Corporate Governance

Corporate Governance Practices and the Failure of the Delaware Model: The Need for Reform

By J. Robert Brown

When this Blog started almost two years ago, we listed ourselves as a Pro-SOX Blog.  In other words, one of our stated purposes was to defend Sarbanes Oxley against the withering criticism from much of the legal blogosphere.  The efforts generated an article:  Criticizing the Critics: Sarbanes Oxley and Quack Corporate Governance. 

What has become clear is that SOX, rather than going too far, did not go far enough.  For one thing, SOX largely relied on the stock exchanges to improve the governance process, making audit committees with independent directors a listing standard rather than a statutory requirement.  But what is clear is that SOX attempted to fix the problem of financial fraud and inaccurate financial disclosure.  SOX left undressed the broader issue of fiduciary duties.  This was accurately captured in an editorial in the WSJ :

• Today's financial crisis has shown what a real debacle looks like. And it has made clear that executives' duties to public companies have, if anything, been loosened, not reinforced. What is worse, the post-Enron crackdown appears not only to have failed to stop flagrant corporate risk-taking, but to have lulled Washington to sleep.

We can look at some of the specifics, such as the absence of any real obligation of the board to supervise unusual risk-taking by a company.  Thus, when Bear Stearns exceeded its own risk parameters in bulking up on debt obligations, it's safe to say that the board never reviewed or approved the practice.  Why not?  Because the board had no legal obligation to do so.

But the problems are far broader.  What about the fact that in the US, among the largest companies, most boards are chaired by the CEO?  Of the largest publicly traded companies, only 11 have chairmen who are independent directors.  In other words, the approach applied today in the US (not in most other countries) is to rely on the board to protect shareholders but to allow the CEO to control the board.  On its face that approach is inconsistent with the purpose of the board and its fiduciary obligations.  So is the process for approving self interested transactions (most noticeably executive compensation) or nominating directors.  All of these issues require reexamination.  In other words, as Gordon Smith notes, fiduciary duties are on the table.

Full post as published by The Race to the Bottom on October 29, 2008 (boomark / email).