Book Review Interested In Minimizing Directors' Liability? This Book Is Must Reading

The Recurrent Crisis In Corporate Governance by Paul W. MacAvoy and Ira M. Millstein should be read by all corporate counsel who are called upon to counsel their companies' directors about how to minimize potential personal liability.

Mr. MacAvoy is the former dean of the Yale School Of Management (SOM) and currently its Williams Brothers Professor of Management Studies. Mr. Millstein is the senior partner of Weil, Gotshal & Manges LLP, a member of SOM's International Institute for Corporate Governance's board, and a long-time SOM visiting professor. Both MacAvoy and Millstein have had many years of practical experience with boards of directors - MacAvoy having served on fourteen corporate boards and Millstein as a nationally known corporate governance consultant to major companies.

Their book, which was named by The Economist as one of six "best books" in economics and business for 2003, presents a comprehensive and serious analysis in only 149 pages. John Plender, in The Financial Times, describes it as being "short, wise, and to the pointÉfalling squarely into the must read category." The New York Times calls it "an expert assessment on what went wrong on corporate boards and how to fix them," and The Economist, says that it is "a convincing explanation of why, despite all the recent reforms in American corporate governance, there will probably be more firms that go the way of Enron." The Telecommunications Policy Review says the book "Étakes pains actually to be right."

Additional light will be shed on directors' responsibilities as courts consider suits brought against the directors of companies involved in the scandals. Inevitably, the courts will seek to determine whether the directors of those companies acted in "good faith." Based on the interviews that we have done with Chief Justice Veasey and Vice Chancellor Strine, it is evident that the specific applications of "good faith" will become clear as the cases are considered by the courts. Nevertheless, it is a given that "good faith" means acting in a way that the director believes is in the best interests of the shareholders. In interpreting what constitutes "good faith," the courts may well consider the views of authoritative commentators like the authors of this book, particularly where, as in this book, those views are based on well reasoned arguments supported by careful consideration of history and sophisticated economic analysis.

The companies involved in the scandals shared one important characteristic. They had traditional passive boards - boards where the directors viewed themselves as protected by good faith reliance on reports served up to them by management and on legal, accounting and compensation experts selected by management. Until the scandals erupted there was little reason for the directors of the affected companies to believe that their behavior when viewed by perfect hindsight would expose them to years of litigation and potentially disastrous personal liability.

Although nominating committees are charged with electing new directors, it is nevertheless clear that typically there is an implicit understanding on the part of all members of the nominating committee that the directors so selected must pass the ultimate test of being acceptable to the CEO. Yet, those directors are responsible for protecting the interests of the shareholders, not the CEO.

What this book deals with is whether and how directors, who as a practical matter owe their appointment and continuance in office to the CEO, can discharge their duty to shareholders in situations like those involved in the scandals where the interests of the CEO clash with those of shareholders. The thesis of the book is that the dilemma presented - and the associated risk of personal liability - can be effectively addressed only by separating the office of chairman of the board from that of the CEO accompanied by deeper and more questioning involvement by the directors, under the leadership of the independent chairman, in the development of corporate strategy and review of executive performance and compensation.

The authors argue that this approach will create an environment that encourages directors to focus single-mindedly on their obligations to shareholders. They present an impressive case for this proposition. They argue from history and economic analysis that companies that elect to go down this road will be more likely to prevent a CEO from acting in his or her self interest (rather than in the interest of shareholders) and that their economic performance will be improved.

The authors suggest that failure to adopt the reforms that they suggest may in itself be treated by the courts as a breach of the "good faith" test. Their arguments may persuade some courts. Even if this proves not to be the case, adoption of the authors' proposals could provide further insulation against director liability. Since it is your directors who are exposed, you may feel that they should have the opportunity to consider whether that additional insulation is necessary or desirable. Under these circumstances, corporate counsel will want to read this book and consider the arguments presented.

Published February 1, 2004.