One of the principal criticisms of my director primacy model of corporate governance has been that it doesn't describe the real world of boards. In my essay, Director Primacy, which was published in The Research Handbook on the Economics of Corporate Law , I explained that my model was developed for a very different purpose:
I set out not to reform the statutory allocation of power, but simply to understand it. My premise is that corporate law tends towards efficiency. A state generates revenue from franchise and other taxes imposed on firms that incorporate in the state. The more firms that choose to incorporate in a given state, the more revenue the state generates. Delaware, the runaway winner in this competition, generates so much revenue from incorporations that its resident taxpayers reportedly save thousands of dollars a year.
In order to attract capital, managers must offer investors attractive terms. Among those terms are the corporate governance rules imposed on investors by the law of the state of incorporation. Accordingly, managers have an incentive to incorporate in states offering terms preferred by investors. In turn, states have an incentive to attract incorporations by offering such terms. State competition for charters therefore results in a race to the top, driving corporate law towards efficient outcomes. Accordingly, the task was to develop a model that explains and predicts the structure of corporate law as it exists today.
Yet, I also argued in The New Corporate Governance in Theory and Practice that director primacy has increasing real world relevance as boards have become more active and stronger.
Forty years ago, managerialism dominated corporate governance in the United States. In both theory and practice, a team of senior man¬agers ran the corporation with little or no interference from other stake-holders. Shareholders were essentially powerless and typically quiescent. Boards of directors were little more than rubber stamps.
Today, American corporate governance looks very different. The Imperial CEO is a declining breed. Some classes of shareholders have become quite restive, indeed. Most important for our purposes, boards are increasingly active in monitoring top management rather than serving as mere pawns of the CEO.
Several important trends coalesced in recent decades to encourage more active and effective board oversight. Much director compensation now comes as stock rather than cash, which helps to align director and shareholder interests. Courts have made clear that effective board proc¬esses and oversight are essential if board decisions are to receive the defer¬ence traditionally accorded to them under the business judgment rule, especially insofar as structural decisions are concerned (such as those relating to corporate takeovers). Director conduct is further constrained, some say, by activist shareholders. The Sarbanes-Oxley Act mandated enhanced director independence from management, as did changes in stock exchange listing standards.
Today, as a result of these forces, boards of directors typically are smaller than their antecedents, meet more often, are more independent from management, own more stock, and have better access to information. As The Economist reported in 2003, “boards are undoubtedly becoming less deferential. . . . Boards have also become smaller and more hard¬working. . . . Probably the most important change, though, is the growing tendency for boards to meet in what Americans confusingly call ‘executive session,’ which excludes the CEO and all other executives.” In sum, boards are becoming change agents rather than rubber stamps.
Today board primacy is even more a valid description of corporate governance in the real world than was the case when I wrote those words 5 years ago. In the latest issue of The Economist, the Schumpeter columnist explains that:
For most of their history, boards have been largely ceremonial institutions: friends of the boss who meet every few months to rubber-stamp his decisions and have a good lunch. Critics have compared directors to “parsley on fish”, decorative but ineffectual; or honorary colonels, “ornamental in parade but fairly useless in battle”. Ralph Nader called them “cuckolds” who are always the last to know when managers have erred. The corporate scandals of the early 2000s forced boards to take a more active role. The Sarbanes-Oxley act of 2002 and the New York Stock Exchange’s new rules in 2003 obliged directors to take more responsibility for preventing fraud and self-dealing. This led to a big increase in the quality of boards. But it also wasted a lot of talent on form-filling and box-ticking.
In a new book, “Boards That Lead ”, Ram Charan, Dennis Carey and Michael Useem argue that boards are in the midst of a third revolution: they are becoming strategic partners. ...
Mr Charan and his co-authors lay out two clear rules. The first is that boards should focus on providing companies with strategic advice.
I agree, but the problem is that US legal rules put so much emphasis on the board's monitoring role, that the board's advisory role gets squeezed out of the way. Too many quack corporate governance rules impede effective board functioning.
The second rule is that boards should focus on getting their relationship with the CEO right. It is not enough to act as monitors in the Sarbanes-Oxley mould. They need to act as personal mentors and high-level talent scouts.
Again, I agree, but I wonder whether the amount of time and effort the law requires boards to put into monitoring interferes with the board's mentoring role. In addition to the lack of time, effective monitoring can have an adversarial component that makes mentoring relationshiops difficult to create and sustain.
There are problems with this new model board. Can directors fulfil their legal duties to monitor performance if they are also responsible for helping to set strategy and appointing the CEO? Are organisations that meet a dozen times a year capable of offering strategic guidance in a fast-paced world? Will CEOs willingly give up more power to boards, or will they fight back? Getting the new model right will entail careful negotiations not only between boards and executives but also between firms and regulators.
Again, I agree, but these sort of questions are precisely the reason Todd Henderson and I proposed our Boards R Us Model:
State corporate law requires director services be provided by “natural persons.” This Article puts this obligation to scrutiny, and concludes that there are significant gains that could be realized by permitting firms (be they partnerships, corporations, or other business entities) to provide board services. We call these firms “board service providers” (BSPs). We argue that hiring a BSP to provide board services instead of a loose group of sole proprietorships will increase board accountability, both from markets and judicial supervision. The potential economies of scale and scope in the board services industry (including vertical integration of consultants and other board member support functions), as well as the benefits of risk pooling and talent allocation, mean that large professional director services firms may arise, and thereby create a market for corporate governance distinct from the market for corporate control. More transparency about board performance, including better pricing of governance by the market, as well as increased reputational assets at stake in board decisions, means improved corporate governance, all else being equal. But our goal in this Article is not necessarily to increase shareholder control over firms – we show how a firm providing board services could be used to increase managerial power as well. This shows the neutrality of our proposed reform, which can therefore be thought of as a reconceptualization of what a board is rather than a claim about the optimal locus of corporate power.
We think our model solves a lot of these problems.
Boards-R-Us: Reconceptualizing Corporate Boards (July 10, 2013). University of Chicago Coase-Sandor Institute for Law & Economics Research Paper No. 646; UCLA School of Law, Law-Econ Research Paper No. 13-11. Available at SSRN: http://ssrn.com/abstract=2291065