The SEC's proposed shareholder access rules are premised on the monitoring model of the board of directors. We see this, for example, in SEC Chairman Mary Shapiro's comments that:
The nation and the markets have recently experienced, and remain in the midst of, one of the most serious economic crises of the past century. This crisis has led many to raise serious questions and concerns about the accountability and responsiveness of some companies and boards of directors, to the interests of shareholders. These concerns have included questions about whether Boards are exercising appropriate oversight of management, whether Boards are appropriately focused on shareholder interests and whether Boards need to be more accountable for their decisions regarding such issues as compensation structures and risk management.
The trouble with this argument (or, more precisely, one of many problems with it) is that the monitoring model is a terribly incomplete understanding of the board's role.
In my article Why a Board?, I puzzled over the fact that corporation law expects the corporation to governed not by a single autocrat but by a committee acting by consensus. In the course of teasing out the rationale for this structure, I noted that boards have several different functions:
What then does the board produce and how does it produce it? First, and foremost, the board monitors and disciplines top management. Second, while boards rarely are involved in day-to-day operational decision making, most boards have at least some managerial functions. Broad policymaking is commonly a board prerogative, for example. Even more commonly, however, individual board members provide advice and guidance to top managers with respect to operational and/or policy decisions. Finally, the board provides access to a network of contacts that may be useful in gathering resources and/or obtaining business. Outside directors affiliated with financial institutions, for example, apparently facilitate the firm’s access to capital.
... At the core of the board’s service role is providing advice and counsel to the senior management team, especially the CEO. At the intersection of the board’s service and monitoring roles is the provision of alternative points of view. Put another way, most of what boards do requires the exercise of critical evaluative judgment, but not creativity. Even the board’s policymaking role entails judgment more than creativity, as the board is usually selecting between a range of options presented by subordinates. The board serves to constrain subordinates who have become wedded to their plans and ideas, rather than developing such plans in the first instance.
As an admittedly anecdotal example, consider the saga of RJR Nabisco’s efforts to develop a smokeless cigarette. As the story goes, management spent millions of dollars on the project. When the board was finally informed, many directors were reportedly angered by management’s failure to consult with them beforehand. Their anger was wholly justified, for the smokeless cigarette flopped. Those responsible resigned to avoid being fired. The corporation would have been better served if the board had been advised of the project early in its development. Those responsible seem to have been wedded to the project, a tendency the board might have been able to counteract.
I also noted that Congress in Sarbanes-Oxley and the stock exchanges in their corporate governance listing standards have been pushing for ever more independent boards of directors and to focus the board on its monitoring role. Although there is much that is commendable about greater board independence, a focus on the board's monitoring role can become counterproductive if it results in an adversarial relationship between the CEO and the board. In such a case, even if the board remains able to monitor effectively the CEO, the board's ability to fulfill its other roles may be compromised.
My argument found support in a paper by economists Renee Adams and Daniel Ferreira:
This paper analyzes the consequences of the board's dual role as an advisor as well as a monitor of management. As a result of this dual role, the CEO faces a trade-off in disclosing information to the board. On the one hand, if he reveals his information, he gets better advice. On the other hand, a more informed board will monitor him more intensively. Since an independent board is a tougher monitor, the CEO may be reluctant to share information with it. Thus, our model shows that management-friendly boards can be optimal. Using the insights from the model, we analyze the differences between a sole board system, such as in the United States, and the dual board system, as in various countries in Europe. We highlight several policy implications of our analysis.
The current shareholder access proposal reflects a moronic mindset on the part of its drafters that one size fits all. As someone with my, shall we say, "robust" physique can attest from long experience, that is always a lie. Even so, the SEC seems determined to further increase board independence, with no regard to the impact of the proposal on the board's other functions.
Whatever incremental enhancement the proposal provides in board monitoring is likely to be swamped by the deleterious impact on the board's other functions.
