Many economists have been distinctly uncomfortable with the notion of a company owned by shareholders but run by corporate executives hired by a board of directors since at least 1932, when Adolf A. Berle, Jr., and Gardiner C. Means wrote a book called \”The Modern Corporation and Private Property.\” The early decades of the 20th century saw a huge transformation of the ownership of large U.S. companies, away from being owned (or effectively controlled) by a family or an individual, by and toward being owned by shareholders.
\”In 1928, when the project was launched, the financial machinery was developing so rapidly as to indicate that we were in the throes of a revolution in our institution of private property, at least as applied to industrial economic uses. … The translation of perhaps two-thirds of the Industrial wealth of the country from individual ownership to ownership by the large, publicly financed corporations vitally changes the lives of property owners, the lives of workers, and the methods of property tenure. The divorce of ownership from control consequent on that process almost necessarily involves a new form of economic organization of society.\”
The \”separation of ownership and control,\” as it is often called, has been an ongoing problem ever since. The well-founded concern is that the board of directors, which is supposed to function on behalf of the shareholders who technically own the company, is instead effectively chosen by corporate management. There have been periodic pushes for corporate board to have broader representation, or members from outside the circles of that industry, or with greater independence from management. But ultimately, most board members are part-timers who parachute in a few times a year for board meetings. They often lack information and incentives to oversee or tow challenge corporate management effectively.
Stephen M. Bainbridge and M. Todd Henderson offer an alternative vision of how corporate boards might work in \”Boards-R-Us: Reconceptualizing Corporate Boards,\” which appears in the May 2014 issue of the Stanford Law Review. They write (footnotes omitted):
Almost every corporate governance reform proposed over the past several decades has focused on the board of directors. . . .This battle is fought on the grounds of who board members are, whether they are independent, who appoints them, how they are elected, how they are compensated, what the standards for their conduct and liability are, whether there should be more independent directors, what the optimal board size is, and so forth. All of these reforms are an attempt to optimize the monitoring and governance role played by the board. Despite the long and zealous efforts of corporate law reformers to understand and improve the board of directors, there is a gaping hole in the corporate governance literature. No one has yet questioned a fundamental assumption of the current corporate governance model—that is, only individuals, acting as sole proprietors, should provide professional board services.
Bainbridge and Henderson propose that when a a firm is choosing a board of directors, instead of hiring a group of individuals to be on the board, the firms should be allowed to hire a \”board service provider,\” an outside company that would provide board of director services to the firm. They write:
In other words, just as companies outsource their external audit function to an accounting firm rather than multiple individuals, the board of directors function would be outsourced to a professional services company. To see our idea, imagine a firm, Boards-R-Us, Inc., serving as the board of Acme Co. Instead of Acme shareholders hiring a dozen or so individual sole proprietors to provide board functions, they instead hire one firm—a BSP—to provide those functions, whatever they may be.22 Boards-R-Us would still act through individual agents, but the responsibility for managing a particular firm, within the meaning of state corporate law, would be that of Boards-R-Us the entity. This means, for instance, that a suit by shareholders for breach of the board’s fiduciary duties would be against Boards-R-Us, and not against individuals
or groups of individuals.
A company acting as board service provider would continue to make all the same decisions as a current board of directors: that is, hiring and firing top management, setting compensation, having final approval over major decisions like takeovers and mergers, and so on. As the authors write: \”the basic version of our proposal is substantially similar to the current board model, with the one key difference that the board consists of an “it” instead of a collection of individuals.\” Indeed, in choosing a board of directors, it would be possible to have a slate of individuals run against a board service provider–or against several different board service providers. It would be possible to have a board of directors that was, say, half made up of a board service provider, while the other half was the typical individual board members chosen separately by shareholders.
What\’s the case for believing that, at least for some companies, a board service provider company might be an improvement? One set of argument is that current boards of directors often face problems of limited time, limited information, and a lack of specialist expertise. A board service provider might be well-positioned to have full-time providers of board services, with access to both internal and external sources of information, and the ability to draw on specialist expertise.
And what about the risk that if we are already worried about mutual backrubs between boards of directors and top management, the problem might get even worse if there was only a single board service provider? This concern seems legitimate, but it\’s worth remembering just how incestuous bad some of the current board situations are. Bainbridge and Henderson remind us that when the board of directors at Disney decided that Michael Eisner deserved $140 million for one year of work, the board included a number of Eisner\’s friends, \”including actor Sidney Poitier, the principal of the elementary school Eisner’s children attended, and the architect who designed one of Eisner’s homes.\” More recently, the media conglomerate IAC, chaired by Barry Diller, \”appointed thirty-one-year-old graduate student Chelsea Clinton to the board. … [F]ormer board members of IAC include Diller’s wife, the fashion designer Diane von Furstenberg, and General Norman Schwarzkopf, and … the current board also includes von Furstenberg’s son, Alex.\”
Given that the oversight of current boards of directors is often pretty low, Bainbridge and Henderson argue that board service providers \”would be more accountable than the group of individuals currently providing board services; indeed, we believe that the accountability of the whole would be greater than the sum of the liabilities of the parts.\” They argue that a board service provider might worry more about reputation than a random individual board member, and also that a company providing board services might be more susceptible to legal oversight and liability.
Allowing companies to become board service providers is no magic potion to solve all the problems of corporate governance. But more than 80 years after Berle and Means described the problems that arise from a separation of corporate ownership and control, any new proposals for addressing it are welcome.
From The Economist, August 16.