Felix Salmon smackdown watch, corporate-governance edition

October 18, 2012
Justin Fox is not a fan of the video where I take the Goldman Sachs board to task.

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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.


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