Corporate Governance and the Bailout::

Did I miss it, or is nobody even paying lip service to the idea that only the Board of Directors can make decisions for (banking) corporations of the kind the banks have apparently made by "accepting" the Treasury's latest plan? As I understand things, Bernanke, Paulson, Geitner and the other gov't officials met with the CEOs of the 9 big banks and laid out their plan and sought the banks' "voluntary" acceptance — yes or no, all or nothing. The conversation presumably went something like this:

Paulson: "Here's the plan: We inject capital and we take equity back. You agree to certain conditions (on e.g. executive compensation), we'll extend the FDIC guarantees to all your deposits. Etc. We could force you to accept the deal (or at least we'd argue that we could, based on authorization contained in the bailout bill to re-capitalize the banks), but for various reasons we don't want to — we want you to accept the deal voluntarily. We have to get all of you on board at once — otherwise, if we went one bank at a time, it would look like the bank we're helping out is in particularly bad shape, and that would send the wrong message to investors."

And the CEOs agreed (and the market went up 900 points).

The CEOs, though, can't possibly have the power to agree, on behalf of their corporations, to a deal of this magnitude, can they? Surely the Boards of Directors, and only the Board of Directors, can commit the banks to a plan involving the issuance of billions of dollars of new equity. It's possible, I suppose, that each of the CEOs spoke to a specially-convened Board meeting and the Boards all voted to go along (and nobody mentioned anything about it because it's just too boring). Or maybe everybody is assuming that the respective Boards will just retroactively rubber-stamp the deal some time this week (though from what I hear from a source inside JP Morgan/Chase, there are a whole lot of people there who are very unhappy with this deal (and the dilutive effects on the value of current shareholders' shares).

Update. As some commenters pointed out, it looks like the possibility that I mentioned in the original posting — that the Boards of the banks did convene by phone at some point, and they all voted to go along, and nobody said much about that part of the process because it was just too boring and insignificant — was indeed how things played out.

To some commenters, that makes it all a "non-story" — they all hooked up by cellphone, had brief discussion (the entire meeting took 3 hours, from the initial statements by Paulson to the signature of the CEOs on the document), and that was that.

It seems to me, though, that the non-story is the story. Board action is treated by pretty much everyone as an afterthought to the real action, which was in the room. The NY Times story today about the whole drama — 37 paragraphs + sidebar — mentions the Boards of Directors at the very end, the penultimate paragraph, in passing. It is treated as an unimportant afterthought because it is an unimportant afterthought. That, it strikes me, is interesting, on two levels: first, illustrating the obvious but interesting point that deliberative bodies (like Boards of Directors, or legislatures) are ineffective during "crises," and, second, that it illustrates how we still haven't solved the problem that AA Berle and Gardiner Means (two members of FDR's "brain trust," incidentally) wrote about in their 1932 classic "The Modern Corporation", viz. the separation of "ownership" and "control" in corporate governance. Shareholders (owners) are supposed to control corporations through Boards of Directors — but they don't, in reality; management controls corporations. It's a big problem, and I'm not sure we've made a great deal of headway on it since 1932.

Mike& (mail):
Great point; makes one wonder how many other obvious issues we're overlooking. Cuz, like, if we don't overlook them, we're doomed.
10.14.2008 11:21pm
DNL (mail):
Boards are shills for the CEOs anyway. That's part of the problem in the first place.
10.14.2008 11:28pm
gecko (mail):
Maybe someone should ask this blogger:
10.14.2008 11:34pm
Crunchy Frog:
I wonder how many of these supposedly independent boards are made up of the CEOs of the other banks involved?
10.14.2008 11:41pm

I wonder how many of these supposedly independent boards are made up of the CEOs of the other banks involved?

I may be wrong, but isnt "none" the correct answer?
10.14.2008 11:45pm
When you're staging a coup you don't worry about the legalities of the details - first you seize control during the chaos of the crisis, then once you've cowed all opposition and it's a fiat-acompli where everyone accepts the new order you can go back and dot all the i's and cross the t's.
10.14.2008 11:45pm
The answer wasn't hard to find -- perhaps you should, say, read the WSJ? I think this is the operative quote:

"The top bankers were then told to show up for a meeting Monday at 3 p.m., but were given few details. Expecting an uproar over the plan, government officials secretly planned to break off the first meeting, giving CEOs time to vent, talk to their boards, clear their heads, and reconvene at 6:30 p.m."

The second meeting never happened, because there wasn't the uproar they expected. Paperwork was all in by 6:30.
10.14.2008 11:54pm
CB55 (mail):
Remember the movie the movie the "GodFather"?! If not the movie makes it very clear that when you are not in a position of grabbing leverage you bend over and take whats on the table. The banks were not in a position to talk and think things over. The power of the United States government came into the room with the IRS, FBI, the FED and other operatives for the state. Every bank has a life line to the state by law, standard business practice and regulation and the state can make life very difficult or be a good neighbor. So when the state came coming to the Wells Fargo CEO carrying bags of money and gun with an offer, you know he could not refuse...he knew he did not want to have an extra hole in the head.

Kay Adams: Michael, you never told me you knew Johnny Fontane!
Michael: Sure, you want to meet him?
Kay Adams: Well, yeah! Sure.
Michael: My father helped him with his career.
Kay Adams: How did he do that?
Michael: ...Let's listen to the song
Kay Adams: [after listening to Johnny for a while] Tell me, Michael. Please.
Michael: ...Well when Johnny was first starting out, he was signed to a personal services contract with this big-band leader. And as his career got better and better he wanted to get out of it. But the band leader wouldn't let him. Now, Johnny is my father's godson. So my father went to see this bandleader and offered him $10,000 to let Johnny go, but the bandleader said no. So the next day, my father went back, only this time with Luca Brasi. Within an hour, he had a signed release for a certified check of $1000.
Kay Adams: How did he do that?
Michael: My father made him an offer he couldn't refuse.
Kay Adams: What was that?
Michael: Luca Brasi held a gun to the bandleader's head, and my father assured him that either his signature or his brains would be on the release.
Kay Adams: ...
Michael: ...That's a true story.
10.14.2008 11:59pm
John (mail):
Yeah, you got the Paulson conversation wrong. I believe it started with him saying, "nice bank you got there..."

As to the governance issue, I am sure the boards will be involved (and have been already). The most likely scenario is (a) the boards were told in a telephone meeting that the CEO was going to the meeting, (b) a subsequent phone meeting relayed what happened at the meeting, and comments were received and considered, and (c) a formal in-person meeting will occur shortly to adopt the proposals, or to reject them, as the case may be.
10.15.2008 12:09am
At least one report I read said that these preferred shares would *not* be dilutive to existing shareholders. That doesn't make a lot of sense to me but preferred shares are a lot more like debt than equity. These shares pay a 10% return and might not include any regular dividends. Perhaps boards don't have to be involved for issuing non-dilutive debt? Still doesn't sound right though.
10.15.2008 12:20am
It worked with Congress - why not with corporations...?

A handful of politicians in Congress did the negotiating with Paulson, leaving committees of jurisdiction, and every other rank and file legislator outside the closed door meetings that determined our collective fate. No democratic debate, no democracy. Just raw political power shoving a pre-formed, non-negotiable plan down the throats of party members, or else. It's how our "Congress" now works on every issue of import to the White House and its allied worshippers atop the two political parties.

Pattern established - repeat as desired. Next up: Bank CEOs. What are the Boards of Directors going to do - say no? Ask the majority of the House of Representatives how that ended up working out for them in the hysterical media-manipulated aftermath.

Nevertheless, they oughta say no, if they disagree and it's the wrong move for their company (Barclay's did just that in Britain). Anything else - rubberstamping to CYA like the politicians feel entitled to do - would just be a repeat of the (Congressional and corporate) behavior that got us into this mess in the first place.
10.15.2008 12:39am
Waldensian (mail):
I'd be very surprised if the respective boards weren't consulted in each and every case.
10.15.2008 12:41am
CB55 (mail):

You forget bank board members includes some people that are the executives and or board members for some major major government contractors and their companies must lobby said government for access and for the passage of certain laws and regulations including tax cuts.
10.15.2008 12:48am
Christopher Cooke (mail):
The board can ratify the CEO's approval and the paperwork may have made the deal contingent on obtaining board approval.
10.15.2008 1:27am
There were special board meetings on Monday. (I don't know people at every bank, but at some.)

This blog post confuses me. Doesn't Prof. Post have any friends at any of the bank or their outside law firms? Why doesn't he call some of them to confirm that boards did meet? Professors are so divorced from the real world.

Regarding one of the comments above, I don't have the bylaws of each bank in my possession, but, in general, boards can meet by telephone. There is no need for a later, "formal" meeting to confirm the telephone meeting. If anyone is more interested than I, the bylaws of the relevant entities are probably available on-line somewhere, or by calling Investor Relations.
10.15.2008 10:08am
The CEOs contacted their boards before signing, at least according to the NY Times:

"As the meeting wound down, participants said, the bankers focused more on contacting their boards before signing the agreement with the Treasury Department."
10.15.2008 10:43am
"If anyone is more interested than I, the bylaws of the relevant entities are probably available on-line somewhere, or by calling Investor Relations."

Go to any corporation's 10-K and scroll to the exhibit list, under exhibit 3 it will provide where you can pull the bylaws (or it will be attached if it was recently amended).

If you are interested in the composition of a board and their independence, go to their proxy statement for the last annual meeting which will be coded as a DEF 14A unless the annual meeting is also held to vote on a business combination in which case the S-4 registering the securities to be issued or the 424(b)(3) proxy mailed to shareholders will have the information.

And yes, in rush situations board meeting are held by telephone and can be done quite efficiently. If they weren't, nothing would ever get done. This is a complete non-story.
10.15.2008 11:27am
arg11 (mail):
Naked Capitalism has a post on this.
10.15.2008 12:44pm
Gene Hoffman (mail) (www):
Having performed such meetings before, blackberrys and now iPhones make it easy to round up the board and hold a 15 minute call with CEO, board members and counsel. Emailing around the written consents or minutes of the special meeting completes the matter.

10.15.2008 1:03pm
Pyrrhus (mail) (www):
I think we need to get back in control of the italics...
10.15.2008 1:44pm
I don't see why this "separation of ownership and control" is such a problem. The shareholders elect the directors, who appoint management. If the claim is that the directors can't or don't replace management, then talk to Stan O'Neal. If the claim is that the modern corporation doesn't produce good financial or economic results, then come to my 33rd floor Manhattan office and look out the window.

Now if the theory is that human life is happier, or more real, or something, when all the villagers collectively decide on what to plant, and all work in the same field, and dispense justice collectively in the lord's court, and so on, then I can't help with that.
10.15.2008 2:38pm
A Shareholder (mail):
David Post:

Shareholders (owners) are supposed to control corporations through Boards of Directors -- but they don't, in reality; management controls corporations.

Amen. This is precisely why the perhaps unnecessarily-provocatively-named concept of "shareholder empowerment" is beginning to get more attention in academia. When the corporate democracy of some firms suffers systemic failures resulting in the thwarting of the collective will of the owners of the corporation, it is time to reevaluate the constitutional structure, as it were, of those corporations. The problem of board failure to control management has become especially bad--and the need for increased shareholder involvement concomitantly acute--in contexts where the interests of shareholders may conflict with those of the board, such as CEO compensation (many directors are CEOs themselves, and have every incentive to approve of very generous compensation packages for the CEOs on whose boards they serve).
10.15.2008 2:50pm
plutosdad (mail):
I very much agree, boards have a hard time controlling corporations, reigning in management. Sometimes they do, but often not. Every time a company blows up, or senior management is brought up on charges, it just points out these failures that I think are inherent in the system.

One thing, it is tangentially related, is I don't understand why when a company breaks the law we fine the company. this is, in effect, fining the owners. But if as noted above boards barely can control management, this seems hardly fair. Should we not instead fine the managers who made the decisions to break the law? This would not only actually punish the people committing the crime, but also be a much more effective discouragement.
10.15.2008 3:41pm
Houston Lawyer:
Corporate boards are required to be adequately informed before making decisions on behalf of the corporation that they represent. If I were a shareholder who suffered harm as a result of this action, I would have an easy case proving that the board acted as a rubber stamp for management and did not fulfill their fiduciary duties. You can't explain a 10 billion dollar equity investment in 15 minutes on a Crackberry.
10.15.2008 4:44pm
Doc W (mail):

The CEOs, though, can't possibly have the power to agree, on behalf of their corporations, to a deal of this magnitude, can they?

The relevant power involved here is not that of CEOs but of the bully, aka the feds.

Shareholders (owners) are supposed to control corporations through Boards of Directors — but they don't, in reality; management controls corporations. It's a big problem, and I'm not sure we've made a great deal of headway on it since 1932.

Well, if it was a small corporation, the shareholders could exert direct control. What happens with large corporations (in a free market) is that if they're run counter to shareholders' interests, then shareholders begin selling, so the stock price declines, so corporations become vulnerable to hostile takeover with the management losing their jobs. Of course, the feds have their ways of blocking or manipulating market processes, and THAT's the problem.
10.15.2008 4:48pm

if they're run counter to shareholders' interests, then shareholders begin selling, so the stock price declines, so corporations become vulnerable to hostile takeover with the management losing their jobs.

However, the management can employ poison pills that prevent takeovers, so that they can keep on enjoying the perks of their positions. If it was not for such tactics, I would agree with you.
10.15.2008 5:57pm
As has been noted above by other commenters, it's more probable that by having the nine CEOs in one room, that meeting sufficed as a quorum of all nine Boards.
10.15.2008 6:00pm
I don't understand the claims that shareholders, acting through the board, don't control management. Senior corporate executives get fired all the time. It's particularly amusing that university professors, who have guaranted lifetime jobs, come in ranting about how investment bankers have too much job security.
10.15.2008 6:34pm
Christopher Cooke (mail):
I still don't get the criticism. Is it of the terms of the deal? the process? Either way, I don't get it.

My understanding (from the WSJ) is that the government offered to invest money (lots of it) in each bank at the meeting and handed out terms sheets which specified that, in exchange for billions of dollars, the government only wanted preferred shares, paying a 5 percent dividend, and agreement to the very loose restrictions on executive compensation that Congress enacted (which are laughable). The CEOs likely sent the term sheets around to the board members, who, with their lawyers, could easily understand and justify their approval of the terms.

What is wrong with the process, is it (1) that the CEOS received the outlines of the deals and accepted only a few hours later or (2) that the goverment didn't negotiate with the entire board?

The latter never happens. The former is only a problem if the board was not adequately informed of the details of what it was asked to approve and thus could not make a prudent business decision. I haven't seen the term sheets, but they do not sound very complicated, so I would venture a guess that the boards could easily understand the terms.
10.15.2008 9:25pm
Everyone, except the people who were in the room, are assuming how the conversations went. What we do know for a fact is that lots of money, in some cases $25 billion dollar chunks, were offered to individual banks in exchange for commitments. That is a lot of money to help a company with a liquidity problem. It would be very hard for any person to pass on it. Still, I heard on the radio that Well Fargo at first balked on the offer. Hopefully the Boards of Directors were involved. Some, even a little, involvement is better than none.
10.15.2008 10:30pm
TEvanFisher (mail):
A lesson for Paulson....
10.16.2008 11:40am