Corporate Governance

Jon Macey on Corporate Governance (Part 5)

By J Robert Brown Jr et al.

Jon Macey, Deputy Dean and Sam Harris Professor of Corporate Law, Corporate Finance, and Securities Law at Yale, has recenlty published a book titled Corporate Governance, Promises Kept, Promises Broken.  We are discussing the book in a series of posts.

In addition to the dual functions expected of boards, he emphasizes in Chapter 4 that diretors are inherently subject to capture by management.  Capture applies not only to the inside directors, but those considered independent under the relevant definitions.  As he describes:

• The problem with boards is their unique susceptibility to capture by the managers they are supposed to monitor. The problem of capture is so pervasive and acute that no board, not even those that appear highly qualified, independent, and professional, should be relied upon entirely.

Id. at 57.  What are some of the foundations for the capture phenomena? He relies primarily on the cognitive bias that arises out of constant interaction between directors and officers and the control of management over the flow of information to the board.

• Boards select top management and "become committed to and responsible for theirs managers. For this reason, as board tenure lengthens, it becomes increasingly less likely that boards will remain independent of the managers they are charged with monitoring."

The phenomena is enhanced by the advisory function expected of directors.  This leads to constant interaction, presumably in a trusting enviornment, that contributes to caputre.  Likewise, capture is exacerbated by an organizational structure that invariably combines the positions of CEO and chairman of the board.  The CEO, therefore, controls the flow of information to the board.  At the same time, the CEO has an incentive to paint himself/herself in the most favorable light possible.  in other words, the board by definition gets a skewed body of information.  

This analysis recognizes that "capture" occurs not necessarily before a director joins the board (say through friendship with the CEO0 but afterwards.  Moreover, as Macey emphasized, the current structure makes capture inevitable.  Interestingly, the courts in Delaware courts have all but excluded structural bias from consideration when examining director independence.  It is another example of the pro-management bias of these courts.  They provide legal advantages to "independent" boards but then systematically ignore evidence that suggests the boards are not in fact independent.

Unlike the Delaware courts, governance systems overseas have recognized the capture phenomena.  A numbe of them specify that after a certain number of years on the board, a director will no longer be considered independent.  Thus, in Great Britain, the period is set at nine years.  The approach is blunt and does nothing to address capture prior to the expiration of the relevant time period.  Nonetheless, it recognizes that directors and CEOs serving together for long periods cannot approach decisions in a neutral manner.

The positions on this Blog are consistent with the capture analysis set out by Macey.  Recognizing that boards are captured begs the question of what to do about it.  On this point, Macey and The Race to the Bottom diverge.

Full post as published by The Race to the Bottom on December 04, 2008 (boomark / email).