Based on a proposal discussed in a recent issue of the Stanford Law Review, this recent Economist article promotes outsourcing corporate boards as a solution to corporate governance failures of the type we have experienced historically. As proposed, outsourcing would consist of replacing individual directors with a new category of professional firms – identified as BSPs or Board Service Providers – that companies would retain to supply them with a “full complement of board members.” The article claims that, despite some reforms over the past decade, boards are (still) fundamentally flawed. Specifically, here is how the article characterizes boards:
Boards are almost exactly as they were a hundred years ago: a collection of grey eminences who meet for a few days a year to offer their wisdom. They may now include a few women and minorities. There may be a few outsiders. But the fundamentals remain the same. Board members are part-timers with neither the knowledge nor the incentives to monitor companies effectively. And they are beholden to the people they are supposed to monitor. Boards are thus showcases for capitalism’s most serious problems: they are run by insiders at a time when capitalism needs to be more inclusive and are dominated by part-timers at a time when it needs to be more vigilant about avoiding future crises.
I couldn’t disagree more. And I think a survey of GCs and Corporate Secretaries who interact with their boards on a regular basis would reveal a very different picture that is more comparable to what I myself experienced as GC & Corporate Secretary of two public companies, which is that – among other things – the vast majority of directors are appropriately engaged; hard-working; ethical; knowledgeable; responsive; thoughtful; intelligent; independently-minded while being sufficiently colloborative and respectful of management to forge a mutually beneficial (to the company) relationship; and use their tenure with the company appropriately to inform their current decision-making. And actual survey data (see numerous surveys posted in our “Corporate Governance Surveys” Practice Area) refutes the article’s rhetoric about directors devoting scant time to board matters. In addition, an outsourced board as proposed fails to take into account the importance of the mix of directors and associated ability to function well as a group – which is critical to an effective board.
See also Cydney Posner’s blog, where she raises a number of additional, legitimate concerns that would appear to undermine the proposal, including:
- If management has a role in selecting the BSP, why wouldn’t the BSP be just as “beholden” to management as the current crop of “cronies” is to the CEO?
- Could the problems inherent in “group think” be exacerbated by this approach, e.g., a BSP that fails to detect a problem besetting an industry would fail to detect it at many companies, not just one or two?
- What about the loss of genuine hands-on experience that some directors bring?
- What standards would be set and qualifications required for “professional directors” that would distinguish them from current directors?
- How would success or failure of a BSP be determined under ordinary circumstances and who would make that determination in the context of dismissal or reengagement of a BSP?
- What accountability or duty would BSPs have to shareholders, who are the owners of the company?
What Makes a Great Board?
This recently issued RHR International/NYSE Governance Services report reflecting the results of their poll of 300 directors about what factors make a great board appropriately challenges the often-exclusive focus on the attributes of individual board members and process – as opposed to the quality of boardroom dialogue and debate and other intangibles. While the attributes of individual directors are – of course – critical to an effective board, it’s possible to have a boardroom full of great directors, but an ineffective board due to their inability to function well as a group. To illustrate the point, the report quotes RHR’s global practice leader as noting that the directors of the boards of many of the top financial services companies that suffered in the 2008 financial crisis were “often composed of a ‘who’s who’ of highly accomplished business leaders. Yet, the whole in many cases was less than the sum of its parts. The way board members operate together, not who they are, is what differentiates a great board from an average one.” Having spent countless hours over the years in boardrooms observing how differently composed boards function while serving as GC & Corporate Secretary, I couldn’t agree more.
Top factors that most contribute to the making of a great board
– Quality of boardroom dialogue and debate – 88%
– Ability to ask the tough questions of management – 77%
– Diversity of thought and experience – 62%
Top factors that undermine the making of a great board
– Lack of candor in the boardroom – 77%
– Lack of mutual respect/collaborative culture – 68%
– Lack of independence from management – 53%
Additional insights to board effectiveness include directors’ perceived importance of diversity of backgrounds & perspectives (as opposed to gender and racial diversity per se) and CEO evaluation/succession processes, and the need for continued focus on improved peer and self-evaluation processes. See our heaps of additional memos, surveys, checklists and other helpful resources posted in our “Board Composition” Practice Area.
Guest Post: Randi Val Morrison is Associate Editor of The Corporate Counsel.net, CompensationStandards.com and DealLawyers.com. She has approximately 20 years of experience as in-house counsel with publicly-traded companies, having most recently served as Senior Vice President, Legal, Secretary & General Counsel of DineEquity, and, prior to that, Senior Vice President, General Counsel & Secretary of CSK Auto Corporation. This post originally appeared on The Corporate Counsel.net blog as Outsourcing the Board Isn’t Warranted or Remedial on August 28. Publisher’s note: I added the graphics.
I think Bainbridge goes too far. He throws out several options as to how Board Services Providers would be appointed/elected at any one company, but it seems likely they will be appointed by the CEO. Dislodging a BSP would likely be even more difficult than dislodging an entrenched board.
His revolutionary option of having the CEO nominate two BSPs, allowing shareowners to choose the best, does not warm my heart, since the CEO can simply nominate Tweedle Dee and Tweedle Dum. Mark Latham made a somewhat simlar proposal in his 1999 paper, The Corporate Monitoring Firm (available at http://www.votermedia.org/publications), although Latham leaves the board intact. Latham’s proposal is much more to my liking, being both board and shareholder-centric. However, through a series of real life experiments, Latham’s proposal evolved.
One of the latest iterations was my proposal last year at Cisco, written with Latham’s help. See Cisco System: Prime Target for Proxy Advisor Competition at https://corpgov.net/2013/11/cisco-systems-prime-target-for-proxy-advisor-contest/ That system keeps the proven system of having a board of directors but allows shareholders to get proxy voting advice from professionals, such as hedge funds and other industry specialists, with much more expertise than ISS or Glass Lewis when it comes to analyzing proxy and other governance issues at specific individual companies. Proxy analysis, under that system, could become whole system analysis.
Related post by Keith Paul Bishop Does The Corporations Code Permit “Boards R Us”? at http://calcorporatelaw.com/2014/09/corporations-code-permit-boards-r-us/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+CaliforniaCorporateLaw+%28California+Corporate+Law%29
However, the California Corporations Code does allow corporations to implement the Professors’ idea to a significant extent. Corporations Code § 300(a) provides:
“The board may delegate the management of the day-to-day operation of the business of the corporation to a management company or other person provided that the business and affairs of the corporation shall be managed and all corporate powers shall be exercised under the ultimate direction of the board.”
I’m not familiar with any corporations that have taken advantage of this provision.