How Stuff Works: Board of Directors

I’ve been keeping an eye on the expanding compensation scandal at the Blue Cross/Blue Shield of Massachusetts, and it struck me that many of the people commenting on the story have no idea what a Board of Directors is or what it is supposed to do – and the reporters covering the story aren’t helping. Then it occurred to me that the reporters may not know either – most of my students don’t know until I explain it to them, and they’re all graduating seniors in a top business school, not political/public opinion journalists. So I thought we would continue with our occasional series on How Stuff Works, and look at what the Board at Blue Cross was supposed to do – and why they may not have done it…

In theory, any corporation (public or private) is nothing more than a group of people who have pooled their money in order to start a company. You or I don’t have the cash to start a new car company, for example, but if we get a hundred million or so of our friends together and we each put in $100, that’s $10 billion of capitalization, enough to start a new GM, for example. The problem we run into is that none of us has the time to run the company – we all have to have jobs to make the $100, and even if we didn’t, most of the people chipping in the money don’t have the experience or training to run an automobile company in the first place. So we hire a CEO to run the company for us. The problem there is that we can’t really supervise the CEO, despite the fact that he or she actually does work for us; we don’t have the time or the expertise. So what we do is hire a team of people who know about running big manufacturing companies, tell them what we want the company to accomplish, and have them tell the CEO what we want him or her to do. This team of experts is called a Board of Directors…

Right off the bat, you can see how there would be problems with this. First off, the Directors are not going to work for free, so we’re going to have to pay them. Keeping track of all of the factors involved in running a large company takes a lot of time (try it if you don’t believe me), so we’re going to have to pay them to be on the board – and experts at that level will not work for cheap. Then there’s the board independence issue – depending on who we get, the Directors may have more loyalty to the CEO than they do to the stockholders, or they may run their own companies and have reciprocal understandings with our CEO. Even if they don’t have these problems, the Directors will almost certainly have their own public relations issues, and they may have political or personal reasons for voting a specific way on certain issues…

In the case of the Blue Cross board members, the Boston Herald online is raising cane because several of the Directors who voted to give their (failed) outgoing CEO an $11 million severance package are also crusaders against rising healthcare costs – at least, publically. Certainly the Chamber of Commerce President and Union President involved have a vested interest in appearing pro-business and anti-cost. Commenters on the site (and people in Boston generally) appear to be outraged by the idea that these supposed reformers were paid large salaries (&70,000 to $80,000 per year), and made no effort to screw the outgoing CEO out of money his contract promised him. The problem is that while this may be hypocritical, it isn’t even unusual, let alone improper…

Board members may only meet four times each year, but all of them are assumed to spend weeks reading up on the issues before those meetings. The board salaries cited may seem excessive – especially when, as the article notes, they’re higher than the average person’s salary – but they’re probably not out of line for the qualifications of the people holding those posts. As to trying to deny the outgoing CEO his contractual bonus funds, the Board might have been able to win the court case – but they would also have had to risk losing it and costing the corporation three times (or perhaps more) in judgments. The suggestion that the Directors should be willing to do those jobs for free because the organization is a non-profit is equally silly; a non-profit isn’t necessarily a charity, and even if it is, the people who work for it still need to make a living. The kind of people who will serve on a board for no compensation probably aren’t the same people who know how to run a large (and complicated) organization like Blue Cross in the first place, and the kind of people who have that expertise will not work for free…

The bottom line in this case is that the Directors haven’t done anything wrong. If the people who own the company – in this case, probably the people of Massachusetts – don’t approve of the Board’s actions, they can fire the Directors and get new ones. They can also vote any of the Directors who hold public office out, and demand the resignation of anyone who holds a private position. But claiming that there has been wrongdoing in this case just proves that the people doing the complaining don’t understand How Things Work…