Opinion

Felix Salmon

Felix Salmon smackdown watch, corporate-governance edition

By Felix Salmon
October 18, 2012

Justin Fox is not a fan of the video where I take the Goldman Sachs board to task. Yes, he says, the Goldman board is packed with insiders and fails just about every rule of corporate governance — but so what?

There’s little or no evidence that the modern criteria for good corporate governance actually lead to better-governed corporations. What’s generally seen as the most important good-governance move of them all, pushing insiders off boards in favor of independent directors, may actually hurt performance. At least, that’s my reading of the voluminous academic research on the topic.

What’s more, says Justin, I’m wrong about the idea that the job of the board is to represent shareholders and to keep management under control.

As Cornell Law School professor Lynn Stout explains here, the board is actually responsible to the corporation, not its shareholders. And no, the shareholders don’t own the corporation — they own securities that give them a not very well-defined stake in its earnings, and the freedom to flee with no responsibility for the corporation’s liabilities if things go pear-shaped…

In the case of financial firms like Goldman Sachs, shareholders contribute only a small portion of the balance sheet and lenders (and taxpayers) are in many ways truer owners. Multiple studies have shown that it was financial firms with the most shareholder-friendly governance and executive compensation schemes that got into the most trouble during the financial crisis. That only makes sense — shareholders pocket the gains if big risk-taking pays off, but they aren’t on the hook when a bank collapses. Goldman’s relatively smooth sail through the crisis was in part the product of a governance culture that doesn’t put the short-term interests of shareholders first.

So who’s right, me or Justin? Easy: it’s Justin, completely, on this one. My video was a lazy recapitulation of this article by Eleanor Bloxham, and the opportunity to indulge in a bit of squid-bashing was just too juicy to resist. If Goldman Sachs fired its current bunch of muppets and replaced them with, say, the Citi board, or in any case a group of vertebrates, it’s not entirely obvious whether or how the bank would be improved.

Justin says that “a truly effective board” is “one full of committed, expert members who generally have a constructive, supportive relationship with management but are curious enough to keep digging into the company’s business and tough enough to take a stand when management begins to lose the plot”. Which sounds great, but risks being tautological: as he says, on paper, the HP board should fit the bill, and it’s been a complete and utter disaster. And in general, while it’s easy to spot bad boards, like HP’s, and utterly ineffective boards, like Goldman’s, it’s hard to point to boards which are particularly good. Often, good boards are like a good movie soundtrack: if the job is done well, it’s not noticed at all.

What’s more, great leaders neither want nor need great boards: they just want people who’ll get out of the way. After all, when boards do take matters into their own hands, they end up doing things like firing Steve Jobs from Apple. More generally, we’ve reached a level of CEO turnover these days which is clearly excessive: boards seem to be making up for their day-to-day spinelessness by panicking every so often and overreacting by firing the boss. Which rarely does much good.

One of the problems is that the job of directors is not well defined. Many of them think it has something to do with increasing the share price as fast as possible; almost none of them have clear roles like representing unions. In general, it seems, directorships are a nice prize you get for being Important; they can pay very well, but most of the time they end up going to people who don’t need the money. The real problem is not with any individual board but rather with the whole lot of them, as a group: they’re an insular group, made up largely of CEOs and former CEOs, and as such they tend to sympathize with senior management and pay those executives much more than they’re worth.

In the judicial system, juries are made up of randomly-picked members of the general public — and the jury system tends to work surprisingly well. I’m not saying that corporate boards should be chosen the same way. But I do think that the universe of potential board members is, as a rule, far too small. You want real diversity? Don’t put Dambisa Moyo on the board of Barclays. Put Cathy O’Neil on the board of Goldman. That would be awesome.

Comments
8 comments so far | RSS Comments RSS

“Glamour boy who jump to conclusion sometimes get hair mussed.” (Charlie Chan)

“felixsalmon The Loeb award was nice. But I never truly made it until I was the subject of a Daily Beast Facebook poll. facebook.com/thedailybeast/…
about 1 hour ago · reply · retweet · favorite”

“He who squanders today talking about yesterday’s triumphs, have nothing to boast of tomorrow.” (Chan too)

TaTa, stud.

Posted by MrRFox | Report as abusive
 

The board does have to answer to the shareholders, not that they ever hold them accountable. And while their responsibility is not just to maximize profits (just like it isn’t for management), they are selected by shareholders to make sure the corporation is run correctly. They have a responsibility to customers, suppliers, and shareholders to make sure the management doesn’t screw up – directors often get sued by shareholders when they don’t provide enough oversight of the management.

To say the board “isn’t responsible” to the shareholders is like saying Congress isn’t responsible to the people in the U.S.. Congress answer to the voters, and while voters think congress should act in the best interests of their specific district, Congress is supposed to do what they think is best for the entire nation. Just like the board is supposed to do what is best for the corporation. And they answer to the voters/shareholders.

And why play semantics when it comes to ownership of the corporation? While there’s no doubt management of most publicly traded corporations runs them for their own benefit, the shareholders DO own the corporation. If you own enough shares, you get to do whatever you want with the company. If you own enough shares, you get to specify what to do with the profits. When you own shares, you own a piece of the company; that it gives you no well-defined stake in the earnings is not different than no one voter being able to specify how the government is run. If enough shareholders band together, they can get a well-defined stake in the earnings, if that’s what they want.

For extreme examples of how shareholders own the corporation and directors act responsible to them, look at any VC-funded start-up. The board often micro-manages executives, and ensures that management does what the majority of the shareholders want the company to do. Those lines between shareholder and corporation only get blurred when ownership gets widely distributed, but they are still there. If institutional shareholders fulfilled their civic duty, there would be much more oversight of publicly traded corporations.

Posted by KenG_CA | Report as abusive
 

Felix, this is largely a well-done mea culpa, but you should really try to avoid the casuistry that got you in this mess in the first place. “After all, when boards do take matters into their own hands, they end up doing things like firing Steve Jobs from Apple.” That sentence makes no sense whatsoever – I can think of no other event “like” that one. Likewise, the strength of Justin’s response is not in the cases he mentions, but in the aggregation of the literature he cites.

Posted by absinthe | Report as abusive
 

Well said KenG.

TO say that the board doesn’t work on behalf of the shareholder is to be confused about what the actual legal structure is.

Posted by QCIC | Report as abusive
 

” Great leaders neither want nor need great boards: they just want people who’ll get out of the way. ”

False. Autocrats don’t want great boards or anyone who could stand in their way.

But great leaders actually seek challenging opinions and accountability for themselves. A really competent board of directors is also the best sounding board a CEO can get.

Posted by Frwip | Report as abusive
 

I like how Felix’s last paragraph basically sums up to “People I agree with should be on boards, and people I don’t, shouldn’t!”

Posted by duh2 | Report as abusive
 

Felix,

You got it right the first time. Goldman Sachs needs a corporate governance revamp. Here’s one more example of how screwed up the board is: Goldman has three key committees… audit, compensation and corporate governance/nominating. Each has the same 10 “independent” directors. The reason boards have committees is so that a few of them specialized in each area can delve in depth and report back to the board. Not so at Goldman.

A proxy access proposal is desperately needed to get new blood on the GS board.

Posted by Corpgov.net | Report as abusive
 

Felix,

You got it right the first time. Goldman Sachs needs a corporate governance revamp. Here’s one more example of how screwed up the board is: Goldman has three key committees… audit, compensation and corporate governance/nominating. Each has the same 10 “independent” directors. The reason boards have committees is so that a few of them specialized in each area can delve in depth and report back to the board. Not so at Goldman.

A proxy access proposal is desperately needed to get new blood on the GS board.

Posted by Corpgov.net | Report as abusive
 

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