared, and rely on management and outside experts while asking questions and exercising appropriate skepticism.
Directors also must insist on adequate information from management. If they do not think they have enough information to make a decision, they must ask management to provide additional data or analysis. Being informed and prepared is essential to fulfilling the duty of care obligation, as it ensures that directors make decisions based on a full understanding of the situation.
In addition, directors should rely upon management and outside experts as appropriate. They should seek advice and expertise from individuals who can help them make informed decisions. However, they must also ask questions and exercise appropriate skepticism. They should inquire into areas of concern that seem to merit particular attention and spend the time in consideration and deliberation mandated by the issue.
Finally, the importance of process cannot be overstated. Through the board minures, directors should have a record of their decision-making process, including the information considered, questions asked, and rationale for their decision. This helps ensure that the decision-making process is transparent and defensible, and it helps protect directors from liability in legal action.
Duty of loyalty
Directors have a duty to act in the organization’s best interests, which requires avoiding conflicts of interest. Personal financial interests or other matters should not interfere with furthering the organization’s goals. The most obvious concern involves “interested” transactions, where a director’s personal interests may diverge from those of the organization. For example, when a director engages in commercial relations with the organization, invests in a competing enterprise, or seeks to invest in or acquire the organization.
It’s important to note that conflict of interest transactions are not inherently improper, and can be entirely appropriate. State corporate law mechanisms have been developed to deal with such situations with full disclosure and approval by a disinterested group as key touchstones. Special or independent committees can be designed to facilitate arm’s length negotiations and provide independent advice.
The directors must ensure that the organization’s activities and transactions are, first and foremost, advancing the mission and that they are making decisions that are in the best interest of the organization—not in the best interest of the individual director or any other individual or entity.
By avoiding conflicts of interest and following established protocols for interested transactions, directors can fulfill their duty of loyalty to the organization and promote its overall best interests.
It’s essential to prioritize the organization’s goals over personal financial interests or other concerns, maintaining integrity and transparency in all dealings.
Duty of obedience
Directors play a crucial role in ensuring that organizations comply with applicable laws and regulations, adhere to their stated mission, and follow their by-laws. This duty of obedience is critical to effective governance, ensuring that the organization operates with integrity and accountability.
In addition to the duty of obedience, directors must also fulfill other important duties. The duty of candor and disclosure requires directors to provide full and accurate information to the board and other stakeholders. The duty to account requires them to oversee the organization’s financial reporting and ensure that funds are used appropriately.
Directors also have a duty of confidentiality, which requires them to safeguard sensitive information and use discretion in their communications. Finally, duties may be imposed under specific statutory or regulatory regimes, such as those governing data privacy or environmental protection.
By fulfilling these duties, directors can help ensure that the organization operates with transparency, accountability, and compliance with applicable laws and regulations. By prioritizing the organization’s mission and following established protocols for governance, directors can promote sustainable long-term growth in value and support the overall best interests of the organization.
Responsibilities beyond legal duties
The board of directors does not exist solely to fulfill legal duties and be the fiduciary of the organization’s assets. Board members also play very significant roles in guiding organizations by contributing to the organization’s culture, strategic focus, effectiveness, and financial sustainability, as well as serving as ambassadors and advocates. Beyond fulfilling legal duties, board members are important resources for the organization in multiple ways.
One of the most important responsibilities for many boards is to hire and set the compensation of a talented CEO/executive director to run the day-to-day management activities of the organization and then supervise and evaluate the CEO. Board members provide foresight, oversight, and insight rather than steering the boat in managing the day-to-day operations.
Prioritizing effective governance for sustainable business practices
Effective governance is critical to the success and sustainability of any organization. The core principles of governance–engaged oversight, informed decision-making, and conflict-free business judgments—provide guideposts for boards of directors as they navigate complex issues and fulfill their duties to the organization. From discharging oversight responsibilities to ensuring compliance with applicable laws and regulations, directors must act with integrity, accountability, and transparency, prioritizing the organization’s mission and promoting long-term growth in value.
By adhering to established protocols for governance and fulfilling their duties with diligence and care, directors can help ensure the organization’s success and promote sustainable, responsible business practices.
Contact Scheid Investment Group today for experienced board advice and governance consulting.