Stephen Bainbridge has an idea for addressing the shortcomings of how corporations are governed today: replace the board of directors with a company.
The UCLA law prof and his counterpart from the University of Chicago, Todd Henderson, have co-authored both a paper and a book on the topic. They argue that it’s time to allow consultant-like firms to oversee the corporation. The duo even has a kitschy name for their fictitious creation: “Boards R Us.”
Bainbridge talked recently about his board-services provider (BSP) idea, why we don’t have it today and the state of boards today. The interview is edited for length and clarity.
Quartz: Where did the Boards R Us idea come from?
Bainbridge: We suggested this because we were unable to find any interesting, out-of-the-box ideas for fundamentally remaking the board, and the board needs remaking.
The only other idea with any potential is getting rid of boards altogether and directly electing the CEO. But there’s a theoretical justification for having a board, not an individual, at the top of the organization. Groups are empirically superior to individuals at tasks that involve critical, evaluative judgment. That’s been tested in numerous ways.
Having said that, the board often fails—and sometimes rather spectacularly. The problem is that it has essentially become a group of unrelated independent contractors who, for a variety of regulatory reasons, we now require to know nothing about the corporation. They have to be radically independent from the corporation. That leaves them lacking in knowledge and highly reliant on insiders for information, which limits the board’s effectiveness.
So we thought if you contracted out the board function to a company that would assemble a team to act as the board, then you could preserve the advantages of having a decision-making group, but also get better accountability—if for no other reason than we think courts would be more likely to hold a BSP liable than an individual director.
What operating advantages would a BSP have over a traditional board? How would it work?
First, you’d have a team within the BSP that was basically serving full-time as the client company’s directors. They would be more available to management for meetings. They would be able to spend more time gathering information and studying the company.
It would be easier to present a united front. When Sunbeam fired Al Dunlap, the board had to go through all sorts of machinations to present a collective front. Boards R Us would speak with one collective voice, so you wouldn’t have that problem.
It also would introduce a whole new dynamic to the idea of proxy contests. An activist investor like Dan Loeb, instead of saying ‘I want to nominate a short slate of directors’ could say, ‘Let’s fire Bainbridge Consulting as our BSP and bring in Henderson Consulting’ and then put that to a shareholder vote.
Broadly speaking, it could make shareholder voting much more effective. As a shareholder it’s very difficult to gather information about how Joe Schmo, member of the board, is doing. But if a company is acting as the board, you only have one entity to evaluate.
If the BSP were publicly held, the value of the its stock price would presumably be correlated with how well they’re doing in providing board services, which would allow shareholders to monitor the board at a much lower cost. So they would be better informed than today’s part-timers, and more accountable.
It also would bring together expertise. If a company ran into an environmental or cyber issue, there would be someone with that expertise inside the BSP to help.
Additional expertise sounds like a big selling point. How would it work?
When I was in private practice, I worked with the lead General Mills partner in our law firm. If General Mills had a legal issue outside of his group’s wheelhouse, like an ERISA problem or a tax problem, that partner would bring in lawyers from other departments. So there was a team of people working together pretty much full-time on the company, backstopped by people with specialized expertise.
We think the same thing would happen with BSPs: You’d have a central team that works with management and shareholders all the time, but then if an off-the-wall question or unusual situation arose that the core BSP team didn’t know the answer to, they’d have someone in the firm who does. Having access to broader expertise ought to translate into a better-functioning board.
Why don’t we have BSPs now?
Under American law it’s not possible. All 50 states, including Delaware, require that directors be “natural persons.” If you look internationally, a lot of countries have the same rule. And some countries that allow companies to be individual directors, like the United Kingdom, are getting rid of that rule. You also have other factors, like stock-exchange rules around director independence that assume directors are natural persons.
The “natural persons” requirement is about having someone to assign liability to?
Presumptively. But it’s also an unwillingness to consider something different. Ninety percent of the people who object to this say, ‘Directors are people. They’ve always been people. How could they not be people?’ There’s inertia, a path-dependency that needs to be overcome to make it happen. We’re saying ‘why not?’ I certainly wouldn’t want to make it mandatory. But I’ve yet to come up with a good reason for why it’s not an option.
Who would operate Boards R Us?
I would think that ultimately you would see big consulting outfits like McKinsey offering the service. But it also could be the consulting arms of law or accounting firms, or compensation consultants ramping up to provide a more comprehensive network of services. You also might have firms like Boards R Us that specialize as BSPs.
Couldn’t that leave the door for someone like a hostile activist investor to have their own BSP?
Yes. And why not? Let the market decide. The BSP will be elected by the shareholders. I think what you might ultimately see would be something that looks a little more like a political campaign than the current proxy voting system, where if it was a big enough company, you might have three, four or five firms throwing their hats in the ring, competing to persuade shareholders that they were the best option.
What would they campaign on?
They would campaign on, ‘Look at our track record at other companies: We’ve been the BSP at Tesla for the last five years, and in that time Tesla has achieved record growth in the following areas. If you look at the portfolio of companies where we are the BSP, we have outperformed the BSP industry by X percent. And look at our experts: We have Joe, the leading corporate governance expert in the country; the leading compensation consultant in the country is a member of our team, helping to make better pay decisions.’
They might say, ‘This is our vision for Apple. We think the company made a fundamental mistake trying to get into driverless cars; if we’re elected as BSP, we will get Apple out of that business.’ Or they could even say, ‘Tim Cook is not the next Steve Jobs. We think we know who the next Steve Jobs is. If we’re elected, we’ll replace the CEO.’
You could see all those sorts of arguments being made. It would give the shareholders more information and choice. Why wouldn’t that be a good thing?
How would BSPs be paid?
I think you would need to have some sort of negotiation between management and the BSP about the BSP’s salary. And then when the BSP comes up for a shareholder vote, you’d disclose to shareholders their compensation. It could be a factor that shareholders would take into account in the voting process.
Wouldn’t management negotiating the pay of the group overseeing it be a potential conflict of interest?
I take your point. But at present directors basically set their own compensation, although they usually seek shareholder approval, so how is this all that different? And who else would do it? If the BSP replaces the board, there is no compensation committee. The key thing will be to require shareholder approval.
Would BSPs get paid in stock like board members to link their pay to performance?
Todd would say they should at least get some stock. He thinks equity would be a powerful way to align the BSP’s interests with those of shareholders. If it was up to me, I would prefer to see BSPs compensated just in cash. We generally don’t want outside law firms and independent auditors taking stock in their clients. I think the same thing should apply to BSPs.
What do critics of the idea say?
The simple critique is, ‘If this was a good idea we would have been doing it all along.’ The more constructive critiques are around cost. Companies would probably wind up paying BSPs a lot more than they pay human directors.
Some question if you could really expect to see the superior accountability and decisions that we think you would get: Would the BSP really be better-informed?
Others worry that the BSP would be too-well-informed with their minions scurrying around the company. They visualize someone going into Apple headquarters and poking their noses into everybody’s cubicle, which wouldn’t be a good idea.
I acknowledge those are legitimate concerns, but on balance I don’t think they justify saying it can’t be done, because what we have now is not working that great.
So what will it take to make Boards R Us a reality?
You’d need to strike the requirement out of state law that boards of directors shall be comprised of “natural persons,” and insert “legal persons,” because companies are legal persons. You’d also need to address other rules, like the stock-exchange listing standards, that either implicitly or explicitly have board members as human beings, not entities.
Could we see an innovative state making this legal to attract corporate headquarters?
That’s very possible and I hope that scenario happens, but for a slightly different reason. I’ve been studying Delaware corporate law for 32 years, and the minute another jurisdiction comes up with an interesting reform, Delaware adopts it because it wants to maintain its position as a preferred corporate-headquarters state. So if a state like South Dakota shows interest in BSPs, I guarantee that within a year Delaware would amend its code to permit it.
If we can get Delaware to allow this, we’ve won.