The Governance Revolution

What Every Board Member Needs to Know, NOW!

Deborah Hicks Midanek

• Publisher: De Gruyter
• Year: 2018
• ISBN:
  9781547400386
• Edition: 1
• Topic: Negocios y empresa
• Subtopic: Gobierno empresarial

Boards of directors are sitting ducks. Shareholders complain and even attack, management manipulates, and individual board members have little power, able to act only as part of the board as a whole. Governance issues are front and center, yet there is often little understanding, even among board members, of the key role that they play.

Written in an accessible and human voice, The Governance Revolution: What Every Board Member Needs to Know, NOW! provides information and context essential to anyone seeking to understand how corporations and their stewards—the board of directors—can and should function in the volatile world we inhabit.

Deborah Hicks Midanek offers useful insight into what board members of corporations actually do, the current standards for board members and why they exist. She includes a timely discussion of how clarity of purpose can improve board and director effectiveness. Informed by her long experience serving public, private, and family owned corporate boards as well as those of charitable, and government organizations, she provides essential context regarding the evolution of board practice as well as candid discussion of the issues involved in the relentless effort to improve corporate governance processes. Focused mainly on the dominant public corporation, she also explores the special challenges of serving private and family owned as well as nonprofit and public agency boards.

Written by a seasoned board member, and liberally laced with stories and cases illustrating the tricky issues directors wrestle with, this book is the essential common-sense companion for anyone working with a board, serving on a board, or wanting to do so. Directors, aspiring directors, investors, and students of corporate behavior will benefit from this highly readable description of the cloistered boardroom.

For Roger Trapp's article in Forbes featuring a discussion of this title click here

https://www.forbes.com/sites/rogertrapp/2018/10/22/independent-directors-nehttps://www.forbes.com/sites/rogertrapp/2018/10/22/independent-directors-need-to-stand-up-to-activists/#7060008826b0ed-to-stand-up-to-activists/#7060008826b0

For a Roundtable discussion in Financier Worldwide Magazine featuring Deborah Hicks Midanek please click here

https://www.financierworldwide.com/roundtable-risks-facing-directors-officers-aug18#.W1BqQdVKiUk

Click here for a review in Financial Analysts Journal

https://www.cfapubs.org/doi/abs/10.2469/br.v13.n1.10

Click here for an excerpt on Corporate Board Member:

https://boardmember.com/what-is-the-governance-revolution/

Part I: The System and How It Came To Be

Boards of directors are sitting ducks. Shareholders complain and even attack, management manipulates, and individual board members have no power, able to act only as part of the board as a whole. Worse, the board meets only occasionally, typically quarterly, in fairly ritualized circumstances, and board members rarely have the opportunity to speak candidly to each other or to management.

And yet, the board bears ultimate responsibility for the health of the corporation. The director’s role is not an easy one, and we can empathize with the many directors who stand on ceremony rather than substance, hoping at best that they look good in the proxy statement and the photo in the annual report. As they seek strategies to boost company health and shareholder wealth, today’s board members must also navigate unprecedented investor scrutiny and deliver greater transparency and accountability while protecting against cyber and other kinds of terrorism and understanding the potential impact of new technologies such as cryptocurrency.

How can board members fight back when the deck is so seriously stacked against them? What is required is a revolution in governance, powered by a revolution in the thinking and behavior of corporate directors. The role is an ambiguous one and requires much effort and attention not only in meetings but in the many hours between them.

In this part, we explore the current dominant system of corporate governance and how it came to be. Our primary focus is on the United States, and the public company. You may think we are spending too much time on history and skip ahead, but to my mind, we all need the insight that the history of the corporate form offers to provide a firm foundation for the way corporations are governed today, so bear with me. Today’s directors operate in a complex environment composed of many markets, players, and instruments. Every director’s toolkit should include a sense of how these have evolved.

Chapter 1
How Our Governance System Began

Boards of directors and their perceived poor performance have been castigated for over 400 years. As economist Adam Smith wrote in The Wealth of Nations in 1776, corporate directors managed “other people’s money” and this conflict of interest meant directors were prone to “negligence and profusion.”

Yet the corporate form of organization and its use to raise and deploy capital has had an extraordinarily positive impact on global development. And every jurisdiction in the world requires that a board of directors be appointed in order to form a corporation and maintain it. To understand this apparent conundrum, we look first at how the corporation and its companion, the board, evolved. Its history is fascinating, at least in part due to its durability over the centuries. Very little has changed.

The First Limited Liability Corporation

In 1597 four tattered and battered Dutch ships struggled home from the East Indies with a few bags of peppercorns. With decimated crews and cargo, a far cry from the riches imagined, the merchants who paid for the voyage were disappointed. Their expedition nonetheless galvanized Dutch determination to best the dominant Portuguese in the battle for control of the spice trade with the East Indies, known today as Southeast Asia. To do this, they needed what none alone had: capital to build ships and to staff and provision them for long and dangerous journeys.

Bold action was needed. The government of the Dutch Republic mandated the combination of all the trading companies, then competing in separate shipping guilds, into a single entity in exchange for a monopoly on trade with the East Indies for 20 years as well as certain sovereign rights in territories discovered. In 1602, the resulting Dutch East India Company (“Verenigde Oostindische Compagnie” or “VOC”) received its charter.

This may sound simple, but first consider the distance, the dangers and the plain unknown. These merchants had long operated independently, choosing and financing their own journeys and paying out to investors, or collecting to fund losses, at the end of each journey. Think how novel it was to decide collectively how to allocate capital, and to be trusted with keeping the capital rather than returning it at journey’s end. Add to that the danger of the Portuguese rivals, the native peoples in the New World, and the demands of long sea voyages. It was a remarkable series of actions the Dutch undertook.

VOC was organized as a stock company with two types of shareholders: the participanten, economic participants but not managers; and the bewindhebbers, who acted as managing directors. In this case the liability of not just the participanten but also of the bewindhebbers, whose exposure, in the past, was typically unlimited, was limited to the paid-in capital. The VOC therefore was a limited liability company, likely the world’s first.

Amsterdam Stock Exchange Established to List VOC Securities

VOC also appears to have pioneered the use of investing in the company rather than in a specific venture governed by the company and required that the capital remain invested (or be “locked up” in modern parlance) for the life of the company. To make this palatable to investors, the Dutch needed a mechanism to allow investors to access their capital. The world’s first stock exchange was thus created, and VOC listed its shares on the Amsterdam Stock Exchange, the first company in history to list its shares on a formal stock exchange. Although it listed only VOC instruments at first, it soon grew.

VOC Completes Initial Public Offering, Possibly World’s First

In VOC’s next pioneering move, the company’s stock as well as bonds were offered to the general public, with a minimum participation level of 3,000 guilders, a price that allowed many merchants and entrepreneurs to participate. This offering was unprecedented and became the first recorded initial public offering or IPO. Remarkably, the annual dividend paid out averaged around 18 percent of capital over the course of the company’s ensuing 200-year existence.

The capital VOC was able to raise using these new techniques put it far ahead of any rival. Estimates suggest that the company raised more than ten times the capital acquired by the English East India Company, chartered by Queen Elizabeth in 1600, which appears to have continued the practice of financing voyages one-by-one at least until mid century.

In 1688, Joseph de la Vega, an Amsterdam trader as well as a successful businessman, published the delightfully entitled Confusion of Confusions, about the workings of the city’s stock market. The earliest book about stock trading, it took the form of a dialogue between a merchant, a shareholder and a philosopher. He described a market that was sophisticated but prone to excesses, and de la Vega offered advice to his readers on such topics as the unpredictability of market shifts and the importance of patience in investment.

To see VOC’s achievements in perspective, consider this: not only was it granted quasi-governmental powers in the areas it explored, allowing it to maintain its own army and rule certain colonies itself, but between 1602 and 1796 VOC sent almost a million Europeans to work in the Asia trade on 4,785 ships, and netted more than 2.5 million tons of Asian trade goods. By contrast, the rest of Europe combined sent only 882,412 people from 1500 to 1795, and the fleet of the English East India Company (EIC), VOC’s nearest competitor, was a distant second to its total traffic with 2,690 ships and a mere one-fifth the tonnage of goods carried by VOC.

The Governance of VOC Establishes the Model

VOC was a private enterprise, organized in six chambers (kamers) based on the various ports and predecessor guilds. Seventeen delegates were selected from the bewindhebber shareholders and convened as the Heeren XVII (the Lords Seventeen), including eight delegates from Amsterdam (one short of a majority on its own), four from Zeeland, and one from each of the smaller chambers, while the seventeenth seat rotated. The Heeren XVII defined the VOC’s general policy and divided operating tasks among the chambers, which carried out the necessary work, built their own ships and warehouses, and traded the merchandise.

The same governing structure that had previously existed to enact and enforce rules governing the conduct of independent merchants in the guilds found itself pressed into service to manage a large business venture in the joint stock company. This appears to have happened without evident consideration as to the different nature of these tasks, or whether an institution developed for one task best fit the needs of the other function, though it is likely that including the members of the prior structure with careful balancing of representation was the most effective way to assure adoption and compliance by all.

The Lords Seventeen Governance Structure Drawn from Guild System

We will dig more deeply into this, but for now, note that this first fairly autonomous board of directors did not originate in the joint stock company with its passive investors. It was instead a form of governance inherited when the business corporation evolved out of societies of independent merchants in which the members each conducted their own businesses. These earlier merchant societies or guilds, in turn, had apparently adopted boards to replace decision-making by assemblies of the entire guild membership. Instead of having an oversight function, the role of the board in these earliest trading companies was legislative (passing ordinances to regulate the membership) and adjudicative (hearing disputes involving the members). Nonetheless, they provide a useful mechanism to use as ownership and control were increasingly separated.

VOC Confronts a Large Activist Shareholder

VOC’s Lords Seventeen may also have been the first to confront dissident shareholders. Isaac Le Maire was the largest shareholder in VOC and a bewindhebber sitting on the board of governors. Le Maire apparently attempted to divert the firm’s profits to himself by undertaking fourteen expeditions under his own accounts instead of those of the company, which had been the traditional method under predecessor forms of organization. Since his large shareholdings were not accompanied by greater voting power, Le Maire was ousted by the Heeren XVII in 1605 on charges of embezzlement, and forced to sign an agreement not to compete with VOC.

Mr. LeMaire seems not to have taken his removal lightly. In 1609, he complained of VOC’s shoddy corporate governance, and petitioned for the liquidation of VOC. Failing in that effort, he later sought to create the French East India Company, in continuing efforts to break the Dutch government sanctioned monopoly on trade routes and the lucrative spice trade. Notably, he approached Henry Hudson, to lead an expedition for LeMaire and the French. VOC, learning of this plan, made Hudson a better offer, which financed the voyage searching for the northeast passage to the Pacific that led to the discovery of the Hudson River and the settlement of New Amsterdam.

. . . And a Bear Syndicate

Again thwarted, and still the largest shareholder with close to 25 percent of VOC stock, LeMaire next formed a secret company with eight others, for the purpose of trading in VOC shares. This new company sold short shares of VOC, hoping to force the price down. In 1609 the share price fell significantly, perhaps owing to rumors spread by LeMaire. VOC in turn complained to the States-General of the Netherlands, who decided in 1610 to prohibit the sale of shares not in the seller’s possession. During 1610 and 1611 the stock price of VOC increased, causing Le Maire and company to suffer big losses when they had to deliver shares at a lower price than market.

Here we have the first known instance of the use of the corporate form and its ability to transform the world. Though limited in life by the terms of its charter, which was periodically renewed through payments of fees to the Dutch government, VOC brought to life a social contract that allowed for a publicly traded joint-stock corporation, an entity with rights similar to those of states and individuals, with limited liability and significant autonomy.

The stage was set for transferable ownership interests in which voting power can depend upon the number of interests purchased. And in a further step, by being publicly offered and traded, that voting power could become widely dispersed among passive investors and began the long running discussion of what tools are needed to govern the corporation when ownership is so clearly separated from control. Importantly, even then, it was clear that the fiduciary duty of the directors was owed not to LeMaire as the largest shareholder, but to the enterprise and its prospects. Remember this as we move forward.

The Corporate Form Advances and Spreads—And with It, the Board

To track the history of the corporation is to see the evolution of the corporate board. The English East India Company (EIC) may have been the first (or at least the first well documented) corporate charter to grant the power to the governing board to elect the corporation’s governor, rather than keep that power for the crown or leave it in the hands of the company’s members. Somewhat later, the board elected a chairman and deputy chairman to preside over their meetings, thereby establishing an office of chair separate from that of governor. In another example, an act of Parliament in 1773 introduced staggered terms to the company’s board of what were by then referred to as directors, with one-quarter of the directors elected every year.

King William III sought to modernize the kingdom’s finances to pay for its wars, and thus the first government bonds were issued in 1693 and the Bank of England was set up the following year. Soon thereafter, English joint-stock companies began going public.

London’s first stockbrokers, however, were barred from the old commercial center known as the Royal Exchange, reportedly because of their rude manners. Instead, the new trade was conducted from coffee houses along Exchange Alley. By 1698, a broker named John Castaing, operating out of Jonathan’s Coffee House, was posting regular lists of stock and commodity prices. Those lists mark the beginning of the London Stock Exchange.

Corporations Arrived in the New World

As sovereign focus shifted from how to expand territory through discovery into how to develop said territories into profitable activities, the model of the joint stock corporation was again used to raise the capital and govern the new colonies. Not only did the various trading company boards help preserve political ideas of governance through representative b...