Some Useful Definitions–Stakeholders, Inside Directors and Outside (External) Directors

I’m working on a post on the Board of Directors and thought to set the stage with some useful vocabulary.

As it relates to a company, a stakeholder is someone who has a stake, that is, an interest or a concern, in a company.  Examples of common stakeholders include:

  • investors, who put money in to the company and have an interest in earning a (hopefully large) return on their investment;
  • employees, who have an interest in keeping their jobs and income;
  • suppliers, who have sold the company goods or services and have an interest in (1) getting paid and (2) selling the company more goods or services;
  • customers, who have purchased goods or services from the company and have an interest in continuing to receive support for the goods or services they purchased and buying more goods and services; and
  • financial institutions, who lent the company money and have an interest in receiving that money back. Plus interest. And fees. LOTS of fees. My G-d. It’s just incredible, the fees. I picked the wrong profession. I should have gone into banking. Or computers.  ☹  Anyway….

And so on and so forth.

A company’s list of stakeholders will vary based on various factors, such as the company’s  industry, size or location. For example, if a 10-person startup in Tel Aviv closes, the impact on Tel Aviv is tiny. Tel Aviv doesn’t really care. I know, that sounds cold, but it just doesn’t. It has lots of other companies; the ten laid-off employees should find new employment with relative ease.  So Tel Aviv’s interest in this tiny company’s demise is miniscule. It’s not really a stakeholder. However if a large factory employing several thousand people in a poorer city—say Dimona—were to close, the impact on the area would be enormous. Dimona is poor to begin with and the local job market probably is not going to be able to offer ready alternatives for the laid off workers.  This is liable to create significant financial and social issues for the city. As a result, in this case, Dimona is a stakeholder, that is, it has an interest or concern in the company’s fate.

Inside & Outside Directors
Boards of Directors include inside and outside directors.

Inside directors are company stakeholders; they have an interest in the company. The most common types of inside directors are

  • shareholders (including the people they select to serve as their represenatives)
  • company employees, such as the CEO.

However other stakeholders may receive a seat on the board. For example, if the company receives a loan, the lender might negotiate the right to appoint a director as part of the deal.

Outside directors (also called external directors) have no interest in the company.  If you refer back to the article on audited financial statements , you will recall that we reviewed the concept of independence.  An outside director offers some of the same benefits as an independent auditor: they have no flesh in the game and this allows them to operate more objectively.

Shareholders may appoint outside directors in order to bring in additional professional qualifications, perspective and experience (e.g. industry expertise) to a Board.  In addition, depending on where it is  incorporated, a company might be required to appoint external directors. For example, publicly traded corporations in Israel are required to appoint two external directors, one of which must have accounting and financial expertise.

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