Corporate boards have a daunting array of tasks, including hiring and firing the chief executive officer, setting the CEO’s compensation, monitoring the CEO’s decisions, ensuring compliance with laws, and above all, representing the interests of shareholders. Critics have long complained that boards are not up to the task.
There are many reasons boards fail to police managers adequately or make good decisions. Directors are part-timers with weak incentives and limited information. They also are generalists, meaning the average board is unlikely to have all the experts it needs at any given time. CEOs pick directors based on an unknown set of factors, and shareholders have no information about how decisions are made or how individual directors perform.
Corporate governance experts have proposed many reforms, some of which ended up in the Sarbanes-Oxley Act and the Dodd-Frank Act. All the reforms share several unattractive features. They are one-size-fits-all, notwithstanding the huge differences across companies and industries. While say-on-pay or more independent directors might make sense for some companies, it may actually destroy value for others. In addition, the reforms rely on academics or other “experts” knowing more about what is good for particular companies than the managers and owners of those organizations.
There is a more fundamental and unappreciated problem with all these reforms: They rely on individuals to provide professional director services to companies. We propose a better way: permitting independent firms (e.g., partnerships, corporations, etc.) to provide board services. We call these businesses “board service providers” (BSPs). The idea would be for a corporation, such as Microsoft (MSFT) or ExxonMobil (XOM), to hire another entity, call it Boards-R-Us, to provide director services, instead of the group of unrelated individuals it currently hires to provide these services.
Companies provide almost all the goods and services in our economy, including such professional services as accounting or law, because they offer some well-known advantages compared with sole proprietorships. For instance, providing director services as a group would allow directors to decrease individual risk in ways that are more efficient than third-party insurance. It would also allow directors to deploy experts as needed to address particular problems as they arise, just as consultancies and law firms do.
Board members currently have to get expertise from outsiders hired typically by the CEO, which creates conflict-of-interest problems. (Conflict problems arising from BSPs could be handled through rules limiting cross-selling of services, just as Sarbanes-Oxley did for accounting and consultancy services.) Allowing these experts to be under the same roof would reduce this problem, as well as transaction costs. Finally, service firms have reputations that exceed those of individual members, meaning the potential for slack or opportunism is reduced. When an individual acts alone, only one reputation is at stake, but when a firm acts, it is effectively betting the reputation of the firm each time.
Hiring a BSP to provide board services instead of a loose group of sole proprietorships will increase board accountability, both from markets and judicial supervision. For instance, BSPs traded in public markets will be disciplined to provide quality services at competitive prices, and courts may be more willing to enforce fiduciary duties against companies than against individuals.
There currently is no market for directors. They find their way onto boards largely through personal connections, often with the CEO, or the opaque headhunter process, and because votes are private and decisions are made collectively, the accountability to shareholders is greatly diminished. Although it is possible for any individual to run for a board seat on any company, the publicity and voting costs are prohibitive. A BSP with a national reputation and the ability to provide all director functions would be able to reduce the cost of winning board seats. For instance, BSPs can use their brand and economies of scale to lower the costs of communicating with and persuading shareholders to hire them.
This is not to argue that all public companies should hire BSPs to provide their board services. We are not fans of one-size-fits-all arrangements, generally. Companies should merely have the choice to use BSPs—and to understand their potential benefits—just as they do for all other services they require.