The Case for Professional Boards

by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, December 6th, 2010.

In 2002, Congress passed the Sarbanes Oxley (SOX) to prevent a repetition of the corporate governance debacles at Enron and WorldCom. All boards of public companies as well as their important committees would be comprised mainly of independent directors. A public company’s executives would conduct a yearly assessment of internal controls, subject to a special report by its external auditors.

Six years later, many of the largest financial institutions in the US had to be rescued by massive injections of federal assistance. Yet all these institutions were SOX compliant. Most members of their boards as well as all members of their important committees were independent. They all had evaluated their internal controls and the reports of their auditors showed no material weaknesses in 2007.

So why were the SOX reforms so ineffective? This article will identify the main deficiencies of current corporate boards — too many directors and too few experts with too much emphasis on procedures. Then this article will present a new model for boards of complex global companies — a small group of professional directors with enough relevant experience and sufficient time to hold management accountable.

 

Smaller Size. The average board size for companies in the S&P 500 was almost 11 in 2009, typically with over 80% independents. In most groups of 10 or more, individual members engage in what psychologists call “social loafing”, instead of taking personal responsibility for the group’s actions, they rely on others to take the lead. A large group is particularly dysfunctional in the context of a board of directors since these generally operate by consensus.

Psychology research on group dynamics suggests that groups of six or seven are the most effective at decision-making. Groups of this size are small enough for all members to take personal responsibility for the group’s actions; they also usually reach a consensus quickly.

Moreover, a group of six outside directors will allow a board to achieve an appropriate composition for the main committees — audit, compensation and nominating. Three directors can be chairs of the committees, and the other three directors can each serve on two committees. (continue reading… )

 

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