Board Engagement with Shareholders

Recent academic research, such as the paper by Simon C.Y. Wong of the Northwestern School of Law (Brunswick Review, No. 2, pp. 53-56, Winter 2009) suggests that boards of directors engage directly with shareholders on a regular basis in order to establish relationships of trust. We believe that this is an inherently risky strategy, without commensurate benefits.

It is certainly true that institutional owners want to feel comfortable that they understand the character and motivation of the managements of their portfolio companies. It is less clear what they expect, and have a right to expect, from the board of directors. The primary charter of the board of directors is to appoint, incent and monitor the performance, character and integrity of a professional management team. Very, very few members of public boards are conversant and current with the character and personality of institutional investors, particularly with the momentum investors, hedge fund investors, and activist investors.

Sad to say, but widely reported, is the fact that boards of many financial service companies are not fluent with the business models of their companies or where the risk resides on the balance sheet. Were it otherwise, we wouldn't have had the recent debacle and the subsequent conversation about enterprise risk management in director forums.

This conversation with investors should be the meat and potatoes of the CEO and CFO duties. There should be at least one director whose brief it is to follow these issues carefully and to provide additional color to the board, as required in quarterly meetings. It is an area where professional advice from skilled and knowledgeable outside professionals pays large dividends and mitigates risk.

If a conversation were to take place between, let's say a hedge fund investor and an untutored director, the conversation would quickly be steered to eliciting material, non-public disclosures from the director. These investors are Zen masters at filling out the information mosaic with repeated, seemingly unrelated questions. The management would never know what had been divulged or not. An additional question would be "Which investors merit a private meeting with a director?" Is it a question of size? If so, then the information playing field is not level, which is something about which past SEC commissioners have felt strongly. So much so that they passed Reg FD.

If the relationship with a company's larger institutional owners is poor, this is a critical problem that needs to be addressed, but the academic solution proposed is one that should be avoided.