Outsourcing the Board

How Board Service Providers Can Improve Corporate Governance

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In this groundbreaking work, Stephen M. Bainbridge and M. Todd Henderson change the conversation about corporate governance by examining the origins, roles, and performance of boards with a simple question in mind: why does the law require governance to be delivered through individual board members? While tracing the development of boards from quasi-political bodies through the current 'monitoring' role, the authors find the reasons for this requirement to be wanting. Instead, they propose that corporations be permitted to hire other business associations - known as 'Board Service Providers' or BSPs - to provide governance services. Just as corporations hire law firms, accounting firms, and consulting firms, so too should they be permitted to hire governance firms, a small change that will dramatically increase board accountability and enable governance to be delivered more efficiently. Outsourcing the Board should be read by academics, policymakers, and those within the corporations that will benefit from this change.

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Event Transcript

Operator:  Welcome to The Federalist Society's Practice Group Podcast. The following podcast, hosted by The Federalist Society's Corporations, Securities & Antitrust Practice Group, was recorded on Wednesday, September 12, 2018 during a live teleforum conference call held exclusively for Federalist Society members.  


 Wesley Hodges:  Welcome to The Federalist Society's teleforum conference call. This afternoon's topic is Outsourcing the Board: How Board Service Providers Can Improve Corporate Governance, a book written by some of our speakers here today. My name is Wesley Hodges, and I'm the Associate Director of Practice Groups at The Federalist Society.


      As always, please note that all expressions of opinion are those of the experts on today's call.


      Today we are very fortunate to have with us one of the authors of the book, Professor Stephen Bainbridge, who is the William D. Warren Professor of Law at the UCLA Law School; fellow author, Professor Todd Henderson, who is the Michael J. Marks Professor of Law at the University of Chicago Law School; and also with us today is Professor Charles Elson, who is the Edgar S. Woolard, Jr. Chair in Corporate Governance and the Director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. After our speakers give their remarks today, we'll move to an audience Q&A, so please keep in mind what questions you have for the book, for the subject, or for one of our speakers in particular. Thank you all for speaking with us. Professor Bainbridge, I believe the floor is yours to begin.


Prof. Stephen Bainbridge:  Well, thank you, and I'm very grateful that you had Todd and I on to talk about our book. Everybody knows that boards of directors have failed to perform optimally for a long time. Critics of board performance go back as far as the 1930s and even further back than that. And there're a variety of reasons why boards fail. These include the fact that directors are part-time employees with weak incentives. Charles Elson is going to comment later, did a lot of yeoman's work on getting directors more engaged by encouraging them to have equity ownership. But it's still the case that directors have relatively weak incentives and an inherent information disadvantage with respect to management.


      Directors also tend to be generalists. So the average board of directors is not going to have the experts that it needs at any given point in time. And finally, we point out that the market for director talent is not really very transparent. It's certainly not characterized by anything resembling vigorous competition. CEOs and nominating committees pick directors on the basis of factors that are not well-disclosed. Elections of directors are almost always irrelevant. Shareholders have very little information about board processes and very little ability to judge how individual directors perform.


      And so even though we rely on the board of directors to perform critical functions, most importantly monitoring the management of corporations, it just strains the imagination to believe that a group of 10, 12, however many outsiders to the firm, given access to limited information, could possibly be an effective check of management. Even a management that's essentially honest can still make mistakes. And yet, boards are poorly positioned to correct, to advise and to make sure that management is optimally performing.


      At a conference a few years ago, someone was presenting a talk on board reforms, and Todd threw out a great question with a curl of really, I thought, brilliant idea which was, look, what if boards instead of being comprised of 10, 12 natural persons were comprised of an entity? Just as corporations outsource their independent auditing function to a firm of accountants and just as they outsource their legal work to a law firm, why not allow them to outsource the board function to an entity that we call a board service provider? And the problem that I immediately saw with this idea was, well, every corporation statute in the country says the board of directors shall be comprised of natural persons. And so there was a legal obstacle to this, but Todd aptly pointed out, well, the law can always be changed. If it's a good idea, then we could press for legal reform, but we ought to think through whether or not it is a good idea.


      And that was sort of the genesis of the book was thinking through the question of whether or not board service providers could provide a more effective, a more accountable, more transparent board functions than the current system. And we think there're a number of benefits that a board service provider would offer. And maybe what I'll do at this point is throw it over to Todd and let him address some of the benefits, and then maybe I can come back and talk a little bit what the board service provider would look like.


Prof. Todd Henderson:  Super. So thanks, Steve. I'll start with the view that, I think, everybody would probably think if we had a statute that required companies when they were hiring lawyers to hire sole proprietors, we would think that that statute was crazy. Of course, there would be benefits to hiring only solo practitioners, but the benefit of letting lawyers associate with each other through an entity called a law firm are so big that they overcome any gains from accountability or independence or the like from hiring sole proprietors who are therefore required to associate with other lawyers that they might need through contracts.


      So you could imagine every company's got to hire a solo lawyer and that solo lawyer if they need help with a tax issue or an MNA issue, they could contract with an expert to provide them with advice. But I think we would all see that that would be a very inefficient system. There are very big economies of scale from associating with people through a hierarchy, through an entity, as opposed to through individual contract. This goes back to Ronald Coase's pioneering work on the theory of the firm. And the same reason that most economic activity takes place through entities, firms, because of the benefits of firms—economies of scale being one—at least that's also true on the governance side.


      As Steve pointed out, a board of 12 individual sole proprietors could not possibly know all of the issues that a modern company is faced with. And so whether it's accounting or compensation or crisis management or cyber tech or whatever the issue is—foreign issues, strategic issues, technological ones—whatever those things are, if the board members don’t have them, they have to buy them in the marketplace. And there's obviously issues with how they get the money for that and whether they're going to do that, and it might just be, even if they had the money, it might be not as efficient as walking down the hall and consulting the expert on compensation and getting that information that way as opposed to having to go out into the market to get it.


      So in terms of economies of scale and scope, that's a big one. Jeff Gordon has pointed out this example, which I'll borrow. J.P. Morgan 20 years ago -- if you compare J.P. Morgan with what it was 20 years ago with today, or 30 years ago, the two companies -- they're both still banks, but they are unrecognizable. J.P. Morgan today is 30 times bigger than it was a couple of decades ago. And that doesn't even capture the complexity of their business internationally, with different kinds of derivatives, the markets they operate in. J.P. Morgan is orders of magnitude more complex as a business to run than it was two decades ago. And yet, the board is exactly the same size. It's 12 people, the same kinds of people: former executives, some politicians, some diversity hires, whatever the issue is the board is composed of people who are not experts in all of the businesses or all of the demands that J.P. Morgan requires for governance.


      Vertical integration in governance, just as in other fields, can bring massive efficiencies. You know, we estimate that governance is a $20, $30 billion industry that is provided mostly through the point of sole proprietors. So massive gains that are possible there.


      Some other things that are benefits: right now, as you all probably know, liability for breaches of fiduciary duties run right through directors. They have to be individual persons. Firms can share risk more efficiently than individuals, where sharing increases, if anything, the likelihood of judicial supervision of governance. It is probably the case today that a lot of Delaware judges are gun shy about holding directors to account personally for the losses their conflicts of interests or violations of their fiduciary duties impose on shareholders because it's coming out of the director's personal pocketbook. This might explain, for instance, why the Delaware Supreme Court ruling in Disney in the famous Michael Ovitz's case was sort of like, "Well, you didn't do it, but we'll give you a pass. We hope you do it better next time," as opposed to hitting them with liability. Firms can share liability and reduce the risk by cooperating through a firm, and I think this is the kind of -- it could paradoxically make boards more accountable by having them be firms.


      Part of the gains from associating a firm are reputational. Bigger is better reputation wise. Think of a law firm. If an individual lawyer misbehaves vis-à-vis a client and that lawyer is a sole proprietor, their reputation is harmed. That same lawyer who's in a firm misbehaves, they suffer a reputational hit as a partner on that particular case, but the reputation of their law firm also goes down by a little bit, meaning every single lawyer at that firm is harmed a little bit by the cheating of their colleagues. And that encourages those colleagues and that firm to make investments in quality control to make sure those reputational externalities are not present and that leads to better quality. There's work on this by Larry Ribstein and Ed Iacobucci, and so this is, I think, another value.


      Branding, the power of brand is very powerful. Brands are powerful because a brand is a kind of bond against breach, and large BSP's, large governance providers, whether it's McKinsey or Goldman Sachs or KPMG or a company that arises to serve these things could build brands and those brands would be a bond against bad performance.


      Another potential gain is the idea of just measuring corporate governance. We have this incredibly important thing in our world called corporate governance. We spend enormous amounts of money on it, academics spend all this time acting as investors, talking a lot of about it. It's extremely important; no one has any way of measuring it. The only measurement of governance is inexorably intertwined with corporate performance. Like before Enron collapsed, it was regarded widely as the best performing board in America. And, of course, that wasn't true. What we'd want to know is the counterfactual: how would Enron have been doing had it been governed by a different board? And we can't know that because we don’t have counterfactuals in the world. Normally, we would measure things like how does the market react when a new company takes over or a new auditor or a new consulting firm or whatever it is gets work. Here we can't really do that in governance. But if we had firms that were providing governance, we would all of the sudden be able to measure governance a lot of better.


      Boards are also hired to be the board of ACME Inc. We can measure the impact that that decision has on ACME value. We can look at -- if Boards-R-Us is a publicly traded company, we can look at how the market values Boards-R-Us. So we would get some measure about governance that is distinct from the operational performance.


      Market discipline: there's very little accountability currently among directors. Proxy contests are rare. There are reimbursement asymmetry problems and informational problems, so we don’t get a lot of proxy contests. What we do is we have academic investors and putting individual board members as part of the group—that raises its own set of problems. In an alternative universe you could imagine a board service provider that because they have a national reputation, because they have these economies of scale, they could come in, they could effectively bid for the governance work for a particular firm and say, "Look, this is how much we will charge you to provide governance services that would give shareholders currently what they don’t have," which is some information about how much the company is spending on governance, that would allow shareholders to make better choices about who boards would be because we would know, instead of the current system where we've no idea how any individual directors votes on a particular issue and the market does not really operate efficiently, we would get some of that through a better market.


      So there's more, I think, benefits that are laid out in the book, but that's a pretty good start of what we think the primary ones would be. I'll note that there's a close parallel with our proposal to the private equity world. Private equity is premised largely on governance. There's badly performing, badly governed firms. The private equity industry steps in, buys the economics of the company, fires the governance team, including the management team, and replaces them with a better governance mousetrap. That is limited in scope because of the economic cost of having to take over a company. Sure, there are still going to be private equity deals in cases in which the person who wants to take over the company wants to do so both economically and governance wise. What we propose with the BSP model is sort of an extension where governance could be improved on the margin without having to take over the economics. So it's basically just a cheaper way for us to get improved governance in firms in cases in which the private equity option doesn't work for whatever reason.


      So maybe back to you, Steve, and then we can follow up on these topics in the Q&A.


Prof. Stephen Bainbridge:  Okay. Just very briefly, following up on the point Todd made. We envision this as a market where once you get rid of the requirement that directors be natural persons, we were not proposing that all corporations hire BSPs. What we're proposing is that corporations have the option to do so. But we think once you get rid of the legal requirement that board members be natural persons that there would naturally be some groups such as consulting firms like McKinsey, maybe accounting firms through their consulting arms, and so on, would get into this business of offering board services. And as Todd suggested, one of the advantages of this is under current system if you look at a board that's struggling, shareholders have very little ability to identify which of the directors is the problem. Are they all a problem or just some of them? And if so, how do we replace the problem ones? With a board service provider, you've got one entity, and you can basically compare how that entity's performing to its competitors that would provide the same service.


      And that idea leads, I think, to some interesting potential changes in governance. Martin Lipton once proposed that boards be elected every five years so as to prevent sort of short-termism among board members. Our idea could be blended with that. We could, for example, say, okay every three years there will be an election, but instead of this sort of election that we now have where the incumbent nominating committee puts forward a slate, and in the absence of a proxy contest, that slate's put out for an up-or-down on vote.


      One of the ideas that we've sort of tossed around is, well, suppose you had a competitive election where the incumbent board service provider would have to compete with one, two, three, four other potential board service providers and shareholders could compare them based on their record because now shareholders would have much more transparent information. What is the return that these various providers are generating for their portfolio of clients? And if that sort of information was publicly available, shareholders would be able to have a much more efficient way of selecting who's going to act as the board of directors, which at the same time might address some of the concerns that incumbent managers have about shareholder activism. If the shareholders were more confident that okay, every couple of years, every three years, we're going to get to pick among a number of options and select the one that we think can best run the company. They may be less inclined to do the sort of Dan Loeb model of lobbing in shareholder proposals and running these sort of activist campaigns that we've become familiar with.


      So in conclusion, I think that suggests that one of the advantages of the board service provider model is that it's not really geared towards the interest of the incumbent managers or activist shareholders. We think both would find reasons to support the proposal because it's designed neutrally so that it doesn’t favor one side or the other. But I'll be interested to hear what Charles has to say about it.


Prof. Charles Elson:  Well, thank you very much both of you all. It's an intriguing book. I enjoyed reading it. I think there's promise in the book. It's accessible to a wide range of people, not just us governance junkies and lawyers, which I think is important.


      Steve and I go back, oh, gosh, almost 40 years. We were in law school together and started in this business about the same time and have been colleagues and good friends for a long time. So anything Steve writes, I'm going to read and read thoughtfully and carefully and, I know, enjoyably. Todd I've known since about the time he started as well at Chicago and have admired his work tremendously over the years, and it's fun to have the chance to comment.


      My comments are going to start out adulatory, move to a little critical, and then come back kind of adulatory again with, I think, a rather interesting take on the idea. But before I get started, a couple of things. First of all, I look upon this not only as a law teacher and law of corporate governance junkie, I've been a director and am serving currently as a director—been involved in a number of companies as a director—but have also worked with a number of corporations as a consultant or involved party. So I'm pretty familiar with the practical operation of the board and obviously the practical operation of a corporation or a large-scale enterprise in and of itself, which I think is important to looking at this particular idea.


      A couple of things that Steve said to begin with, and Todd, I'd kind of quickly respond to. Number one, the view that boards need more expertise. You know, boards have changed a lot of over the last 20 years. A piece that Ann Mulé and I wrote for directors of boards a little while ago talked about the necessity of experts on the board because we could talk about the danger of the management knowledge-captured board. Where management traditionally captured the board through appointment, today the argument is they capture it through intimate knowledge of the firm, and you need more people on the board with that kind of knowledge. And interestingly enough, you've seen a real shift, whether it's nominating committees or shareholders advocating those with significant expertise in the industry. And it came from, oddly enough, the activist investors. It was, in the context of proxy fight involving Hess, that the activist bunch, the directors of Hess said retail or oil experience. And this was basically a retail oil company and that they needed folks with that expertise. And they were nominating people for the board with greater expertise in this area that was to be on the board. And then ultimately, the firm was successful and the company compromised with them and you saw a very different board.


      So I think that has changed. I think that that's one of the, I think, correct criticisms that Steve and Todd have directed at boards is that lack of expertise, independents over expertise. I think you need independents plus the expertise, and I think you're beginning to see it. Nominating committees today come up with expertise grids and they use independent recruiting firms to find those with that talent, looking specifically for individuals with those talents to be effective monitors because that's what the board's supposed to be doing. You can't monitor somebody unless you understand the industry you're monitoring.


      That being said, it's also good to have on a board someone from outside the industry because, frankly, when you're in a certain industry your whole career—and I think the three of us in the legal business we've been in can attest to this—you get a bit myopic. And sometimes people from outside have a unique viewpoint that those within the industry don’t think about. They get out of the box, and I think, frankly, an outsider is important for a well-functioning board as well.


      Secondly, CEOs don't pick directors any more. They did. They clearly did. My first board I went on was -- the position was offered by the CEO and I, frankly, don’t recall meeting the other directors until I was actually elected. Today, different story. Nominating committees look for directors. They look for, quote/unquote, "experts in the area" and the CEOs involvement in most companies, well-governed companies, is at best minimal today for obvious reasons because the CEO can't serve on the nominating committee anymore. Can't serve on the audit committee. Can't serve on the compensation committee for obvious reasons. In fact, the CEO serves on no committees, and I think the point is that nominations come from within the board itself, and frankly, given the pressures of large institutional shareholders and the voting patterns of those shareholders, the requirement for director expertise and skills is much more greatly demanded by the investors and viewed by the investors as they decide whether or not to reelect directors. Very different world. Your large pass of funds have taken a much greater role in assuring the board represents the kind of independent, expert-containing monitoring device it should've been.


      Now, that being said, what about this proposal? I think it's really interesting. I enjoyed the book a lot. I think that they do a very good job of getting us through what I think Steve has pointed out are the legal issues, à la a natural person. I think they developed a very clever way legally to work their way around various corporate law restrictions to get them to a place where you could, in fact, create this.


      The question is, and the biggest question is, does this ultimately make sense for the way boards function? What do boards do? Boards are there to monitor management for the benefit of the investors. Pure and simple. They hire management, they fire management when necessary and they monitor management in between those two points. And I think the suggestion of the book is that given skills and expertise of large-scale enterprises as opposed to solitary individuals that a board monitoring firm or a board oversight firm will do a better job representing investor's interests in assuring effective management than a group of independent individuals.


      And the idea has some attraction to it. I mean, I think they make some excellent comparisons to law firms and other -- canning firms and other large-scale enterprises. But I think the role of directing is very different, in my view, than the provision of canning services or legal services or things like that. I mean, the director is there, frankly, he's elected to exercise judgment—judgment on who to hire, when to hire, and when to fire. Judgment. And from my experience in life as a director and experience working with big companies, corporations, frankly, don’t have the ability generally to exercise judgment. They're too big. They're too many complications within the enterprise. They're less likely to act quickly and with judgment than individuals. And I think that that to me is the fundamental problem with this. Companies themselves don’t have big judgment -- don’t have judgment; they make recommendations as a result of a lot of interplay within the organization. But, frankly, sometimes good judgment on a sound and expedited basis is necessary as a director. Things come up and that's why you're there. The best directors have good judgment. And judgment is something that's hard to quantify. It's usually developed through years of expertise and reputational development that goes along. That's why typically directors are usually a certain age and they have a broad range of experience because they're there not necessarily for their expertise itself but their, we call it, "business judgment." Just sound judgment.


      Secondly, as far as the companies go, you've got to make decisions as directors. That's critical. A big part of your job is deciding 'x' or 'y', 'x' or no 'x'. Acquire, don’t acquire. Terminate, retain. Companies have difficulties doing that too. If you've ever worked—and I know each of you all have and I'm sure those in the audience have—worked for a large corporation, which these board service providers would be, corporations find it very difficult to make any kind of judgments or any kind of decisions. That's why typically entrepreneurial ventures tend to do better than the large establishment ventures. Decisions are more easily made in a smaller venture. Not necessarily true in a large corporation, and I think that in this area, individuals make judgments, make decisions. Corporations typically don’t or have difficult times of it. And I think that what an investor's looking for in a director, obviously judgement, obviously ability to make a decision, make a decision promptly and effectively. I don't think you will ever find in a large service corporation and I think those are critical. Expertise, I agree a large company can fan out and find folks with this expertise. But so can boards, and that, I think, is what's happened.


      Finally, the concern is the agency issues, and this is a big one too. I mean, the whole problem, the great conundrum in corporate law is agency. How do you make sure the agents, à la the directors, represent effectively the principles, à la these shareholders, or if you want to use a fiduciary example those for whom they owe fiduciary duties. I don't think substituting a corporation for an individual, frankly, makes much difference in that one. The agency issue is still the same; the question is how do you incent the individual? That's where stock ownership, significant ownership comes in, independents comes in. How do you incent a large corporation? I think in the book the point was made that perhaps you could use stock ownership too. But I think corporations have different incentive structures than individuals, and to an individual the business corporation has, let's say, hundreds of clients which they own lots of stock, it's rather different than an individual, let's say, serving on one, two, or, three boards to whom the investment is significant, personal, and meaningful.


      Additionally, the argument was made, well, corporations will have greater accountability because judges are more likely to hold corporations accountable because you're not going to take money from an individual. It's interesting to note, by the way, that in the accounting business where, historically, you sign your firm's name, today under the new PCOB rules, the individual accountant, who prepares the thing, has to put their actual name on it. And the view is having an individual responsible with their name there is much more effective than the firm itself, even though as we know the firm itself probably picks up the financial tab anyway if things go wrong. And I've always been a great believer in individual accountability than corporate accountability. Corporation is ephemeral; an individual has their own reputation, their own livelihood, at stake and I think people are more careful as individuals than they are, frankly, in a corporate existence. Listen, look at buying a car. People are much tougher in buying their own car than having the corporation purchase an automobile for corporate purposes. That's why corporate cars are usually pretty junkie and individual cars are always a little bit better.


      On the judgment point, by the way, it's interesting to note that if outsourcing other's judgment is effective, why don’t we outsource juries? And the answer is pretty simple that individuals, we've discovered over time, are much better fact finders than another sort of body. A judgment of your unskilled or objective or however you want to describe an individual is more effective in the end in determining truth or falsity, and that's why I think we've never outsourced juries.


      Now, that's the critique. Is there a good side? Yeah, actually I think they've come up with a really good idea that has application but not quite in the way they originally anticipated from the book. And I'll tell you where I put it. We were going through a big controversy in this country today over dual-class stock; that is stock were you have disproportionate voting rights compared to your economic interest. Those with small economic interest, just as the founders, retain, despite taking the company public, significant voting control over the company. Their votes count 20 times more than everyone else's, and that's how they exercise control over the enterprise. You've seen it in the whole Viacom/CBS dispute over the last couple of weeks, which was apparently settled on Friday. But the idea is that in those cases where the manager, if you will, or founder has a smaller economic interest than their voting interest would represent or would suggest, à la the one-share-one-vote.


      How do boards operate in that situation? And answer is, seeing what we've seen of late, they operate really badly. They're basically the creatures of the controlling shareholder, who has this super voting with a smaller economic interest, and they rarely bite the hand of their feeder, so to speak, or whomever brought them to the dance. And they really serve in those companies as paper tigers. They don’t exist as real monitors because if they monitor effectively and terminate the CEO, the CEO who has all the stock or voting interest in the company will terminate them.


      And so the shareholders in those circumstances are really left out in the cold. They have token votes, you know in the case of Google or Facebook there is shareholder voting, but they will never elect a director and any director who opposes the management will get replaced by the management and the investors who hold the majority economic interest in these companies are basically stuck. And I think that's why in these companies you see such controversies over and over and over, whether it's misfeasance, malfeasance, or just board's crummy judgment. In those situations, investors are stuck. And the corporate law has been trying to deal with this for a long time. I've been one of those who've argued that just get rid of the structure entirely. It doesn't bring benefit and the costs are too significant to the investors.


      But I think Todd and Steve, or Steve and Todd, depending on what upside the alphabet you work on, have come up with a really interesting, potential solution to this issue. If you don’t want to give up the dual-class structure and you want effective or some counterweight to management, which you're never going to get with a shareholder or a management effectively appointed board through a structure, what about a structure where the other investors, though they obviously vote for the board is meaningless in the case of Snap, nonexistent, what about requiring that a board service provider serve as the investors, if you will, directors in those corporations?


      In other words, in a dual-class corporation, instead of having a board or in addition to the board, you have a board service provider representing the interest of the other investors who they elect as their effective monitor. I think in that situation the issues that I've raised that would be prevalent in a standard public company really wouldn't be around because the controller makes the judgment, makes the decisions. But having this independent, expert firm outside, because there's no way these other folks can elect directors, may provide an appropriate, reputational, and a liability counterweight to management. In that regard, I think they've got a really pretty good idea here that would be really, in my view, worth exploring further. If one doesn't wish to eliminate the dual-class structure, this is kind of an interesting solution, if you will, to the problem with whether it's self-dealing or inappropriate decisions or just bad decisions made by management in the dual-class company. This is an interesting counterweight that I think would be worth thinking about.


      Steve, as I told you when we first started this call, I'd surprise you a little bit, so with that, I turn it back to the authors.


Prof. Todd Henderson:  Steve, you want to respond quickly, and then I have a couple of things to say, or I can do it.


Prof. Stephen Bainbridge:  Sure. So first off, I want to thank Charles for his very good comments. He is an old friend and someone who has been a great inspiration to me through his own work in corporate governance and somebody who has actually has been a player in that arena, not just an academic commentator.


      I think, fundamentally, we disagree with Charles over the idea that individuals are better decision-makers and better investigators and better monitors than entities. And what we try to do in the book is to lay out both the difficulties that individuals have in performing the basic board functions—and they are serious and pervasive—with the incentives that groups have, and as Todd said in the beginning, there are reasons why firms exist to provide services and among those reasons are greater bargaining power than an individual has, economies of scale, incentive structures.


      And so we acknowledge Charles's concerns, but at the end of the day, we also have to say, well, what would be wrong with running an experiment? What would be wrong with saying, look, let's just change the law so that the board service provider option is available and let's see what happens. And if Charles is right and we're wrong, then Darwinian competition in a free marketplace would prove that. On the other hand, if we're right, then again, market competition would tend to show that. And we would acknowledge that markets aren't perfect, but why not give the market a chance to test whether, in fact, boards are optimally structured these days because we've been locked into this model of individual boards members for decades and we see that it hasn't solved the problem. And so I think the idea of creating a market in which alternative governance structures could compete with one another is something that ought to be hard to argue with. Todd?


Prof. Todd Henderson:  Yeah, so I do agree. So thank you, Charles. I've admired him for a long time and it's great to -- I'm touched that he read our book. So that's great. I will agree that I think he's right that boards have gotten a lot better, and we still think there's work to do. But I would just echo what Steve said. We could imagine having this exact same discussion about law, about the statutory requirement that companies have to hire solo lawyers. Well, individual lawyers are going to have better judgment and they're going to have better incentives and all these things. And I would say, let's let them try.


      For instance, because we don’t really lay out exactly what a board service provider would look like internally, so imagine that a company hired a BSP, how would that BSP work? Would they have a kind of -- would they have one partner who is the director, the only director for a company and then that person just has a support staff? Or would they have 12 people, including the Charles Elson's of the world, who serve as a kind of shadow board that deliberates just as it does now in exactly the same way and then votes just as they do now, and then makes a decision, and that decision is the decision of the BSP?


      We could imagine an infinite number of kinds of permutations like that, of various structures that BSPs could use to address Charles's concerns because if it is true, and he know boards inside a lot better than I do, if his concern is true, than the board service providers who meet his concern sufficiently, given the other benefits of BSPs, those would be the ones that would succeed in the marketplace. And if it is the case, as Stephen pointed out, that they can't and that there is something, some kind of x-factor that makes individuals be the secret sauce, then we'll see BSPs form and fail and shareholders refuse something else.


      So I think there's a pretty -- all we're asking for here -- we don’t think we've got some kind of silver bullet; we're just merely pointing out that there is this very strange legal prohibition on experimentation in governance, and we think there are reasons to believe that that legal prohibition has inhibited governance from being even better than it is today, notwithstanding the progress that has been made. And so that's all we're just saying. Free the market up from this law, which to the best of our knowledge has no justification. If companies want to experiment in governance, we should let them do it.


Prof. Charles Elson:  How about the dual-class idea? I like that one.


Prof. Stephen Bainbridge:  I think it's an interesting idea. You kind of sprung it on us, so we haven't had much time to think about it. But I am confident enough -- you know, Charles was the one who pointed out that director compensation wasn't working and got the current system under which most directors get at least a substantial part of their compensation in the form of stock. That was his idea and it was his activism that made that happen. And so I think any idea that Charles comes up with is worth not shooting from the hip but taking seriously. And I think it's a very interesting idea. I think it's something that would make a very useful add-on to our proposal. And so, again, I would just thank him for throwing that idea out there. I think it's potentially a really interesting idea.


Prof. Todd Henderson:  Yeah, I would agree. And I would just point out as we lay out in the book, there's a bunch of rules, New York Stock Exchange listing rules, that say you have to have a certain number of independent directors and certain types of expertise on your boards. All those things are derivative of the natural person requirement. So we'd have to change those, and we would expect some experimentation, and you know, if Charles's idea is a good one, and, again, I need to think about it. I took notes and will do that. But right now it's hard to see how that could work given all of these kinds of requirements. So maybe that's a kind of narrow case where a first mover would do that, but right now we can't even have that kind of experiment.




Prof. Charles Elson:  Yeah, but in a controlled company, a lot of the exchange requirements don't apply. The independents requirements. And that's why I suggested the objections I have to the -- or I shouldn't say -- not objections, but concerns I have about the proposal really evaporate in the dual-class company.


Prof. Todd Henderson:  Well, we will think more about it, Charles. Thank you.


Prof. Stephen Bainbridge:  I think it was definitely an idea to think about.


Prof. Charles Elson:  Mr. Moderator, are we supposed to take questions or what happens?


Wesley Hodges:  That is correct. It looks like we do have one question in the queue. Let's go ahead and move to our first caller.


Doug Anderson:  This is Doug Anderson, Chicago. That was an interesting discussion. The one question I have is why you can't get most of the benefits you're talking about from board service providers currently by just having an entity that's a board service provider, except what it does is it provides a slate of nominees, and it's effectively responsible for those nominees. It has access to the services of the company to inform those nominees and help them out in performing their duties. And it's the reputation of that entity on the line as to the performance of the company.


Prof. Stephen Bainbridge:  Well, I'm happy to answer that. One of the ideas that we discuss in the book is precisely a sort of hybrid model in which you continue to have individual board members but that they would be candidates of and employees of a board service provider. We are certainly open to those sort of hybrid models and it would certainly perhaps be easier to effectuate without significant legal change, although I think it would raise a concern about is the company now a controlled person since all of the board members would be employed by a particular company, and would the board members be deemed independent under the New York Stock Exchange listing standard rules. As you probably know, one of the New York Stock Exchange independents requirements is that the director not be affiliated with a company that does more than, I believe it's $2 million a year in business with the company on whose board the individual serves. And so assuming that the board service provider was paid either directly or indirectly more than that, then its candidates would not qualify as independent.


      So I think it would still require a certain amount of legal tweaking in order to make that happen, but, I think, it's certainly an interesting hybrid option, and it's an option that we do, in fact, discuss in the book.


Prof. Todd Henderson:  Yeah, that's a great point, Doug, and I think it goes to the point I was making about private equity firms. I mean, that's what private equity firms do effectively. They don’t run a slate for the shareholder; they just get rid of the shareholders and put in individuals. But those individuals are employees of the private equity firm or people who are beholden to them. And so I think the idea, going in your direction, is we could do that but go directly to the shareholders. I think the legal problems that Steve lays out are significant ones.


      But it might be the case that an aspiring entrepreneur -- if our book inspires someone who is starting a company, who's bold, who wants to disrupt things, and says "This is what I'm going to do, and then I'm going to dare the New York Stock Exchange not to list me because of this," or imagine that someone with standing would sue to say this is a violation of the natural person requirement -- that's what we're trying to encourage is innovators to push for better governance solutions in whatever form they would be. But thank you for your question.


Wesley Hodges:  Thank you very much, caller. Do any of our speakers have any final remarks they would like to make before we finish the call today?


Prof. Stephen Bainbridge:  Well, I'd just like to thank you for making this opportunity available to us. Charles for giving such detailed and thoughtful comments. And as always, my co-author, Todd Henderson, for being the best co-author anybody could want to have.


Prof. Todd Henderson:  Thank you very much to all those people and right back at you, Steve.


Prof. Charles Elson:  And I wish to thank both of you all for writing such a good book that creates such good thought and discussion. And I'm sure our audience is overwhelmed with thinking to ask a question right now. But we'll hear from everyone.


Prof. Stephen Bainbridge:  Thank you, all.


Wesley Hodges:  Well, we thank each of you. Again, everyone, the title of the book is Outsourcing the Board: How Board Service Providers Can Improve Corporate Governance. I encourage you all to check it out and buy a copy for yourselves and for a friend.


      Well, on behalf of The Federalist Society, I'd like to thank our experts for the benefit of their valuable time and expertise today. We welcome all listener feedback by email at [email protected]. Thank you all for joining. This call is now adjourned.


Operator:  Thank you for listening. We hope you enjoyed this practice group podcast. For materials related to this podcast and other Federalist Society multimedia, please visit The Federalist Society's website at fedsoc.org/multimedia.