How Much Blame Do Boards Deserve?

Directors belong on the list of those who made this messjust not at the top

How culpable are boards of directors in the current economic crisis? —Hugo Beit, New York

Without a doubt and with perfect hindsight, some boards could have acted more boldly in trying to avert the current meltdown. But the real fallacy of corporate governance in this crisis is not what boards did and didn't do. It's what was expected of them.

Not that we're board apologists. Over the past three years our columns have taken boards to task several times. But in this case, we think boards have a right to defend themselves against the scolds who cry: "Where were they?"

The answer: They were mostly where they were supposed to be, doing their jobs, within the limitations of reality.

Shareholder activists may want board members to act like superheroes, honing in on detailed company operations like forensic accountants and cops wrapped up together in pinstripes. But let's get real. Most boards meet one or two days a month and are composed of individuals who also hold demanding full-time jobs. Given those circumstances, it's absurd to believe that board members, even the most experienced and best-intentioned of them, will uncover systemic flaws or acts of malfeasance, particularly in complex financial institutions. That's what regulators, outside accountants, and internal controls are for—to help boards ferret out excessive risk and wrongdoing.

Boards serve a different purpose. Their job is to hire and fire the CEO based on his performance and values, the quality of his team, and the coherence of his business model. When boards are operating as they should, directors are engaged in a vigorous, candid dialogue with the CEO and his lieutenants about strategy and having the right talent in place to execute key initiatives. And they're spending time in the guts of the organization, talking to "regular" employees and looking for signs that the CEO's vision is understood and shared, that company values are more than lip service proffered for the board's entertainment. They're protecting shareholders not by wielding calculators but by deploying good judgment.

Unfortunately, even boards with sound judgment didn't stand much of a chance against the newfangled financial instruments that sparked this crisis. You can imagine how the meetings went. Financial wizards put on gee-whiz presentations showing how they could capitalize on the "homeownership society" by repackaging mortgages to minimize risk. Quants told their boards that consumer credit was rapidly increasing, but the models projected modest defaults. Directors were assured that, with low interest rates, huge private equity loans were somehow different this cycle.

"Don't worry," the whiz kids surely said. "We have the downside covered."

Obviously, that wasn't true. Should boards have known that? The simple answer is no; CEOs and their direct reports should have. But if they didn't, boards should at least have sensed that "knowledge gap" in their bones—and indeed, that's where they merit some flak for this crisis. Surely some board members of financial institutions should have pressed their CEOs and executive teams harder about their risk assessment systems, demanding to know how risk managers were being rewarded. Instead, too many boards waited for the media to ask such questions before ousting their CEOs. In the future, perhaps boards won't wait for the "ratification" of negative publicity.

But that can happen only when boards have the right kind of people serving on them: Members who, in very limited time, can exercise good judgment and act with courage. Members who have a special ear, the kind that can hear a presentation and discern between ­overpromisers and overdeliverers, between glib salesmen and those they would bet their own money on. Members who have skin in the game, know the company, and care about it deeply.

If there is to be a governance lesson in this crisis—besides the need for realistic expectations—let that be it.

Look, the list of guilty parties involved in bringing on the current economic situation is long, and boards do belong on it. Just don't put them near the top. That would give them too much credit for a job they couldn't do.

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