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The lack of a clear, shared consensus about why a company exists, to whom directors are accountable, and what criteria they should use to make decisions—in the law as well as in society at large—is a significant obstacle to increasing the effectiveness of the corporate governance function. When boards operate with tacit assumptions about their objectives and loyalties, they may hide potential disagreements among their members and sacrifice effectiveness. Such hidden disagreements make it difficult to get consensus on complex issues, such as what qualifications a CEO should have, whether or not to outsource parts of the value chain, or how to evaluate and compensate top management.
Lorsch (1989) first identified the confusion among directors about their accountabilities. Based on their beliefs, he categorized directors as belonging to one of three groups: traditionalists, rationalizers, or broad constructionists.Lorsch (with MacIver) (1989), chap. 3. Each has a different vision of what the modern corporation’s fundamental purpose is and, therefore, to whom and for what a board should be held accountable.
TraditionalistsDirectors who see themselves as being accountable only to shareholders. see themselves as accountable to shareholders only. For them, there is no need to debate the fundamental purpose of the modern corporation—it is and always has been the maximization of shareholder value. They do not believe there is a conflict between putting the shareholder first and responding to the needs of other constituencies, and therefore experience little role ambiguity or conflict. Members of this group find support for their position in a narrow interpretation of current state and federal law. They also tend to view the highly publicized abuses at Enron, WorldCom, Vivendi, and other companies as anomalies made possible by imperfections in the current system rather than as indicators of more systemic problems.
A second, larger group—the rationalizersDirectors who recognize the tensions that occur in the interests among different constituencies but who nevertheless act primarily for the sake of shareholders.—experiences more anxiety about their role as directors. They recognize that, in today’s complex, global economy, real tensions can occur between the interests of different constituencies and that not all decisions can be reduced to the simple “What is good for the shareholder is good for everyone else” formula. Examples include whether or not to close a domestic plant in favor of manufacturing in a low-cost, foreign location; whether or not to outsource production to lower cost suppliers; or how to respond to pressures for “greener” operations. Nevertheless, feeling constrained by the law and guided by the (primarily Delaware) law, that is the way rationalizers behave.
The final group, which Lorsch labels as the broad constructionistsDirectors who recognize and are willing to act on responsibilities to constituencies other than shareholders., recognizes specific responsibilities to constituencies other than shareholders and is willing to act on its convictions. Directors belonging to this group constantly struggle to balance their views with the more traditional view of a director’s accountabilities and—to stay within the boundaries of the law—frame their decisions in terms of what is in the best long-term interest of the corporation as a whole.
Lorsch summarized his findings as, “Thus we found the majority of directors felt trapped in a dilemma between their traditional legal responsibility to shareholders, whom they consider too interested in short-term payout, and their beliefs about what is best, in the long run, for the health of the company.”Lorsch (with MacIver) (1989), p. 49. He further observed that it appeared that, in many boards, a group norm had evolved, prohibiting open discussion of a board’s true purpose and that a lot of directors were unaware of recent rulings in the evolving legal context that grant them the latitude to consider constituencies other than shareholders.
In recent years the issue of a board’s primary role and accountability has, if anything, become even more confusing. Despite strong rhetoric from many quarters advocating maximization of shareholder value as a company’s primary goal, there is a growing recognition that a company and the board have broader responsibilities. This trend reflects the fact that real—that is, economic and psychological rather than legal—ownership of the corporation is moving from shareholders to employees, customers, and other stakeholders that make up the human capital of the firm.
This has created real problems for directors. As Lorsch notes,
Boards have a real challenge in deciding to whom they are really responsible and where their commitments ultimately lie. Directors must think about and discuss among themselves the constituencies and the time horizons they have in mind as they think about the board’s responsibilities. Many boards have skirted discussion of these complex issues. They seem too abstract, and reaching a consensus among board members about them can take more of that most precious commodity—time—than directors want to devote.Carter and Lorsch (2004), p. 57.