Thursday, April 28, 2011

The Appearance of Reality: Directors

This is the fifth post in my effort to clarify corporate governance terms that now seem misleading to me. We all know what these words mean in a literal sense but in the context of governance, of business and of our post-crash world do they still mean the same thing?
I look forward to your comments.
There persists an almost desperate focus on the Board as the primary agent of effective corporate governance. Discussion about boards of directors is always confusing. There is no general agreement on the optimum scope of board responsibility. Indeed, in a forthcoming book Jay Lorsch and Marty Lipton conclude: “It is not an exaggeration to say that directors operate in a vacuum as to the purposes boards ought to be pursuing.”

Peter Drucker has long raised the question as to whether the current standard of board functioning is so unsatisfactory as to require structural change.
“Whenever an institution malfunctions as consistently as boards of directors have in nearly every major fiasco of the last forty or fifty years it is futile to blame men. It is the institution that malfunctions.”  (“The Bored Board,” in Toward the Next Economics and Other Essays (Harper & Row, New York, 1981)
In the years subsequent to Drucker’s characterization, just the utter failure to control executive compensation leads me to conclude that the current board model is derelict.  If the principal cannot manage his agent’s compensation, he has no right to assume that he exercises effective accountability in any other area. 
It is time to recognize that a fundamental and irreconcilable conflict exists between the perception of what boards should do and how they should be comprised. Our efforts to achieve functionality within the context of the traditional single board can be understood as the inability to square a circle. We cannot hope to make progress until - once and for all – we face up to the reality that a self-selecting board cannot ever overcome conflicts of interest and the real governance need for independence.
We may have to recognize that there is no single board solution.  There are some board functions that absolutely depend on collegiality and confidentiality; there are other board functions that absolutely depend on “independence.”  Why not design a new board structure based on the very incompatibility of collegiality and independence? A self perpetuating board might be the optimal instrument for strategy, succession and compliance, while independence is essential in those areas where conflict of interest between agent and principal are apparent. Enabled shareholder involvement might prove the best way to discharge the responsibilities involving conflicts of interest.  Without the involvement of active and engaged shareholders, the entire corporate system lacks its basic foundation.   

One model might be a shareholder proposal I first put to Exxon Mobil twenty years ago. In order to incorporate shareholder initiative, I proposed a new Shareholder Advisory Committee at the 1992 Exxon Annual Meeting and the SEC required the company to include it in its proxy.  It reads,

“This new committee, authorized by a by-law amendment, would consist of three paid representatives elected by the company’s largest institutional shareholders; it would be funded with a penny a share by the company itself, and have a right to meet with the company, propose candidates for director and publish its views annually in the proxy statement. This is one way to deal with the adverse problems of “collective action” or “free riding” and to make possible economically rational involvement by conscientious fiduciaries (It is doubtful if any trust scheme would condone fiduciaries’ failure to act pursuant to this by-law) and other shareholders.” (See entire proposal in Emperor’s Nightingale, p. 66-67)
 Here are my questions:
1.     Do you think the current model for boards is successful?

2.     What needs to happen to:
a.     Ensure a well-functioning board?
b.     Remove conflicts of interest regarding management oversight and compensation?
c.      Enable Shareholder input?

3.     What do you think of the 1992 proposal to Exxon presented above?
April 28, 2011 in accountability , directors , fiduciary duty , independent directors , Disinformation  |  2 comments  | 

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Posted by Andrew Shapiro on Apr 29, 2011 at 10:11 PM
1) The current model for self selection of board nominees as well as election of the eventual board (eg. no real cost effective access for alternative director nominees) is highly flawed.

2) regular accountability of board through annual not staggered elections; economically efficient mechanism for shareowner removal and election of directors via improved nomination and alternative election structure.

3) Exxon proposal was quite novel but its not clear whether it was advisory or precatory to nominating committee or could legally have at least the binding power of nominating committee and preferably the full board.
Posted by Jim McRitchie on Apr 29, 2011 at 2:27 PM
I think I like the original version of the 1992 proposal a little better, if I\'m reading it correctly. Here, you are proposing the companies largest institutional investors select the three advisory board members. In the original you appears they would be voted on by all shareowners using a plurality vote.

I think it is a good idea, better than the ancient Greeks drawing lots to see will serve. However, I think there are individuals, such as someone like you, who can better serve in such advisory capacity then someone chosen who may be chosen by BlackRock or Fidelity.

My tendency would be to open it up, putting some limitation on the number of candidates, and to use instant runoff voting for their election. Whatever the mechanics, the idea of democratically elected shareowners committee able to put up alternative candidates to those self-selected by the board seems to be a good one.

As a standing committee with resources, the committee would have a much greater ability to monitor than is likely for normal shareowners. Your proposal has the advantages of proxy access, but through a route that is more likely to be grounded in greater knowledge of what is really needed.

PS, I\'m reading your new book with Alex on corporate valuation and am getting quite an education. Thanks.
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