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“Who needs a board of directors, anyway?”: A Reply

Fortune editor-at-large Justin Fox offers the provocative question: "Why do companies have boards of directors, anyway?" It's a very good question. Unfortunately, he offers a very bad answer. Go read his piece and then come back for my parsing.

Fox offers the following historical claim:

... as recently as the early 1900s, the board had a pretty clear function. It was the perch from which big shareholders and creditors watched carefully over the men they had hired to manage their companies (as is true today at companies controlled by private equity firms). But the very success of some of these pioneers of industrial capitalism led to the undoing of this model. Corporations outlived their founding shareholders, outgrew the need to borrow money, and, as the stock market captured the public imagination in the 1920s, found their shares in the hands of thousands of small investors in no position to watch carefully over anything. Managers naturally took charge, and boards became appendages entirely beholden to them.

As I explained in The Politics of Corporate Governance, however, this notion that there was a golden era in which ownership and control were united is a misreading of history. Economic separation of ownership and control in fact was a feature of American corporations almost from the beginning of the nation. Even in the antebellum period of the 19th Century, publicly held corporations already had all the essential elements of modern public corporations, as Walter Werner explained: "a tripartite internal government structure, a share market that dispersed shareholdings and divided ownership and control, and tendencies to centralize management in full-time administrators and to diminish participation of outside directors in management."

Fox then turns to the modern corporate governance arena, observing that:

... stock ownership was becoming reconcentrated in the hands of huge pension funds and mutual funds whose managers were far less patient and far more able to make their impatience known than small individual investors were.

Again, there's a factual error. As I explain in Shareholder Activism and Institutitonal Investors, institutional investor activism is rare and limited primarily to union and state or local public employee pensions. These activists often are pursuing a private agenda not shared by and often in conflict with that of passive investors.

Finally, Fox offers two alternatives to the board, both of which he contends are impracticable: direct shareholder democracy and a unitary executive:

Because direct shareholder democracy isn't going to happen (the nation's CEOs would be violently opposed) and corporate monarchy, while perhaps a more honest representation of the true power relationship in corporations, just wouldn't feel right. "If you had self-perpetuating management and no representation, people would question why that was," [Gevurtz] says. "There's this feeling that managers shouldn't be in charge of these large aggregations of power, even though that's the way it is." So that's why companies have boards of directors: To make the rest of us accept their existence.

What Fox overlooks, however, is the very real economic function provided by having a small group - rather than either an individual autocrat or a large mass of voters - at the top of the corporate hierarchy. As I explained in Why a Board?:

The default statutory model of corporate governance contemplates not a single hierarch but rather a multi-member body that acts collegially. Why? This article reviews evidence that group decisionmaking is often preferable to that of individuals, focusing on evidence that groups are particularly likely to be more effective decisionmakers in settings analogous to those in which boards operate.

In sum, there are very good economic reasons for corporations to have boards of directors. Fox just needed to look harder.