With so many changes happening in the corporate marketplace, it should be no surprise that publicly traded companies are rethinking their board composition model to ensure that they have a board built to drive success. The central question is, “What governance model best serves public companies in today’s climate?”
The quality of corporate boards and managers is inarguably under more scrutiny than ever before. The current state of the marketplace demands that board directors of public companies be at the top of their game. Board directors are expected to be informed about the trends and happenings in the marketplace. Rising shareholder activism presents many new challenges for board directors.
Could the board model that private equity firms use serve publicly traded companies equally as well while helping them defend against activist hedge fund campaigns? Some fairly new research indicates that it’s a very good possibility.
Is It Time for a New Model of Corporate Governance?
A working paper by Ronald Gilson, a professor at Columbia Law School and professor emeritus at Stanford Law School, and Jeffrey Gordon, who is also a professor at Columbia Law School, takes a look at various governance models that they refer to as 1.0 and 2.0 to determine the best model of corporate governance for today’s publicly traded companies. Their conclusion is that neither is well-suited for today’s corporate governance needs, stating that the current model for boards leaves directors “thinly informed, under-resourced, and boundedly motivated.”
In their paper entitled “Board 3.0—An Introduction,” they call for a new model of corporate governance — one that would help them with a better approach to shareholder activism and better align the board with its institutional shareholders.
The Evolution of Corporate Governance Models
The paper suggests that the first board model, which was the dominant governance model during the 1950s and 1960s, was more of an advisory board model. They’ve deemed this the Board 1.0 model and describe it as a model where the board directors were unconditionally loyal to the CEO; other corporate officers; and others with links to their lawyers, bankers and investment bankers. The downfall of Board 1.0 came about because corporate failures made it evident that boards were not aware of challenges that the company was facing; they weren’t able to manage conglomerate mergers successfully; and they turned a blind eye to such things as illegal campaign contributions in the U.S. and international bribes.
The Board 1.0 model eventually gave way to the current Board 2.0 model, which is primarily comprised of part-time independent board directors. Independent board directors are largely dependent on the management team for information. They tend to be strongly influenced by stock market prices to measure the company’s performance.
As institutional investors began increasing their stakes in public companies from the 1970s to the 2000s, they insisted that boards become more independent, with the assumption that they would be better able to promote shareholders’ interests than under the previous model. According to Gilson and Gordon, as boards became more independent, they also became less knowledgeable about the companies they were serving. As a result, they were forced to rely on public information and presentations that managers provided for them. They lacked access to research and the resources they needed to dive deeper into company operations. In the end, the only true way they had of measuring a company’s performance was to monitor stock prices.
Modern Change Demands a New Corporate Governance Model
Most large public companies have made a shift toward institutional ownership. Along with economic changes, this shift led to the popularity of activist hedge funds, which don’t always act in the best interests of shareholders.
One model that stands out as a possibility of better governance in today’s economic climate is the private equity board model, especially where it concerns defending against activist hedge fund campaigns. Gilson and Gordon state, “One inspiration for Board 3.0 is found in private equity, in which the high-powered incentives of the PE sponsor have produced a different mode of board and director engagement that seems associated with high value creation.”
The 3.0 model is a new model that combines the best of the 2.0 model and the needs of today’s boards and investors. The new model includes 3.0 board directors who would serve on special committees and compliance teams. The 3.0 directors would serve on a strategic review committee that’s charged with monitoring the company’s strategy and performance. 3.0 board directors would be compensated for their role in the long-term performance of stocks. These directors would receive back office support from the company and may be allowed to work with outside consultants. The model supports them serving for only a limited time in this role. The authors of the paper believe that institutions would likely support such a model.
Modern Governance Processes Fueling Board Composition Models
Diligent Corporation recognizes that corporate governance needs to change to keep up with the changes in the economic landscape. Today’s corporate leaders need the technology, insights and processes to help them fuel good governance.
What the authors of this paper recognized is that today’s corporations are currently operating with a governance deficit. They lack the right information at the right time to ask the right questions that will lead them to the types of decisions that will move the company forward. They need the help of technology to help them predict future changes and trends.
Modern boards also need highly secure digital tools that allow them to communicate, collaborate and share files without fear of having their board work compromised by hackers and spammers.
Diligent Corporation is a board management software innovator and industry leader. Modern governance requires an electronic board management system that brings useful and different digital tools under one state-of-the-art platform. Diligent Boards and Governance Cloud bring tools for board meeting management, voting and resolutions, board evaluations, secure file-sharing, entity management, and more into a fully integrated platform to enable seamless management and reporting. As corporate governance models evolve to meet the needs of companies, shareholders and the public, Diligent promises to meet the needs of modern corporate governance solutions.