Corporate Governance

Jon Macey on Corporate Governance (Part 8)

By J. Robert Brown

Jon Macey, Deputy Dean and Sam Harris Professor of Corporate Law, Corporate Finance, and Securities Law at Yale, has recenlty published a book titled Corporate Governance, Promises Kept, Promises Broken. We are discussing the book in a series of posts.  This is the penultimate one.

We agree with Macey's analysis in Chapter 4 that boards are captured by management.  He relies on a reinvigorated takeover market to overcome this problem.  In addition to our disagreement with this as a solution, it is not likely to happen.  The Delaware courts are not going to suddenly outlaw poison pills.  As a result, we can either leave the captured boards in place and suffer the consequences or seek to address the problems posed by these boards.

This is of course the great conundrum in the corporate governance area today.  Macey is quite right that the emphasis on packing boards with "independent" directors is not a solution.  As he notes:

• The myth is that outsiders, since they lack a connection to the CEO or to other senior managers, will serve as effective, independent sources of monitoring for management. It may well be true that reducing the number of 'management cronies' on boards of directors is a good idea. But the case studies presented above, particularly the Enron case, clearly demonstrate that even boards completely dominated by independent outsiders are not immune from capture.

That is, assuming they are even independent to begin with.  As we have noted time and time again, directors considered independent under the rules of the NYSE or by the Delaware courts in fact are not.  The outside directors of Goldman Sachs were listed as independent despite earning compensation of approximately $700,000 for ten meetings. 

But he notes that this problem of capture does not apply to one group of directors, "so-called dissident directors."  In other words, directors nominated not by management but by shareholders have the capacity to act in a manner that protects shareholders.  As he describes:

• They are not expected to socialize with the other directors or to use their positions to gain access to other board appointments.  By definition, their allegiances lies with the shareholders, and thus their success is determined on the basis of how independent they are, not how cooperative they are.  In other words, dissident directors fit the monitoring model of directors rather than the managerial model that aapplies to directors appointed through traditional channels. 

The chapter discussing dissident directors notes the current impediments to the election of dissident directors (the control of the nomination process by management).  In later chapters (see p. 211), Macey points out some of the practical difficulties that shareholders will confront in nominating directors and the problems with reform in the area (that reimbursement of expenses alone will not solve the problem). 

The book says little about the issue of shareholder access to management's proxy statement except to criticize the 2003 efforts by the Commission to authorize the practice.  Macey views the effort at a "poorly described" attempt by the agency to link itself to a "new constituency," activist shareholders.  

Nonetheless, these difficulties and problems do not make the case that the presence of dissident directors should not be encouraged as a solution to the capture problem.  Moreover, the benefits would extend beyond the companies that actually have dissident directors.  Existing, captured directors would know that they could be voted out of office and be replaced by shareholder nominated candidates.  This would presumably better focus their attention on the interests of shareholders.  Macey contends that a robust market for corporate control would cause directors who are not subject to takeovers to engage in profit maximizing behavior in order to avoid an offer (and the loss of their job).  Similarly, directors who realistically confront the risk of being replaced by shareholders would likely engage in more shareholder behavior.

The presence of dissident directors could upset the traditional consensus decision making process in the board (although this is speculation; the board could simply come to a more reasonable, pro-shareholder consensus).  But it would certainly reduce capture.

We have one last post, looking at the impact of derivative suits on corporate governance.

Full post as published by The Race to the Bottom on December 09, 2008 (boomark / email).