In his D&O Diary post on June 13th, Kevin LaCroix discussed University of Connecticut Law Professor Steven Davidoff’s observation that directors of public companies are rarely held liable when a company’s irresponsible behavior damages its stakeholders.
Mr. LaCroix postulates three possible reasons for seeking more civil liability for corporate directors: recompense, retribution, and deterrence.
Recompense is generally available following a successful judgment or settlement, but usually is not borne by the malefactor. Payment is undertaken by the D&O insurer. Should the judgment fall upon an individual director, the company will make him whole through additional compensation or indemnification. More often, the convicted director will simply resign and take a position on a different board.
Retribution, Mr. LaCroix suggests, is appropriate in criminal actions or enforcement but is rarely sought in civil proceedings.
Certain deterrents are already in place but, as the headlines keep showing us, they are not sufficient to prevent careless oversight or inappropriate actions by directors. Neither the reputational damage of a corporate scandal nor the expense of a civil lawsuit will impact an individual director’s personal assets, which are difficult to target without triggering serious collateral damage.
In fact, nothing will stop people who are prepared to sacrifice the well-being of stakeholders for their own gain; the corporate culture often encourages and rewards such individuals. However, there are some basic steps which can be taken to mitigate the extent of the damage they cause:
- Eliminate “professional” board members. Many individuals have grown wealthy sitting on multiple boards, collecting compensation from all of them but contributing little, if anything, to the management of the companies. Limiting the number of public company directorships any individual can hold would reduce the number of seat-warmers and allow the participation of directors committed to the company’s well-being.
- Establish requirements for directors. A company should be governed by a board whose members have knowledge and experience in the industry, specific skills that can support the work of the CEO, or a personal financial interest in the company’s long-term success.
- Pay directors in restricted shares instead of cash. Giving directors “skin in the game” would align their interest with those of other shareholders, and reduce the likelihood they will allow management to take any action that is not in the company’s best interest.
- Publish the votes of individual board members. Was the board divided on a particular action? Who supported the best interest of the investors? Voting records, if reviewed with insider trading reports, would provide a very clear picture of a director’s performance.
The majority of public companies are run with transparent accounting and responsible corporate governance; the others are not. In either case, increased transparency and fewer short-term cash incentives will strengthen directors and create a climate that encourages their active participation on behalf of the shareholders they serve.