Yahoo’s board members may or may not be “doofuses” as departed Yahoo CEO Carol Bartz declared after they sacked her, but the one thing for sure is that the events surrounding her firing, and the more recent CEO turnover at H-P, sure have folks riled up. Whatever else you want to say about these events, they certainly have provoked an interesting dialogue about the role and function of corporate boards.
A particularly interesting discussion of these issues appears in Alison Frankel’s September 23, 2011 article on Thomson Reuters News & Insights entitled “Want More Board Accountability? It Won’t Come Through Litigation” (here). Her opening salvo in her call for board reform is that shareholders have “precious little power over corporate directors.” She notes that while derivative lawsuits “give investors an opportunity to blame boards for breaching their duties, “ all the suits really do is to provide shareholders “an opportunity to air allegations without a lot of hope they’ll make difference.”
Frankel is particularly concerned that when derivative suits are filed, board members are able to rely on the business judgment rule and also on the procedural requirement that shareholders first make a demand on the board to take up the claim before pursuing the lawsuit. She also is concerned that derivative litigation defense expenses and rare settlement amounts are often paid by insurance. As a result she says, “there’s really little consequence for board members from even the rare derivative suit that ends with a sizeable payment to shareholders.” She concludes by questioning how boards can be reformed “when board members have so little incentive to change.”
Frankel makes a number of interesting points, and as usually is the case for her, she makes her points well. Nevertheless, I have a number of comments about her article. I want to emphasize at the outset that by offering these comments I mean no disrespect -- I am in fact a huge fan of Frankel’s. I offer these thoughts here purely in the interests of the exchange of ideas.
I should also acknowledge my biases. I have basically spent my entire career involved one way or the other with the interests of corporate boards. I tend to look at things from the perspective of corporate officials, which undoubtedly affects my view – although I do not think that disqualifies my opinions. What it means is that when some people think of corporate board members, they can only think of fat cats in fancy suits lighting cigars with hundred dollar bills. Whereas I think of the conscientious, hard-working, well-intentioned men and women I have known over the years who try hard to do what is best for their companies.
There is some irony that this debate is arising in the context of two recent board actions to fire their companies’ CEOs. It used to be that boards were criticized for being too cozy with the CEOs they were supposed to be supervising. Now Yahoo’s and H-P’s board are being criticized for the actions they took in throwing their CEOs out. I think a fair case could be made that these events played out the way they did not because the boards lack “incentives” to change as Frankel asserts, but rather because the boards are under excruciating pressure and feel a tremendous urgency to act forcefully. We may or many not agree with their actions or the way they went about it, but no one can question their willingness to act aggressively to try to make changes they think are necessary.
I think it is important to keep the extraordinary pressure facing board members today in mind when thinking about the desirability of trying to hold directors more accountable through shareholder derivative litigation. My own view is that it would be highly detrimental to the general aims and purposes of the corporate business enterprise if the defensive safeguards to derivative litigation were significantly reduced.
The expression of the need to “hold boards accountable” represents fine sentiment. But does anyone think that the economic purpose of the corporate business enterprise would be advanced if corporate officials could more easily be hauled into court and more frequently forced to defend their business decisions in court? In particular, does anyone really think that the increased threat of litigation would produce better business results and outcomes? And what would this omnipresent threat of litigation do to corporate decision-making if at the same time these corporate officials could not resort to insurance to protect themselves?
Personally, I have an experienced-based bias against anything that would encourage more litigation. I began my career litigating business cases. It is very hard to come in contact with our civil litigation system without concluding that the litigation process in our country is a colossal waste of time, energy and resources. All too often, the only ones who benefit from the system are the lawyers, and even they hate it. While I will concede that there are meritorious cases, it is the rare case indeed that produces benefits even remotely commensurate with the hideous waste of resources the process entails. It is impossible for me to believe that removing barriers to litigation will do anything to improve corporate performance or board functioning.
It is far likelier that increased litigation threats and liability exposures will undermine the kind of decision-making our companies need to be able to compete in the global economy. It could also exacerbate the enormous pressures that directors already face and magnify the kinds of pressures that arguably caused the Yahoo and H-P boards to act precipitously in their recent actions.
The fundamental issue here is the question of what it means to “hold boards accountable.” I start with the proposition that the corporate enterprise is a financial venture pursuing a business purpose and run by a group of individuals. Investors’ participation in this venture is purely voluntary and entirely optional, and based on the investors’ own assessment of the venture and the individuals trying to run it. Whether to invest, to stay invested or to stay away altogether are the tools investors have – and they are powerful tools, as in the end access to investment capital could be determinative of whether or to what extent the venture succeeds. Investment selection is the truest and most effective form of shareholder democracy.
One valuable thing that has emerged from the recent events and the ensuing discussion is a renewed appreciation for the importance of board functioning. An effective board is an important part of any successful corporate enterprise. But rather than producing bigger cudgels with which to chastise boards of lagging enterprises, what we need are better tools to understand how to identify companies with effective boards. In the long run, picking winners rather than punishing losers will be better for individual business enterprise and for our general economic well-being.
I would like to see improved board functioning as much as anyone else. In a highly competitive global economy it is going to be increasingly important for companies to have wise and visionary leadership. But subjecting corporate stewards to increased hindsight second-guessing in a courtroom will do little to bring that type of leadership about.
My earlier post discussing the question of whether directors should be held liable more often can be found here.
Looking in the Hermit Kingdom: According to a September 17, 2011 article in The Economist magazine (here), North Korea is once again facing a severe food shortage. The article examines the question of how a regime that so persistently leaves its population in hunger and misery remains so entrenched. The article speculates that population distribution and transportation shortcomings have internally isolated the country’s underclass and minimized the risk that they might act collectively.
A question worth asking is what the country’s leadership is doing to address the current crisis. The answer is that, well, they are looking at things. Indeed, based on pictures published in North Korean newspapers, looking at things is the country’s leader’s principal occupation – so much so that there is a website descriptively and accurately entitled “Kim Jong-il Looking at Things.” The site, which notes that “the dear leader likes to look at things,” consists of pictures of, well, Kim Jong-il looking at things. What kinds of things? A fish, umbrellas, doner kabab, scientists, glass bottles, corn, chemicals, bread…I guess there are a lot things to look at when you a “Supreme Leader.”
According to Wikipedia (here), Kim Jong-il’s official biography claims that his birth “was foretold by a swallow, and heralded by the appearance of a double rainbow over the mountain and a new star in the heavens.” Many North Koreans believe that he has the "magical" ability to "control the weather" based on his mood. In 2010, the North Korean media reported that Kim's distinctive clothing had set worldwide fashion trends.
The whole bizarre situation would be funny if it weren’t so tragic.