What Financial Report Readers Can Learn from Watching the Board of Directors

Watching the board of directors can be a helpful tool for financial report readers. The shareholder landscape changed dramatically after the corporate scandals of the 2000s exposed severe corporate governance problems, beginning with the collapse of Enron.

Today shareholder groups — many led by institutional investors such as pension plans and mutual funds that own large blocks of shares in various companies — closely watch the following four major issues in the companies in which they own shares of stock.

Composition of the board of directors

Shareholder groups monitor the makeup of the board, how board members are chosen, and how many members serving on the board are truly independent — meaning that they're not directly involved in the day-to-day operations of the company. Outsiders prefer that a majority of the board members be independent because independent board members can be more objective (they aren't protecting their own jobs and their own income).

Compensation packages for board members and CEOs

These details are on public record now. In addition, shareholders must approve of or be notified of any major benefits or compensation offered to the company's executives, such as stock option plans (offers to buy company stock at prices below market value). Shareholders complain bitterly if they believe executives are receiving excessive compensation.

Takeover defenses and protections

In some cases, board members place defenses against the possibility of a company takeover. For example, Comcast unsuccessfully attempted a hostile takeover of Disney during the battle between shareholders, led by Roy Disney, who was attempting to oust Michael Eisner. Sometimes these defenses help protect shareholders from a corporate raider hoping to buy the company and sell off the pieces, which can leave shareholders with stock that's worth very little.

Other times these defenses prevent a takeover by some other company that may benefit the shareholders but not the current management team and board of directors (especially if the leadership ranks would change under the new owners). Shareholder groups watch whatever takeover defenses or protections the board puts into place to be sure their best interests are protected, not just the best interests of the directors and the management team.

Audits

The primary responsibility of the board of directors is to review the audits of the company's books to be certain that both the internal accounting team and the external auditors are accurately handling them. Today the Securities and Exchange Commission (SEC) requires that independent board members make up the audit committees.

Before the Enron scandal, many audit committees weren't as independently run, which allowed company insiders to control not only how money was spent, but also how it was recorded in the company's books and how the financial results were reported to outsiders. This insidious practice allowed top executives to more easily hide any misdeeds or misuse of funds.

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