Although Mr. Buffett’s boardroom priority reflects neither the spirit nor the letter of the Sarbanes-Oxley Act, it does capture the core conflict haunting corporate governance worldwide: When should board oversight — when must board oversight — become active intervention? As directors become more accountable to shareholders, regulators, and the courts, how much more accountability does the board demand of its C-level executives?
Multibillion-dollar governance debacles have understandably created new demands for radical reform. A “zero-tolerance” environment is evolving for both directors as individuals and boards as fiduciary institutions. The days when “independent” directors could receive hundreds of thousands of dollars in “fees” for marginal investments of time and effort are over.
Yet although the current sense of urgency and accountability may be new, the underlying problems of corporate governance are not, as Yale economist Paul W. MacAvoy and attorney and governance guru Ira M. Millstein point out in their quirky but compelling collaboration, The Recurrent Crisis in Corporate Governance, which explains why boards consistently, persistently, and predictably fail in their fiduciary duties.
Despite legislation as onerous as Sarbanes-Oxley, and despite ongoing threats of public and private litigation, Professor MacAvoy and Mr. Millstein maintain that the governance conundrum will get worse unless further reforms are undertaken. In a pithy, provocative 160 pages, they not only synthesize and summarize the best academic research on the economic importance of governance; they persuasively argue that boards need to be institutionally reconstituted and redesigned.
They are blunt: The authors want the American era of the combined chairman/CEO to come to an end. Now. They believe that boards should be far more independent. Now. They expect that making boards more accountable will make them more productively proactive. Directors should be investors. Managerial capitalism is dead; long live the return of investor capitalism.
“The major element of [board] self-help, as suggested throughout this book,” they write, “requires boards to own up and recognize a basic truth: a board needs a leader, separate and independent from management, whose primary function is to help the board design and carry out its processes and thereby obtain the information that it needs to adequately protect against the misuse of resources and the squandering of investors’ capital.”
Professor MacAvoy and Mr. Millstein sport impeccable credentials and employ rigorous analysis, but the governance conflicts they identify may prove even more intractable than they fear. Rather than creating a rational mechanism for corporate checks and balances, the ongoing rise in governance legislation, litigation, and regulation instead may be creating unrealistic expectations for effective oversight.
That’s worrisome news for directors. Look at a recent white paper from the American Insurance Group (AIG) on the future of directors and officers (D&O) insurance, and the California Public Employees’ Retirement System (CalPERS) Web site on corporate governance. AIG is one of the largest underwriters of D&O insurance. CalPERS is the largest U.S. public pension fund, with more than $160 billion in holdings, and has championed the limiting of investments to those companies that use “best practice” governance principles. What becomes disconcertingly clear is that the public market for directorial transparency, accountability, and responsibility is becoming as overheated as the market for Internet stocks was in 1999.
“New litigation trends continue to indicate that D&O liability will become greater and greater,” begins AIG’s 2004 white paper. “Trends point to increases in derivative litigation against directors; a rise in securities claims against smaller companies; and new vulnerabilities, including expensive pension fund litigation against directors and officers. There is also the specter of unforeseen litigation arising out of new accounting pronouncements and regulatory changes.” Just for context, AIG’s paper points out that the number of companies sued in securities litigation nearly doubled from 1996 to 2003, while the average settlement for non-accounting-related cases more than tripled, to $24.8 million. In other words, says AIG, you ain’t seen nothin’ yet.