New Models for Broken Board Governance System

To say that these are challenging times to be a corporate director is an understatement. Shareholders are clamoring for greater ability to determine what happens in the boardroom and who sits in the seats; the SEC is proposing a host of new rules requiring a broad range of expanded disclosures; the pace of new lawsuits continues unabated. All this occurs with memories still fresh of the financial system’s near collapse, against a backdrop of an economy still struggling emerge from the “Great Recession.”

As if that’s not enough, directors continue to struggle with their roles as monitors ensuring management properly deals with legal and regulatory compliance issues and otherwise does the right thing, while focusing on company strategy and performance in a fast changing and highly competitive environment. The need to spend increasing amounts of time on board business is exacerbated by expanding committee service, where governance/nominating, compensation, and audit committees are subject to more and more rules and taking on a life of their own. And when a regulatory action, takeover initiative or other life-changing corporate event creates something akin to a crisis environment, the pressure and demands on directors’ time becomes almost unbearable.

Directors, institutional investors, and other shareholders are asking a legitimate question: With the current governance model, can boards of directors truly meet the expectations thrust upon them? An emerging view is in the negative, concluding that today’s governance model of Corporate America necessarily must change. At least three different models have been put forth as offering improvement. For what it’s worth, let’s take a look.

I - Greater Shareholder Authority

Some would say this “new” model already is emerging as a reality. With rules requiring ever expanding corporate disclosures, shareholders should have greater transparency into the workings of their companies. We’re looking, for example, at additional disclosures having to be provided on how compensation policies drive risk, director and nominee qualifications, the board’s leadership structure, and potential conflicts of interest. And there’s little doubt that proposed rules enabling shareholders to put forth director nominees will soon become regulatory requirements. (See my September 2009 column, “The Shareholder Rights Express Rolls On.”

Under this model, shareholder rights would continue to expand. Carried to the extreme, we can imagine shareholders being positioned to make absolute and final determinations on such matters as strategic initiatives, management compensation, who takes on or keeps the job of CEO, and of course, who serves on the board of directors.

While it might seem appealing conceptually for a company’s owners to make whatever decisions they want about how the company is governed and how it’s run, reality is their decisions will have little if any foundation. Quite simply, shareholders do not sit in the boardroom, and regardless of the amount of paper or electronic communications, shareholders cannot be positioned to make informed judgments on what’s best for the company and its owners.

II - Two Boards: One Monitoring, Another Adding Value

Begin with the premise that no single board of directors can reasonably satisfy both principal governance responsibilities: (1) to monitor what management is doing to keep it and the company in compliance with laws, regulations, and board policies and directives; and (2) to provide value-added advice, counsel and where necessary direction to help drive corporate profitability, growth and return. Hence this model calls for splitting these responsibilities in two, a monitoring board being the watchdog and a performance board doing what’s necessary to promote corporate success.

This too has some surface appeal. As responsibilities and expectations of directors grow but time remains limited, doubling director resources certainly would help alleviate the burden.

But this model, too, is flawed. For one thing, because boards use much the same information to carry out both their monitoring and value-add responsibilities, having two boards would require more of management’s time and energy to deal with the two different bodies. Could you try to avoid that problem by having both boards sitting at the same table at the same time? Yes, but that would result in much of the discussion being of little interest to one board or the other.

Another problem is that management likely would look to the value-add directors as the “real” board, since those directors would be the ones (hopefully) providing great advice and counsel, and in any event would be making final determinations on strategic and other business issues. The monitoring board would likely be viewed simply as a nuisance, to be dealt with much like a regulator.

III - A Full-Time Board

Yes, there are indeed proposals for turning boards of directors into full-time positions. The argument is simple: with boards taking on more and more responsibility, and expectations rising seemingly incessantly, they can no longer do their jobs well when meeting four, eight or 10 times a year. With board meetings, committee meetings and work done off-line, average time commitments are estimated in the neighborhood of 250 hours per year. But, the thinking goes, that kind of time commitment isn’t nearly enough to do the job properly, so a full-time role is the answer.

Sure, full time boards certainly would have the time (probably more than enough time) to carry out their monitoring and value-add responsibilities effectively. But alas, here too we have a significant downside.

First, the quality of directors would suffer. Difficult as it now is to recruit a sitting CEO or other senior corporate executive to a company’s board, under this model it would be impossible. And finding retired executives or other qualified individuals also would be a challenge, inasmuch as accomplished people who have reached retirement age typically don’t want to work full time.

Second, management would probably find itself spending inordinate amounts of time with a full time board. We know from experience that a director with too much time on his or her hands can get into management’s hair, crossing the line from oversight to management. Just think what would result with the entire board being full time!

A Solution

This heading is misleading, as I don’t purport to have a clear solution to this problem. Here, however, are a few thoughts to consider.

One approach is simply to keep the current model. It works reasonably well (never mind the investment banks and other financial institutions where boards failed miserably; in truth, most companies aren’t crashing and burning like them), and any change in oversight structure would require a host of changes to federal and state governance laws and regulations. And there would be no case law providing guidelines and precedent. Frankly, we can do better than either wholesale scrapping of the system, or leaving it exactly as it now exists.

An approach worth considering is to maintain the existing model but further expand the time directors devote to their board responsibilities so they can devote the needed energy and attention. This would help meet shareholder expectations and reduce potential liability; it would also call for higher compensation, and reduce the number of board seats a director could reasonably take on.

A related alternative is to have one director—the non-executive chair or lead director—devote more time to the job, perhaps even moving toward a full-time role. Care would be needed to ensure the additional time is devoted to board processes and issues, and not cross the line into management. Additionally, other directors might find it beneficial to devote somewhat more time to their board responsibilities.

These last two ideas have much merit and little downside. There might be other models with potential of working well, and hopefully they will be put forth and considered. There’s little doubt directors are spread too thin, and terribly challenged to meet increasing expectations. Something has to give. One essential action is to rethink the increasing level of responsibility and expectations being heaped upon corporate directors, and determine whether or not they really make sense.

With appropriate rules and expectations in place, if change is deemed necessary, then I suggest that the powers-that-be remember that the present system, while now strained, has worked reasonably well over many years. We don’t want to overreact. And whatever changes are put forth should be carefully analyzed and tested under real business conditions to ensure they truly work.

If all goes well, there will be a balancing of reasonable expectations, additional time devoted by directors resulting in better corporate performance, and a win-win all around.