Where were the directors? While the focus is on William McGuire, who stepped down last week as chairman and chief executive of UnitedHealth Group, not enough attention is being paid to that company’s board of directors. What were they doing while McGuire set new records for executive pay?
Why did they gaze on serenely as he arranged to pay himself $1.8 billion? Didn’t anyone question the unprecedented level of options McGuire got? What did they do to earn their keep over the past decade?
Would any of us have been more vigilant if we were on UnitedHealth’s board? Probably not, and therein lies the problem.
The freshman econ view of corporations is simple. A corporation’s stockholders own the business. They elect a board of directors to oversee operations and maximize the long-run value of their shares. The directors hire managers who run the company, focusing on shareholder value.
MBA-level courses point out at least two problems. The “principal-agent” problem is the first. Agents, or the hired managers, face their own motivations that frequently are at odds with the objectives of the principals or owners. Stockholders want maximum return on their investment. The CEO might want to get a big bonus before leapfrogging to another company.
The second catch is an “information problem.” Key decision-makers often lack information needed to make decisions. Self-interested managers can filter information flowing to their boards. The “fog of war” hanging over business battlefields might be deliberate.
Both problems lead to waste of resources. Both hurt stockholders in lower long-term value for their stock. Both also hurt the general public indirectly. Society gets less useful goods and services when resources are used inefficiently. Students learn that directors must carefully structure compensation packages that align managers’ incentives with those of the stockholders.
The real world is even more complicated. Directors face their own motivations that don’t jibe with those of bread-and-butter shareholders. There is a lot of pressure not to rock the boat.
Corporate boards are self-perpetuating in a cultural sense as well as a legal one. A board chooses its own replacements. Moreover, the CEO has great influence in board decisions, including who gets named to be a director. New directors seldom challenge practices or assumptions, particularly those regarding the CEO.
While directors represent stockholders, they have more direct and ongoing contact with managers. That can compromise their integrity. McGuire had undisclosed business with a director on UnitedHealth’s compensation committee.
If you ask whether McGuire ever would have gotten $1.8 billion in potential eventual compensation at an annual meeting of stockholders, the answer seems to be a resounding no. There is no easy solution, but as long as the corporate governance problem remains unfixed, the general public and individual stockholders will pay a price.
© 2006 Edward Lotterman
Chanarambie Consulting, Inc.