The waves of accounting scandals, company meltdowns, and related fiascos have destroyed billions of dollars in shareholder wealth. The ongoing crisis has raised the question of what value, if any, do corporate boards of directors add to the corporations they ostensibly serve.
Mistrust in American corporate management is evidenced by the growing number and scope of shareholder resolutions contained in proxy statements. The issues at stake in corporate elections are becoming increasingly governance-related, suggesting that shareholders as well as managers and incumbent directors all are trying to recruit fresh, new talent to boards in order to improve on the status quo.
Despite the rash of proposed new laws and regulations, the market ultimately will determine what model of corporate governance will dominate. There are several possibilities.
One is the old-fashioned collegial model. Board members were valued for their ability to reach consensus. Getting along with other members was a virtue. Unanimity was the unvarying outcome of board votes. Dissent, particularly public dissent, from board decisions was not tolerated.
A second possibility is the adversarial model of board service. In this model, board members are valued for their independence. The willingness to challenge the CEO and to push dissenting opinions on management is the critical value of the adversarial model.
We support the ability of shareholders to choose whatever model of governance they feel will maximize the value of the firm and of their investments. It would be a mistake, however, for shareholders to lose sight of the value that directors can add as advisers to management.
The ‘third way'
This “third way” that combines the obscure virtues of the collegial approach with the clear virtues of the adversarial approach is similar to the relationship that the U.S. Senate has with the President of the United States under Article II of the Constitution. The President (CEO) manages the firm with the “advice and consent” of the Senate (board of directors). Sometimes this relationship is adversarial. Sometimes it is collegial. In all cases, board members must be more than mere watchdogs or lapdogs.
Lapdogs are obviously unsuitable in today's corporate world. It also is the case, however, that directors limited to serving merely as watchdogs will do little to add real value for shareholders. If board meetings evolve into a vigilance-only agenda, managers will simply manage the board the way that they manage other, hostile constituencies.
Checks and balances are vital in corporate and civic government alike. But a board that engages exclusively in “checking” management will be as ineffective as a board that acts merely as a rubber stamp. Rather, the relationship between the CEO and the board should mimic the relationship between the Chief ÂExecutive of the United States and the Congress. In normal times, the company probably will flourish if the board has a healthy sprinkling of representatives of different perspectives, just as the U.S. appears to flourish when the dominant party in Congress is not the same as the party that controls the White House. On the other hand, a united government may be preferable during a time of crisis.
Jeff Immelt's expectations
General Electric Chairman Jeffrey Immelt voiced a similar view when he said, “I want directors to probe with hard questions, which stretch management. I want board meetings that deal in depth with the core issues confronting GE. By the same token, I expect directors to have even greater involvement and participation in GE, in understanding the company and advising the management team. Directors must be our most constructive critics and our wisest counselors.”
Often, the best boards will be populated by people with diverse skills who have demonstrated the ability to function as part of a team. Unfortunately, directors are frequently selected for their reputations as managers rather than for any particular set of skills. Directors who spend most of their business careers at the top of highly hierarchical environments may not perform well as a member of an ensemble cast, in which they do not have the starring role. Nominating committees that interview candidates for directorships should be sensitive to how candidates will interact with their board colleagues during difficult and stressful times. Directors who are able to work as part of a team are more likely to enhance shareholder value.
There are plenty of bad directors populating corporate boards. The worst of these bad directors are lapdogs who have been “captured” and co-opted by the very officers they are supposed to monitor. But some of bad directors are self-styled watchdogs, who sit on the sidelines and criticize but add little of real value. In our view, boards dominated by either of these sorts of directors are likely to underperform boards that are dominated by team players and by people who know a lot about the business of the company on whose board they are serving. Removing unknowledgeable, inexpert, or ineffective directors needs to be addressed decisively by board nominating committees, whose fiduciary duties to shareholders should dominate their loyalty to board colleagues.
Respect for outside nominees
Stockholders, particularly holders of significant minority blocks, should be permitted and even encouraged by boards to add director candidates to the proxy without those outside nominees being viewed as “outside dissidents.” All board nominating committees should adopt clear and transparent procedures for soliciting from shareholders nominations for new directors. Nominating committees also should strongly consider term limits for board members.
The danger that directors become an unhelpful threat to, rather than a resource for, management is just as great as the danger that board members will continue to be lapdogs. The sooner the board emerges as a collegial group of professional, independent advisers to management, the better. â
The authors can be contacted at jonathan.macey@yale.edu and steven@seidenkrieger.com.