Are Corporate Directors Becoming Obsolete?

When The Liabilities Exceed the
Benefits of Being a Director

By Peter Cohen

January 9 2005

In the last week, some corporate directors have written checks out of their personal accounts to settle suits against the companies on whose boards they served.  Earlier this week, 10 former WorldCom directors paid a total of $54 million -- $18 million from their own pockets representing 20% of their net worth.  Today is was announced that 18 Enron directors agreed to pay $168 million, 10 of them paid $13 million from their own pockets, to settle their portions of securities class action suits.  These events probably mark the beginning of a trend that will cost directors of other bankrupt companies more money.

 

While these directors no doubt made these payments to avert the risk of even higher ones, their decisions alter the cost/benefit analysis for current and potential corporate directors.  It is no longer enough to show up at quarterly meetings, enjoy the CEO’s hospitality, and collect checks and stock grants.   With the increased scrutiny resulting from Sarbanes-Oxley, the risks – and potential legal fees – required to serve as a corporate director are increasing.  And many directors will conclude that the potential costs exceed the benefits.

 

This could make it increasingly difficult to recruit directors with the skills needed to serve effectively – further weakening an already hamstrung governance body.

 

This raises a fundamental question of why corporations have directors in the first place.  In theory, directors are supposed to assure that a company’s managers are acting to increase the value of the firm – and if not – to take corrective action.  The simple reality is that most directors are appointed by the CEO and therefore have multiple incentives to preserve that CEO’s position. 

 

More importantly, directors with the business experience needed to add value are so busy with their main jobs that they may not have the time to understand and make important contributions to key business decisions.  As a result, there is a danger that boards do not evaluate rigorously corporate resource allocation decisions.

 

Directors are caught in a system that makes it difficult – if not impossible – for many of them to protect shareholder’s interests.  With insurance covering less of their potential costs, directors are finding that they bear a larger personal responsibility for a company’s failure to act in the shareholder’s best interests while exercising very limited control over the company’s conduct.

 

There are no ideal solutions to this problem. 

 

One alternative might be to replace the notion of ‘directors as shareholder intermediaries’ with ‘shareholders as directors who represent their own interests.’  Under this scheme, directors would be selected based on two criteria:

  1. They were among the company’s largest shareholders; and 

  2. These big shareholders were investing a large percentage of their wealth (or their funds under management) in the company.

Presumably such investors would have an incentive to know more about the company’s operations and would use their clout as big shareholders to influence corporate actions. 

 

Another alternative might be to create a class of professional directors with the business knowledge and experience to offer useful advice.  Such professional directors would serve full time as directors on a small enough number of boards that they could invest the time to challenge in a meaningful way the corporation’s actions.  And they would be paid out of a shareholder insurance fund created by a pool of shareholders – rather than by the corporation.  These professional directors would be graded – and receive incentives -- based on the long-term shareholder value created or destroyed by the companies on whose boards they served.

 

Whichever solution ultimately emerges, I believe it will grow clear to corporate directors that they are part of a system in which it could become unprofitable to participate.  This suggests it’s time for a change.

 

 

Peter S. Cohan & Associates           e-mail: peter@petercohan.com

 

 

 

 

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