Professor Bainbridge...on law, politics, religion, culture & food

The Revitalization of Boards of Directors

When I’m not working on insider trading, my scholarship focuses on developing the theory of the firm I call “director primacy.” In this model, the corporation is viewed as a vehicle by which the board of directors hires various factors of production. The board of directors thus is not a mere agent of the shareholders, but rather is a sui generis body — a sort of Platonic guardian — serving as the nexus of the various contracts making up the corporation.

On paper, the rules of corporate governance closely track the predictions of director primacy. The powers of the board of directors are not delegated to the board by shareholders – as an early New York decision put it, the board’s powers are “original and undelegated.” Manson v. Curtis, 119 N.E. 559, 562 (N.Y. 1918). Accordingly, as Delaware General Corporation Law § 141(a) puts it, the corporation’s business and affairs are “managed by or under the direction” not of management or shareholders but rather “of a board of directors”

In practice, of course, director primacy all too gives way to managerialism. Managerialist corporations are bureaucratic hierarchies dominated by professional managers. In such firms, directors are mere figureheads, while shareholders are nonentities. Managers of such firms thus are autonomous actors free to pursue whatever interests they choose.

There is growing evidence, however, that boards are being revitalized and that power is shifting back to boards from managers. Consider what’s going on in the media sector, where boards have recently brought successful pressure to bear on the top management of firms like AOL Time Warner, Vivendi Universal, and Hollinger International. More recently, Roy Disney and Stanley Gold have shaken things up at Disney, which reportedly has encouraged other critics of CEO Michael Eisner to add their voices to those calling on him to step down. All of which is good news for the director primacy model. After all, any law-and-economics model worth its salt should be able to make predictions not only about the content of legal rules in the statute books but also about how those rules actually work in the real world.

What has led corporate power to shift back where it belongs? Over the last two decades, several trends coalesced to encourage more active and effective board oversight. Much director compensation is now paid in stock, for example, which helps align director and shareholder interests. Courts have made clear that effective board processes and oversight are essential if board decisions are to receive the deference traditionally accorded to them under the business judgment rule, especially insofar as structural decisions are concerned (such as those relating to management buy-outs). Third, director conduct is constrained by an active market for corporate control, ever-rising rates of shareholder litigation, and, some say, activist shareholders. Fourth, the stock exchanges have mandated tough new director independence rules. As a result, modern boards of directors typically are smaller than their antecedents, meet more often, are more independent from management, own more stock, and have better access to information.

Granted, we have not arrived. Too many boards are still staffed by ceremonial directors. Too many others are complacent rubberstamps for management. Yet, things are stirring.

In the Two Towers, Gandalf says: "A thing is about to happen which has not happened since the Elder Days: the Ents are going to wake up and find that they are strong." Perhaps we are seeing the first signs that boards are also going to awake and rediscover that they too are strong. Wouldn't it be ironic if a media chieftan like Eisner met Saruman's fate (in a figurative sense, of course).