The board structure of a corporation is critical to aligning the incentives between principles and agents, or board members and stakeholders. Thus, the perfect structure of a corporation should include governance mechanisms that mold the behavior of board members to align the behaviors with the interests of stakeholders, reduce the problem of information asymmetry that enables board members to mislead stakeholders, and institute mechanisms that hold agents who fail to act in the interest of stakeholders accountable.
The composition of the board of directors is the first component of the corporate governance system that must be modified in achieving the three outlined goals. Because board members are directly elected by the stockholders of the company, the structure of the board must ensure that board members possess an incentive to act on behalf of the stockholders and fully share pertinent information with stakeholders. The first structural feature of the ideal board is that it will be divided in composition between inside and outside directors. As the ASX Corporate Governance Council recommends, the majority of boards should be independent directors in order to obtain neutrality during the oversight process (ASX Corporate Governance Council 16). Thus, the ideal composition should consist of 70 percent outside directors and 30 percent inside directors. Inside directors include senior employees who bring critical information on the company’s performance and activities. Outside directors are board members who are not employees of the company and who might be professional directors who serve on the board of several companies.
The appointment of the chair is another critical factor that contributes to the success of the Board of Directors. The positions of chairman and CEO should be kept separate in order to limit the control of the CEO over the board. Both inside and outside directors may serve on committees that facilitate board functions, including auditing committees, governance and nominating committees, compensation committees, and evaluation committees. In selecting the board committees, effort should be taken to ensure that the nominating committee consists of neutral parties. The nominating committee serves a vital function by providing an efficient mechanism for selecting suitable candidates for directors (ASX Corporate Governance Council 19). According to guidelines, an effective nominating committee should have at least three members and be chaired by an independent director (ASX Corporate Governance Council 19). By ensuring that sensitive committee positions are filled by independent directors, the board structure will promote the interests of shareholders by eliminating conflicts of interest that undermine oversight.
The benefit of a board divided between inside and outside directors is that the board will be able to obtain the inside information that it needs from employees of the company to perform its monitoring responsibilities while obtaining the reservation and objectivity of outside directors. Further, professional directors possess expertise in corporate governance that is necessary to efficiently monitor corporate activities. However, it is important to have a balance to ensure that the board does not have the appearance of being “taken over” by outside entities. By separating the CEO and chairman function, the structure prevents the CEO from taking actions that might deflect criticism of the company or his or her own performance.
ASX Corporate Governance Council. Corporate Governance Principles and Recommendations with 2010 Amendments. 2nd ed. 2007. Web. 25 Mar. 2014.