Director Responsibility
Directors are responsible for their actions at many levels. Their duties toward the firm's stakeholders go beyond their simple duty to maximize the shareholders' wealth. One may divide the directors' responsibility according to three criteria:
Fiduciary duty
Duty of loyalty
Duty of care
Fiduciary duty
The most important duty of board members is probably that of being a representative of the firm and its stakeholders. One may define the fiduciary duty board members as a combination of both integrity and competence. Any board member must therefore be trustworthy enough to represent with all possible diligence the firm, and must act in the best interests of the company.
The problem is that representing the corporation as a whole may put the director in the middle of a conflict between different classes of shareholders who expect different things from the corporation, or in the middle of a conflict between the different types of stakeholders in the corporation. The fiduciary duty of directors toward the corporation then means that shareholders' wealth maximisation should not be the directors' main concern as much as the maximisation of the firms' value. As I stated previously, this may cause conflicts within the firm and tear the loyalty of the directors at the seam. As a result, directors must be able to aggregate the utility functions of all stakeholders in the firm using a utilitarian approach. In smaller corporations, where the ownership is more concentrated and where conflicts between shareholders may be more personal, simple stating that the directors' fiduciary duty is to maximize shareholder wealth may miss the point completely.
Even in large corporations, maximizing the firm's profits or the shareholders' wealth still represents an unclear concept. For example, Drucker (1980) states that the simple notion of profit and its impact on shareholder wealth is not clear because the accountants' notion of profit is a contemporaneous measure of the firm's wealth whereas shareholder wealth represents the present value of cash flows generated by the firm in the uncertain future. In particular, investment in research and development does not generate profits in the current annual statement, but may increase the shareholders' wealth.
The discrepancy between firm profit and shareholder wealth is much larger for firms that operate in a very risky environment such as the high-technology and the biotechnology industries. As a result, the board of directors' fiduciary duty may be even harder to define in firms operating in these industries than in firms operating in mature industries. The harder it is to define the directors' fiduciary duty to the firm and its shareholders, the harder it will be to show that the directors did not meet their obligation.
If defining profit and shareholder wealth were not difficult enough, the directors' fiduciary duty also extends to other stakeholders, including employees, clients and society as a whole. For example, a firm may devote resources to social activities (typically charities) that in no way increases the firm's profits or the wealth of its shareholders because shareholders are part of society so that they benefit, albeit very indirectly, from these social activities.
Duty of loyalty
Upon his nomination on the board of directors, any director implicitly swears allegiance to the corporation and its board. As a result, the personal welfare of any board member is subordinated to the welfare of the corporation and its multiple stakeholders. A board member therefore cannot personally benefit from his position on the board. This includes but is not limited to insider trading and the selling of inside information. The duty of loyalty also extends to the duty of not engaging in direct competition with the corporation.
The duty of loyalty also encompasses a duty of fair dealing. This means that any board member who may be in a conflict of interest because of a business opportunity of the firm must reveal to the other board members that such a conflict may exist. Put differently, any professional dealing a director does with the firm on whose board he sits must be done in an up-and-up manner so that there can be no apparent use of his position as a director to extract undue rents for himself or for another corporation. The director's duty of fair dealing does not mean that he is barred from any professional dealing with the corporation who board he sits on; rather, the director must reveal the existence of such a conflict of interest so that the corporation's officers and other directors are aware that it exists. He must also refrain from voting on topics in which he has an interest.
Duty of care
The duty of care stipulates that a director must act in accordance to what any reasonable person would do if that person was a corporate director (this is in contrast to the "prudent standard" in force in the United States). This duty extends to the amount of time, effort and resources a director must invest in verifying the behaviour of the firm's corporate officers, just like any ordinary reasonable person would do.
The duty of care does not mean that the director is responsible for knowing all that is going on in the corporation; no normal person can do that. In that sense the director is allowed to trust other directors, the officers or any external body that has a better knowledge of the situation of the firm (for example the firm's independent auditors). This means that although directors are not responsible for knowing all that is going on, it is their responsibility to hire the right set of people as managers, auditors and advisors so that they are better able to gather the true information about the health of the firm.
Of particular importance in the director's duty of care is that he must do all in his power to supervise correctly and efficiently the officers. In particular, the supervisory duty addresses the question of the knowledge that directors must have about the firm's operations and finances. The supervision by the board of directors also means that it is the directors' duty to develop a policy regarding ethics in the corporation and on the board. The board members' ethics policy encompasses the nomination of members on the board's auditing committee whose task is to provide accurate reporting of the corporations' health. Finally, the most important aspect of the directors' duty of care is to meet on a regular basis to discuss firm's strategic positioning and ask incisive questions to the management team, just like any reasonable person would do.
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