HomeChapter 6: One-Tier Board Attributes in the US6.3 State Level: The Attributes of One-Tier Boards Under State Corporation Laws

6.3 State Level: The Attributes of One-Tier Boards Under State Corporation Laws

While federal and state securities laws focus on the disclosure of the structure and the composition of corporate boards in publicly held corporations, state corporation laws (statutes) provide the regulatory framework that regulates the structure, the composition and the responsibilities of corporate boards of directors. State statutes more or less regulate the minimum size of boards of directors, the minimum number of board meetings and the formation of board committees. Other provisions relate to the nomination, the appointment and the removal of directors, the rights of directors to amend the by-laws of the corporation and to approve certain mergers and consolidations. Some 37 states, excluding the State of Delaware, have adopted sections from the Model Business Corporation Act (MBCA or “Model Act”) to regulate the governance structure of corporations. The Model Act is no corporation law. It is a legal model that has originally been developed by the American Bar Association in 1933. Its main purpose is to guide legislators and other regulators in the development and amendment of state statutes on corporate governance. Its sections become only part of state corporation laws after they have been enacted by state legislators. The Model Act has been revised in June 1984. This version is called the RMBCA. Although no single state has fully adopted either the entire Model Act or the Revised version of 1984, the Model Act is recognized as a codification of modern corporation law in the US (Clarkson et al., 1989).

 

Delaware’s Corporation Laws

Delaware is the “State of Incorporation” in the US due to its tax structure, its rather liberal regulatory framework and its large body of existing case law (Soderquist and Sommer, 1990). The State of Delaware has its own legal system with highly specialized lawyers in corporation laws. The latest figures from Delaware’s Division of Corporations indicate that some 250,000 corporations are incorporated in Delaware. Nearly fifty percent of corporations listed on the NYSE and the American Stock Exchanges, and approximately 58 percent of Fortune 500 corporations, are incorporated in this small state[3]. Like the Model Act, Delaware’s statutes on corporate governance substantially influence corporation laws in other states. For the purpose of this study, both the Model Act and Delaware's statutes are helpful guides to describe the formal organization of one-tier boards in publicly held corporations. The following paragraphs elaborate in more detail on the legalistic aspects of the internal governance structure of publicly held corporations in the US.

          

Articles of Incorporation and By-Laws

The Model Act states that the by-laws of the corporation may contain any provisions related to the regulation and the management of the affairs of the corporation when these are not inconsistent with state corporation laws or inconsistent with the corporation's articles of incorporation. In general, by-laws cover the following subjects:

  • offices of the corporation and shareholders’ meetings;
  • number of directors and their qualifications;
  • number of board meetings;
  • officers;
  • transfer of shares and certificates of shares;
  • corporate seal;
  • fiscal year;
  • procedure for amendment;
  • miscellaneous matters pertaining to the particular corporation.

Source: Grange et al. (1967).

 

Control over the amendment of these internal rules of management in the by-laws rests with the board of directors if this right is not granted to the shareholders by the articles of incorporation[4]. Accordingly, state statutes can almost give the corporate board a “carte blanche” to determine the organization of the board and the powers of the board (Soderquist and Sommer, 1990). This provides a great variety in governance structures in publicly held corporations in the US. According to Baysinger and Butler (1984:562): “State's indifference to prescribing board composition and size has fostered much experimentation and, hence, diversity in the structure and composition of corporate boards.” The corporation's articles of incorporation, the by-laws and boards’ powers to amend the by-laws provide this diversity (Soderquist and Sommer, 1990).Although provisions for directors in by-laws vary considerably among corporations, state corporation laws provide certain minimum requirements that shape the organization and composition of one-tier boards in the US. These requirements refer to directors’ legal duties and responsibilities, the size and the composition of the board, the positions of chair and the CEO, the formation of board committee structures, and the election and removal of directors. These requirements are further explored in the following paragraphs.

          

The Responsibilities of Directors

State corporation laws formally provide a description of board responsibilities. According to ICMG (1995:53), state corporation laws “. . . have in the past provided that the board shall manage the company; increasingly the statutory formulation is that the board shall oversee or monitor the management of the company or that the company shall be managed under the direction of the board.” As such, state corporation laws recognize that corporate boards of directors do have a responsibility to monitor the management of the corporation. According to the American Bar Association (ABA) and The Business Roundtable[5], it is the responsibility of directors “not to manage, but to oversee” the management of the corporation. An inherent problem with this definition lies in the legal responsibilities of both executive and non-executive directors. Corporation law does not provide a distinction between the responsibilities of executive directors to manage the corporation and the responsibilities of non-executive directors to oversee management. The responsibilities of both classes of directors include:

  • approval of fundamental operating, financial, and other corporate plans, strategies, and objectives;
  • evaluation of the performance of the corporation and its senior management;
  • selection, regularly evaluation and determination of the compensation of senior executives;
  • approval and the implementation of senior executive succession plans;
  • adoption of policies of corporate conduct, including compliance with applicable laws and regulations, and the maintenance of accounting, financial, and other controls;
  • review of the process of providing appropriate financial and operational information to decision makers (including board members);
  • selection of board candidates with diverse backgrounds, talents and perspectives who can work effectively together;
  • evaluation of the overall effectiveness of the board and the review of its own structure, governance principles, composition, agenda, process and schedule;
  • provision of advice and counsel to management.

Sources: ABA (1994); The Business Roundtable (1997).

 

The Revised Model Act requires directors to act according to generally accepted standards of conduct. A director is obliged to discharge his duties in good faith, with care and in a manner reasonably to be in the best interests of the corporation. These fiduciary duties are formalized by director's “Duty of Care”[6] and “Duty of Loyalty.” Directors for example need to attend meetings regularly, have a duty to exercise a reasonable amount of supervision and need to be properly informed on corporate matters (Clarkson et al., 1989). The National Association of Corporate Directors (NACD) indicates that these board responsibilities “ . . . are founded in legal imperatives, but . . . [they are, eds.] . . . by no means limited to them. Beyond its duties of loyalty and care on behalf of shareholders, each board has the freedom – and [. . .] the obligation - to define its role and duties in detail” (NACD: 1996:1).

Directors are increasingly exercising responsibilities that go beyond the formal description of the fiduciary duties in the Model Act (see also box 6.1). The expanding role of US-corporate boards beyond its duties of care and loyalty is reflected by a 1993 survey among 495 corporate secretaries (The Conference Board, 1996). The study found that boards spend some 25 percent of their meeting time on strategy (setting corporate objectives, determining resource allocation and strategic direction). Another study also indicates an expanding role for directors in the strategic course of corporations (The Conference Board, 1977).

Box 6.1

The NACD on Board Professionalism

 

“A professional boardroom culture requires that the governance process be collectively determined by individual board members who:

  • are independent of management;
  • are persons of integrity and diligence who make the necessary commitment of time and energy;
  • recognize that the board has a function independent of management and explicitly agree on that function, and;
  • are capable of performing that function as a group, combining diverse skills, perspectives, and experiences.”

Source: NACD Blue Ribbon Commission on Director Professionalism (1996:vii).

 

A total of 60 percent of participating directors and senior executives indicates that their boards devote more meeting time to strategy discussion compared to the 1993 survey[7]. A majority of 51 percent of the participating corporations also indicated that the board has a greater role in strategy formulation. The 1995 NACD/Deloitte and Touche LLP Corporate Governance Survey indicates a similar development. Compared to a NACD 1992 survey, the 1995 survey showed: “In 1992, over one-third of CEOs described their boards - in extreme terms - as ‘passive’ or ‘captive’ on the one hand, or as ‘micro-managing’ on the other. In 1995, only one in ten used these descriptions; the great majority called their boards ‘proactive’ or monitoring’ ” (NACD/Deloitte and Touche LLP, 1995:1)[8].

 

The Independence of Directors

State corporation laws do not specify the degree of independence a director should have from a corporation[9]. Yet, the certificate of incorporation or by-laws of the corporation may prescribe qualifications of directors related to the type of business relationships directors can have with the corporation[10]. The Corporate Director’s Guidebook provides the following definition of board independence:

“As a general rule a director will be viewed as independent only if he or she is a non-management director free of any material business or professional relationship with the corporation or its management. The circumstances and various relationships that have been often identified as presumptively inconsistent with independence include a close family or similar relationship with a member of key management; any business or professional relationship with the corporation that is material to the corporation or the director; and any ongoing business or professional relationship with the corporation, whether or not material in an economic sense, that involves continued dealings with management, such as the relationship between a corporation and investment bankers or corporate counsel” (ABA, 1994:1258).

The American Law Institute's (ALI) definition of directors’ independence is similar to the American Bar Association’s (ABA) definition. The ALI identifies that an independent relationship exists between directors and the corporation when, e.g., the director has not been employed by the corporation, when directors are not immediate family of executive officers of the corporation and when directors have not received more than USD 200,000 in commercial payments from the corporation during two years prior to an appointment. Affiliations with law firms and investment banking firms are considered to influence the relationship directors have with a corporation (ALI, 1992). See also paragraph 6.4.5 in this chapter for the NYSE rules on director independence and the composition of audit committees.

 

Board Responsibilities and the Business Judgement Rule

Directors are protected by the Business Judgement Rule from liabilities if they have acted in good faith and have acted in what they consider to be in the best interests of the company. The Business Judgement Rule “immunizes” directors and officers from liabilities “. . . when a decision is made within managerial authority, as long as the decision complies with management’s fiduciary duties . . . and as long as acting on the decision is within the powers of the corporation” (Clarkson et al., 1989:725). Other means to protect directors from costs associated with liabilities are officers and directors’ liability insurance and the possibility to include provisions in the by-laws that indemnify directors against most litigation expenses and liabilities (ICMG, 1995).

 

6.3.1    Board Size

The Model Act states that all corporate powers shall be exercised by or under the authority of a board of directors unless the articles of incorporation determine otherwise. Although a board of directors is a requisite in most of states, the size of the board is not directly regulated by state statutes. The Model Act and Delaware's corporation laws require only a minimum of one director (Varallo and Dreisbach, 1996b). The certificate of incorporation of the corporation sets the initial size of the board. The articles of incorporation may determine a minimum or maximum quorum of directors. The by-laws of the corporation finally prescribe the exact number of directors.

 

6.3.2    About Board Composition

The Model Act indicates that directors are not required to be residents of the state of incorporation. Directors also do not need to be a shareholder of the corporation and do not need to be independent of management. As such, state corporation laws do not provide requirements with respect to how the board of directors should be constituted (ICMG, 1995). Only a handful of states require a minimum age of directors (Clarkson et al., 1989). As with the size of the board, the Model Act and state statutes give corporations the freedom to prescribe qualifications for directors in the articles of incorporation and the by-laws of the corporation.

          

The Election of Directors and Classified Boards of Directors

Directors are elected by a majority vote of shareholders at the annual shareholders’ meeting. State statutes may provide the formation of a “staggered” board of directors when the board consists of nine or more members. A staggered board exists of several classes of directors who each serve for a two- or three-year term. Each year, only one class of directors is re-elected or replaced by new candidates at the general meeting of shareholders.

 

Box 6.2

The Appointment of Directors

 

“In the typical American company, the board of directors must be elected by the shareholders. Generally, in publicly held companies, nominees for the board are formally proposed for election by the board of directors (in a company with a nomination committee of the board, the committee will recommend the nominees to the full board, which will in turn recommend their election by shareholders). The reality is that the CEO of a publicly held company still frequently proposes new members for the board, after which the nominating committee and/or board will simply endorse his/her choice. However, nominating committees in many companies are playing a more decisive role in searching for and nominating directors, and it is expected that this trend will continue.”

Source: ICMG (1995:55).

 

According to Varallo and Dreisbach (1996b), staggered boards are widely used as anti-takeover devices. Staggered boards are also used to discourage proxy contests. Investors who seek control over the corporation through changes in the composition of the board are confronted with a protective shield when a board is divided into classes. On the other hand, staggered boards may provide stability in the composition of corporate boards because abrupt changes are less likely to occur. Second-tier regulatory agencies under SEC jurisdiction may include provisions related to board classes. The NYSE for example permits corporations to form a board with a maximum of three classes as part of its listing requirements (NYSE Listed Company Manual, section 304.00). These classes should be of approximately equal size and tenure. The NYSE listing rules also dictate that directors’ term of office should not exceed three years in classified boards.

The Removal of Directors

As stated in the by-laws or the articles of association, shareholders have the inherent right to remove directors “for cause” (breach of duty or misconduct) by a majority vote at the general meeting of shareholders. The articles of incorporation can also grant rights to shareholders' meetings to remove a director at any time “without cause” by a majority vote. Directors can also be held liable for breach of their fiduciary duties. Cases dealing with such violations typically involve directors in:

  • competing with the corporation;
  • usurping a corporate entity;
  • having an interest that conflicts with the interests of the corporation;
  • engaging in insider trading;
  • authorizing some corporate transaction that is detrimental to minority shareholders;
  • selling control over the corporation.

Source: Clarkson et al. (1989).

 
6.3.3    About Board Leadership Structures

Delaware’s corporation laws provide the so-called “integration of offices.” This means that one natural person can combine the positions of director, president, treasurer and secretary. The Model Act also allows officers or directors to hold multiple offices[11]. In this provision lies the legal foundation of the combination of the positions of chairman and CEO of the board (CEO-duality) in the US. According to the Corporate Director’s Guidebook (ABA, 1994), the discussion on board leadership in the US has resulted to several suggestions to improve the independence of the board and to strengthen the role of non-executive directors. Proposals include the separation of CEO and the chair and the designation of independent lead directors to boards of directors. Bagley and Koppes (1997) recently proposed an amendment to the NYSE and NASDAQ/NMS listing rules.

The authors suggest that corporations should be required to disclose whether there is an independent chair and whether or not the board has designated a senior independent lead director. Accordingly, “the use of the listing requirements as an instrument for change provides a practical and easy way to promote the consideration by publicly traded companies of board leadership structure and methods for improving it, without requiring the SEC to amend its proxy rules or states to amend their corporation laws” (Bagley and Koppes, 1997:153). According to this proposal, the board would be required to explain why it is in the best interest for the corporation to support the integration of chairman and CEO roles and why the board has decided not to appoint a lead director to the board of directors. These aspects of board independence are discussed in more detail in paragraph 6.4.

 

6.3.4    About Board Committees

In general, state corporation laws do not require corporations to designate directors to board committees. Yet, the Model Act provides the possibility that the full board of directors may designate from its members an executive committee and other special committees. Delaware’s General Corporation Law also provides the possibility that boards can designate directors to board committees by majority vote. The Model Act and Delaware’s statutes restrict the permissible activity of committees. Some corporate actions may not be delegated to board committees.

Board committees can not:

  • initiate amendments to the certificate of incorporation;
  • amend the by-laws of the corporation;
  • designate candidates for the office of director for the purpose of proxy solicitation or otherwise, or fill vacancies on the board of directors or any committee thereof;
  • authorize the distribution of dividends;
  • adopt an agreement of merger or consolidation;
  • perform transactions outside the “ordinary course of business” like major capital transactions and entry into new lines of business.

Source: Clarkson et al. (1989).

 

6.3.5    Summary

State corporation laws (statutes) provide the regulatory framework that regulates the governance structure of corporations. A majority of states have based the statutes on the Model Act and Delaware’s corporation laws. As such, the Model Act and Delaware’s corporation laws substantially influence general state corporation law in the US. Most states require corporations to have a board of directors. Yet, the articles of incorporation and the by-laws can provide much diversity in the structure and composition of corporate boards. Control over the amendment of the internal rules of management in the by-laws can rest with the board. This gives corporate boards much power to determine its responsibilities, size, composition and structure. Although provisions for directors in by-laws vary considerably among corporations, state corporation laws provide minimum requirements that shape the composition and the organization of one-tier boards. These focus on three distinctive attributes of one-tier boards in the US: (1) board size and composition, (2) board leadership structures and (3) board committees.

Board Size and Composition Most state corporation laws are indifferent to the size and the composition of the board. A board can be composed entirely of executive directors or - for example - can be composed of a majority of non-executive directors. The Model Act and Delaware’s corporation laws require a minimum of one director. Only a handful of states require a minimum age of directors. State statutes give corporations the freedom to prescribe qualifications for directors in the articles of incorporation and the by-laws of the corporation. Directors are elected by a majority vote of shareholders at the annual shareholders’ meeting.

Board Leadership Structure Corporation laws do not make a distinction between the fiduciary duties of executive and non-executive directors. Directors can combine executive and non-executive positions such as those of the CEO, the president and the chairman of the board.

Board Committees Boards of directors are authorized to establish board committees by majority vote of the board. State statutes only restrict the permissible function and activities of board committees. Committees - for example - are not authorized to initiate amendments to the certificate of incorporation and to alter the by-laws of the corporation.


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Maassen, G.F. (2002). An International Comparison of Corporate Governance Models. A Study on the Formal Independence and Convergence of One-Tier and Two-Tier Corporate Boards of Directors in the United States of America, the United Kingdom and the Netherlands.

Maassen, G.F. (2002). An International Comparison of Corporate Governance Models. A Study on the Formal Independence and Convergence of One-Tier and Two-Tier Corporate Boards of Directors in the United States of America, the United Kingdom and the Netherlands. Amsterdam: Spencer Stuart Executive Search.