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

Executive Compensation
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.

Corporate Governance
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.

SEE: How The Sarbanes-Oxley Era Affected IPOs

Related Articles
  1. Professionals

    The Rich Get Richer: Global Wealth is Rising

    Global wealth is rising and expected to continue. Advisors should know that the wealthy value fee transparency, performance.
  2. Investing Basics

    What is a Public Company?

    A public company has sold stock to the public through an initial public offering (IPO) and that stock is currently traded on a public stock exchange.
  3. Entrepreneurship

    Bill Gates Success Story: Net Worth, Education & Top Quotes

    Learn about billionaire Bill Gates, and how the computer genius forged his own path from an early life and eventually changed the world with his innovation.
  4. Economics

    What Does Human Resources Do?

    Human resources (HR) is the department within a company that handles all matters relating to employment.
  5. Entrepreneurship

    Donald Trump Success Story: Net Worth, Education & Top Quotes

    Discover more about Donald Trump the man. Learn about his history and back story, path to success and current political aspirations.
  6. Entrepreneurship

    Hillary Clinton Success Story: Net Worth, Education & Top Quotes

    Learn about Hillary Clinton's early life in Chicago, her years in Arkansas with her husband, and her time as first lady, senator and secretary of state.
  7. Entrepreneurship

    Mark Zuckerberg Success Story: Net Worth, Education & Top Quotes

    Learn about Mark Zuckerberg, the founder and CEO of Facebook. Understand where he came from and what in his life helped him achieve success.
  8. Entrepreneurship

    Charlie Munger Success Story: Net Worth, Education & Top Quotes

    Learn about Charlie Munger. Understand what drives him, how his early life shaped his later success, how he found that success and what he's doing with it.
  9. Entrepreneurship

    Jim Yong Kim Success Story: Net Worth, Education & Top Quotes

    Learn information about the life and success story of Jim Yong Kim, who rose from humble beginnings to become the head of the World Bank.
  10. Entrepreneurship

    Jim Cramer Success Story: Net Worth, Education & Top Quotes

    Learn about Jim Cramer the man and how he got to be successful. Understand his different levels of success and what he is doing in 2015.
RELATED TERMS
  1. Dividend Payout Ratio

    The percentage of earnings paid to shareholders in dividends. ...
  2. Organizational Behavior - OB

    Organizational Behavior (OB) is the study of the way people interact ...
  3. Outstanding Shares

    A company's stock currently held by all its shareholders, including ...
  4. Board Of Directors - B Of D

    A group of individuals that are elected as, or elected to act ...
  5. Ex Gratia Payment

    A payment made to an individual by an organization, government, ...
  6. Holacracy

    A holacracy is a system of governance where members of a team ...
RELATED FAQS
  1. How do modern companies assess business risk?

    Before a business can assess or mitigate business risk, it must first identify probable or likely risks to its bottom line. ... Read Full Answer >>
  2. Why has emphasis on corporate governance grown in the 21st century?

    Corporate governance refers to operational practices, management protocols, and other governing rules or principles by which ... Read Full Answer >>
  3. What impact did the Sarbanes-Oxley Act have on corporate governance in the United ...

    After a prolonged period of corporate scandals involving large public companies from 2000 to 2002, the Sarbanes-Oxley Act ... Read Full Answer >>
  4. Why should investors research the C-suite executives of a company?

    C-suite executives are essential for creating and enacting overall firm strategy and are therefore an important aspect of ... Read Full Answer >>
  5. What is the difference between a direct and an indirect distribution channel?

    A direct distribution channel is organized and managed by the firm itself. An indirect distribution channel relies on intermediaries ... Read Full Answer >>
  6. What is the difference between the Sarbanes-Oxley Act and the Dodd-Frank Act?

    The Sarbanes-Oxley Act (SOX) was enacted to protect investors from potential fraudulent accounting by companies, whereas ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!