Questioning Authority: The Critical Link between Board Power and Process

By Sharpe, Nicola Faith | Journal of Corporation Law, October 1, 2012 | Go to article overview

Questioning Authority: The Critical Link between Board Power and Process


Sharpe, Nicola Faith, Journal of Corporation Law


Many corporate directors lack a basic understanding of their companies' business, such as how their companies make money. Yet broadly accepted theories of corporate governance are founded on the faulty premise that these directors have the authority to stop corporate managers from behaving badly. These theories, as well as the corporate governance laws that draw on them, assume that boards have practical authority over managers.

This Article directly challenges that assumption and argues that flawed board decision-making processes prevent board members from exercising actual authority over managers. Accordingly, it asserts that an effective decision-making process is essential to securing a corporate board's actual authority. Unless boards engage in such a process, regulators will continue to expect boards to perform tasks that exceed their capabilities. Drawing from organizational behavior theory, this Article identifies and analyzes attributes of an effective decision-making process. Based on these insights, the Article introduces the Process-Oriented Approach to board reform and develops the Process Matrix, which serves as a roadmap for future attempts to increase directors' actual authority.

I. INTRODUCTION

The overwhelming majority of outside directors rely exclusively on executive management for information.1 Few chief executive officers (CEOs) believe their boards of directors understand the strategic factors that determine their corporations' success.2 In fact, some long-term directors "confess that they don't really understand how their companies make money."3 Yet corporate law expects that boards of directors will stop managers from behaving badly. It assumes that the ultimate governing authority within corporations rests with their boards, and not with the managers who run them.4 State corporate codes, federal reform efforts, judicial decisions, and a significant body of legal scholarship share an axiomatic assumption: corporate boards exercise significant control within the corporate hierarchy. Even Delaware-whose corporate law enjoys quasi-national authority within the United States5-assumes that boards have the power to manage their corporations.6 Although boards, as a practical matter, delegate the majority of this management work to the top-level managers within the firm,7 recent legislative efforts only reinforce the assumption that boards effectively control corporate governance.8

This assumption is highly dubious. One need only look at recent corporate failures for illustrations of managerial as opposed to directorial control. Take, for example, Eastman Kodak's recently filed bankruptcy petition.9 Although the board decided to file for bankruptcy, it was a series of decisions by management to prioritize Kodak's film business over its digital business that lead to the company's decline.10 American Airlines also gave in to a strategy it had resisted for over a decade and declared bankruptcy in November 2011.11 Gerard J. Arpey, American Airlines' former CEO, was opposed to bankruptcy, and in fact resigned as a result of the Chapter 11 filing.12 It was the CEO's strategic decision, not the larger board of directors, that caused the company to struggle financially while industry competitors profited.13

Kodak and American are only a small sampling of widespread corporate failure that illustrates the reality of U.S. businesses-managers, not boards, control most of the steps in the corporate decision-making process.14 Moreover, courts and legislators have failed to acknowledge this fact. Against the backdrop of repeated, management-driven corporate failure, there has been a consistent shiftaway from descriptively accurate managerial models of corporate governance (which assume corporate boards perform a cursory advisory role) to descriptively inaccurate board-oriented models (which assume that independent boards are necessarily well positioned to actively monitor manager behavior). Congress has recently enacted legislation geared toward solidifying boards' de facto authority within the firm through implementing structural changes in the board. …

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