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The case for outsourcing company boards
Aug 16th 2014
CORPORATE boards are among the most important institutions in capitalism. Their
job is to police the relationship between shareholders who own companies and
managers who run them. This means keeping an eye out for managerial
incompetence and fraud. It also means standing back and offering strategic
advice on hiring new managers or buying competitors.
Yet their record might politely be described as mixed. The first decade of the
21st century produced an embarrassment of dismal oversight, from the Enron and
WorldCom scandals of 2001-02 to the financial crisis of 2007-08. I actually
don t think risk management failed, said Larry Fink, the boss of BlackRock, an
investment firm. I think corporate governance failed, because the boards didn
t ask the right questions.
Problems have been widespread and deep-rooted. Chief executives have packed
boards with cronies: Michael Eisner s board at Disney once included the former
headmistress of his children s school and the man who designed his house. They
have sidelined critics: when a member of the Bank of America s board criticised
the CEO s compensation in 2000 she was dropped.
The past decade has seen several attempts to bring boards up to date. In
America the Sarbanes-Oxley act (2002) and the Dodd-Frank act (2010) forced
companies to appoint more independent directors and disclose more information
about compensation. Good-governance advocates have pressed companies not just
to choose white men as directors, and to publish more data so shareholders can
make better informed decisions. But big companies continue to make
extraordinary appointments: in 2011 IAC, a media conglomerate chaired by Barry
Diller, appointed Chelsea Clinton, then a 31-year-old graduate student, to its
board. And some magic bullets have proved to be blanks. Everyone thinks
independent directors make better board members but there is no academic
evidence to prove it. When Lehman Brothers went bankrupt, eight of its ten
directors were independents.
These reforms have left the basic problem untouched. Companies have almost
always been admirably ruthless when it comes to reinventing themselves. They
have experimented with every imaginable organisational form and have contracted
out everything from manufacturing to strategy-making. Yet when it comes to
boards they have been astonishingly conservative.
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.
In the May edition of the Stanford Law Review Stephen Bainbridge of the
University of California, Los Angeles, and Todd Henderson of the University of
Chicago offer a proposal for fixing boards that goes beyond tinkering: replace
individual directors with professional-services firms. Companies, they point
out, would never buy legal services or management advice from people only
willing to spare a few hours a month. Why do they put up with the same
arrangement from board members? They argue for the creation of a new category
of professional firms: BSPs or Board Service Providers. Companies would hire a
company to provide it with board services in the same way that it hires law
firms or management consultants. The BSP would not only supply the company with
a full complement of board members. It would also furnish it with its
collective expertise, from the ability to process huge quantities of
information to specialist advice on things such as mergers.
Messrs Bainbridge and Henderson argue that this would require only a simple
legal change but could revolutionise the stick-in-the-mud world of boards. It
would replace today s nod-and-a-wink arrangements with a market in which rival
BSPs compete. It would create a new category of professional director. And it
would allow BSPs to exploit economies of scale to recruit the best board
members, introduce more rigorous training programmes and develop the best
proprietary knowledge. Now, even the most diligent board member can only draw
on his or her experience. BSPs would be able to draw on the expertise of
hundreds. This would increase the chances that corporate incompetence will be
corrected, corporate malfeasance found out and corporate self-dealing, in the
form of inflated pay, countermanded.
Back to the drawing board
There are objections to the Bainbridge-Henderson plan. It might deny companies
the insights of genuine outsiders people with a record of producing
industry-changing ideas. The very professionalism which will make BSPs better
monitors of corporate performance might make them too conservative when
advising on strategy. There could be conflicts of interest if, say, rival firms
used the same BSP. But all professional-service firms (such as management
consultants) have such problems and ways of dealing with them. The idea might
also deprive big shareholders of a chance to nominate board members. These
problems could be overcome by creating a hybrid system in which the BSP filled
a majority of board positions and a minority were reserved for others.
Corporate boards have always been one of the weakest parts of the capitalist
system collections of cuckolds, in Ralph Nader s phrase. Messrs Bainbridge and
Henderson have come up with an intriguing idea for keeping companies from
straying.