Chapter 6 Quiz

The founders of X Corp. are interested in bringing in the best qualified directors. To do so they need to immunize these individuals of personal liability as much as possible. Which of the following will help X Corp. achieve this goal:

- Amend the articles of incorporation to abolish a director's duty of care liability - Provide director's and officer's (D&O) liability insurance - Incorporate in Delaware which offers the business judgement rule

An effective board:

- Can be a valuable asset to a young company - Brings together people with a variety of strengths and skills - Gives independent, informed advice to management and the CEO

Compensation of board members

- Compensation (and perks/benefits) is usually quite high considering how much time is spent by most directors. - Some will argue (our text in this course) that the amount is nominal. - Board work for a private-company board that meets quarterly is only about eight working days each year. - If board compensation was set at 2% of the CEO's salary - be wary the use of percentages is often misleading - 2% of $100,000 is only $2,000, while 2% of $10 million is $200,000 for 8 days of work. - Many directors are hired for their influence with politicians or because they are an elected official, and their salaries are often in the hundreds of thousands for 8 days of work. - Many companies compensate directors with equity in the company.

Legally the directors are fiduciaries and they owe the corporation a:

- Duty of loyalty - Duty of care - Duty of good faith

All of the following should be included in the information provided to directors during meetings, except:

- General statistics od the company's overall performance - Long-term trends related to financial performance - Research and development plans

John and Susan are both engineers who have started a company and are now looking for additional board members to round out the team and advise them, particularly in matters that are important as the company enters its growth phase. Board members with the following traits would be good choices:

- Industry experience - Financial and marketing expertise - Technical knowhow

The Key function of the board is to develop and periodically reevaluate the company's

- Long-term strategic plan - Operational implementation of the plan - Keeping in mind the mission, purpose, and performance. - The CEO's performance

Limits of Liability & Indemnification

- Many states permit the certificate of incorporation to limit or abolish a director's liability for a breach of duty of care, except for clear cases of bad faith, willful misconduct, or fraud. - Many companies reduce the liability a director faces by providing in the corporate charter and bylaws for both indemnification and the advancement of expenses. - Corporations also often enter into agreements that provide for the advancing of legal fees should a director be sued.

The board of Y Corp. is comprised of inside directors and they cannot have a disinterested vote on an important matter. To immunize themselves from fiduciary liability as much as possible they should ensure that:

- The directors are all informed - They have access to independent advice - The transaction is fair to the company and all shareholders

Duty of Care and Oversight

- The duty of care requires board members to act with the level of care that a reasonably prudent person would use under similar circumstances. - General corporation law authorizes directors to rely on reports prepared by officers of the corporation or outside experts, but not purely passive reliance on these reports. - Duty of Oversight - Directors must use their best efforts to ensure that adequate procedures are in place to prevent violations of law. - Directors are not required to search out malfeasance, but they can not ignore signs of impropriety.

Duty of loyalty & good faith

- To satisfy the duty of loyalty, directors must subjugate their personal interests, financial and professional, to the interests of the corporation. - In determining whether a board of directors is sufficiently disinterested in a decision, a relevant factor in some jurisdictions is whether a majority of the board members are outside directors. - If a transaction approved only by interested directors is challenged, the burden of proof is on them to show that the transaction was fair. - Directors may not passively stand by when they become aware of potentially troubling developments.

Business Judgment Rule

- a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company - Protects directors from having their business decisions second-guessed. - This rule requires the plaintiff to prove that the directors were grossly negligent or acted in bad faith before liability for breach of the duty of care will attach. - This protects directors from being liable merely for poor decisions.

Directors are fiduciaries that owe...

- duty of loyalty - duty of care - duty to act in good faith - duty to disclose all material info within the board's control when seeking shareholder action

What will bette equip the CEO to choose a board?

- evaluating the resources the company currently controls - anticipating its needs

2 major aspects to consider regarding board members

- functional skills of members - mix of personalities and diversity of perspectives

In what kind of companies do boards meet monthly?

- large companies -Venture-capital-backed private company

Benefits of an independent board

- provide a set of complementary skills for CEO - someone the CEO can trust - lend an air of credibility to the venture

Directors should...

- set the ceos compensation - review their own performance as well

Once a company is fully operational, most CEOs find that a good, manageable board size is comprised of:

5-7 directors

Boards are often

5-7 members

If the founders dislike criticism and having their leadership abilities questioned, the board will most likely consist of:

Agreeable family members and personal friends

A corporation is legally required to have a ________ to protect the interests of the corporation and its equity holders.

Board of directors

Many believe that it is often desirable to separate the roles of...?

CEO and chair

The board of Z Corp. wants to include key performance indicators to evaluate the CEO's performance. All of the following are key performance indicators, except:

CEO compensation

Felipe is considering nominating an individual to join the board of his company. Andrea is soft-spoken and shy. Barbara is strong-willed, voices her opinion and often dominates meetings by silencing others. Charles is a long-time friend of Felipe's and would rarely ever challenge him. David is a good listener, offers experience that the company currently lacks and has no problem challenging others in a respectful manner. Felipe's best choice is:

David

The directors of Z Corp. have ignored the warnings and citations issued to the company by a government regulator for several years. Even though the company has eliminated director liability for violating the duty of care, the directors may be liable for breaching the:

Duty of care and oversight

The directors of XYZ Corp. rely passively on the expert opinion of investment bankers to decide if the company's sale price is adequate. The situation called for greater inquiry and active involvement of the board to determine if the price was appropriate. The board in this case is subject to:

Duty of care liability

If a director usurps an opportunity that is in the corporation's lines of business for themselves without first disclosing the opportunity to other board members and obtaining permission to pursue it, the director will violate the:

Duty of loyalty

If directors fail to use their best efforts to ensure that adequate procedures are in place to prevent violations of law they could be liable for violating their:

Duty of oversight

The investors of WSF Corp. want to bring suit against the company's directors since they approved investments that later brought significant losses to the company. The directors who approved these investments were disinterested and informed. The lawsuit will likely:

Fail since the courts will likely apply the business judgment rule, finding no liability absent evidence of gross negligence or bad faith.

Individual board members have no...?

Formal power, the board must act as a body

Many companies compensate directors with:

Stock options

Toby is a director and would like other directors to pay closer attention to the company's priorities, growth, learning potential, profit and long-term viability. Toby wants the board to pay closer attention to the company's:

Strategic plan

Benefit of closely held/controlled boards:

allow the founders for better control over business

Board should be aware of balance between...

meddling too deep into operations of company and rubber-stamping company's decisions

In what kind of company do boards meet quarterly?

smaller private companies