DEFINITION of Inside Director
An inside director is a board member who is an employee, officer or direct stakeholder in the company. Inside directors and outside directors both have a fiduciary duty to the company of the board they sit on. They are expected to always act in the best interests of the company. Because of their specialized knowledge about the inner workings of the company, inside directors can be a key element in a company’s success.
BREAKING DOWN Inside Director
Inside directors typically include a company's top executives, such as the chief operating officer (COO), the chief financial officer (CFO) and the chief operating officer (COO), as well as representatives of major shareholders, lenders, and additional stakeholders, such as labor unions.
An institutional investor who is considering making a sizable investment in a company will often insist on appointing one or more representatives to the company's board of directors.
Inside Director and Outside Director
Inside directors and outside directors help balance each other on a company’s board. An outside director (also referred to as a non-executive director), is not an employee or stakeholder in the company. Outside directors receive an annual retainer fee in the form of cash, benefits and/or stock options, while inside directors do not.
Public companies are required, from a corporate governance perspective, to have a certain number or percentage of outside directors on their boards. In theory, outside directors are more likely to provide unbiased opinions.
In addition, they can bring in external expertise. A downside of outside directors is that they may have less information upon which to base certain decisions since they are removed from the day-to-day operations of the company. Also, outside directors risk facing out-of-pocket liability if a judgment or settlement occurs that the company and/or its insurance policy does not fully cover.
Inside Directors and Conflicts of Interest
Strict rules apply to inside directors with regards to securities trading. Since inside directors have access to classified company information (also called insider information), they cannot trade on material information that is not public.
For example, if an inside director knows that the company is about to change CEOs and senses this will highlight a significant weakness in the company’s management structure, which could subsequently lead to a decline in share price when divulged, the director may not sell or short company shares prior to the announcement being made. This would be a case of insider trading that is punishable up to several years in prison, along with hefty financial fines, depending on the gravity of the case and how much the public is affected.