Is corporate governance really broken?

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Professor Stephen Bainbridge of the UCLA School of Law was not impressed with my essay last week on “Who needs a board of directors, anyway?”

“It’s a very good question,” he wrote in his blog, “Unfortunately, he [me, that is] offers a very bad answer.” Bainbridge’s main complaint appears to be that I attributed the existence of the corporate board of directors to historical factors. He’s a law and economics guy, which means he’s dubious of explanations like that. If corporations have boards of directors, there must be an economic reason for it.

I’m actually pretty sympathetic to such arguments. Business practices don’t survive for centuries unless they help make somebody money. But the article (it’s a pdf file, so I don’t want to link without warning, but here it is) I cited by University of the Pacific law professor Frank Gevurtz did posit an economic reason for boards’ survival: that they make the existence of large corporations, which are important engines of our economy, palatable to the citizenry.

That may not be an entirely convincing explanation, but neither is Bainbridge’s. He says boards exist because groups make better decisions than individuals. That in itself is debatable–although Bainbridge marshals an array of empirical evidence to back it up. But even if it’s true, Gevurtz points out, the chief decisionmaking group at most large corporations is top management, not the board.

So where does that leave us? Confused. The board of directors isn’t going away, but neither does it appear capable of reliably serving the role envisioned for it in law–that of ultimate decisionmaker at a corporation.

The big question, really, is whether we need to do anything about this. Most of the commenters to my original post seemed to think we do. “Boards would be fine if they were truly elected by shareholders,” wrote Dale Lamm of Canton, Ohio, expressing a sentiment shared by several others.

As it stands now, board nominees are chosen by the existing board and management and almost always run unopposed. A couple years ago, the SEC proposed changing proxy rules to enable large, long-term shareholders to place candidates on a company’s director ballot–but opposition from corporate executives kept the plan from getting anywhere.

Bainbridge opposed the proposal, too. His key objection, as he put it in his comment letter to the SEC, was this:

Large-scale investor involvement in corporate decisionmaking seems likely to disrupt the very mechanism that makes the public corporation practicable; namely, the centralization of essentially non-reviewable decisionmaking authority in the board of directors. The chief economic virtue of the public corporation is not that it permits the aggregation of large capital pools, as some have suggested, but rather that it provides a hierarchical decisionmaking structure well-suited to the problem of operating a large business enterprise with numerous employees, managers, shareholders, creditors, and other inputs. In such a firm, someone must be in charge …

My sense is that there’s a continuum of shareholder involvement in corporate decisionmaking, and over the past two decades in the United States we have gone from almost none to a little. The SEC proposal would have pushed things slightly farther in that same direction, but I find it hard to believe that it would have dramatically shifted the balance.

Do we need to dramatically shift the balance? Well, it depends whether you think corporate America is a pit of self-dealing, waste, and fraud or a spectacularly successful economic endeavor marred by occasional breakdowns and more frequent blind spots. However sympathetic I am to the arguments of the Jack Bogles and Bob Monkses of the world, I invariably find myself landing in the latter camp. So I’m basically a fellow traveler of Stephen Bainbridge. (Which bums me out, because I’d been hoping to milk this into a debate that dragged on for months.)

Finally, for those of you who went to the trouble to read Bainbridge’s post: He claims that a couple of my descriptions of changes in corporate governance through the years (the decline of shareholder and creditor power in the first few decades of the 20th century, and the modest rise in shareholder clout in recent years) are factually incorrect. That’s a bit much. The real story is that I was repeating the standard history, while Bainbridge favors the work of a few revisionist scholars who have chipped away at the edges of it.