No to superfluous service providers

Tony Featherstone explains why outsourcing board governance functions would not be advantageous.

Allan Gray Australia managing director, Simon Marais, believes boards should put forward a few candidates for shareholders to choose from when voting on director appointments, rather than nominating one person.

Much like a political election, directors would campaign on why they should be elected. “Board elections would be a fair and open competition where the best talent can state their case and shareholders can choose. We should have proper, contested elections,” Marais said in an interview with me earlier this year for a Company Director feature on shareholder activism.

Boards could argue that they already sift through several candidates before nominating a new director for election, sound out key shareholders on their views before the formal nomination, and that shareholders nearly always approve the board’s recommendation. It is hard to see a problem. 

In that same July article, Arnold Bloch Leibler partner, Jeremy Leibler MAICD, said: “Through shareholder activism, we are starting to see a shift from director-centric governance to shareholder-centric governance.” Some shareholder activists, or ‘active’ shareholders, clearly want more input on corporate strategy and greater ability to force strategic change. Is this the start of a bigger trend of shareholders wanting more say on core board functions, such as overseeing strategy and director nominations? Why not go a step further and outsource core board work – even directors – to professional service firms?

The Economist reported in August on research that argued companies should outsource their board work to a new category of professional service firms that specialise in governance. Stephen Bainbridge of the University of California and Todd Henderson of the University of Chicago suggested the creation of “board service providers.”

In theory, they would recruit and train full-time governance consultants who would provide “board services.” Employed by the service provider, the governance consultant would have a greater arms-length relationship with management and supposedly be able to provide more specialised board advice as needed.

In practice, it is one of the stranger governance suggestions. I do not understand why investors want more say on board functions, or why academics believe outsourcing governance to a consulting firm is more advantageous than a board of appointed, capable directors.

If shareholders are unhappy with directors, they should use board spill powers, under the ‘two strikes rule’ to force board change or send a protest message, or vote against the re-election of directors at the annual general meeting. Otherwise, let boards get on with the job.

Australia has one of the best-governed corporate sectors in the world. Yes, there are always ‘outliers’ that make a mockery of contemporary governance and treat shareholders like patsies. But to suggest a system that mostly works well and has improved in areas such as executive pay and diversity should be radically altered to create new work for professional service firms is ludicrous.

Boards are agents of shareholders. As an investor, I hate the thought of a professional service firm choosing a consultant to safeguard my interests, via the board. Would an institutional investor who owns 10 per cent, or a cornerstone investor with 40 per cent, be happy with such an arrangement?

Messrs Bainbridge and Henderson’s suggestion of a hybrid system, where the board service firm provides the majority of board seats and investors appoint a
minority of directors, would not work for all shareholders.

Also, directors take on significant personal, legal and reputational risk when joining a board. Would the board service provider take on similar risk when supplying consultants and what legal recourse would shareholders have if the consultant breached director duties? What of cost? I know plenty of non-executive directors who put in considerable ‘discretionary’ effort for no extra pay. I do not know a professional service firm that works several weeks for clients each year, without charge.

My biggest quibble relates to expertise. It is demeaning to suggest highly experienced non-executive directors, many of them former CEOs, can be easily replaced by governance consultants. Would the CEO form as strong a working relationship with governance consultants, or ride roughshod over them and ‘capture’ the board? How would potential conflicts be managed? Moreover, most directors I know take on the role for the mental stimulation, learning, networking, experience and teamwork. Outsourcing governance would kill the boardroom’s greatest assets: collegiality and corporate memory. Governance consultants coming and going on boards would never have the same history, passion and commitment. Bainbridge and Henderson’s idea is catchy for those who believe boards are full of lazy, overpaid directors. But that is far from the case, and it could never happen in Australia without significant regulatory change and shareholder buy-in.