Why Corporate Boards Are Still So Out of Touch - And What Needs to Be Done About It

Corporate governance remains a problem area for public policy makers charged with overseeing businesses in the US and Europe. The reason it is a problem can be summed up in one word: risk. Without sensible oversight, corporations, especially banks, will continue to serve the interests of the management, not the shareholders or the larger society which charters them and, as the world has seen, bails them out when the overreach. Regulators tend to be underfunded and undercompensated; a veritable speed bump for a determined, well-funded company. Without effective governance, another financial crisis is inevitable.

Paul Strebel offers this essay in Forbes:


"We have the best opportunity ever to advance corporate governance," said Joe Dear, the head of Calpers, the Californian pension fund, in the middle of the financial crisis. Two years later the crisis is over, but the governance of banking companies seems stuck in the past. Banks still haven't fully cleaned up their balance sheets and really increased their lending to Main Street. Bankers are again giving themselves outsized compensation packages, despite the fact that many owe their survival to bailouts with public money. Little wonder that public trust in the banking industry and, by extension, trust in business as a whole is very low.

Where are the bank boards? Many of them have been recomposed with new directors who have much more financial market expertise. So why do they remain so out of touch with society and with critical stakeholders who can make or break a company--as well as out of touch with what's needed to reestablish the social legitimacy of their firms? The problem is that the world of chief executive officers and board directors is made up largely of other CEOs and top executives, and they interact mainly with one another, with management and occasionally with analysts, consultants and government officials.

Board directors owe their loyalty to those who nominate them, and in many widely held companies they are people from the same world. Hewlett-Packard ( HPQ - news - people ), whose board split over the departure of former CEO Mark Hurd, has now recruited five executives to its board with industry expertise but also with business ties to the new CEO, Leo Apotheker. "They are not there to support Leo or me," HP Chairman Ray Lane said in an interview with Bloomberg News on Jan. 26 at the World Economic Forum, in Davos. "They are there to take independent decisions." According to HP spokesman Bill Wohl, Lane and Apotheker personally contacted the candidates. "Ray did a lot of work to reach out to the people being considered," Wohl said. "Every one of them said, 'Sign me up.'"

As long as directors are nominated by existing board directors on the nominating committee, which often includes the CEO, they will continue to empathize with the CEO of the company on whose board they sit. In the words of Nell Minow, cofounder of the Corporate Library, "There's only one thing that matters, and that's who gets to decide who sits on the board." Fellow CEOs are not going to raise the red flag because of a little societal criticism, nor will they deny the company's CEO and his top people an increase in compensation, since they are in a similar position relative to their own boards. There needs to be fundamental change.

We are seeing some steps in the right direction. For widely held companies in the U.S., the Securities and Exchange Commission now has the legal authority to require shareholder nominees to be included with management's nominees for election to the board. In Britain, the Financial Services Authority has been given veto power over the nominees to big bank boards. In Sweden, large shareholders form the nominating committees of listed companies. When minority shareholders are legally protected, as they are in Sweden, with strong rights to block certain decisions with a minority vote at shareholders' meetings, it becomes more advantageous to have large owners nominate the directors.

However, bringing direct stakeholder representatives beyond the owners onto a board is not the obvious next step. Indeed, non-governmental organizations, partnerships, and other diffusely held organizations have found that having too many stakeholders on a board can lead to gridlock. I've spoken to some chairmen of Northern European companies who believe that the effectiveness of their boards could be greatly improved by having the employee representatives sit on the nominating committee rather than the board itself. In fact, the contributions of employee representatives on northern European boards are marginal, because management and the directors elected by the shareholders usually meet before board meetings to settle the key agenda items