Sunday, November 4, 2007

how to fix corporate boards

today's nyt story about the failures of merrill lynch's board to understand what risks the company faced in the credit markets highlight once again why it's time for real reform at boards, which have never been structured in the long-term interests of our economy or society.

first of all, corporations are people without conscience or morality. their statutes require them solely to seek maximum profit. while there is nothing wrong with this, it's worth noting that it can create moral hazard by encouraging and rewarding very short-term thinking. this is nothing to begrudge. it should be taken for granted that CEOs will seek to commit fraud. the assumption shouldn't be that executives are ethical people driven by a sense of right. after all, the rules governing corporations REQUIRE them to seek maximum profits at the expense of all other considerations. once we know it's the case, why not create another agency to counter that initiative and keep the organization balanced.

secondly, we now exist in a global capital market. over the next few years, we see more and more financial intermediation move to other jurisdictions. as decades of US domination ends, other countries' legal systems and regulations will gain credibility versus our own. before, foriegners had to accept our way of doing things because they had no choice. in the future, they will be able to choose the jurisdiction with the best and most ethical rules. investors will recognize which countries have the best rules and those markets will trade at premiums, which will draw more capital. while sarbanes oxley might be one of the big factors driving issuers away from the US, we need to think holistically about the overall situation and what permits all the misdeeds -- from abuses at RJ Nabisco in the late 1980s to Enron to Merrill Lynch -- renegade senior management teams that grew increasingly bad the longer they were in power.

thirdly, capitalism is becoming the world's philosphy. we are probably entering a period that will last another 20-30 years in which much of the former underveloped world will rise as market economies and modern financial intermediation spread. especially with chinese leadership and support, capitalism will spread. instead of relying on ineffectual organizations like the UN with governance problems of their own, corporations and business appear some of the best ways to improve human life in the future. other kinds of pressure will emerge from blogs and NGOs. but the vanguard of history will be corporations.

as a result of these considerations, I think the best way to start dealing with the corporate board problem is to create a corps of people to become independent board members. we could recruit a series of professors, community leaders, accountants, policemen, lawyers, military officers, and journalists. each company board of say 12 would have to include 3-6 such independent directors, who would rotate every 1-2 years. these outsiders would be prohibited from recieving compensation from the company or owning its shares, or those of any others (maybe.. not sure about how expansive this should be)

we could come up with a series of qualifications to find the right kinds of outside directors. they would be charged with maximizing the company's long-term success (maybe they could be paid in very long-term stock ownership). their main job would be to guard against the abuses that inevitably arise from any imperial CEO.

another potential offshoot of this idea would be for boards to have staggered compensation packages, that break the directors into factions so they have different kinds of priorities -- some short term profiteering and others long-term sustainability.

but the message from all these experiences are clear: boards work, but can be better. we've had a so-so system for decades. just like now people are demanding higher quality food, more efficient cars and healthier lives, it's time to raise the bar in terms of how companies are run. for our financial system to move on to the next level, we need to boards to fulfill their missions more completely. only by breaking up people's interests can you get them to look at things from multiple points of view.

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