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We are witnessing an organic change in American corporate governance. The balance of power among owner, manager, and director is in the process of transformation. The once archetypal model of the CEO’s unchallengeable control of the board of directors and shareholders is fading. The future will definitely see a new paradigm of governance. What is uncertain, as we enter a new century, is exactly how the power to control corporate behavior will be configured among shareholders, directors, and managers.
A series of factors is triggering a modification of the current structure of corporate governance. Financial institutions, which have pressed openly for changes in corporate directors’ roles, now own a growing proportion of shares. The hostility to, and the lessened availability of financing for, hostile corporate takeovers has diminished takeovers as catalysts for corporate change, at least for a time. The Securities and Exchange Commission has modified its rules to facilitate communication among shareholders and has pressed corporations to reveal more information concerning senior management compensation. At the same time, the business press and academic journals, in their increasing attention to governance issues, have suggested an urgent need for governance reform.
In this article, our focus is on the role of the board of directors in corporate governance and the range of potential changes in the rules and norms governing board behavior. We believe that an independent board of directors is best suited to perform the essential functions of corporate governance. The flaws in the present governance system lie in the self-imposed rules and cultural norms under which most boards operate. To enhance the board’s ability to govern, the “culture” of the board and the balance of power between independent directors and the chief executive officer need to be changed to make the board function as a cohesive unit.
We present here eleven options for reform, weighing the pros and cons of each. We believe that these options, if adopted, would lead to a visible change in the board’s character and significantly strengthen its monitoring function. However, we need to be careful not to overstate their potential. The success or failure of a business enterprise still rests overwhelmingly with the quality of its management, and by that we mean the management team and not just the CEO. This argues for a certain degree of modesty in advancing claims for reform.
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1. A.A. Berle and G.C. Means, The Modern Corporation and Private Property (New Brunswick, New Jersey: Transaction Publishers, 1991, originally published in 1932).
2. M.C. Jensen and W.H. Meckling, “Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure,” Journal of Financial Economics 3 (1976): 305–360.
3. M.C. Jensen, “Takeovers: Their Causes and Consequences,” Journal of Economic Perspectives 2 (1988): 21–48.
4. M.C. Jensen, “The Modern Industrial Revolution, Exit, and the Failure of the Internal Control Systems,” The Journal of Finance 3 (1993): 831–880.
5. Jensen (1993), p. 850.
6. J.W. Lorsch and E.A. MacIver, Pawns or Potentates: The Reality of America’s Corporate Boards (Boston: Harvard Business School Press, 1989).
7. C.K. Brancott and P.A. Gaughan, “Institutional Investors and Capital Markets” (New York: Columbia University School of Law, Center for Law and Economic Studies, Columbia Institutional Investor Project, September 1991).
8. See, for example, E.W. Johnson, “An Insider’s Call for Outside Direction,” Harvard Business Review, March–April 1990, pp. 46–55.
9. R.M. Ferry, “Board Composition and Governance, 1983–1992,” The Corporate Board, September–October 1993, pp. 15–20.
See, also: Korn/Ferry, Board of Directors, Nineteenth Annual Survey, 1992 (New York: Korn/Ferry International, 1992).
10. W.G. Bowen, Inside the Boardroom: Governance for Directors and Trustees (New York: John Wiley & Sons, 1994).
11. J.G. Smale, “Why Do Great Companies Lose Their Leadership?” (Cincinnati, Ohio: address at Commonwealth and Commercial Clubs, October 21, 1993).
12. See, for example, I. Millstein and W. Knolton, and also K. Dayton, quoted in Bowen (1994), p. 83 and p. 173.
13. Bowen (1994), p. 91.
14. Forty-two percent of those responding to the Korn/Ferry survey (1992) favored term limits.
15. Bowen (1994), p. 72.
16. Jensen (1993), p. 865.
17. Bowen (1994), p. 1054.
18. Jensen (1993), p. 865.
19. Johnson (1990), p. 55.