A Radical Idea for Restructuring Corporate Boards

Last week’s Schumpeter
column
in the Economist carries a provocative idea that involves a complete
relook at the way boards of companies are structured and operated. It borrows a
proposal from an article titled “Boards-R-Us:
Reconceptualizing Corporate Boards
” authored by two leading US corporate
law academics. The column summarizes the proposal as follows:
In
the May edition of the Stanford Law
Review
Stephen Bainbridge of the University of California, Los Angeles, and
Todd Henderson of the University of Chicago offer a proposal for fixing boards
that goes beyond tinkering: replace individual directors with
professional-services firms. Companies, they point out, would never buy legal
services or management advice from people only willing to spare a few hours a
month. Why do they put up with the same arrangement from board members? They
argue for the creation of a new category of professional firms: BSPs or Board
Service Providers. Companies would hire a company to provide it with “board
services” in the same way that it hires law firms or management consultants.
The BSP would not only supply the company with a full complement of board members.
It would also furnish it with its collective expertise, from the ability to
process huge quantities of information to specialist advice on things such as
mergers.
Messrs
Bainbridge and Henderson argue that this would require only a simple legal
change but could revolutionise the stick-in-the-mud world of boards. It would
replace today’s nod-and-a-wink arrangements with a market in which rival BSPs
compete. It would create a new category of professional director. And it would
allow BSPs to exploit economies of scale to recruit the best board members,
introduce more rigorous training programmes and develop the best proprietary
knowledge. Now, even the most diligent board member can only draw on his or her
experience. BSPs would be able to draw on the expertise of hundreds. This would
increase the chances that corporate incompetence will be corrected, corporate
malfeasance found out and corporate self-dealing, in the form of inflated pay,
countermanded.
While this
proposal is an interesting one and merits further consideration, it also evokes
a great deal of skepticism. A few concerns are discussed here. First, merely because there are problems
with current board structures that place an overemphasis on board independence,
it may not necessarily justify a complete overhaul. Perhaps it may be
preferable to address the problems with the current structure through
refinements that may involve less cost and may be more efficient. For example,
the focus may be on revamping institution of independent directors and the
support systems available to independent directors to carry on their role more
effectively.
Second, the BSP concept would encounter
the same agency problems as other third party intermediaries that operate as
“gatekeepers”. In that sense, the incentives of BSPs are likely to operate in a
manner that is similar to those of auditors, credit rating agencies and the
like. If instances of corporate governance failures have provided the impetus for
a total overhaul of board structures, history is replete with instances where
such intermediaries, despite their strong reputation incentives, have
themselves partaken in responsibility for such failures. Corporate governance
scandals involving board failures are usually also accompanied by deficient
conduct on the part of the auditors. Hence, by creating an institution such as
the BSPs, it is likely that the problem with individual directors may be relocated
to corporate intermediaries who may suffer from distorted incentives that may
cause a different set of governance problems.
Third, the concept of having corporate
directors is not novel. For instance, in some jurisdictions, it has been
possible for one company to be a director of another company. Closer home,
historically the concept of “managing agency” was prevalent in India for nearly
150 years even before every company was required under law to have a board of
directors. Managing agents were appointed by companies under a contract to
manage and control companies. Each managing agent could undertake such a function
across a portfolio of companies. However, the concept of managing agency ran
into significant governance issues and problems, and was ultimately abolished
in India as long ago as 1970. Readers interested in the historical role of
managing agencies in Indian corporate governance may refer to (i) “Chapter 2:
Evolution of Corporate Governance in India” in Subhash Chandra Das, Corporate
Governance in India: An Evaluation
, and (ii) Kamal Ghosh Ray, “The
forgotten managing agency system: a nineteenth century model of Indian
corporate governance
”, Social Responsibility Journal, Vol. 5 Iss 1 pp. 112 –
122 (subscription required) (where the author is somewhat sanguine about the
ability of the managing agency concept to address modern-day corporate
governance problems).
Finally, the answer to the shortcomings
of corporate boards may lie somewhere in-between. While professionalization of
corporate boards is desirable, a total outsourcing to an outsider service
provider may not be. One option, which has been considered before would be the
appointment of professional independent directors (as I have argued
elsewhere
).
Despite the doubts
raised regarding the viability of the BSP model, the discourse and scholarship
towards a total overhaul of the current board governance mechanisms cannot be ignored.
A deliberation of such ideas, as radical as they are, could help shape the
direction in which board and governance structures are likely to shift.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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