Corporate Governance

Sometimes it’s fun to blog about things I really don’t understand. Hence, I’ll say that I found Justin Fox’s 2006 post on the uselessness of boards of directors very interesting. I won’t go through the part where he explains why they’re useless, just to the part where he talks about alternatives:

So what are the alternatives? Well, there’s direct democracy–putting all major corporate decisions, including the choice of a new CEO, to a shareholder vote. And then there’s absolute corporate monarchy–allowing management to make all the decisions without oversight. Law professor Gevurtz sees strengths in both. Shareholders “know as much as boards do,” he says. On the other hand there are lots of successful investment vehicles (hedge funds, for example) that aren’t governed by boards or subject to shareholder votes. Unhappy shareholders can simply vote with their feet.

However, even after observing in his article that boards have a lot in common with tonsils (“a largely useless, if mostly harmless, institution”), Gevurtz shies away from recommending their abolition. Why? Because direct shareholder democracy isn’t going to happen (the nation’s CEOs would be violently opposed) and corporate monarchy, while perhaps a more honest representation of the true power relationship in corporations, just wouldn’t feel right.

One thing I learned when trying to understand the difference between Switzerland (well-governed!) and California (terribly governed!) is that different forms of direct democracy can work out very differently. And I think that if you use a different conception of direct democracy, you can actually blend these ideas and come up with something better than the current system.

What if instead of Fox-style direct democracy (which basically amounts to a referendum system) you instead had managerial dictatorship checked by the possibility of shareholder initiatives? The way this would work is that nothing “has to” be put up to a vote. But a shareholder could start a petition. And if he could get shareholders who together own some large fraction of the firm to sign on to his petition, then that would force a vote of a shareholders on whatever his petition proposed. In practice, I suspect that would amount to managerial dictatorship in most firms most of the time, but it would preserve the principle that managers work for the owners of a firm.