Corporate Governance

Jon Macey on Corporate Governance (Part 4)

By J Robert Brown Jr et al.

We are discussing Corporate Governance, Promises Kept, Promises Broken, the provocative book by Jon Macey, Deputy Dean and Sam Harris Professor of Corporate Law, Corporate Finance, and Securities Law at Yale.

Singularly the most provocative portion of the book is the discussion of the board of directors in Chapter 4.  He does two things.  First, he notes the almost schizophrenic purposes given to directors.  They are expected not only to monitor but also to advise, tasks that are in many ways irreconcilable.  Moreover, the relative weight given to each function has normative implications.

• [A] board structure that emphasizes independent directors reflects a corporate governance policy of favoring monitoring over managing because the independent directors inevitably will have less information and therefore will be less able to contribute to managerial decision-making than will inside directors. On the other hand, a board structure designed to maximize the efficacy of board participation in strategic planning and other managerial functions will have relatively few outside independent directors.

In other words, increased independence weakens the advisory function; reduced independence weakens the monitoring function.  For Macey, the impossibility of this dual function raises concern about whether the board, as currently configured, can ever fulfill its role in the corporate governance process.

The discussion of these responsibilities highlights one of many weaknesses in the current approach to corporate governance.  The emphasis is on independent directors, with exchange traded companies required to have a majority of such directors on their boards.  Moreover, many companies rely on a super majority of independent directors, with the CEO often the only non-independent director on the board.  As data by Sherman and Sterling on the top 100 largest publicly traded companies notes, independent directors constitute 75% or more of the boards of 89 of the Top 100 Companies surveyed this year, with the CEO the only non-independent director in 44 of the top 100 companies. 

Moreover, while the NYSE definition of independent has many problems (excluding consideration of fees for one), it clearly encourages the use of directors who have no existing business relationships with the company.  In other words, these boards really have no one on them except the CEO who really knows about the business of the corporation.  This highlights the consequence of allowing CEOs in the US to also serve as chairman of the board.  The position gives them almost complete control over the information about the company that is communicated to directors.

They are, therefore, expected to monitor management but then are subject to extensive controls over the information that they need to accomplish the task.  At a minimum, the two positions (chairman and CEO) must be separated (a position Macey takes in his book).  Provisions in SOX governing audit committees and internal control seek to address this imbalance by essentially requiring companies to report certain kinds of information to the board, taking it away from the CEO's discretion and monopoly.  But even if the information is given to the board, they have to understand it.  The provision in SOX that all but requires boards to have directors with financial expertise edges in this direction.

Full post as published by The Race to the Bottom on December 04, 2008 (boomark / email).