All public corporations in the United States are required to have a board of directors that is tasked with the oversight of corporate activities and protects the interests of the company's shareholders. The board is headed by a chairman, who has influence over the direction of the board. In many companies, the chief executive officer (CEO), who holds the top management position in the company, also serves as chairman of the board. This is often the case with companies that have grown rapidly and still retain the initial founder in those roles.
The issue of whether holding both roles reduces the effectiveness of the board is a hot topic and often rears its head at shareholder meetings. There are good reasons to separate the two positions in order to strengthen the overall integrity of the company.
SEE: The Basics Of Corporate Structure
One of the events that gets the most attention from a company's shareholders is an increase in executive pay. Increases come at the expense of shareholder profits, although most understand that competitive pay helps to keep talent in the business. However, it is the board of directors that votes to increase executive pay. When the CEO is also the chairman, a conflict of interest arises, as the CEO is voting on his or her own compensation. Although a board is required by legislation to have some members who are independent of management, the chair can influence the activities of the board, which allows for abuse of the chair position.
One of the board's main roles is to monitor the operations of the company and to ensure that it is being run in conjunction with the mandate of the company and the will of the shareholders. As the CEO is the management position responsible for driving those operations, having a combined role results in monitoring oneself, once again opening the door for abuse of the position. A board led by an independent chair is more likely to identify and monitor areas of the company that are drifting from its mandate and to put into place corrective measures to get it back on track.
Audit Committee Independence
In 2002, the Sarbanes-Oxley Act, legislated as a response to several high-profile corporate failures, set out stronger regulations for corporate oversight, including a requirement that the audit committee consist of only external board members. This means that no member of management can sit on the audit committee. However, because the committee is a sub-group of the board of directors and reports to the chair, having the CEO in the chair role limits the effectiveness of the committee.
This is especially true for the whistleblower clause. Sarbanes-Oxley requires that the audit committee puts in place a procedure where employees and other connected individuals can report fraud and other abuse directly to the committee without reprisal. When the board is led by management, employees may be less likely to report such activities and the audit committee may be less likely to act on such reports.
The Bottom Line
The relationship between a company's management and board of directors continues to be an important topic for both shareholders and regulators. Any future corporate failures linked to this lack of segregation of duties will heighten the conversation and may lead to even stricter legislation in the future.