The Recurrent Crisis in Corporate Governance

 The Recurrent Crisis in Corporate Governance pushes the edge of mainstream thought in this growing discipline. Authors Paul W. MacAvoy and Ira M. Millstein, giants in the field, have well deserved reputations as practitioners and scholars. This thin volume will quickly guide the course for progressive board members concerned with building solid companies, rather than future Enrons.

Although MacAvoy and Millstein stop short of urging direct nomination of directors by shareholders, the author’s do recognize the real benefit of boards being truly independent from the CEO. “The independent and professional board is the ‘grain in the balance’ of survival in the long run.”

Directors who are unwilling to grow should look elsewhere. “Directors on the verge of quitting because of increasing responsibility and liability are not the ‘productive’ directors and, by leaving, imply an average increase in the quality of boards.” This book is for those who choose to stay and focus on what the author’s consider the real target, maximizing the generation of wealth and the return of profit to investors.

The recurrent crisis referenced in the title is primarily the “incapacity to deliver in practice on heightened expectations for governance. There is a void of capability (on corporate boards) which, if not filled will culminate again in misleading and inadequate reported financial results and large managerial extractions of wealth from failing companies.”

In a few brief chapters, the authors review recurrent themes during the last thirty years, from failure of the Penn Central Railroad to the decision by the General Motors board to publish governance guidelines after discharging its CEO, an act once widely acclaimed as a virtual Magna Carta for directors. They also discuss significant initiatives by public pension funds and court decisions that have affirmed the responsibility of directors to review and approve long-term goals and strategies. Yet, even with significant reforms, systemic flaws remain that will result in a continuing cycle of crisis and reform. However, the frequency and severity of such cycles can be significantly reduced through recommendation actions. 

Their central theme is the need for independent directors, not just as defined by recent exchange reforms, but real independence, citing for example, studies like that of Shivdasani and Yermack who found that CEO involvement in the selection of directors negatively affected the quality and independence of nominees. P.33 Of course, one of the most significant studies in this area is one which MacAvoy and Millstein published in 1997. Examining data from 154 US companies, they found a positive correlation between active/independent boards and Economic Value Added.

Consistent with those findings, we cannot expect a CEO who is also chairman of the board to prepare the board to adequately evaluate their own lapses or those of senior staff. Therefore, the first and most important reform recommended by the authors is to end that dual role. “Ideally, the board’s chairman should be an independent director.”

The least painful time to make this transition is upon succession, which now often occurs every few years. Because a “lead” director is “still just another director subject to the influence if not dominance of the singular CEO/chairman, we have no confidence in that role as more than a temporary step on the road to separation.”

Other recommendations for boards from the book include the need to:

• Determine that management has appropriate processes in place to meet certification required by Sarbanes-Oxley
• Take responsibility for the company’s strategy, risk management and financial reporting
• Reward extraordinary, not market, performance
• Assure themselves of the integrity of management.

“The board cannot function without leadership separate from the management it is supposed to monitor.” It has the legal responsibility to do so. “Now it must be empowered with the opportunity to fulfill this responsibility.”

MacAvoy and Millstein end with the following: “Perhaps with these reforms, the recurring crises in governance will take place with less frequency and intensity.” Without these actions, shareholders, and maybe even the great unwashed masses, will be storming the corporate gates demanding much more in the way of a shift in power. The SEC’s latest proposal to allow up to three shareholder nominees could be just the beginning.

Directors should be shaking in their boots. From the January 19, 2004 BusinessWeek – “Lucent Technologies is asking shareholders to scrap its staggered board elections, a takeover defense despised by governance gurus. Allstate ditched its poison-pill takeover defense, citing ‘shareholder sentiment.’ And Alcoa is putting ‘golden parachute’ payments to a shareholder vote. In each case, the action followed a majority shareholder vote at the last annual meeting. Says Patrick McGurn, special counsel at proxy adviser Institutional Shareholder Services: ‘The only way you can explain the difference in behavior is the threat that proxy access may be available.’”

The board that MacAvoy and Millstein envision may be independent from the CEO, but it still is not directly accountable to shareholders. Although not my ideal, it would be a significant step in the right direction for most corporations and might just head off further reforms radical democrats like me have been calling for.