Research Matters: Todd Henderson on “Boards-R-Us: Reconceptualizing Corporate Boards”
Research Matters is a biweekly feature in which a member of the faculty talks about some of his or her latest work and its impact and relevance to law and society. All the Q&As in the series can be found here.
M. Todd Henderson, Professor of Law and Aaron Director Teaching Scholar, wrote “Boards-R-Us: Reconceptualizing Corporate Boards” with Stephen M. Bainbridge of the UCLA School of Law. It will be published in an upcoming Stanford Law Review. The paper proposes a radical reform for corporate governance: that boards, legally required to be made up of individual persons, should actually be made up of firms that the authors dub “board service providers.”
Q. How did this idea materialize?
A. I was at a conference at UCLA, and in the Q&A for someone else’s paper about corporate governance, I asked a question: why do we have the boards that we have? That is, board services provided by a group of individual sole proprietors as part of a larger group. If we look at the board of any company, we see individual people who are picked by the CEO and nominally elected by the shareholders; these board members are then supposed to be the boss of the CEO and the caretaker of the assets for the shareholders. There are law review volumes filled with criticisms of this structure, and attempts to tweak it with countless innovations. There has been legislation, too, like the Dodd-Frank Act and the Sarbanes-Oxley Act. They offered minor adjustments: more transparency, or pay CEOs differently, etc. My question was, why do we have this model as opposed to some other model? And that question generated discussion, and then I came back to my office and did some research, and that was the origin of the paper. And because I was at UCLA, Bainbridge called me up and said, we should work on this together. Steve is kind of a legend in corporate law circles, so it was a nice opportunity for me to work with somebody whose work I admired.
Q. Had you ever thought about the problem of individuals serving on boards before you asked that question at the conference?
A. It hadn’t occurred to me before. It was more the kind of reflexive question that a Chicago person would ask. It goes back to Ronald Coase, who asked, why do firms look the way they look? Coase asked this in the question of where the boundaries of one firm stop and another firm starts. For me, the Coasian question was, why is the firm for board service made up of one person? And then all of the support that person needs – information, expertise, liability insurance, all that stuff – is all organized by contract. So an individual board member needs to get expertise about particular issues from some other firm. And it struck me as very strange that economic activity would be organized around a firm size of one person. We don’t really see that anywhere else.
Q. Why are boards made of sole proprietorships?
A. That’s a great question. I have no idea. It’s deeply puzzling to me. An easy answer is, the law requires it. The background question is, why in the world is there this rule? It is strange. As we say in the paper, it would be akin to a rule requiring accounting services or legal services to be delivered by a natural person as opposed to a corporation. Let’s say you hire a corporate lawyer to do a transaction, and she needs advice about tax. Instead of being able to go down the hall and just ask her law partner, who’s a tax expert, she’s got to go out and hire the tax expert. Maybe the latter is efficient, but it wouldn’t strike us that this is necessarily so.
One possible explanation is in a historical story that goes back to the origins of corporations. Back then, there was this view that individuals ultimately had to be responsible, and that board service was more like political representation. But I don’t think modern boards are like that. They’re not political bodies. They’re decision-making bodies, they’re monitoring bodies and oversight bodies, and those things could be more efficiently provided by firms.
Q. What reform are you suggesting?
A. In some sense, the reform is a pretty banal one, and that is, let people decide for themselves. Just let people have the freedom to arrange governance in ways that will maximize the value of their firm. Remove this legal restriction that says, you must do it this way.
Even if that was successful, we think it’s unlikely that boards would change quickly or even at all, because there are a lot of vested interests in the structure the way it is. Companies are kind of risk-averse when it comes to governance. The people who provide services to board members currently – compensation consultants, the directors’ and officers’ insurance providers, the various strategy firms – all of those people have a very vested interest in keeping the status quo and resisting change. And the CEOs who get to appoint the board members, and populate it with their friends, in a kind of worst-case scenario, also may resist this.
So we go a bit further in the paper and try to lay out a case for why we think this new model, what we call “board service providers,” would be an improvement. We try to show that there are real reasons why hiring another firm, a board service provider, to be your board would actually be beneficial for the company. We’re trying to encourage people to innovate in governance in ways that are fundamentally different than just little tweaks at the edges.
Q. Any hope that this will actually change?
A. I don’t know. A director of several public companies read the paper and contacted me about it. He thinks so, and I’m cautiously optimistic. We’re organizing a sit-down with a bunch of public company directors in the next month to get them engaged with the idea. We’ve talked about doing that more broadly, trying to go out and proselytize and explain this concept to people. It’s sensible, but it is nevertheless a completely radical break. So I think we have to introduce people to the concept and go out and sell it. I do think that the power of our argument, the efficiencies that could be gained, the increased transparency for shareholders about board processes, increased competition for board services, the possibility of getting economies of scale and scope that will lower the total costs of boards, market evaluation of board governance that we currently don’t have – all of those things, I think, ultimately, are so powerful that there’s a compelling case for this. But any kind of change takes a long time.
Of course, I could be