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California Corporations Law: Board is the Boss, CEO is the Employee

Many people get confused about how corporations are run. We are used to seeing the Chief Executive Officers of a company in the news and the media. It is tempting to see that person as the “boss” and, no doubt, the CEO of a corporation makes many decisions and wields a lot of power within the corporate structure. In the end, the CEO is an employee; the Board of Directors is the boss. Here is a quick discussion of these legal principles under California law.

San Diego Corporate Governance: Shareholders, Board, and Upper Management

Many of the legal principles involving corporate governance involve the law of agency. Almost everyone has personal experience with the law of agency. Take, for example, employment relationships. These are among the most common example of agency law. The boss is legally designated as the “principal,” and if you are an employee, you are the agent of the boss and business when you are working. Conversely, if you hire an employee, you are the principal and the employee is your agent. In mundane matters, spouses are often agents for one another. Or if you buy or sell your house, you often hire a real estate agent. Again, you as the home owner or buyer are the principal and the realtor is your agent. Importantly, agents owe duties to their principals (such as the duty of loyalty, no self-dealing, etc.)

In general, your agent is expected to help you accomplish your goals and to represent your interests in dealings with third parties.

With respect to corporation governance, there are two sets of agency relationships:

Board of directors as agents for the owners/shareholders (principal) and
Upper management as agents for the board (principal)

As can be seen, depending on what actions the board is taking, the board can be acting as an agent AND as a principal. Often, the board of directors can be acting in BOTH capacities at the same time. Thus, when a board hires the CEO of the company, they are acting collectively as the principal (from the perspective of the CEO) AND as the agent of the shareholders/owners. This is reflected in California law. See Frances T. v. Village Green Owners Assn., 723 P. 2d 573 (Cal. Supreme Court 1986) (“… directors are not subordinate agents of the corporation; rather, their role is as their title suggests: they are policy-makers who direct and ultimately control corporate conduct.”)

Interestingly enough, an individual member of a board of directors is neither an agent nor a principle. An individual director as no power to control the corporation on his or her own; the board only acts as a collective.

As noted above, agents owe duties to their principals. Thus, the CEO of a corporation owes a duty of loyalty — for example — to the board of directors, but not to the shareholders. This is a nuanced point in the law, but an important one.

Contact San Diego Corporate Law

If you would like more information, contact attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard provides legal services related to business law, private securities offerings/sales, the sale/purchase of a business, and mergers and acquisitions. Mr. Leonard can also assist with setting up a new corporate entity, annual corporate maintenance, and review and draft business contracts. Mr. Leonard can be reached at (858) 483-9200 or via email.