Publicly traded companies should look to private-equity firms when thinking about better ways to operate their boards, new research shows.
The current model for a board at a publicly traded company leaves directors “thinly informed, under-resourced, and boundedly motivated,” according to a working paper published by Ronald Gilson, a professor at Columbia Law School and professor emeritus at Stanford Law School, and Jeffrey Gordon, also a professor at Columbia Law School.
The paper, published Tuesday and entitled “Board 3.0 — An Introduction,” argues that a new model of corporate governance could help publicly traded companies better handle shareholder activism and would better align a company’s board with its institutional shareholders.
“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 authors wrote.
According to the paper, the current board structure, which its authors call Board 2.0, is “dominated by part-time independent directors who are dependent on company management for information and are otherwise heavily influenced by stock market prices as the measure of managerial performance.”
These boards are in part the result of institutional investors, who had been continuously increasing their stakes in publicly traded companies from the 1970s through the 2000s, the paper said. Institutions wanted boards that were more independent and could better promote shareholder interests than their predecessors, according to the paper.
But while boards have become more independent, they have become less knowledgeable about the very companies they serve, relying on public information and presentations given to them by the company’s management, the paper said. They often lack the resources necessary to do deep dives on a company’s operations, according to the research.
As a result of this under-resourcing, board members rely on stock prices to monitor a company’s performance, according to the paper.
“The particular business problem that urgently calls out for a new board model is created by the interaction of two developments: the dramatic shift towards majoritarian institutional ownership of most large public companies and the rise of a new form of financial intermediary, the activist hedge fund,” the paper said.
According to the authors, activist hedge funds often may not be acting in the best interest of shareholders. Institutions may back them up via proxy votes in the hopes of dissolving a dispute, the paper said.
But the private-equity model of boards could better suit publicly traded companies, the paper said. The model would include directors from the 2.0 model, as well as those that follow a 3.0 model, the paper said.
The 2.0 directors, according to the paper, would serve on compliance and special committees. The new directors would serve on a “strategic review” committee that would monitor the strategy and performance of the company, the authors recommended.
The 3.0 directors would be compensated for their role through stocks in a long-term manner, the paper said. They would receive back office support from the company itself and, if necessary, could work with outside consultants, the paper said. The 3.0 directors would serve for a limited time in their role, according to the paper.
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According to the authors, institutions would likely support a model like this.
“The large asset managers have made it clear that the major focus of their corporate governance scrutiny is the quality of the company’s directors,” they wrote.
