A New Year's Editorial: It's the Board of Directors, Stupid

This Blog does not take issue with the general proposition that companies should act in the best interests of shareholders and that this generally translates into profit maximizing behavior.  But at the same time, this Blog views the system of corporate governance in the United States as insufficient to insure that this occurs.  There are many who disagree with this point, viewing the US system of corporate governance as optimal.  It is a short sighted perspective, not supported by any good empirical evidence.  It is a view that guarantees opposition to any reform, including SOX.  SOX over the last five years has contributed to improved investor confidence, improved financial integrity and, probably, a reduction in the amount of corporate fraud. 

In addressing the problems of corporate governance in the United States, the most significant problem is the fiction that "independent" directors can protect the best interests of shareholders.  As we have noted time and time again the definition of independence does not ensure that in fact directors are independent.  The idea that they protect the interests of shareholders is, therefore, a fiction. 

An editorial a few weeks back in the WSJ by a senior finance officer for Citigroup in the UK took financial institutions to task for having boards that "consist principally of leading clients, ex-politicos, and community leaders." The criticism was not made only in connection with US financial institutions, but those overseas as well. According to the piece, "many of the biggest bank boards resemble retirement clubs. Without current corporate, banking or risk expertise, it's hard to see what these directors are adding, save a few more deal contacts."

We haven't singled out the boards of financial institutions, although we note that directors can be well paid. Take Merrill Lynch for example. The data below comes from the 2007 proxy statement . Total compensation paid to the non-employees directors generally fell into the $250,000 range, although some directors received compensation in excess of $300,000.  This is the board that was in place when the CEO, Stan O'Neal, "retired" and received compensation with an estimated value of $160 million .  Merrill has an independent board, but notes in the proxy statement that "[c]ompensation for service as a Director is not considered in making independence determinations."

In other words, directors can be paid enormous amounts, with the payments treated as having no role in their status as independent, under both state and federal law.  Directors often meet a modest time during the year, receive large payments, and are selected by their peers on the board (the "independent" nominating committee).  In other words, they have every incentive to want to maintain their position and, as we have noted, the best way to do so is to maintain good relations, not with shareholders but with corporate management.

In the end, the access proposal considered by and ultimately refused by the Commission would have had marginal impact on the corporate governance process.  The proposal would rarely be adopted by shareholders.  Even if adopted, large shareholders would probably not use the authority often.  Even less often would a shareholder director actually be elected.  But it was a symbolic effort.  It was an attempt by shareholders to gain acknowledgment that they have a right to elect non-management nominated directors.  The Commission's decision puts it smack in the middle of the anti-shareholder contingency, protecting the status quo and symbolically telling shareholders that they must rely on the inadequate system of independent directors to protect their interests.