Or how about the CalPERS governance Web site? Among the warning shots delivered is this one: “In the past, CalPERS encouraged the independent directors as a group to act as catalysts on the board and to heighten their oversight of management. In future campaigns, CalPERS may call directors to account for their individual [emphasis in the original] performance. It may urge directors to devote more time to fewer boards, avoiding the problem of ‘multiple directorships.’ Or, it may encourage boards to restructure for optimum size, diversity, and independence.”
The problem with this new governance ideal is that boards of directors are effectively being asked to develop fiduciary split personalities. On one hand, boards are asked to ensure that management actively seeks to “maximize shareholder value.” On the other, hostile legal and ethical climates compel directors to be conservative in ensuring compliance with complex and conflicting accounting rules and regulations. (Consider the huge battles over expensing stock options.)
Where Sarbanes-Oxley demands that directors devote disproportionate effort to overseeing compliance processes to preclude any chance of fraud, misrepresentation, or financial malfeasance, the markets rightly demand that directors push for strategic value creation. Powerful institutional investors who once pressured a company’s top management to perform better — or else — now tell boards of directors to get top management to perform better — or else.
In other words, directors, particularly the truly independent directors now required by law to populate the boardrooms of publicly traded companies, must be bolder yet more risk-averse. Maximize shareholder value, but be certain to dot every legal i and cross every compliance t. Practice “Hippocratic governance” (first, do no harm!), but also deliver the “high-performance governance” that pushes management to greater results.
Resolving these tensions is difficult in the best of times. As the MacAvoy–Millstein book, the AIG paper, and the CalPERS Web site attest, these are not the best of times. Regulatory redesigns, in fact, complicate the governance challenge because they promote institutional distrust between the company management and the board. Sarbanes-Oxley, for example, effectively calls for boards consistently to substitute verification for trust. Section 404 of the act requires management at all levels to “sign off” on the financials. Top managers can’t be trusted either to police or to compensate themselves, so audit and compensation committees must consist solely of independent directors.
Is that all bad? Of course not. Trust and verification are not incompatible. Skeptical inquiry typically yields better operational decisions than passive acquiescence. But effective governance is about striking a reasonable accommodation between verification and trust — not about elevating one over the other.
If you accept that governance reforms are intended to minimize managerial excess and indulgence while boosting executive accountability, then honesty compels acknowledgment that reforms must also encourage a more contentious relationship between management and the board. The history of human nature reveals that adversarial relationships create their own pathologies of miscommunication and mismanaged expectations with respect to risk and reward. That’s why defining the trade-offs that shape effective governance is so hard.
So is better governance defined primarily by the active prevention of abuse? Or by the active promotion of profits? Or, to “Buffett-ize” the issue, is better governance defined primarily by making sure the right people are in the top jobs — the board as C-level human resources department?
“Better governance” champions, including Mr. Millstein, Professor MacAvoy, and the CalPERS board, argue that it should mean all of those things. Good luck. As recurrent crises in global corporate governance affirm, it’s difficult to do even one of those things consistently well. No wonder D&O insurance rates are rising.
The problem emerging in the governance debate is straightforward: A board trying to do all of these things well is not merely an active board; it is a board actively running the company. This is not overseeing management or supervising management or holding management accountable — it is management. So the corporate governance reform agenda risks becoming an initiative effectively to dissolve most of the critical, traditional distinctions between the chief executive and the board.