The Role of Corporate Boards: A Roundtable Discussion of Where We're Going and Where We've Been

In this roundtable that took place at the 2016 Millstein Governance Forum at Columbia Law School, four directors of public companies discuss the changing role and responsibilities of corporate boards. In response to increasingly active investors who are looking to management and boards for more information and greater accountability, the four panelists describe the growing demands on boards for both competence and commitment to the job. Despite considerable improvements since the year 2000, and especially since the 2008 financial crisis, the clear consensus is that U.S. corporate directors must become more like owners of the corporation who “truly represent the long‐term interests of all of the shareholders.” But if activist investors appear to pose the most formidable new challenge for corporate directors—one that has the potential to lead to shortsighted managerial decision‐making—there has been another, less visible development that should be welcomed by wellrun companies that are investing in their future growth as well as meeting investors’ expectations for current performance. According to Raj Gupta, who serves on the boards of HewlettPackard, Delphi Automotive, Arconic, and the Vanguard Group,

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THE ACTIVE BOARD OF DIRECTORS AND ITS EFFECT ON THE PERFORMANCE OF THE LARGE PUBLICLY TRADED CORPORATION

In recent years, boards of directors have become more active and independent of management in pursuing shareholder interests. But, up to this point, there has been little empirical evidence that active boards help companies produce higher rates of return for their shareholders. In this article, after describing the new board activism, the authors argue that past failures to document an association between independent boards and superior corporate performance can be explained by two features of the research: its concentration on periods prior to the 1990s (when most boards were largely irrelevant) and its use of unreliable proxies (such as a minimum percentage of outside directors) for a well-functioning board.
The authors hypothesize that an independent and resourceful board takes steps that require management to increase earnings available to investors. To test this hypothesis, the performance of a sample of large U.S. corporations was examined over the period 1991-1995 using two proxies for the "professionalism" of each company's board: (1) the letter grades (A+ to F) assigned by CalPERS for corporate governance; and (2) a "presence" or "absence" grade based on three key indicators of professional board behavior. Both of these governance metrics were associated in statistically significant ways with superior corporate performance, as measured by earnings in excess of cost of capital and net of the industry average. While acknowledging that such results do not prove causation, the authors conclude that, in the first half of the 1990s, corporations with active and independent boards added significantly more value for shareholders than those with passive, "rubber-stamp" boards.     

Board 3.0: What the Private‐Equity Governance Model Can Offer Public Companies∗

The authors view board structures as an adaptive institution that responds to the key challenges faced by public companies: helping management solve the problems of production and organization of large‐scale enterprise; limiting managerial agency costs; serving as a delegated monitor of the firm's compliance obligations; and responding to the governance environment of changing shareholder ownership patterns. U.S. company board structures are shown to have evolved over time, often through discontinuous lurches, as particular functions have waxed and waned in importance. This article is part of a larger project that traces two iterations of the public company board, what the authors call Board 1.0 (the “advisory board”) and Board 2.0 (the “monitoring board”). The authors argue in particular that Board 2.0, as embedded in both current practice and regulation, now fails the functional fit test for many companies. First, it does not scale to match the dramatic increase in the size and complexity of many modern public corporations. Second, at a time of reconcentrated ownership achieved through institutional investors and increased activism, it does not have the expertise and commitment needed to resolve the tension between managerial or market myopia, or “short‐termism,” and managerial “hyperopia.” This article holds out an optional alternative, Board 3.0, which would bring to the public company board some strategies used by private equity firms for their portfolio company boards. Such “Portco” boards consist of directors who are “thickly informed,” “heavily resourced,” and “intensely interested.” Bringing such “empowered directors” to public company boards could facilitate evolution of the public company board model in response to dramatic changes in the corporate business environment. The authors also suggest possible routes for implementing Board 3.0, including the enlisting of PE firms as “relational investors” that would have both capacity and incentives to engineer changes in board structure.     

The Evolving Shareholder Activist Landscape (How Companies Can Prepare for It)

Shareholder activists remain an important force in the boardroom. More than 60 activist campaigns were initiated against S&P 1500 companies in 2016. And although activist hedge funds have under‐performed the broad market since 2013, activists’ assets under management are still nearly double their level of four years ago, and announcements of their campaigns continue to be met with increases in the target companies’ stock prices. At the same time, shareholder activism continues to evolve in constructive ways. Most important is the growing support of mainstream investors, as reflected in the increased backing of activist proposals by traditional institutional asset managers and the falling number of openly confrontational campaigns. Activists have also had continued success in gaining board representation, particularly at the largest target companies. And more board seats are being gained by activists in early settlements, which have also been associated with higher stock returns than those campaigns that resulted in later settlements or ended in a proxy contest. During the period 2006–2016, over 40% of activist campaigns made public demands for specific strategic actions, such as selling assets, spinning off divisions, or seeking buyers for the companies. And activist investors have been remarkably effective in accomplishing such changes in that those activist targets urged to seek buyers were four times more likely to be acquired than the average company. At the same time, a growing number of campaigns have focused on operating efficiency, capital allocation, business strategy, and other changes that often require longterm engagement. Perhaps because of their longer‐term focus, such campaigns have also more been likely to result in board seats for the activists. The authors' findings contain a number of messages for corporate managements and boards: listen to your shareholders, and assess your strengths and vulnerabilities through an activist's eyes; build an effective board; articulate your strategy clearly; consider the possibility of activist intervention when planning M&A transactions; and engage early when approached by an activist.     

An insider's call for outside direction

The large public corporation has been an unrivaled creator of wealth and jobs in our century. But public corporations depend on patient capital, and patient capital depends on boards of directors that are conscientious and responsible. Unfortunately, the prosperity and economic stability of the last 50 years have allowed boards to grow complacent, clubby, and passive. Now explosive developments in five areas have shaken the corporate world to its roots: information technology, flexible manufacturing, global markets, workplace democracy, and pension-fund capitalism. As a result, large corporations find themselves under attack from a hornet's nest of small, aggressive competitors, and at the same time, professional investors and the constant threat of takeover have forced corporations to focus on short-term results rather than on long-term investments. Although pension funds ought to behave like any other patient capital, the fact is we cannot count on institutional investors to buy stock for the long term and to hold a board's feet to the fire to protect their investments. One reason is legal. Securities laws hinder stockholders from working together to make their weight felt with boards of directors. So they tend to vote with their feet instead and sell the stock when unhappy with management. The author recommends a variety of measures to reinvigorate corporate boards, reduce their fear of fiduciary liability in the investment of pension-fund monies, and encourage pension-fund investors to take a more active role in the direction of the companies whose stock they own.     

Materiality in Corporate Governance: The Statement of Significant Audiences and Materiality

Materiality is an elusive, but fundamentally important concept in corporate reporting of all kinds—not only in traditional financial reporting, but in sustainability and integrated reporting as well. In the end, materiality is entity‐specific and based on judgment. Moreover, it is a judgment that should ultimately be made by a company's board of directors, which makes materiality as much a governance as a reporting issue. Whether a given ESG issue is material is in large part a function of the corporate stakeholders, or “audiences,” that the company's board of directors deems to be “significant”—that is, important to the company's ability to create value over the short, medium, and long term. The identification of such audiences—together with the time frames the board uses to evaluate the impact of the company's decisions on these audiences—provides the basis for determining the sustainability issues that corporate management must focus on for performance and reporting purposes. To help ensure that decisions about materiality receive the attention they deserve, the authors propose that corporate boards articulate their views in an annual “Statement of Significant Audiences and Materiality.” Contrary to the prevailing belief that the fiduciary duty of the board is to place shareholders’ interests first, nothing precludes corporate boards from issuing such a statement. Recent research, including the compilation of legal memos on fiduciary duty and nonfinancial reporting for all G20 countries, makes it clear that the board's fiduciary duty is to “the corporation itself.” In exercising this duty, directors have full discretion, under the business judgment rule and other authorities, to decide which audiences, along with the company's shareholders, should be deemed significant.     

Delaware Public Benefit Corporations: Widening the Fiduciary Aperture to Broaden the Corporate Mission

As a past practitioner of corporate law in Delaware for 26 years who remains convinced that the for‐profit corporation remains the best vehicle for raising and allocating private capital, the author nevertheless also believes that the stockholder primacy model that currently animates corporate fiduciary principles is too narrow. In the excerpts from his new book that make up this article, the author describes the “benefit corporation,” which introduces a corporate governance model based on stakeholder principles. This model encompasses a more complete recognition of the complex interdependencies between all aspects of a global society, and of the responsibility of corporations to reflect those interdependencies in their decision‐making. Although initially a skeptic, the author now believes that benefit corporation law offers an important opportunity for companies to align the interests of their investors with those of their stakeholders in a potentially value‐increasing way that is discouraged by traditional corporate law. State legislatures began authorizing benefit corporations in 2010, and they are now available in 32 U.S. jurisdictions. Over 3,000 benefit corporations have been formed. What's more, they are raising capital from traditional funders, including venture capitalists, and at least one benefit corporation has already gone public. As the author says in closing, “the stakeholder governance model facilitated by benefit corporations provides a clear path to a future of shared value creation, and some investors and corporations have started down that path.”     

Monitoring,Corporate Performance and Institutional Directors

Our main objective is to study the effect of institutional directors on firm performance, distinguishing directors according to whether they maintain business relationships (pressure‐sensitive) or not (pressure‐resistant). Our results show that in weak regulatory and low investor protection environments, institutional directors have a negative impact on corporate performance. Our evidence shows that this negative effect is mainly driven by the role of pressure‐resistant directors and not for those directors representing mainly banks and other financial institutions with a long‐term investment horizon. These findings have implications for numerous parties, such as institutional investors, regulators, potential new board members and other corporate governance reform proponents, who frequently examine board characteristics to assess the effectiveness of boards in value‐creation policies.     

U.S. Corporate Governance: Accomplishments and Failings A Discussion with Michael Jensen and Robert Monks

Two of America's most prominent shareholder activists discuss three major issues surrounding the U.S. corporate governance system: (1) the case for increasing shareholder “democracy” by expanding investor access to the corporate proxy; (2) lessons for public companies in the success of private equity; and (3) the current level and design of CEO pay. On the first of the three subjects, Robert Monks suggests that the U.S. should adopt the British convention of the “extraordinary general meeting,” or “EGM,” which gives a majority of shareholders who attend the meeting the right to remove any or all of a company's directors “with or without cause.” Such shareholder meetings are permitted in virtually all developed economies outside the U.S. because, as Monks goes on to say, they represent “a far more efficient and effective solution than the idea of having shareholders nominate people for the simple reason that even very involved, financially sophisticated fiduciaries are not the best people to nominate directors.” Moreover, according to both Jensen and Monks, corporate boards in the U.K. do a better job than their U.S. counterparts of monitoring top management on behalf of shareholders. In contrast to the U.S., where the majority of companies continue to be run by CEO/Chairmen, over 90% of English companies are now chaired by outside directors, contributing to “a culture of independent‐minded chairmen capable of providing a high level of oversight.” In the U.S., by contrast, most corporate directors continue to view themselves as “employees of the CEO.” And, as a result, U.S. boards generally fail to exercise effective oversight and control until outside forces—often in the form of activist investors such as hedge funds and private equity—bring about a “crisis.” In companies owned and run by private equity firms, by contrast, top management is vigorously monitored and controlled by a board made up of the firm's largest investors. And the fact that the rewards to the operating heads of successful private equity‐controlled firms are typically multiples of those received by comparably effective public company CEOs suggests that the problem with U.S. CEO pay is not its level, but its lack of correlation with performance.     

The Economics of Director Heterogeneity

We investigate the potential costs and benefits of firms constituting a heterogeneous pool of directors relative to more homogeneous boards. We measure director heterogeneity along six separate dimensions and divide board heterogeneity into occupational and social components. Our empirical analysis indicates that corporate complexity and managerial control exhibit significant influence on board heterogeneity. Using the heterogeneity of the county population of the firm's headquarters as an instrument, we also find that investors place valuation premiums on heterogeneous boards in complex firms but discount heterogeneity in less complex firms. Overall, our analysis indicates greater heterogeneity may not necessarily improve board efficacy.     

Columbia Law School Roundtable on A Governance Research Agenda for the Academy

Since Jensen and Meckling's formulation of the theory of “agency costs” in 1976, corporate finance and governance scholars have produced a large body of research that attempts to identify the most important features and practices of effective corporate governance systems. But for all the research that has been done in the past 40 years, many practitioners continue to see a disconnect between theory and practice, between the questions researched and the questions that need to be answered. In this roundtable, Martijn Cremers begins by challenging the conventional view that limiting “agency costs” is the main challenge confronted by boards of directors in representing shareholder interests and, hence, the proper focus of most governance scholarship. Especially in today's economy, with the high values assigned to growth companies, the most important function of corporate governance may instead be to overcome the problem of American “short termism” that he attributes to “inadequate shareholder commitment to long‐term cooperation.” And he buttresses his argument with the findings of his own recent research suggesting that obstacles to the workings of the corporate control market like staggered boards and supermajority voting requirements may actually improve long‐run corporate performance by lengthening the decision‐making horizon of boards and the managements they supervise. Vik Khanna discusses Indian Corporate Social Responsibility (CSR) spending and its effects in light of a recent law requiring Indian companies of a certain size to devote at least 2% of their after‐tax profit to CSR initiatives. One unintended effect of this mandate, which took effect in 2010, was that all Indian companies that were spending more than the prescribed 2% of profits cut their expenditure back to that minimum, suggesting that CSR and advertising are substitutes to some extent, and that such legal mandates can discourage CSR spending by early adapters or “leaders.” Nevertheless, Khanna also found evidence of social norms developing in support of CSR, including a spreading perception that such spending can help some companies achieve strategic goals. Jeff Gordon closes by arguing that, to the extent investors are short‐sighted, their short‐sightedness is likely to be justified by their recognition that public company directors have neither the information nor the incentives to do an effective job of monitoring corporate managements. The best solution to the problems with U.S. corporate governance is to replace today's “thinly informed” directors with “activist” directors who more closely resemble the directors of private‐equity owned firms. Such directors would spend far more time with, and be much more knowledgeable about, corporate management and operations—and they would have much more of their personal wealth at stake in the form of company stock.     

The Paradox of Transparency,Short‐Termism and the Institutionalisation of Australian Capital Markets

As the ultimate corporate decision‐makers, directors have an impact on the investment time horizons of the corporations they govern. How they make investment decisions has been profoundly influenced by the expansion of the investment chain and the increasing concentration of share ownership in institutional hands. By examining agency in light of legal theory, we highlight that the board is in fact sui generis and not an agent of shareholders. Consequently, transparency can lead to directors being ‘captured’ by institutional investor objectives and timeframes, potentially to the detriment of the corporation as a whole. The counter‐intuitive conclusion is that transparency may, under certain conditions, undermine good corporate governance and lead to excessive short‐termism.     

Are Busy Boards Effective Monitors?

Firms with busy boards, those in which a majority of outside directors hold three or more directorships, are associated with weak corporate governance. These firms exhibit lower market‐to‐book ratios, weaker profitability, and lower sensitivity of CEO turnover to firm performance. Independent but busy boards display CEO turnover‐performance sensitivities indistinguishable from those of inside‐dominated boards. Departures of busy outside directors generate positive abnormal returns (ARs). When directors become busy as a result of acquiring an additional directorship, other companies in which they hold board seats experience negative ARs. Busy outside directors are more likely to depart boards following poor performance.     

The Icahn Manifesto

The title of this opening chapter in the author's new book on activist investors refers to Carl Icahn's solution to the “agency” problem faced by the shareholders of public companies in motivating corporate managers and boards to maximize firm value. During the 1960s and '70s, U.S. public companies tended to be run in ways designed to increase their size while minimizing their financial risk, with heavy emphasis on corporate diversification. Icahn successfully challenged corporate managers throughout the 1970s and 1980s by buying blocks of shares in companies he believed were undervalued and then demanding board seats and other changes in corporate governance and management. This article describes the evolution of Icahn as an investor. Starting by investing in undervalued, closed‐end mutual funds and then shorting shares of the stocks in the underlying portfolio, Icahn was able to get fund managers either to liquidate their funds (giving Icahn an arbitrage profit on his long mutual fund/short underlying stocks position) or take other steps to eliminate the “value gap.” After closing the value gaps within the limited universe of closed‐end mutual funds, Icahn turned his attention to the shares of companies trading for less than his perception of the value of their assets. As the author goes on to point out, the strategy that Icahn used with such powerful effect can be traced to the influence of the great value investor Benjamin Graham. Graham was a forceful advocate for the use of shareholder activism to bring about change in underperforming—and in that sense undervalued—companies. The first edition of Graham's investing classic, Security Analysis, published in 1934, devoted an entire chapter to the relationship between shareholders and management, which Graham described as “one of the strangest phenomena of American finance.”     

The Effects of Outside Directors and Board Shareholdings on the Relation Between Chief Executive Compensation and Firm Performance

Critics of corporate governance have suggested that improvements in board monitoring will arise from more independent boards consisting of outside directors and from increased stock ownership by directors. Presumably these changes should result in more rational, more defensible compensation decisions in which pay is clearly tied to results. In this paper, we test the premise that boards with a relatively higher proportion of outsiders and boards with significant shareholdings maintain a closer link between corporate performance and executive pay than do boards with fewer outsiders and boards holding little stock. The results of the study, based on a sample of 268 large corporations, are mixed. As expected, boards with significant shareholdings maintain a stronger linkage between compensation and firm-level performance. This finding persists even after controls are included for CEO and outsider shareholdings. Contrary to expectations, however, evidence was not found that firms with a higher proportion of outsiders on the board of directors relate compensation more strongly to firm results.     

The Impact of Corporate Governance on Closed‐end Funds

This study uses a large sample of UK‐listed closed‐end funds to examine whether governance has an impact on two indicators of fund performance: the level of fund‐management fees and the discount at which a fund trades. Fees are under the control of the directors, and we find that they are inversely related to fund returns, even after allowing for differences across investment sectors. Fees are, on average, higher if a fund has a large board, few directors from outside the fund‐family, many directors from within the fund‐family, and low ownership by the management company. Discounts for funds are wider if the management company or any blockholder has a significant long‐term stake, suggesting that investors are wary of entrenched management. The results suggest that boards are frequently compromised in their duty to shareholders by their dependence on fund‐management companies.     

The Labor Market for Directors and Externalities in Corporate Governance

This paper studies how directors' reputational concerns affect board structure, corporate governance, and firm value. In our setting, directors affect their firms' governance, and governance in turn affects firms' demand for new directors. Whether the labor market rewards a shareholder‐friendly or management‐friendly reputation is determined in equilibrium and depends on aggregate governance. We show that directors' desire to be invited to other boards creates strategic complementarity of corporate governance across firms. Directors' reputational concerns amplify the governance system: strong systems become stronger and weak systems become weaker. We derive implications for multiple directorships, board size, transparency, and board independence.     

Far Beyond the Quarterly Call: CECP's First CEO‐Investor Forum

The authors begin by describing how the existing structure of corporateshareholder communications encourages short‐term planning and performance evaluation horizons. Then, after summarizing the substantial evidence that corporate management, boards, and investors are concerned about the failure of current corporate‐shareholder communications to reflect longer‐run corporate investment and its expected payoffs, the article holds up the long‐run plans presented by the CEOs of five large public U.S. companies (and the CFO of IBM) at the first ever CECP CEOInvestor Forum as providing a promising model for the future. Such presentations are also evaluated against a set of criteria the authors propose for assessing the effectiveness of those presentations—criteria that were developed through extensive investor and CEO feedback. The article concludes by discussing the three main programs that make up CECP's Strategic Investor Initiative to further the development of such longterm plans. One program is focused on identifying different kinds of investors, with the aim of helping management attract longer‐term shareholders. A second program is designed to improve the ways companies communicate with their non‐investor stakeholder groups, with particular emphasis on The Statement of Material Audiences and its role in identifying the critical stakeholders and their contributions to the long‐run success of the company. Third and last is the development of a common language and tool‐kit for longterm plans, with the aim of bringing about the broad adoption of longterm plans as a mainstream element in corporate‐shareholder communications.     

Session I: Corporate Purpose and Governance

In this first of five sessions of a recent Columbia Law School symposium devoted to discussion of his new book, Prosperity—and The Purpose of the Corporation, Oxford University's Colin Mayer begins by calling for a “radical reinterpretation” of the corporate mission. For all but the last 50 or so of its 2,000‐year history, the corporation has combined commercial activities with a public purpose. But since Milton Friedman's famous pronouncement in 1970 that the social goal of the corporation is to maximize its own profits, the gap between the social and private interests served by corporations appears to have grown ever wider, helping fuel the global outbreaks of populist protest and indictments of capitalism that fill today's media. In Mayer's reinterpretation, the boards of all companies will produce and publish statements of corporate purpose that envision some greater social good than maximizing shareholder value. To that end, he urges companies to make continuous investments of their financial capital and other resources in developing other forms of corporate capital—human, social, and natural—and to account for such investments in the same way they now account for their investments in physical capital. Although the author appears to prefer that such changes be mandatory, enacted through new legislation and enforced by regulators and the courts, his main efforts are directed at persuading the largest institutional owners of corporations—many of whom are already favorably predisposed to ESG—to support these corporate initiatives. Marty Lipton, after expressing enthusiasm about Mayer's proposals, suggests that mandating such changes is likely neither feasible nor desirable, but that attempts—like his own New Paradigm—to gain the acceptance and support of large shareholders is the most promising strategy. Ron Gilson, on the other hand, after voicing Lipton's skepticism about the enforceability of such statements of purpose, issues a number of warnings. One is about the political risks associated with ever more concentrated ownership of public companies in a world where populist distrust of all concentrations of wealth and power is clearly on the rise. But most troubling for the company themselves is the confusion such proposals could create for corporate boards whose responsibility is to limit two temptations facing corporate managements: short‐termism, or underinvestment in the corporate future to boost near‐term earnings (and presumably stock prices); and what Gilson calls hyperopia, or overinvestment designed to preserve growth (and management's jobs) at all costs.     

Social Concentration on Boards,Corporate Information Environment and Cost of Capital

Prior evidence on the relationship between demographic diversity in corporate boards and firm performance is mixed. Some studies have found that the relationship between board attributes and firm performance is driven by a firm's information environment. This study examines whether corporate transparency also impacts the relationship between gender and ethnic diversity of directors and firm performance. To test this hypothesis, I use a Herfindahl Index based on directors’ gender and ethnicity to measure board diversity, and an opacity index based on analyst following, analyst forecast error, bid‐ask spread, and share turnover to measure corporate transparency. I find that the cost of capital is positively associated with social concentration on corporate boards and that this premium is larger for highly opaque firms. In further analysis, I find that the interaction of corporate information environment and social concentration on boards is more important for operationally complex firms. Compared with simple firms, operationally complex firms pay a greater premium on their capital if they have a socially concentrated board and an opaque information environment.