The average shareholder, who is typically not involved in the day-to-day operations of the company, relies on several parties to protect and further his or her interests. These parties include the company's employees, its executives and its board of directors. However, each one of these parties has its own interests, which may conflict with those of the shareholder.
The board of directors is elected by the shareholders of a corporation to oversee and govern management and to make corporate decisions on their behalf. As a result, the board is directly responsible for protecting and managing shareholders' interests in the company.
For a board of directors to be truly effective, it needs to be objective and proactive in its policies and dealings with management. This helps to ensure that management is generating shareholder value. A more objective board of directors, or one that is separate from a company's management, is more likely to promote or protect the interests of the company's shareholders. For example, a board of directors made up entirely or primarily of management would clearly be hampered by conflicts of interest, and the preservation of shareholder value might not be a priority.
Another factor that has an impact on the effectiveness of a board of directors is compensation. Adequately compensating board members for their work is one way to ensure that they will make every effort to promote and protect investor interests. The members of a board of directors are paid in cash and/or stock. Likewise, management and employees also need to be aligned with investors and this can be achieved through the compensation that both groups receive. This may include making both parties owners (investors) in the company. When management and employees are also shareholders, they will be motivated to protect shareholder interests as their own. This helps to protect a company from mismanagement and weak employee productivity. Also, a bonus targeting system can be used in which employees and managers receive bonuses when certain goals are met. Such strategies help to align the interests of employees and management with those of investors.
If these groups are not aligned with the interests of investors, major problems can arise and destroy shareholder value. Although the average shareholder does not have control over the board of directors or the day-to-day operations of the company, the ultimate responsibility for the protection of shareholder value lies with each individual investor. The investor is ultimately responsible for reviewing corporate policy and governance as well as for the compensation of managers. Investors who feel that a company does not show an adequate level of commitment to shareholders can always sell their investment.
For additional reading, see Governance Pays, The Basics Of Corporate Structure and Knowing Your Rights As A Shareholder.