The SEC Can Not Fix Broken Governance - Shareholders Can

by Odysseas Papadimitriou on September 28, 2009

share-holdersAll along it has been our contention at Wallet Blog, that the board of director’s system for American public companies is in need of significant repair.  Specifically, its problem is that shareholders lack the ability to control who serves on the board of directors of their own companies at any point in time.

Lately, we have seen more and more stories in the financial news telling us that the various boards of directors of American public companies have acted in ways that are either suspicious, irresponsible, or just plain illegal.  With each such story, we see the SEC attempting to curb the corporate excesses one problem at a time.  In a recent story, the SEC has begun investigating the role of consulting firms in setting salaries for CEOs.  Specifically, the question is whether recommendations about CEO pay packages are compromised when the same consulting firm hired by the board also provides other services to the company? In other words, are these consulting companies providing generous recommendations to the board about the CEOs pay packages in order to keep the CEO happy and minimize the chances that the CEO replaces them with another consulting firm for all the other services that they provide?

The SEC’s solution is for companies to disclose their payments to consulting firms.  Their solution handles one symptom of the problem, but not the problem itself. If we imagine the system changed so that each board seat is assigned by 12.5% of the shareholders votes (as we’ve suggested in the past), then this problem would simply never come up.  It would be the shareholders job to make sure they fairly compensate their CEO and not the SEC’s. 

In like manner, New York Attorney General Andrew Cuomo has delivered subpoenas to five of Bank of America’s board members to determine what they knew, and when, about the Merrill Lynch takeover.  Again, though we appreciate the power of this action, these subpoenas would not be necessary if the board members were the actual shareholders or their direct appointees instead of a group of people that is supposed to “act in the shareholders best interests.”  It would be impossible to argue that board members were not operating in the shareholders’ best interests if the shareholders could have removed these errant board members as soon as they began acting in ways out of accordance with their position.  Anyone acting outside their responsibilities would simply be let go by the shareholders themselves, and would not be allowed to continue on so as to allow things like the Bank of America/Merrill Lynch buyout scandal that we now see and which we must now deal with on the tax payer’s dime.

Moreover, under the current board of directors system, though shareholders are absolved of guilt and are seen as powerless victims of the board’s decisions, they still end up paying for the actions of the board.  As these scandals hit, stock prices fall, and the shareholders suffer the consequences.  With immediate access to the board, shareholders would be empowered.  As such, they would have to bear full responsibility for the actions taken by their board, but they would also be given the ability to avoid such scandals and keep the company’s value from plummeting.

In conclusion, there are many ways that the system can be changed so that shareholders can have full control and accountability of their board’s decisions. One suggestion is that every 12.5% of the shareholders vote would have access to one seat on the board, to hire or dismiss at any point in time and for whatever reason.  If a board member were to make an unpopular decision, he or she would be out, and that would be that.  We do not pretend that our system is foolproof, nor do we want to suggest that it is the only system possible for fixing the board of directors system.  However, unless shareholders are given immediate access to the board some way, we do not expect that these indiscretions and breaches of law will stop any time soon.  The SEC can only handle so much, and is being asked to handle problems piecemeal for an entire system that is flawed.

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