The Stock Exchange - The Role of the Board of Directors

What does a Board of Directors do? They are appointed to act on behalf of the shareholders - the owners of the business. They run the day-to-day affairs of the business but they must always remember (and this does not always happen) that their decisions must be in the best interests of the shareholders.

The shareholders may have invested in the business for two main reasons. Some will be looking to get a regular return on their investment in the form of a dividend. A dividend is the proportion of the profits made by the company each year that is returned to the shareholders. A dividend is normally represented as x pence per share. If the dividend was set by the Board at 6.9 pence per share our 1,000 shareholders in the example above would get 6.9 pence x the amount of shares they owned paid to them. A person owning 50,000 shares would get £3,450 in dividend.

Shareholders often have the choice of having the money paid to them in the form of a cheque or directly into a bank account or they can have the dividend in the form of extra investment in shares. The investor would have to keep a careful record of the money received from their shares to declare it to the Inland Revenue. Income from shares is subject to capital gains tax (currently 10, 20 or 40% depending on your income level).

The other main reason for investing in a business is to get a capital gain in the value of the shares themselves. This means that the investor may be looking to buy shares hoping their price will rise and to then sell them to get a capital return. Such investors may be highly speculative in nature therefore and the Stock Exchange plays an important role in enabling those shareholders to exchange their shares quickly and easily.

The policy of the business in relation to its use of profits is therefore an important aspect in the decision making process for shareholders. Some Boards might feel it important to ensure that dividends are paid regularly and that they try to increase the dividend as much as possible. Others might feel that a smaller dividend is the right strategy; the bulk of the profits might be used for re-investing in growing the business. A shareholder looking for capital growth might be very keen to invest in a business with minimal or even zero dividends because it offers the greater likelihood of capital gain if the business is growing. Other shareholders looking for dividend income might not be attracted to this sort of business and so the dividend policy of the Board is important to help investors make the right decision.

The decisions of the Board of Directors, therefore, on how the business is run including what to do with profits is quite important to shareholders who may have little or no understanding of the details of the business. The Board are directly accountable to the shareholders and each year the company will hold an Annual General Meeting (AGM) at which the Directors will provide a report to shareholders on the performance of the company, what its future plans and strategies are and also to submit themselves for re-election to the Board.

This is supposed to invest power in the hands of the shareholders but in reality the picture might be quite confused for a number of reasons:

• The shareholder may have a very small number of shares and so the amount of votes they have is unlikely to make much difference
• The shareholder may have no real interest in the details of the business and is largely apathetic
• The shareholder may be a large institutional investor such as a pension fund or insurance company and might be looking for quite different things to a small individual investor but have very much more power and knowledge and understanding than the smaller investors
• Some of the Board of Directors may also be shareholders of the business and so may have a vested interest in their own welfare as well as that of the business

The issues above may lead to something called the 'divorce between ownership and control'. What this means is that those who own the business may have little or no control over what actually happens in the business and that can be a concern. This tends to manifest itself in the lurid headlines about 'fat cat' pay where company directors vote themselves massive pay rises or resign having presided over poor performance but get a large pay off and the shareholders seem powerless to be able to do anything about it.

There are also potential problems with the issue of so-called 'short-termism' in the markets. This is where shareholders might be more interested in decisions that lead to short-term financial gain rather than decisions made to secure the longer-term financial health of the business. Institutional investors in particular have come in for this sort of criticism because their interest is in maximising the returns for their clients - pension holders, insurance holders and so on.

To ensure that a business is making sensible decisions for the longer-term future as well as meeting the current needs of shareholders (a delicate balancing act in many cases), a company might appoint some non-executive directors to the Board. These are people invariably with some experience in the business concerned that sit on the Board and contribute to discussion about strategy, offer advice and countenance but who do not have a vote on the Board.

When a business comes to the Stock Exchange to raise capital (and remember this is not necessarily a brand new business but can be an existing business that is changing its scale of operations and type of ownership, or an existing business seeking to raise more funds for investment), it will have to provide often detailed plans of what it wants to raise, why it wants to raise it, what its aims and objectives are, how the funds will be used and so on. This is presented in the form of a prospectus, which provides the investor with information on which to base their decision as to whether they think this business is worth investing in.

By law, all PLCs must publish an annual report and accounts detailing their activities to shareholders to keep them informed of the progress and issues relating to the business. Some of these reports are often criticised for putting a gloss on the business and using legal but diverse accounting practices to present the company's position in the best light. This practice is called 'window dressing'. See the following resources for more on this:

Post By Premire Group
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