Questioning authority: the critical link between board power and process.

• Author: Sharpe, Nicola Faith

1. INTRODUCTION II. AUTHORITY IN THEORY AND LAW A. The Board's Control Function B. Authority Defined C. Authority in Theory 1. Managerialism 2. Shareholder Control 3. Director Control D. Board Authority in Law 1. The Significance of Authority to Legislative Efforts 2. The Business Judgment Rule and Legal Authority III. THE GAP BETWEEN DOMINANT LEGAL THEORY, REFORMS, AND PRACTICE A. Process and Practical Authority B. Managerial Authority in the Decision-Making Process 1. Identification 2. Analysis 3. Choice of Response 4. Approval 5. Implementation 6. Information, Process, and Practical Authority IV. FILLING THE GAP: DECISION-MAKING PROCESS--THE CORNERSTONE OF PRACTICAL AUTHORITY A. Adding Value Through Effective Decision Making 1. Types of Decision-Making Processes 2. Programmed Versus Nonprogrammed Decisions B. Organizational Behavior Decision-Making Framework C. Attributes of an Effective Decision-Making Process 1. Forward-Looking Information 2. Multiple Information Gathering Channels 3. Proactive Goal Setting 4. Deliberation Techniques 5. The Process Matrix V. LEGAL IMPEDIMENTS TO PRACTICAL AUTHORITY A. The Detrimental Impact of Structural Reforms B. Objections 1. Changing the Status Quo 2. Pursuing Independence VI. CONCLUSION 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 States (5)--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 shift away 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.

   The effect has been the opposite of what legislators intended. Although the normative position animating legislative response has been to increase the board's authority vis-a-vis managers, such efforts have reduced boards' practical authority by reducing their ability to utilize effective decision-making processes. Listing standards, legislative enactments, and other structural reforms increase boards' ossification by specifying their composition, requiring particular committees, and specifying the tasks that both boards and their committees must undertake. (15) The dominant theories of corporate control in modern corporate governance scholarship similarly emphasize that boards need practical authority over managers to effectively perform their monitoring function. (16) Under each of these theories--which turn either on shareholder control or director control--boards are assumed to be effective at monitoring managers in order to reduce agency costs and maximize shareholder wealth. (17)

   These attempts to identify and implement ways to prevent corporate failure have accordingly focused on making boards better monitors. (18) Unfortunately, they have failed to recognize the core challenge in giving boards actual authority over their managers: managers, not boards, control corporate decision-making processes and the information considered in them. The key to good corporate governance theories and policies lies within the largely unexplored relationship between decision-making process and authority.

   In sum, true authority must originate in an effective decision-making process, not in ossifying structural changes. Analyzing the components of such a process, and identifying which of them are actually controlled by boards as opposed to managers, provides a roadmap for what boards need in order to have both de facto and de jure authority in their corporations. In assessing the ways in which boards can improve their decision-making processes to align them with currently unrealistic legal expectations, this Article also identifies instances where current legal expectations are in fact counterproductive.

   This Article makes three contributions to the corporate governance literature regarding the board of directors. First, it disputes one of the central normative and positive positions found in modern corporate law and theory: that boards actually control corporations. It accepts and revives managerialism's positive assertions that corporate executives, not boards, control corporations and thus identifies the gaping hole between de jure and de facto board authority. It analyzes the components of an effective process and identifies which components are truly controlled by boards as opposed to managers. The Article disputes how much authority boards have in practice and shows that managerialism's positive claims are a more accurate description of the boards' actual authority.

   Second, the Article explains why boards lack de facto authority. It argues that the structure of the board, which is dominated by independent directors, limits directors' access to relevant information and information-gathering channels. Information is the foundation of an effective decision-making process, and is the key means by which the board can exercise authority in practice. By increasing the requirements for director independence, structural reforms impose practical limitations that leave the board without de facto monitoring authority.

   Finally, this Article argues that the board, as the authority-based decision-making body in the firm, is an example of dominant legal theories and reforms disconnected from practice. This divide must be closed to facilitate the type of monitoring that the public, scholars, and regulators clearly expect of corporate boards. Without an effective decision-making process, regulators will continue to ask boards to perform in ways that exceed their capabilities.

   In a prior article, I demonstrated how process is more important than structure in improving board efficacy. (19) This Article extends the analysis and is the first to squarely address what constitutes an effective decision-making process. It argues that information access is critical for decision making. Furthermore, it introduces the Process-Oriented Approach (POA), which is based on an organizational behavior framework that considers both the steps and the foundational attributes of effective decision-making processes. Applying the attributes to the individual steps of such a process is critically necessary if boards are to have the practical authority that theory and law desire.

   Part II of this Article provides a basic overview of the board's monitoring role, which requires boards to have de facto authority over managers. It then examines the importance of de facto authority to the conventional regulatory approach to board reform as well as the dominant theories of corporate control. These theories assume that directors are well-informed and each director is equally well-situated to exercise control in comparison to the next director.

   Part III argues that there is a gap between what theory and law expect and what boards can actually accomplish. Specifically, it argues that outside directors are at a tremendous informational disadvantage, which significantly undermines their practical authority. Through analyzing the component steps of an effective decision-making process, this Part demonstrates that managers, not boards, have actual control of the corporation through their informational advantages.

   Part IV argues that without effective decision making, boards will have authority in theory and law, but not in practice. One negative implication of the lack of the boards of directors' authority is that they are...