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BOARDS-R-US: RECONCEPTUALIZING CORPORATE BOARDS [Stanford Law Review](Stanford Law Review Via Acquire Media NewsEdge) State corporate law requires that "natural persons" provide director services. This Article puts this obligation to scrutiny, and concludes that there are significant gains that could be realized by permitting firms (be they partnerships, corporations, or other business entities) to provide board services. We call these firms "board service providers" (BSPs). We argue that hiring a BSP to provide board services instead of a loose group of sole proprietorships will increase board accountability, both from markets and from courts. The potential economies of scale and scope in the board services industry (including vertical integration of consultants and other board member support functions), as well as the benefits of risk pooling and talent allocation, mean that large professional director services firms may arise, and thereby create a market for corporate governance distinct from the market for corporate control. More transparency about board performance, including better pricing of governance by the market, as well as increased reputational assets at stake in board decisions, means improved corporate governance, all else being equal. But our goal in this Article is not necessarily to increase shareholder control over firms; we show how a firm providing board services could be used to increase managerial power as well. This shows the neutrality of our proposed reform, which can therefore be thought of as a reconceptualization of what a board is rather than a claim about the optimal locus of corporate power. [Alexander] Hamilton would have no trouble recognizing the corporate board of today. The structure and composition of boardrooms have changed surprisingly little in more than 200 years.1 INTRODUCTION Corporate boards of directors are one of the most important institutions in our capitalist system. This is because state law requires boards to mediate the relations between ownership and control of the corporation.2 Separating capital and management is thought to be a source of efficiency, since those with capital may not be best positioned to manage publicly held firms.3 But the separation generates the potential for opportunism since managers may be less careful spending other people's money than they would their own.4 To optimize the tradeoff between management efficiency and opportunism, shareholders elect boards of directors to supervise management of the firm by corporate officers.5 Although day-to-day decisions are made by managers, directors are obligated to make fundamental decisions, like hiring and firing the managers, setting compensation incentives, raising capital, and entering into mergers and acquisi- tions.6 This latter category of decisions routinely involves high stakes and po- tential conflicts among corporate stakeholders, making the board the place where legal rules about corporate governance have the most relevance.7 In recognition of the centrality of the board in corporate governance, judi- cial control of corporate activities is almost exclusively effected through review of board decisions and refinement of board duties to shareholders.8 Through their review of board actions in connection with mergers, executive compensa- tion, supervision of firm risk, approval of conflicted transactions, and so on, state courts have created many of the basic rules of corporate governance.9 Legislation (from both states and the federal government), as well as pri- vate rules from stock exchanges, also focuses on optimizing corporate govern- ance through attempts to perfect the board and optimally define its position in the corporate decisionmaking hierarchy.10 For instance, in response to numer- ous corporate scandals during the late 1990s, the Sarbanes-Oxley Act of 2002 required, among other things, that all listed companies have audit committees composed entirely of independent directors.11 Similarly, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) implemented numerous corporate governance reforms, including new disclosures about con- sultants working for boards and about compensation of directors, as well as new independence standards for board compensation committees.12 Influencing boards is the primary focus of good governance advocates of various kinds, as well. Proxy advisor firms, like Institutional Shareholder Ser- vices (ISS) and Glass, Lewis & Co., spend considerable resources trying to im- prove corporate governance by giving shareholders information about how they should vote in director elections. For instance, ISS sells institutional sharehold- ers recommendations on how to vote for every director of large, publicly traded firms based on firm policies regarding areas ranging from executive compensa- tion to corporate strategy.13 Although the power of ISS and the other proxy ad- visor firms is disputed,14 it is without doubt that their ability to influence corpo- rate behavior is cabined by the current corporate governance structure. Because shareholders have limited ability to directly effect change, much of their pow- er-and thus that of ISS and its ilk-derives from voting on director elec- tions.15 The importance of the board of directors is further illustrated by the con- siderable extent to which academics hoping to improve corporate governance focus on the role and composition of the board.16 Almost every corporate gov- ernance reform proposed over the past several decades has focused on the board of directors.17 The central academic debate is whether boards have too much control over corporate affairs, too little, or just the right amount.18 This battle is fought on the grounds of who board members are, whether they are in- dependent, who appoints them, how they are elected, how they are compen- sated, what the standards for their conduct and liability are, whether there should be more independent directors, what the optimal board size is, and so forth.19 All of these reforms are an attempt to optimize the monitoring and gov- ernance role played by the board.20 Despite the long and zealous efforts of corporate law reformers to under- stand and improve the board of directors, there is a gaping hole in the corporate governance literature. No one has yet questioned a fundamental assumption of the current corporate governance model-that is, only individuals, acting as sole proprietors, should provide professional board services. To be sure, there seem to be legal reasons why this is the case. For example, state law seems to require directors to be natural persons, as do the provisions of federal law per- taining to corporate governance and the listing requirements of stock exchang- es.21 This Article puts these obligations to scrutiny, asking whether this re- quirement makes sense. To do so, it posits a novel alternative: board services could be provided by other entities, be they partnerships, corporations, limited liability corporations, or any other type of business association. We call these firms "board service providers" (BSPs). To be clear, we do not have in mind individual board members forming professional corporations to get the protec- tion of limited liability, but rather all director services being provided by a sin- gle firm. In other words, just as companies outsource their external audit func- tion to an accounting firm rather than multiple individuals, the board of directors function would be outsourced to a professional services company. To see our idea, imagine a firm, Boards-R-Us, Inc., serving as the board of Acme Co. Instead of Acme shareholders hiring a dozen or so individual sole proprietors to provide board functions, they instead hire one firm-a BSP-to provide those functions, whatever they may be.22 Boards-R-Us would still act through individual agents, but the responsibility for managing a particular firm, within the meaning of state corporate law, would be that of Boards-R-Us the entity. This means, for instance, that a suit by shareholders for breach of the board's fiduciary duties would be against Boards-R-Us, and not against indi- viduals or groups of individuals. This Article considers the various details of what this might look like and sets forth the costs and benefits of the BSP approach compared with the current model. To see the basics of the BSP model, it is probably helpful to imagine no other change to governance-that is, holding the current election, function, and liability regimes constant.23 All of the current rules of federal and state law, as well as stock exchange listing standards, governing the nomination and election of directors would continue to apply. All that would change is that instead of multiple individuals, only a single entity would be selected. Our proposal is well grounded in state corporate law theory and supported by analogous cases in which firms serve as boards. Corporate law is generally permissive about how companies structure their governance, providing merely a set of default rules that can be altered by contract.24 Mandatory rules are very rare, and the case for them is weakened when there are significant benefits, as here, that can flow from freedom of choice. In addition, there are many cases in which entities, like our imagined BSPs, are already serving as boards or in board-like capacities. Unincorporated entities, such as partnerships, limited lia- bility companies (LLCs), and the like, are typically permitted to have business associations serve in the management role played by a corporate board of direc- tors for corporate entities.25 In addition, several federal statutes, including the Investment Company Act of 1940, permit directors to be incorporated entities, and the Supreme Court has construed portions of the securities laws broadly to include corporations acting as directors when the policy justifications for that result are strong.26 Our proposal has no ideological or particular substantive corporate govern- ance valence. The use of BSPs would not necessarily result in more shareholder power or more managerial power. What it would do, however, is make either of these options more likely, depending on the other forces at work. If shareholder access to the proxy with the goal of more competition for board seats is desired, our proposal can achieve this more directly, at lower cost, and with less down- side than the current model. On the other hand, if what would maximize share- holder value is greater managerial control and a longer-term view for board decisionmaking, our proposal could be adapted to this goal as well.27 In short, corporate governance experts like both Lucian Bebchuk (shareholder power) and Martin Lipton (managerial power) should see the value in our proposed board model. We are trying to reconceptualize the board, not necessarily move it in a particular direction. Nothing in our proposal should be read to require a firm to hire another firm to provide its board services, in whole or in part.28 We merely question the current regime in which various laws and regulations effectively forbid firms from hiring BSPs; our proposal is to remove this categorical bar. Imagine if there were a state law requiring legal services to be provided by individual sole proprietorships. Such a law might be motivated by a belief that lawyers would be more careful acting alone or that conflicts of interest arising from pooling legal resources outweigh the gains or some other reason. But whatever the rea- son, such a rule would generate widespread opposition from lawyers arguing that by pooling their resources they could offer better services to their clients. Clients would object too. While some clients might prefer to hire lawyers unaf- filiated with a large firm, others might prefer the costs and benefits of hiring a firm instead of a single lawyer. The same is true for corporate governance. It is unlikely that one size fits all, suggesting that a ban on plausible options must be based on an overwhelming case. This case has not been made. To the contrary, we think the case for BSPs is quite strong. Read in the narrowest sense, our proposal is banal. We are simply advocat- ing extending the normal presumption of freedom of contract in state corporate law to the nature of the board.29 In light of the widespread but largely failed at- tempts by lawmakers, courts, and academics to reform board performance through various tweaks of independence, compensation, fiduciary duties, and so on, we think it is time to encourage more fundamental experimentation in corporate governance. Our proposal allows this by freeing firms to rethink and reconceptualize the board. We hope to create a market-the market for BSPs or the market for corporate governance-that will allow governance to be priced in more transparent ways. In this way, our proposal is a half step in the direction of existing mecha- nisms of governance that are believed to be superior to the model prevailing in publicly traded firms. Venture capitalists, private equity funds, and activist hedge funds often have board representatives, but our proposal differs from what those entities do in important ways. First, board representation is ancillary to the principal investment activities of such funds. In contrast, a BSP's princi- pal activity is not investing in corporations but providing professional board services. To the extent a BSP takes an equity stake in a client, it does so as compensation rather than as an investment, just as law firms that take an equity stake in their clients do. The BSP model of governance is about trying to achieve some of the improved governance benefits of the private equity model without the need for investors to stake an economic bet on the entire firm. If there develops a robust market for governance, BSPs would be a threat to any existing board. The potential for a takeover of the board function, separate from the takeover of the firm, would be a real possibility, and with it the possibility that management could be improved by the intervention of a third party offer- ing a better governance mousetrap. This model could, of course, be coupled with the board taking a greater stake in the economics of the firm than it cur- rently has, a possibility that we discuss further below. The use of higher- powered board incentives would thus create a sliding scale of governance, with the full private equity model on one end and the current approach on the other. The BSP model would fall somewhere in between depending on the incentives of the board in any particular case. To make our argument that there are sensible reasons why we should al- low, and even encourage, BSPs, this Article considers a series of questions. First, in Part I, what are current boards of directors supposed to do, and how and why do so many fail to do so? Second, in Part II, what would a BSP model look like? Third, in Part III, why might a BSP have advantages, at least for some firms? Fourth, in Part IV, what legal changes are necessary to permit firms to adopt the BSP model? With those questions answered, in Part V, we offer some preliminary ideas for extensions, using the debate about the level of shareholder control of the corporation as a template. We show how BSPs could be used to achieve either greater shareholder control or greater managerial con- trol over the corporation, as the firm's constituencies may prefer. Finally, in Part VI, we address two objections to our proposal. The first is that limited lia- bility may undermine proper board functioning by discouraging directors from taking care; the second is that BSPs are unlikely to arise even if laws prevent- ing them from doing so are amended. We conclude that while limited liability does not present a significant objection, there is a significant barrier to adoption arising from transition costs and the fact that our proposal upsets a variety of vested interests. We are content to leave it to others to figure out how best to encourage BSPs after we have raised the possibility. I. THE JOBS AND FAILURES OF THE CURRENT BOARD OF DIRECTORS What do boards do? Corporation statutes tell us that the corporation's busi- ness and affairs "shall be managed by or under the direction of a board of direc- tors,"30 but if this statutory command ever reflected real-world practice, it has long since ceased to do so.31 In order to assess the merits of the BSP model, we therefore need to identify the real-world functions performed by modern boards of directors. We then need to explore why the law assumes that those functions ought to be performed by a committee of independent contractors. A. What Do Boards Do? A modern board's job has three components: management, oversight, and service.32 The balance between them has varied over time and from firm to firm, but the long-term trend has been to emphasize the board's role as moni- tors of the top management team.33 Although these board functions are quite familiar to students of corporate governance,34 briefly reviewing what boards currently do will help explain what functions a BSP would be expected to per- form and set up our discussion of why a BSP would perform those functions better than do current boards. Although corporation statutes appear to assign a very active role in firm management to boards,35 public corporations simply are too large and complex for the board to have a day-to-day managerial function. The board's longstand- ing inability to exercise such functions has been compounded in recent years by the significant increase in the number of independent directors at public corpo- rations,36 which has had the effect of creating boards comprised principally of outsiders who have full-time jobs elsewhere and therefore can devote relatively little time to the running of the business for which they act as directors.37 As a result, other than those tasks the law requires be performed by the board, the modern board's involvement in management of the firm is typically limited to hiring and firing the top management team, approving major transactions, and, perhaps, helping set the broad strategic vision for the firm.38 The board's service functions include a number of ways in which board members contribute to the corporation, but the critical service function is providing advice and counsel to the CEO.39 In particular, by virtue of being outsiders, the independent board members can offer the CEO alternative points of view.40 The multibillion-dollar management-consulting industry is a testa- ment to the value of this service. As noted, however, the board's principal function today is monitoring management. Public corporations have long been characterized by a separation of ownership and control, which "produces a condition where the interests of owner and of ultimate manager may, and often do, diverge, and where many of the checks which formerly operated to limit the use of power disappear."41 But the corporation's nominal owners-the shareholders-lack both the legal right and, in most cases, the practical ability to exercise meaningful oversight of the corporation's management.42 As a result, the legal system evolved alternative accountability structures to punish and deter wrongdoing by firm agents, most notably the board of directors.43 As noted above, the relative balance between these functions has shifted over time.44 The role of the typical public corporation board shifted from a mainly advisory function in the 1970s to an emphasis by the late 1990s on ac- tive and independent monitoring of the top management team.45 That emphasis was given statutory imprimatur by the Sarbanes-Oxley Act, which was passed in the wake of the Enron scandal and intended to require directors to be more effective monitors of corporate management.46 The post-financial crisis Dodd- Frank Act likewise "includes significant governance reforms designed to en- hance director oversight of compensation and risk."47 The net effect of these developments has been to elevate the focus on the board as a monitor of man- agement to the status of "conventional wisdom, endorsed by the Chairman of the SEC, the corporate bar, and even the Business Roundtable."48 B. Boards Fail As one of us has elsewhere discussed in more detail, boards of directors have long had bad press.49 From Adam Smith in the 1770s,50 to William O. Douglas in the 1930s,51 to the Securities and Exchange Commission (SEC) in 2009,52 critics have complained that-in Ralph Nader's words-directors re- semble "cuckolds" who are "often the last to know when [their] dominant part- ner-management-has done something illicit."53 While there is some evi- dence that many modern boards outperform their predecessors,54 it would be Pollyannaish to deny that there is still much room for improvement in board performance. The aftermath of the financial crisis of 2007-2008, for example, revealed widespread board failures in areas such as enterprise risk manage- ment.55 Still another widely asserted criticism is that boards have failed to rein in allegedly runaway executive compensation.56 C. Why Boards Fail The reasons boards continue to struggle include inadequate time, misspent time, inadequate information, improper skill sets, and insufficient incentives. Many of these problems are longstanding, of course, but we believe that they have been significantly compounded by the increased emphasis in recent dec- ades on director independence. As a result of stock exchange listing standards mandating director independence and pressure from corporate governance re- formers,57 the percentage of board members who are independent has risen dramatically.58 As a result, boards today are dominated by part-timers, the vast majority of whom have full-time employment elsewhere, which commands the bulk of their attention and provides the bulk of their pecuniary and psychic in- 59 come. 1. Directors are subject to significant time constraints Historically, directors did not spend much time together working as a group.60 Board meetings were few and short. According to one survey, for ex- ample, during the 1980s directors in large manufacturing companies averaged a total of fourteen board and committee meetings per year, with the median board meeting lasting only three hours.61 As we have seen, the legislative and regula- tory fallout from the financial crises of the last decade resulted in directors de- voting greater time to board service. Yet independent directors by their very nature remain part-timers, which has very real costs. Independent directors are part-time participants in a corporation's affairs. By definition they are outsiders. However intelligent, hardworking, or strong minded they may be, they do not have the time or the mandate to challenge management's judgments except as to a discrete number of issues. If they spend all of their time trying to audit the auditors and assure that executive compensation is reasonable, they will have no time for focusing on important business and strategy matters.62 It appears, moreover, that much of the time directors do spend directing is misspent. For example, much of the additional time required of contemporary board members is devoted to oversight activities, which is hardly surprising given that both the Sarbanes-Oxley and Dodd-Frank Acts reinforced the moni- toring model's influence.63 If so, the additional time and effort being expended by directors may have important costs. In particular, as Peter Wallison ob- serves, the "congressional imprimatur" the Sarbanes-Oxley Act put on the monitoring model has encouraged "an adversarial relationship between man- agements and boards that will, over time, impair corporate risk-taking and thus economic growth."64 Even if a firm's board and management maintain an ap- propriately balanced relationship, moreover, the board tasks mandated by the Sarbanes-Oxley Act may not be the best use of a board's limited meeting time. As Wallison further observed, boards today "are more focused on compliance with standards and regulations than they are on obtaining a competitive ad- vantage."65 This leaves boards with less time to devote to their traditional func- tions, including management oversight. 2. Directors have an inherent information disadvantage It is conventional to blame board dysfunction on the information asym- metry between independent directors and inside managers.66 In fact, however, board dysfunction can be the result of having either too little or too much in- formation. On some boards, directors are deprived of information.67 At other corporations, however, an "indigestible overload of information" is dumped on directors.68 In either case, "outside board members" end up being "amazingly out of touch with the corporation for which they bear ultimate legal responsibil- ity."69 3. Directors are generalists In contrast to insiders, who possess significant firm-specific human capi- tal,70 independent directors tend to be generalists with little firm-specific knowledge, skills, or expertise.71 Modern boards thus tend to be "composed of individuals who are not qualified to assess the strategic viability of the corpora- tions they direct."72 Unfortunately, the rules mandating director independence virtually ensure that this problem will remain insoluble, because they effective- ly "rule[] out just about anybody who has firsthand knowledge of the company and its industry."73 While independent directors can develop such knowledge over time, doing so can be a very lengthy process.74 Many independent direc- tors thus never "develop . . . more than a rudimentary understanding of their companies' workings."75 While at least some long-serving directors may develop a reasonable knowledge of the company's inner workings, long service can give rise to close friendships between nominally independent directors and the managers with whom they serve.76 This can compromise the director's ability to take strong action when management falters. In some cases, but not all, long-serving direc- tors "may find it difficult to be truly independent in deciding what's in the shareholders' best interests."77 4. Directors do not have well-designed incentives The most basic way of incentivizing people to do a good job is to pay them for doing so.78 Unfortunately, the longstanding practice of paying directors substantial fees in cash, coupled with management's control of the board nomi- nation process, acted in the past "to align the interests of the outside directors with current management rather than with the shareholders . . . . Directors whose remuneration is unrelated to corporate performance have little personal incentive to challenge their management benefactors."79 Corporate reformers responded by encouraging firms to pay directors "primarily in company stock that is restricted as to resale during their term in office."80 Proponents of this approach believed that doing so would "create within each director a personally based motivation to actively monitor management in the best interest of corpo- rate productivity."81 This approach to director compensation has now been adopted at many firms, but some commentators argue that it has not served to align director and shareholder interests. According to this view, the incentives of directors with substantial stock holdings or in-the-money options are more closely aligned with those of managers than with those of shareholders.82 As a result, if man- agers inflate the company's stock price by manipulating financial data or oth- erwise cooking the books, "directors may go along because they also stand to benefit."83 There is thus an inherent tension between the competing goals of ensuring director independence and incentivizing them to perform at a high- quality level. The more stock a director owns, the less independent the director becomes.84 With this diagnosis of the symptoms of board failures or shortcomings in hand, in the next Part, we propose a treatment in the form of a new model for providing corporate board services. We show what a BSP might look like, alt- hough a precise accounting is impossible to make given the numerous degrees of freedom. Only experimentation in real-world settings is likely to generate answers to the questions about the optimal type of BSP scope and structure. Our goal therefore is merely to show the significant potential upside and the limited downside of doing away with the natural person requirement. II. THE BASIC BSP MODEL In this Part, we briefly sketch out the basics of our proposal for BSPs, that is, that firms be permitted to provide professional director services to other firms. There are innumerable permutations for how exactly a BSP would be appointed, function, be held liable, be removable, and so on, some of which are obvious, but many of which are beyond our capacity to imagine at this point. Our goal in this Article is not to devise the optimal BSP, assuming such a thing even exists. Rather, consistent with the enabling nature of state corporate law and the freedom of firms generally to devise their own approaches to corporate governance, we propose only that firms be permitted to design their own, tai- lored, locally optimal BSP structures. For illustrative purposes, however, we set forth in this Part what one basic version of the BSP idea might look like. Later, we explore some possible extensions. Our goal is to create a small legal change-one that is consistent with the spirit of state corporate law in Delaware and elsewhere-that could unleash experimentation by firms in improving cor- porate governance, and thereby perhaps create an entirely new industry. If our idea takes root, we hope and expect dozens of BSPs to arise, and the landscape of boards to look much different than it does today. The BSPs we expect would develop from our innovation would be designed to address the sources of cur- rent board weaknesses or failures described in Part I. A. The Basic Idea Instead of a corporate board comprised of a group of individuals acting as independent contractors, we have in mind a business entity, be it a partnership, LLC, corporation, or other association, acting as the board of another company. In our model, the board would be an "it," not a group of "hes" and "shes." In- stead of nominating and electing a slate of unrelated individual independent contractors to serve as board members, a BSP would be chosen to provide di- rector services.85 Our proposal can thus be distinguished from merely permit- ting individual directors to form professional corporations (or some other lim- ited liability entity) to shield their personal assets from liabilities that result from their work as a director. Such a regime would bring only the benefits of reduced director liability, without any of the other benefits we think arise when a single firm provides the entire board function. The best way to understand how the BSP model differs from the current board model is to compare the two models along the key dimensions of board activity. These include how directors are appointed, who they are, what func- tions they serve, how they make decisions, how they are elected and removed, and what liability rules govern their conduct. B. Institutional Choices In the next several Subparts, we compare and contrast the generic BSP model with the current approach. For simplicity, we limit the discussion in this Part to the simplest approach. In Part V below, we offer some extensions and potential areas for experimentation. 1. Appointment and elections The first issue to compare and contrast is how directors get their jobs on the board in the first place. Under the current approach, a company's initial board members either are its incorporators or are named in the corporate char- ter.86 Thereafter, shareholders vote to elect board members each year.87 The firm's shareholders or the shareholders' agent (e.g., the CEO) nominate indi- vidual directors to run for election. For exchange-listed corporations, the nomi- nating committee of the board of directors is tasked with selecting new direc- tors and nominating the directors to be elected at the annual shareholder meeting.88 Directors so nominated are submitted as a group (known as a "slate") to shareholders via the company's proxy voting materials, but they run as individuals. Because directors generally run unopposed, the shareholder vote is more advisory than anything else. Indeed, under traditional plurality voting rules, a vote of less than fifty percent suggests only shareholder dissatisfaction, as directors with even a single vote can continue to serve.89 The only sure way to remove a director is through a proxy contest, in which a rival pays, win or lose, the full costs of distributing ballots to shareholders and convincing them to vote for the rival. Firms pay incumbents' costs no matter what, and incum- bents are effectively spending shareholders' money to maintain their jobs.90 Given the asymmetry of costs and benefits of this strategy, proxy contests are exceedingly rare and are seen primarily in cases in which the benefits of win- ning a board seat include gaining control of the entire board, and thus the eco- nomics of the entire firm.91 There is no market for corporate governance, only a market for corporate control. Most of this process could stay the same with a BSP. The promoters of the firm would choose a BSP to serve until the first meeting of shareholders, or name the first BSP in the corporate charter. Once the company went public, the nominating committee of the board of directors would take over the process of selecting a BSP to be submitted to the shareholders for approval. The chosen BSP would serve until the next annual meeting and could be renominated and reelected indefinitely, as is the case today with individual directors. Likewise, a BSP would be subject to removal by the shareholders under the same rules governing removal of individual directors. For existing firms wanting to hire a BSP, there are a variety of processes that could be used. The firm, acting through the nominating committee, a spe- cial committee appointed solely for the purpose, or the CEO, could choose a BSP to run against the current board or as the sole option for shareholders. Two or more BSPs could be chosen to run against each other. Or, perhaps most al- luringly, a BSP could simply challenge the existing board to a proxy contest, giving shareholders the choice of governance model. These approaches could be formalized by statutory command or, preferably, by the choice of individual firms. These and other options for the nomination and election procedures, in- cluding ones that could reduce board turnover, are discussed below.92 2. Composition and function Another dimension along which we can compare and contrast the current board model and our proposed alternative is the composition and function of the board. Today, board members are most commonly current or former CEOs of other companies, but may also be high-profile individuals from business, science, law, academia, accounting, politics, and other fields.93 The choice of directors is undoubtedly based on many factors and is highly situational. For early-stage companies, directors with access to key fundraising connections or with industry expertise may be highly prized, while for later-stage companies, directors with political connections or leadership positions at firms in comple- mentary industries might be more valuable. Boards going through a crisis might need the help of an expert in risk management, someone with government con- nections, or someone who has led an organization through a crisis. Other fac- tors, such as personal relationships and diversity considerations, may also be involved in choosing directors. Some of these reasons may be desirable from the perspective of shareholders, including access to lower-cost capital, business connections, political influence, and strategic vision. Others may not be, includ- ing the personal satisfaction of the CEO, in terms of quid pro quos or rubbing elbows with great figures.94 Our idea is to do away entirely with having individuals sitting on the board. Just as a firm outsources much legal work to a law firm rather than a committee of lawyers and its external audit function to an accounting firm rather than a committee of CEOs, the board function would be outsourced to Boards-R-Us and its ilk.95 To be sure, certain individuals would serve as the point of contact between the corporation and the BSP, just as individual partners serve as the point of contact between the corporation and its law firm and auditor. Where the board is called upon to make a decision, such as whether to approve a mer- ger, the CEO would meet with the contact person at the BSP, who would then bring the full resources of the BSP to bear on making the decision. The precise composition of a decisionmaking team within the BSP might vary with the type of decision at hand, just as law firms put together different teams to handle a given client's varying matters.96 Under the BSP approach, the type of individuals providing board member- like services could more or less be what they are today, or they could be com- pletely different, depending on how the BSP developed over time to meet the needs of its clients. A BSP could hire the exact mix of individuals that currently serve on corporate boards-current and former CEOs, politicians, lawyers, and so on.97 These contractual relationships could be permanent or temporary, meaning some individuals might have a relationship with one BSP or for one particular board services contract, while others might offer their services on a freelance basis. If the current composition of board members is optimal, there is nothing about our proposal that would upset this.98 One benefit of the BSP model, however, is that it would discourage, on the margin, the hiring of indi- vidual board members as window dressing or because of the CEO's domination of the board.99 Current boards still all too often include, say, a famous actor or the child of a President. A BSP hired to provide such services is less likely to include such individuals because it has a profit motive in selecting the best candidates.100 3. Compensation Another dimension of comparison is in how directors are compensated for their work. Directors of large, publicly traded American firms are paid a mix of cash and equity grants in the corporation.101 The latter, a relatively recent inno- vation, are designed to align the wealth of directors and shareholders so that di- rector incentives are improved from the perspective of the firm's residual claimants.102 In the BSP model, we expect that the BSP would bill client corporations a basic annual fee for services, just as law firms and external auditors do. Unlike the latter types of service providers, however, we anticipate that client corpora- tions might wish to pay part of the BSP's compensation in equity-such as re- stricted stock-so as to align the interests of the BSP with those of the client's shareholders.103 Nothing prevents firms from owning stock in other firms, and the stockholding requirements and restrictions currently applied to director compensation could be readily transferred to the BSP. 4. Liability In the BSP model, liability for board misconduct or breaches of fiduciary duty would reside at the entity level, instead of at the individual level. In the event of alleged director misbehavior, the shareholders of the company would sue the BSP derivatively for breaches of fiduciary duties. Liability for any vio- lations would be borne by the BSP as an entity, rather than the directors being jointly and severally liable for the total damages. Entity liability would not pre- clude individual liability as well under extraordinary circumstances. As with any case of entities facing liability, individual agents might also be held liable if there are facts and circumstances suggesting the policy undergirding the legal rule would be furthered by individual liability. III. MAPPING THE BSP TO THE CURRENT BOARD As the preceding Part showed, the basic version of our proposal is substan- tially similar to the current board model, with the one key difference that the board consists of an "it" instead of a collection of individuals. In this Part, we explain why we think this small change might have significant advantages, at least for some corporations. To do so, we map our discussion of BSPs against the analysis and critique of current board functions and lay out an affirmative case for a legal change to permit entities to provide the board services laid out in Part I. As an organizational matter, however, it turns out to be advantageous to reverse the order in which we take up the questions of functions and failures. A. How BSPs Address the Reasons Current Boards Fail The advantages of hiring a business association, as opposed to a solo prac- titioner, working alone or as part of a larger team, to provide professional ser- vices are well known in other contexts. These include the ability to capitalize on economies of scale and scope, to share risk, to invest in specialization, and to generate large reputational assets that can help constrain opportunism. These benefits are the reason why nearly every other professional service has the op- tion of being provided by any type of business association. Lawyers, account- ants, compensation consultants, investment bankers, insurance companies, management consultants, and all other providers of professional services to firms are free to organize the provision of these services in whatever way they believe is optimal. There is enormous heterogeneity, and all business associa- tion forms, from sole proprietorships to corporations, are used. The choice var- ies by firm, by industry, and over time. Law firms used to be general partner- ships, but now are largely limited liability companies or limited liability partnerships.104 The same is true for investment banks and stock and commodi- ties exchanges, which also used to be partnerships, but now are predominantly publicly traded corporations.105 The variation and the dynamic nature of the choices reflect the fact that the choice of associative forms is responsive to the needs of service providers and clients, as well as to background economic and technological conditions. In other words, the experience of other service indus- tries suggests that locking in one type of business association as the sole mech- anism for providing the relevant services would have resulted in some serious inefficiency. Although the benefits of forming various business associations are well known, it is worth unpacking them to see how they would apply in the context of director services, since this will demonstrate the appeal of our proposed re- form. Specifically, we focus on the solutions a BSP could offer to address the ways current boards fail. 1. Economies of scale and scope In Part I, we saw that independent individual board members are part- timers. As a result, they face three important sets of constraints: limited time, information asymmetries vis-à-vis management, and a lack of specialist exper- tise.106 A significant advantage of the BSP model is the potential to ameliorate those problems by taking advantage of the potential economies of scale and scope inherently created when economic activity is brought within an organiza- tion rather than conducted by individuals. Economies of scale and scope allow firms to increase quality and/or lower cost by finding efficiencies in production, spreading fixed costs across a larger asset base, investing in technology, and so on.107 Economies of scale in the production of goods or services are common across all areas of the economy.108 They explain the fact that everything from the production of consumer products to the delivery of highly specialized services is provided primarily by large en- 109 terprises. Even in highly fragmented professional services industries, like law and accounting,110 a substantial part of the services are provided by the largest en- terprises. In legal services, one of the most highly fragmented industries, there are about 180,000 law offices in the United States, generating about $260 bil- lion in revenue.111 But, according to an industry report by First Research, over fifteen percent of total revenue comes from the largest fifty law firms.112 For example, Baker & McKenzie, the world's largest law firm by number of law- yers and second largest by revenue, has more than 4000 lawyers who produce over $2 billion in revenue.113 The top ten firms worldwide have revenues of over $20 billion and employ over 27,000 lawyers.114 Economies of scale are most commonly understood in the context of the manufacture of products. The leading text on organizational theory describes their benefits by observing that a larger manufacturing "firm may be able to af- ford more specialized equipment, more distribution outlets located nearer to customers, a larger number of plants, training programs for its employees tai- lored to particular circumstances, and so on."115 Although directors do not need more factories or specialized equipment any more than lawyers do, the logic of economies of scale readily transfers over to the provision of professional ser- vices. As applied to the problem at hand, the economies of scale that a BSP can achieve help redress all three of the problems faced by individual board mem- bers. a. Time A large organization providing multimember teams to carry out the BSP function inevitably will be able to devote more person-hours to gathering and processing information and exercising evaluative judgment on the basis of that information than can an individual, part-time director. Full-time directors would, by definition, be able to devote more time than part-time ones, and the BSP model provides a mechanism to create professional directors with no other employment. In addition, a BSP would allow professionals to leverage support staff to increase the time spent on any matter, all else being equal. Professional services firms in other areas, like accounting, law, and consulting, deploy py- ramidal structures with multiple levels of full-time professionals, allowing them to spend considerably more time on a given project than if a single, part-time individual were working on the same project alone. In addition, because of the economies of scale achievable by a BSP, it can do so at a lower cost per per- son-hour. As noted above, time, so to speak, can be bought in the marketplace, but the Coasean efficiency concerns raised above obtain here as well. b. Information As just noted, a BSP will be able to devote more time-and, of course, other resources-to gathering information and at lower cost. In addition, a sin- gle BSP wielding the full powers of the board may be in a better position to demand forthrightness by the top management team than would a single, lone- wolf director acting alone. Even a subgroup of individual directors acting in concert would have less bargaining power vis-à-vis top management than a BSP acting as the entire board. Although the information asymmetry between a top management team and the BSP could never be fully eliminated, just as there are persistent information asymmetries between top management and the firm's outside lawyers and accountants,116 we would expect BSPs to have bet- ter access to information than do individual directors. Not only is the BSP like- ly to have better information about the firm it is serving, it will also have much more information about the particular questions it is considering, whether they be about compensation, strategy, finance, or the like. As we consider next, BSPs will enable much greater general knowledge and information to be brought to bear on firm decisions and at much lower cost. c. Specialization In addition to firm-specific information, board members need general hu- man capital in various areas of knowledge and expertise. Boards, thus, may benefit from members with experience in finance, international business, gov- ernment and regulation, risk management, marketing, social media, and the companies' specific industries, not to mention the inclusion of minorities and women.117 Even if a board were to include individuals with all of these skills, however, any reasonably sized board will necessarily be underinclusive of the skills and experience needed to address all of the issues that may arise. In addi- tion, the ideal mix of board expertise is likely to vary over time or even from decision to decision. Directors serve for long periods-the average tenure for directors of S&P 500 firms in 2012 was nearly nine years118-and are general- ly not replaced during any individual year to address particular issues. This means the current board model is likely to be far lumpier than the expertise needed for any particular issue on any particular day. As noted above, an obvious solution to these limitations is for a board to buy the expertise needed at a particular time instead of seeking it internally. This has been and largely remains the practice. Most obviously, management provides much of the information, analysis, and expertise the board needs to make decisions. Unfortunately, of course, this dependence on management is one of the key factors that undermines current boards' ability to function as in- dependent decisionmaking bodies, especially because forthrightness from man- agement may be least likely precisely when the board's oversight is needed most. In addition, external consultants of various sorts provide the board with ad- vice or information. Compensation consultants are routinely hired to advise compensation committees; headhunters advise nomination committees; audit firms help audit committees; and so on. The independence of such advisors, however, is questionable because management traditionally has hired them. There are thus two problems with the current model-efficiency and conflict of interest. At least with respect to the audit and compensation functions, federal law now seeks to ameliorate the conflict-of-interest problem. Federal law now re- quires reporting companies to have a compensation committee comprised ex- clusively of independent directors and provides that this committee shall have exclusive authority to hire, fire, and compensate compensation consultants.119 The same statute further requires the SEC to promulgate rules designed to en- sure that compensation consultants are independent of management.120 Like- wise, federal law requires reporting companies to have an audit committee comprised exclusively of independent directors.121 The audit committee must have exclusive power to hire, fire, and compensate the firm's external audi- tors.122 There is doubt that these new rules have solved the conflict-of-interest problems in these areas because of continued management control and influ- ence. Even assuming that these developments have solved the conflicts of in- terest that long plagued the relationship between consultants and their corporate clients in those areas, conflict-of-interest problems persist outside of those con- texts. Boards remain dependent on management and outside advisors selected by management for much of the information they need. Even if one believes, however, that firms are now at the optimal equilibrium in the build-versus-buy decision for board expertise along this dimension, efficiency considerations remain. The problem is one identified by Ronald Coase in his work on the theory of the firm.123 As Coase explained when describing why firms exist in the first place, there are significant gains to be had from bringing functions or services bought in the market inside of a given firm.124 Buying services or information in the market involves numerous costs, including search costs, bargaining costs, transaction costs, monitoring costs, enforcement costs, and so on. Ringing the boundaries of a firm around these functions or services can reduce these costs by virtue of the reduced cost of the fiat allocation system, but at some point in size, these gains are swamped by the costs of bureaucracy.125 Coase's insight was that firms should be the size where the marginal gain from the addition of another individual or function is equal to the costs of that addition in terms of optimal decisionmaking.126 It is difficult to imagine that the optimal Coasean firm for the provision of director services is comprised of a single individual in all cases, just as it is not for legal or consulting services. As such, potential effi- ciencies in the operation of boards could be realized by removing the statutory constriction on the Coasean firm. For instance, associating with other professionals allows individuals to de- velop and invest in specialized knowledge and expertise. Service professionals are routinely organized as business associations comprised of managers,127 who have decisionmaking authority and supervise other professionals who pro- vide support services. The typical law firm or consultancy fits this model. The pyramidal structure of such firms allows professionals to become experts in particular areas, and then to be deployed as needed as part of a team. Consider a typical management consulting firm. These firms deploy experts with particu- lar skills or knowledge of different industries or fields, technical experts in cer- tain areas (e.g., econometrics, finance, and so forth), lawyers, accountants, sci- entists, psychologists, and countless other professionals, as well as generalist consultants. Just as directors currently are required by law to buy all of their support services, either from the company they serve or from the market, one could imagine consultants or lawyers or accountants being required to do so as well. But the Coasean equilibrium for these professional services firms is larger than for one-person firms, and we expect the same is true of directors. To see how this might translate into the market for BSPs, imagine a BSP vertically integrating with some or all of the experts that currently provide board members with information and advice. In the pure BSP model, one or more of the BSP's senior managers act as a liaison between the BSP and client, just as a lead law firm or accounting partner often acts as the primary liaison between such firms and their clients. Alternatively, the individuals currently serving the client as directors could be hired by the BSP and thereafter continue functioning as the client's board. In either case, the BSP would be a large firm that vertically integrates the BSP function with all board advisory services, ex- cepting those provided by lawyers and accountants, compensation consultants, management consultants, and others serving in support roles. The economies of scale and scope described above would allow the partners in this model to have board services as their full-time occupation.128 The result would likely be not only an improvement in the quality and incentives of directors (or those now serving in that role) but also the creation of a new profession, that of profes- sional director. Professions, as such, are thought to be valuable because they develop codes of conduct and engage in self-regulation to encourage profes- sion-specific reputation.129 Our proposal for BSPs is thus a potential mechanism for achieving Ronald Gilson and Reinier Kraakman's dream of professional directors.130 In Reinvent- ing the Outside Director: An Agenda for Institutional Investors, they proposed creating a class of professional directors who would serve on a portfolio of boards as their full-time job.131 These professionals would know their portfolio companies better because they would be able to devote more time to following those companies, and they would be more dependent on institutional share- holders for their position.132 They recommended the use of a central clearing- house to take care of the logistics of helping institutional shareholders select professional directors to serve on their companies' boards.133 The Gilson and Kraakman proposal went nowhere, perhaps because the idea of turning over the governance of a company to a clearinghouse was a step too far for corporate managers. Our proposal for BSPs is a more modest step, in that it could achieve the same goal but within the current power structure of firms. Yet we can imag- ine this simple change leading to a new profession, just as envisioned by Gilson and Kraakman. 2. Incentives In this Subpart, we consider a variety of ways in which the BSP model could provide improved incentives that would help ameliorate some of the dys- functions of the current board model. Although directors are well paid for the work they do, their monetary incentives to work hard and do well are fairly limited since they capture so little of any gains and suffer so little of any losses from the decisions they make. In light of this fact, reputation plays an important role in the incentive calculus. But, as discussed above, the reputational gains and losses are also highly attenuated from performance. This creates the possi- bility of large welfare gains from improved incentives for directors. a. Compensation incentives Large, publicly held corporations generally pay directors a few hundred thousand dollars annually for their work and require directors to hold a fairly trivial amount of the corporation's stock.134 Microsoft is typical of very large, publicly held corporations. In 2011, Microsoft had a ten-member board, and each director was paid $100,000 in cash and granted stock worth $150,000.135 This mix of cash and stock is designed to give board members a stake in the outcome of their decisions, while compensating them for the time they spend preparing for and in board meetings. Although the stockholding requirement undoubtedly gives board members some incentives to care about firm value, the amounts are routinely so small that critics believe they do little to optimally align shareholder and board incentives.136 Under the BSP approach, compensation may look much as it does today or could be quite different.137 For instance, if a BSP assigns a number of individu- als to serve as permanent board members, the firm might simply replicate the current pay structure of the underlying client company, paying a fixed salary (equal to the company's current annual retainer) and requiring individual em- ployees of the BSP to hold equity in the client, as in the Microsoft example. If instead the BSP deployed a variety of professionals to a particular client de- pending on the situational needs, then one might expect the stock in the client to be held at the BSP level, and the payment to board members to be based on an algorithm tied to individual performance as a director for one or more firms. If the BSP and client opted for the full BSP model, with one or two liaison managers interfacing between client and BSP and the BSP itself serving as the board, we would expect compensation structures within such BSPs to resemble those of other consultancies.138 But there are some possibilities for innovation that could improve the in- centives of board services providers. One option would be for the BSP to take a much larger stake in the client company. A greater ownership stake by the board has the potential to improve incentive alignment, but there are two barri- ers to this with the current board structure. The first is that giving boards large upside stakes with limited downside risks skews decisionmaking in a socially undesirable fashion. The potential solution to this is discussed below. The se- cond is that individual, part-time board members are not well positioned to bear this kind of risk, and their work does not routinely justify such large stakes. Hiring a BSP could help address these concerns. Because of risk pooling, greater reputational stakes, greater efficiency, and so on, a BSP could hold a much larger stake in its client than the sum of the stakes held by individual board members. This prospect raises a potential analogy to the private equity model of gov- ernance. One of the chief virtues of the private equity industry is that it consol- idates the ownership interests of the firm, and thus helps undo the harms that flow from the separation of ownership and control.139 Managers of private- equity-owned firms have a tremendous economic stake in the success of these firms, and therefore, it is thought, better incentives to take care and make good decisions.140 A downside, however, is that the improved governance only ob- tains when the entire firm is taken over, and the public shareholders are dis- placed. A market for corporate governance could be a half step in this direction, since we could see BSPs taking a larger stake in the client company than cur- rent board members but without having to take over the entire company. BSPs could bear more risk than individual directors, and would likely be willing to have an interest in greater economic ownership than the current, rather low lev- els of current board ownership. For instance, Microsoft's directors are required to hold stock equivalent to three times their board services fee of $100,000. As of April 2014, this means the board was required to hold about 0.0003% of the total value of all shares of Microsoft.141 Accordingly, even if a BSP took just a one percent stake in its client, on top of any service fees, this would amount to a thousandfold increase in incentive alignment of Microsoft's board.142 We could go further, and expect BSPs to do so as the market evolves and the initial design and conflict issues are resolved, in the direction of giving BSPs greater stakes to the residual corporate claims. One possibility would be for companies to hold an auction for board services on a periodic basis (e.g., annually or biennially) in which rival BSPs would compete to win the work. In an auction model, the company looking to hire a BSP would write a board ser- vices contract specifying the financial and other terms of the deal. For instance, the company might offer the winner of the auction a portion of the residual claim on the firm's assets, such as a guaranteed dividend or number of shares. BSPs would then submit bids for the minimum amount of dividend or shares they would take in order to perform the work. This would have the dual virtues of giving BSPs greater incentives to perform by making them hold residual claims on firm value and making BSPs compete in a transparent way for the board role. Another potential change to the compensation structure was alluded to above in the discussion of vertical integration of the board services industry. Firms pay a lot more for board services than simply the cash and stock issued to directors. Firms buy directors insurance, self-insure for certain claims against directors, and, as noted above, hire various consultants, accountants, lawyers, and other experts to assist the board in fulfilling its duties. Consider again the case of Microsoft. For a company of Microsoft's size and industry, directors and officers (D&O) insurance costs about $4 million, or about $400,000 per di- rector.143 In addition, Microsoft's corporate charter, like that of most firms, contains a provision indemnifying directors against breaches of the duty of care.144 This self-insurance is difficult to quantify, but is likely a significant cost as well. Additionally, boards routinely hire experts of various kinds, in- cluding management and compensation consultants, law firms, and other ser- vice providers. While there are no good estimates of these costs, there is reason to believe they are in the range of several million dollars per firm per year. All told, for example, Microsoft pays at least $2.5 million for board services, plus a minimum of several million more for insurance and other services, making the total cost of director services nearly $10 million per year. If Microsoft's costs are typical, this means the director services market-for just the Fortune 500 firms-is a $3- to $4-billion-per-year industry. Costs for smaller firms likely are lower, but given that there are about 15,000 publicly traded firms in the United States,145 if the average publicly traded firm has just $1 to $2 million in direct and indirect director costs, there is the potential for a $15- to $30-billion- per-year BSP industry. That this huge industry is delivered entirely through the actions of a group of part-time, sole proprietors is surprising. As noted above, there are likely sig- nificant gains to be had from industry consolidation across the supply chain. This could mean that BSPs would house some combination of decisionmaking, insurance, and support in one corporate body. In terms of compensation, the payment for board services could reflect this combination of services, with BSPs bidding on multimillion-dollar contracts. There are a few potential posi- tive effects of this. First, the significant size of these payments would likely be sufficient to justify the creation of BSPs and to generate competition amongst them for a given board services contract. The vertical integration would help create a vibrant market for corporate governance by raising the stakes of taking over the board. Second, this model would increase the transparency of board costs for shareholders, who currently do not have good information on the total costs of boards. Third, the introduction of potentially more efficient competi- tors in this space might have the effect of driving down board costs, while hold- ing constant or improving corporate governance. b. Liability-based incentives We think the use of BSPs may also have salutary effects on the quality of corporate governance through improved judicial supervision of board activities. Courts may be more willing to hold BSPs liable than individual directors, and this could help make fiduciary duties more robust. The logic is straightforward. As noted above, directors are independent amateurs without deep pockets, but face enormous potential liability for the decisions they make. For instance, the sloppy approval of a merger could subject directors, including individual direc- tors, to multimillion-dollar liability, not to mention the significant risk to their personal reputations. Courts seem reluctant to impose liability on directors,146 perhaps increasingly so in recent years.147 This could be because of institution- al competency concerns, worries about hindsight bias, the potential chilling ef- fect on risk taking, the reluctance to hold individuals (some of whom are not extremely rich) liable for potentially huge damage awards, and the potential impact of increased liability on the supply of individuals willing to provide di- rector services. Whatever the reasons, if directors form associations to share risk, this reduces the potential negative cost on individuals, and thereby may increase the willingness of courts to impose liability. To see the point, consider the impact that the availability of D&O insur- ance has on judicial enforcement of board duties. In the absence of any insur- ance, courts would be significantly less likely to find individual board members liable for breaches of their fiduciary duties. In this way, third-party insurance can, at least in theory, be a mechanism for enhancing compliance with law.148 Sharing risk (in this case through insurance contracts) reduces the costs of lia- bility for individual directors, and therefore may make a finding of liability more likely, all else being equal. The downside of insurance-the moral hazard or shirking problem-can be reduced through monitoring (both ex ante and ex post) and some risk bearing, in the form of deductibles or the like. Self-insurance in the form of organizational choice is simply an extension of this idea to areas of liability beyond those currently covered by contractual insurance. Directors who are able to pool their risk through a business form we call the BSP can reduce their risk. The ability to share, and thus reduce, risk is one of the most powerful reasons for forming a business association. A single individual running a business faces all of the risk if the business fails or gener- ates liabilities that exceed its assets. If all businesses were required by statute to be run by an individual acting as a sole proprietor, risk alone would work a se- rious impediment to the provision of all sorts of products and services. By forming a business association in which risk is shared among various owners, the business can take on more risk than could or would a sole proprietor. This is because some individuals will have greater risk tolerances than others, and the- se tolerances may not line up with other attributes that can be put to use by a firm.149 The additional liability would be doing work primarily in cases in which potential damages exceed liability coverage, since this is the extensive margin where courts are most likely to feel whatever pressure they feel to take it easy on misbehaving directors. The existence of insurance for breaches of certain fiduciary duties already reduces the downside for directors, and therefore makes judicial supervision more robust than it would likely be in the absence of insurance. The additional risk reduction from operating as a business associa- tion would therefore act mostly in those cases in which the expected liability exceeds the insurance coverage. This could be either for large damage awards or for certain actions usually not covered by insurance, such as breaches of the duty of loyalty. The risk sharing of organizational choice may also do some work in cases in which the conduct is completely covered by insurance. There is reason to be- lieve that the D&O insurance market does not work optimally,150 and adding self-insurance or replacing the D&O model with self-insurance could help make corporate liability more effective. While one would expect insurance costs to discipline firms, it is not obvious this translates readily into the market for director talent, since liability is so rare, it is not often linked with necessari- ly bad behavior, and, in any event, the labor market for directors is thought to be so dysfunctional.151 Directors do not bear the liability personally, except in the rarest and most extreme circumstances, and there is some evidence that di- rectors' reputations, which we expect to provide most of the discipline, are not highly correlated with past performance. There is also some evidence that in- surance prices do not obviously respond to incidents of director liability.152 Bringing the insurance function within the firm providing the service (either through vertical integration of the D&O function or simply through risk pool- ing inherent in providing services through firms) may improve the pricing of risk and the judicial treatment of defendants. Not only might the BSP model make courts less reluctant to impose fiduci- ary duties on boards, but the corporate model for boards is also likely to gener- ate more fiduciary duty litigation. Every allegation of serious board misconduct is likely to result in multiple suits: one by the company against the BSP and one by the shareholders of the BSP against the directors of that firm. The addition of the second type of suit could work as an additional deterrent to board mis- conduct, malfeasance, and gross negligence. Of course, if one believes that the current amount of litigation is optimal (or even excessive) because directors face the perfect incentives to behave well, then additional liability may add costs in excess of the benefits. c. Reputational incentives Another benefit of our model is that it will increase the reputational stakes of every board decision, meaning more incentive for good work, all else being equal. Reputation is already an important element of the corporate governance regime. Harnessing the reputation of directors to prevent cheating and shirking is a vital element of effective corporate governance.153 Lawsuits, whether set- tled or reduced to judgment, alleging disloyalty or insufficient care by directors can harm directors' reputations.154 This can cost directors their position on the board in question or seats on other boards, either now or in the future. Since di- rectorships are lucrative given the little work, and one done well usually leads to another,155 a director's reputation could be worth several hundred thousand dollars per year or more. In addition, lawsuits may result in more general losses to directors' reputations in their other endeavors, be they in business, law, aca- demia, politics, or other fields. Modern corporate boards often have directors who have made large investments in their reputations, and these directors can be expected to act in ways to minimize the collateral damage from misbehaving as a director.156 For instance, the Enron board famously included the former dean of the Stanford Graduate School of Business, three CEOs of other compa- nies, political luminaries from the United Kingdom, and the former head of the M.D. Anderson Cancer Center.157 These are important positions that these di- rectors worked very hard to achieve, which adds to the reputational hit for di- rector wrongdoing.158 Some scholars believe reputation is the most important constraint on direc- tor behavior and that it alone can induce efficient board conduct.159 Others, pointing to failures by boards filled with individuals with seemingly valuable reputations, note that the evidence suggests reputation is not doing all the work necessary to ensure good governance.160 Of course, the existence of some cor- porate failures does not mean directors are engaging in suboptimal care levels or that reputation is not sufficient; the optimal level of governance failure is not obviously zero. But we need not resolve this debate to demonstrate the value of BSPs. Reputation and legal sanctions are complementary mechanisms for policing corporate decisionmaking, and as noted above, there is reason to believe legal sanctions are likely ineffective at inducing optimal actions by directors. The business judgment rule may be the optimal rule, but it surely lets some sloppy and self-serving transactions happen without scrutiny. Accordingly, the more work that reputational sanctions can do, the less work that law needs to do or the less we need to worry about judicial enforcement of director duties. From the current baseline of whatever work reputation is doing, greater reputational stakes can only improve governance, especially since it can relieve pressure on courts to police corporate decisions. In theory, the size of reputation, and therefore the work done by reputa- tional assets in disciplining behavior, is correlated with the number of individu- als whose reputations are influenced by a particular decision. This is because for associations providing services, "the reputation of the entire firm is at stake whenever a single [service] is sold."161 If an individual makes a decision, then only the individual's reputation is at stake; if a firm of one hundred individuals makes the same decision, the reputation of the entire firm is at stake. If each of the individuals has the same amount of reputation, the stakes are one hundred times greater in the case of a firm making the decision. Of course, the full repu- tation of each person in a large organization may not be reduced in the event of a failure, but the net impact of reputational losses is likely increasing with the number of individuals comprising the decisionmaking entity.162 Therefore, a significant advantage of creating large business associations to provide services is that they can generate greater reputational assets than the sum of the individ- ual reputations at stake for a given transaction. The greater reputation at stake for a given transaction means higher-quality services. Reputation is a way of bonding the quality of a product or service, and, for a given level of legal scrutiny, the greater the firm's reputation, the more likely the product or service will be of high quality. The bonding theory of reputation holds that "[t]he more [services] sold, all things equal, the more valuable is a reputation for high quality, and thus the stronger is the reputation- al bond to provide high quality."163 Therefore, as a matter of reputation theory, there is reason to believe BSPs will be able to provide higher-quality services than individual board members acting as a group of sole proprietors. Associa- tions of individuals can better commit to quality than individuals acting alone or as a loosely affiliated group.164 Larry Ribstein applied this bonding argument to the law firm setting,165 which is closely analogous to the board services model we propose. Ribstein argued there was a strong relationship between reputation and the size of a pro- fessional services firm: the larger the firm, the greater the cost of reputational losses, and therefore the stronger commitment to quality.166 Applying the in- sight of Ronald Coase, Ribstein noted, however, that increasing size also adds organizational costs. Accordingly, professional services firms will increase the number of professionals until the point at which the marginal cost of monitor- ing an additional professional for quality equals the reputational gain from add- ing the professional.167 It is highly unlikely that this equilibrium point is a sin- gle professional, as state corporation statutes require for the provision of board services. In a recent paper, Edward Iacobucci extended Ribstein's work, pointing out some additional downsides of size. Although Iacobucci started from the posi- tion that business associations "are better able to commit to providing high quality for reputational reasons than sole proprietors,"168 he noted that size has an additional cost beyond monitoring-large size "increases the short-run prof- its from sacrificing reputation and providing low-quality service" in an individ- ual case.169 For large firms, the negative effects from cheating fall on a per- service basis as the size of the firm grows. In addition, the transparency of cheating is reduced across a very large firm, as clients in one part of the world may not learn about poor performance in another part of the world, as they would for much smaller firms.170 Iacobucci resolved this tradeoff by providing conditions in which the reputational gains from scale outweigh the potential for reputational opportunism. For instance, the long-term gains are greater than the short-term opportunism where services are provided nonsimultaneously, such that each sale risks the reputation of the entire firm, but the gains from cheating are limited to a single product or service.171 Giving partners in the association an equal stake in the outcome also ameliorates the potential risk of short- termism. Applying this model to professional services firms, in his case law firms, Iacobucci concluded: "To the extent that the firm adopts profit sharing, a partner's incentives to provide low quality are weaker than a sole proprietor's. This in turn makes a larger firm, all things equal, better able to commit to main- taining a reputation for high-quality legal service."172 The conclusion that size leads to higher quality because of investments in reputation is supported by empirical evidence in the case of law firms. Profits per partner, a standard measure of law-firm quality, are generally higher for larger law firms.173 Larger law firms also perform better along other metrics of quality. For instance, Marc Galanter and Bill Henderson found that ethical vio- lations are more common for sole proprietors and small firms than for larger law firms.174 Other work by Henderson found more equal sharing of profits by more prestigious law firms, which is consistent with Iacobucci's claim about profit sharing being an important check on opportunism.175 As Iacobucci con- cluded, all of these "findings are consistent with larger law firms having better reputations, and thus consistent with the theory" about reputation increasing with firm size, but subject to limits that can be reduced through incentive struc- tures.176 The theory of reputations, subject to the caveats provided by Ribstein and Iacobucci, is as applicable to the provision of board services as it is to the pro- vision of legal, accounting, or consulting services. One can easily imagine a BSP of similar size to the large professional services firms in these other indus- tries. As noted above, the director services industry may consist of as many as 15,000 firms spending tens of billions of dollars per year on hiring, insuring, and otherwise supporting directors. If even ten percent of those firms switched to a BSP, one could imagine an industry arising with numerous large BSPs, each employing hundreds or thousands of professionals serving as corporate decisionmakers and support staff. This is not even considering the other indus- tries that are related to director services or provide services to directors that could easily be integrated into a larger BSP. For instance, companies or their boards routinely hire consultants or experts in tax, compliance, internal con- trols, auditing, strategy, and other areas. Many of these are billion-dollar indus- tries, and BSPs could theoretically provide some or all of these services, either directly or indirectly. In short, the potential for the creation of large, multibil- lion-dollar firms with significant reputational assets is not far-fetched. BSPs with numerous professionals, serving as directors, researchers, experts of vari- ous kinds, and so forth, would have a large reputation at stake in each transac- tion, and this would lead to higher-quality services, all else being equal.177 d. Exposure to market forces Effective corporate governance depends on ensuring directors are account- able for corporate decisions. This is done through several mechanisms, some internal and some external to the company. Businesses use incentive contracts and the power to reappoint directors, as well as reputational sanctions and legal liability. A related benefit of the BSP model is that BSPs would be more accounta- ble than the group of individuals currently providing board services; indeed, we believe that the accountability of the whole would be greater than the sum of the liabilities of the parts. We have already identified a variety of ways in which the BSP model would likely increase accountability: reducing the impact of personal liability through risk pooling, and thus increasing the robustness of fiduciary duties; providing a second-order accountability regime through the threat of suits by two distinct sets of corporate owners (i.e., both the owners al- legedly mistreated by the BSP and the owners of the BSP); and increasing the reputation at stake in each transaction. Beyond these, however, there is at least one additional way in which BSPs would likely be more accountable for bad performance than individual directors. Currently, there is a mismatch between decisionmaking authority and the mechanisms of accountability. Although board members vote individually on all corporate decisions, their actions are made and recorded as a group. This has the potential to undermine the efficiency of the market for corporate directors. The votes of an individual director are not made public, and therefore the abil- ity of shareholders or other corporate observers to hold directors accountable for their decisions is limited. Directors may get reputations in the market for director talent, but information is extremely limited, and the incentives of decisionmakers (e.g., CEOs) may be misaligned with those of shareholders. In part for this reason, critics have pointed out that the market for independent di- rectors is not well functioning. Gilson and Kraakman describe the argument that market forces discipline the choice of outside directors as a "myth" akin to a belief in "directorial noblesse oblige."178 There is effectively no robust mar- ket for board seats based on externally measured performance. This means that internal metrics, like the CEO's preferences, will determine who sits on the board. There is some evidence suggesting the market for directors is not function- ing as robustly as possible. Steven Kaplan and David Reishus examined wheth- er the performance of CEOs influences their ability to earn and retain seats on the boards of other companies.179 They found that CEOs of companies with large dividend cuts (as a proxy for poor performance) are less likely to serve on the boards of other companies, although they cannot distinguish between a the- ory of labor market constraint and a theory of choice by managers to spend more time on their own firms.180 Importantly, however, they find that while negative performance is correlated with serving on fewer boards, it does not result in board members losing their current board seats very often. The data show that over eighty percent of directors who are CEOs of poorly performing firms continue to retain their board seats at other firms four years after the poor performance, as measured by a dividend cut.181 The use of BSPs has the possibility to improve accountability by identify- ing a single entity as the decisionmaker, and by creating a more robust market for board services. Rival board services firms will likely compete for the work, creating a competitive market for governance that exists outside of and beneath the market for corporate control. As discussed below, for example, BSPs could offer their services to shareholders in a competitive election. If a BSP is provid- ing directors services to Acme and rival Board Services Inc. believes it can do the work better or at lower cost, it could bid for the work, either by convincing the individual responsible for nominations of its superiority or by going directly to shareholders in a proxy contest. Importantly, rival BSPs might have the financial incentive to compete for board positions in ways that individual directors currently do not. Currently, individual directors run as a slate, and any competition for individual places on the board happens behind the scenes, through networks, headhunters, building relations with management, and so on. This state of affairs has been criticized as leading to too much deference to management, since board members only get seats by pleasing the choosers.182 The competition does not happen in the open because it is not feasible or cost-effective for an individual board member or group of board members to run as a rival slate or for a particular seat in a proxy battle. Although it is theoretically possible for an individual wanting to serve on the board of Acme to communicate with all the shareholders of Acme urging them to vote to put that person on the board, the cost of identifying the shareholders, convincing them to support the candidate, and then obtaining their proxies would be prohibitively expensive. This is why the current model of board services generates competition only when votes for board members are linked to an economic stake in the firm. Running for a board seat or seats makes sense only when the economic gains from taking over the firm, and thereby having a claim on operational profits, generate sufficient benefits to offset the (large) costs of a proxy vote. In other words, the market for board seats is inexorably tied to the market for economic control of the firm. The BSP approach would delink these to a certain extent. The BSP model would reduce the costs of multiple board members coordinating to take control of a board, and would perhaps lower the costs of providing board services suf- ficiently to make it economically feasible to win a board election without need- ing an economic stake in the firm. Large BSPs could have economies of scale and a brand that would lower the costs of communicating their value to share- holders. It is not difficult to imagine a BSP becoming sufficiently well known, like a prominent law, auditing, or consulting firm, such that the costs of com- municating with and persuading shareholders would be dramatically lower than for individual board members. If Boards-R-Us is the incumbent BSP, and Board Services Inc. believes it can perform board services more efficiently (that is, better governance for the same cost or the same governance at lower cost), then it could inform shareholders of its intention to run for the job and stand for election at the annual meeting. Our approach would create market competition, in a sense, for board ser- vices without the need to change the economic structure or ownership composi- tion of the company. So, if Boards-R-Us is the incumbent board, and Board Services Inc. displaces it in a shareholder election, this would not have any im- pact on the underlying ownership of Acme's shares. It would be similar to Ac- me changing its accountants from KPMG to Ernst & Young. Although board members control the corporation in ways that accountants do not, this does not necessarily turn a contested board election into a battle for control of the firm in the way we think of what is at stake in today's market for corporate control. Today, because board elections are not competitive in the absence of an eco- nomic stake giving voting control to a corporate raider, changing the board and controlling the economic fate of the corporation are inexorably linked. In other words, if one wants economic control of the corporation, one takes a large enough economic stake to be able to control the election of the board. But in our imagined world, board elections would be competitive, even in the absence of insurgents taking large equity stakes in the firm. Board services would be awarded based on a majority (or supermajority or whatever voting rule the firm thinks makes the most sense) vote of the shareholders. Then, once board mem- bers (or, in this case, a BSP) are elected, they owe fiduciary duties to the firm's shareholders, which is true regardless of the associative type of the board. e. Measurability Another benefit of using a BSP is that it may make measuring board- governance quality more straightforward. A significant problem in reaching the goal of improved corporate governance is our inability to measure governance quality at particular firms. This is because "governance" is not something that can be measured precisely in the abstract, since it is conflated with operational performance. Firms are valued based on their operational performance-that is, their ability to generate cash, not on whether they have "good" or "bad" gov- ernance. Although governance and performance might be correlated in some cases, this is not necessarily the case; some "good" performing firms could im- prove their governance, and some "bad" performing firms undoubtedly have great governance. Shareholders, academics, and other corporate observers try to measure governance in a variety of ways, all of which have limitations. First, we can at- tempt to measure the quality of firm governance or a particular governance change (e.g., the appointment of a board member or the declassification of a board) by estimating the impact of the announced change on the firm's overall value. The use of event studies is a widely accepted technique for doing this, but these studies are also subject to many criticisms, not the least of which is that they will not work for small changes to governance that would not be ma- terial to shareholders. In addition, there may be confounding variables, and the results may be noisy and subject to design criticisms. For individual firms, op- erational performance may make governance less salient or important for shareholders. Second, most of the studies of governance do not consider the value for a particular firm or director, but rather involve the decisions by many firms on a particular issue, like whether to have a classified board, whether to separate the role of chair and CEO, and so forth. These studies, while valuable, suffer from the same problems identified above, as well as endogenous factors and causa- tion-direction concerns, and the possibility that they cannot identify local max- ima in broad trends. The use of BSPs could help us better measure board performance separate from the operational performance of the underlying firms. This would be possi- ble, for example, if a group of BSPs provided director services to multiple companies. The stock price of the BSPs would reflect the market's judgment about the quality of these services for a basket of companies. Assuming that the operational performance of these companies was not perfectly correlated, it would be possible to get a better estimate of the quality of governance. Of course, this metric would be imperfect, as governance and operational perfor- mance may be impossible to untangle perfectly. But market-traded BSPs would give us more information about governance quality than the current "market" for director services, which is not transparent and not priced directly by the market. To be sure, directors occasionally serve many firms, and one could try to estimate the market value of directors who do so. But the trend is against multiple directorships, and, in any event, there is no market pricing in the way that publicly traded BSPs would be priced. B. Board Functions In the previous Subpart, we examined ways in which BSPs could help re- duce the pathologies of the current board model of corporate governance. We think the case is strong that BSPs could deliver, at least in some instances, bet- ter corporate governance at lower costs. In this Subpart, we offer some addi- tional reasons that justify permitting experimentation with the BSP model. These reasons track the discussion in Part I, where we discussed the functions played by the modern board: management, service, and monitoring manage- ment. In each of these areas, the BSP has the potential to make improvements or at least do no harm. 1. Managing the firm One of us has elsewhere argued that corporate law favors multimember boards because groups are better than individuals are at the sort of critical eval- uative judgment that characterizes most board decisions.183 While it might seem that a BSP might undermine this by consolidating the multimember board into a single decisionmaking point, this is not necessarily the case. If the client opted to have multiple representatives of the BSP serve as its board (or on a mixed board184), the board itself would continue to function as a group decisionmaker. If the client opted for the pure BSP model, the team within the BSP servicing that client would continue to use group decisionmaking as part of its process. In short, in both cases, multiple individuals will be analyzing and voting, either directly or indirectly, on a particular course of conduct. We see no reason why this group decisionmaking process need take place among sole proprietors serving as board members instead of among employees of a BSP. Furthermore, as noted in Part IV below, state corporate law has moved away from a requirement that boards consist of multiple members, and this suggests that the group decisionmaking benefits may not alone justify the statutory bar on BSPs. At the same time, for the reasons discussed in Subpart A above, we expect that BSPs would make better decisions than current boards. They would have better information, access to specialists with fewer conflicted interests, more person-hours available for exercising judgment, better incentives, and so on. The BSP thus combines the advantages of group decisionmaking with a group composition likely to be better informed and motivated. 2. Providing services As noted in Part II, board members provide various services to their clients, including access to capital, information about industries, experience as CEOs, and so forth. But this alone cannot justify a bar on the use of BSPs. It is possi- ble that particular BSPs will not be able to provide as diverse a set of networks as can a multimember board of unrelated individuals. For some firms, the im- portance of, say, access to a network of investors, may be sufficient to out- weigh the benefits of hiring a BSP. For that firm, for that particular time in its life cycle, there is nothing in our proposal that requires the use of a BSP. More- over, we see no obvious reason why a BSP may not be able to provide these services. For one, modern-day consulting firms and investment banks provide important networks of information and access for companies without relying on individual contracts as in the board model. Large BSPs comprised of hundreds or thousands of professionals, including many individuals currently serving as board members, could likely do the same thing. If current or former CEOs are valuable members of companies' decisionmaking processes, their services will be demanded by BSPs, which could hire them on a permanent or ad hoc basis. Finally, where this is not feasible, a BSP could serve as a matchmaker between clients, just as investment banks often do.185 One final point is worth mentioning. While the current composition of boards may be optimal, opening up new possibilities through the BSP innova- tion may reveal benefits previously unappreciated. The BSP may be superior to current boards at advising CEOs, since the BSP will have better information, better incentives, and specialists on call. While one might object that if this were the case, companies would already be deploying them, as we note below, the current situation may be an artifact of law and the stickiness of the status quo more than a reflection of a first-best equilibrium. 3. Monitoring management The final key function of modern boards is to serve as a monitor of management. In this role, there is an argument that corporate law favors multi- member boards because such boards provide a mechanism for horizontal moni- toring that solves the monitoring problems inherent in a vertical hierarchy. A hierarchy with governance structures that provide only vertical monitor- ing cannot resolve the problem of who watches the watchers. Putting a group of equals at the apex of the hierarchy offers a solution to the problem because the group engages both in vertical monitoring of its subordinates and in horizontal monitoring of one another. In the latter capacity, the internal dynamics of group governance constrain self-dealing and shirking by individual team members and, perhaps, even by the group as a whole.186 As with the board's managerial functions, a BSP contains mechanisms for group decisionmaking that help replicate the advantages current boards receive from organizing as a group. Likewise, the enhanced incentives and superior motivation associated with a BSP should help it be a superior monitor com- pared to current boards for the reasons discussed above.187 IV. BSPS AND THE LAW Current law provides numerous obstacles to effecting our proposal, all of which therefore require rethinking. The most obvious hurdle is the requirement of state corporation law that directors be natural persons. The Delaware Gen- eral Corporation Law, for example, flatly states that each member of the board of directors "shall be a natural person."188 The Model Business Corporation Act (MBCA) effects the same result in a somewhat more roundabout fashion. Section 8.03 states that a board "must consist of one or more individuals,"189 while section 1.40(13) defines individual as "a natural person."190 In either case, "legal persons," such as corporations and other forms of business organi- zation, clearly cannot serve as members of a board or as a replacement for the board.191 Even if a firm wanted to hire a BSP to provide board services and be accountable under state law for board decisions, they could not do so, even with shareholder approval. The natural person requirement thus falls into a very small category of mandatory corporation law rules. As we will show below, we think it does not deserve such special treatment. The listing requirements of the various stock exchanges follow state law. This makes logical sense, since it would be odd for the requirements for being a public company to be incompatible with the state-law requirements for being a lawful company. Listing requirements have typically served to narrow the range of potential governance arrangements, rather than broadening them be- yond what is otherwise legal. For instance, the NYSE Listed Company Manual requires the board of any listed company to be composed of a "majority of in- dependent directors,"192 and the independence test requires each director have "no material relationship with the listed company (either directly or as a part- ner, shareholder or officer of an organization that has a relationship with the company)."193 In addition, the listing rules require boards to have compensa- tion, audit, and nomination committees, all composed entirely of independent directors.194 The rules also implicitly contemplate that directors shall be natural persons by drawing a distinction between "persons or organizations."195 Taken together, these rules seem difficult to reconcile with a model in which an entity serves the entire board function. Federal law also seems to presume service by individual directors acting as sole proprietors. Although no statute specifically requires directors to be natural persons, the premise of recent reforms following the accounting scandals of the early 2000s and the financial crisis of the late 2000s is service by individual di- rectors acting alone. For instance, the rules implementing the Securities Ex- change Act of 1934, as amended by the Sarbanes-Oxley Act, require "inde- pendent" directors to constitute a majority of firm audit committees, and the definitions of independence seem to envision individuals acting alone.196 The response to board failures to monitor firm accounting practices was to make sure board members were more independent of the firm and each other. A simi- lar approach was taken in the Dodd-Frank Act in response to allegedly irre- sponsible compensation practices at publicly traded firms during the run up to the financial crisis. For instance, section 952 of the Dodd-Frank Act requires the SEC to direct the stock exchanges to adopt listing rules requiring greater independence for board members serving on compensation committees.197 The statute, SEC rules, and listing requirements all accept the sole-proprietor model of board services.198 The case for effecting the necessary legal change is fairly straightforward. State corporation statutes consist mostly of default rules that can be changed by firm owners.199 State law thus provides an off-the-rack set of default rules re- garding basic corporation law, but generally allows firms to vary widely in their approach, so long as the divergences are set forth in the corporate charter and are effectuated in ways consistent with law (for example, done with share- holder consent).200 For instance, the Delaware General Corporation Law pro- vides that a board of directors shall manage firms, "except as may be otherwise provided in . . . its certificate of incorporation."201 It is curious that Delaware thus allows corporations to substantially modify the role of the board of direc- tors-and even to opt out of the board model-but mandates that boards consist solely of natural persons. In contrast, our reform brings the statutory rules gov- erning boards even closer into alignment with the fundamental enabling princi- ple of state corporate law. Viewed in that way, several analogous legal developments suggest them- selves. First, unincorporated entities (that is, partnerships, LLCs, and the like) typically should be permitted to have business associations serve in the man- agement role played by a corporate board of directors for corporate entities. For instance, limited partnerships are managed under the direction of the general partner, and state laws typically permit limited partnerships to have corpora- tions or other business entities serving as their general partner.202 The policy of allowing non-natural persons to manage the affairs of partnerships is designed to encourage free contracting, which allows governance to be tailored to partic- ular circumstances and to permit markets that are more complete.203 The driv- ing force, however, is limited liability.204 Many limited partnerships in Dela- ware and elsewhere take advantage of this flexibility to use firms as board equivalents. This suggests that there is a latent demand for governance to be performed by business entities, instead of individuals, for some companies. The same rules apply for other unincorporated entities, such as limited liability companies and business trusts. Indeed, the Delaware Limited Liability Compa- ny Act and the Delaware Statutory Trusts Act are based on the Delaware Lim- ited Partnership Act205 and permit business associations of all sorts to serve in the managerial or board of directors analog role.206 Second, the definition of "director" in the Investment Company Act (ICA) includes incorporated entities. Section 2 of the ICA defines a director as "any director of a corporation or any person performing similar functions with re- spect to any organization, whether incorporated or unincorporated."207 In Chabot v. Empire Trust Co., the Second Circuit held that an incorporated in- vestment company manager was a director for purposes of the ICA.208 In so holding, the court noted that Empire, the corporate entity in the case, was em- powered by the trust certificate to act with all the powers of a typical director, and this therefore brought it within the definition in the ICA.209 The fact that Empire was a corporation was not a barrier to it acting like or, for purposes of the ICA, being treated as a director. What mattered to the court was function, not form, and so long as the corporation was acting as a director would, the law would consider it a director. Third, the Supreme Court has construed portions of federal securities laws broadly to include corporations acting as directors. In Blau v. Lehman, the Su- preme Court held that for purposes of liability under the short-swing profit rule in section 16(b) of the Securities and Exchange Act of 1934, a corporation may be treated as a director if it effectively deputizes a natural person to perform its duties on the board.210 The Court explained that whether a company is a direc- tor by deputization is "a question of fact to be settled case by case and not a conclusion of law."211 The takeaway from this case is that if the policy ra- tionale behind a particular law would be served by treating a corporation as a director, then courts will be willing to look at what the entity was doing rather than whether it was an individual. Fourth, policy considerations have led most states to abandon the require- ment that boards have multiple members, thus opening up the possibility of corporations or other business associations serving the board function through a single seat. Until 1969, Delaware required that the board of directors of corpo- rations with more than three shareholders have a minimum of three mem- bers.212 In 1969, however, the Delaware General Corporation Law was amend- ed to permit all corporations to have single-member boards.213 The MBCA likewise permits single-member boards.214 The shift to permitting single- member boards was driven by concerns about the governance of close corpora- tions. As the drafters of the MBCA explained, requiring close corporations with one or two shareholders to have a minimum of three directors could "require the introduction" to the board "of persons with no financial interest in the cor- poration."215 But we think the application of this logic could easily be extended to accommodate our proposal for BSPs. Since states are willing to forego the advantages of multimember boards by allowing single-member boards, they ought to be willing to allow a BSP to serve as that single member. Fifth, the Bankruptcy Code permits corporate entities to serve in roles analogous to the board of directors. Trustees are empowered by the Code to represent and manage the estate as would the board of directors.216 Section 321 then sets forth the eligibility requirements for trustees: "A person may serve as trustee in a case under this title only if such person is an individual . . . or a cor- poration authorized by such corporation's charter or bylaws to act as trustee, and, in a case under chapter 7, 12, or 13 of this title, having an office in at least one of such districts."217 As these examples suggest, hiring a firm to provide board or board-like services is not as radical a change as it may appear at first glance. To the con- trary, this precise model is permitted in many related areas. The inescapable conclusion from this set of examples is that legislators, courts, and other regula- tors are willing to accept or even encourage corporate entities to act as directors or boards when the firms are serving director functions and the policy rationale for a particular application (such as the insider trading rules) warrants such treatment. In short, where there are good policy reasons to tolerate BSPs, we see the law tolerating them. We see no reason why the same should not be true for BSPs of corporations. V. EXTENSIONS In this Part, we consider a few potential modifications or extensions of the Boards-R-Us model of corporate governance. The examples below demonstrate the flexibility of the model to achieve various and disparate governance ends. We demonstrate how the BSP could be used to achieve greater shareholder power or greater managerial power, for example, depending on how it is de- ployed. Our point here is to show that the BSP is just a tool, not a means to- wards a particular end result. We believe that it is potentially a very useful tool, however, as using the BSP model likely will allow various governance innova- tions to be implemented at lower overall cost and with greater transparency and accountability than the current model. A. Shareholder Access to the Proxy As a theoretical matter, competition for board control could improve gov- ernance and thereby increase firm and social value.218 A proxy contest that threatens to remove all or part of the current board, and thus management as well, provides an incentive for board members and managers to take care to avoid the contest, and therefore reduces agency costs.219 Under the current board model, however, there is a very limited threat of a proxy fight.220 This is because the competition for board seats is, because of its cost, currently em- bedded in the market for corporate control. As noted above, anyone can run for a board seat, but bearing the cost of identifying, contacting, lobbying, and tally- ing the votes of shareholders is prohibitively expensive for the gain of a single board seat. Accordingly, proxy contests are usually conducted only when those seeking control of the board are holders of large economic stakes in the firm, and therefore have more to gain from controlling the board than just the cash flows from governance. The Holy Grail for many corporate governance reformers thus has been ob- taining shareholder access to the corporate proxy.221 Subject to varying re- strictions and exceptions, proxy access proposals typically would allow share- holders to nominate one or more slates of directors whose names would be placed on the corporation's proxy card.222 There is some evidence that giving shareholders access to the proxy to create more governance competition would increase firm value.223 The Dodd-Frank Act accepted the premise of these pro- posals and specifically authorized the SEC to adopt rules that would allow shareholders greater access to the corporate proxy for purposes of creating more competition for director seats.224 In 2010, the SEC promulgated Rule 14a-11, which gave shareholders (either individually or as a group) that have held at least three percent of a company's voting shares for at least three years the right to include their nominees for up to twenty-five percent of the available board seats in the company's proxy materials.225 The D.C. Circuit vacated the rule, however, because the SEC failed to do a sufficient cost-benefit analysis of the rule,226 meaning shareholders still have to bear their own expense in mount- ing a proxy battle. Our proposal would open up the possibility of shareholder access to the proxy without necessarily requiring a new SEC rule. The BSP model readily could be modified to facilitate competitive board elections. To increase compe- tition, corporations could specify in their articles of incorporation a nomination and election process designed to create competitive elections. One option would be for someone, say the CEO, to nominate two (or more) firms to run at each annual shareholder meeting. Shareholders would then choose a firm to serve as the board for that year. Annual turnover might be too frequent, so one can imagine companies prescribing in advance a minimum term (subject to re- moval by shareholder vote), such as three years. This approach could be modified in numerous ways to make elections more or less competitive, more or less under managerial control, and so forth. For instance, if criticisms about excessive managerial control are true, in gen- eral or for a specific firm, the process of choosing the firms competing to pro- vide board services could be insulated from managerial domination, either by statute (if the former) or by corporate charter (if the latter). For example, firms could be required or permitted to have large shareholders who have held their shares for a specified period nominate BSPs to stand for shareholder election at the annual meeting. A minimum number of names, say, two, would be submit- ted on the firm's proxy materials to elect the BSP for that year (or longer, as the case may be). If the market did not give rise to the desired level of competition or share- holder involvement, a state law or new SEC rule similar to Rule 14a-11 could be used to achieve the desired result. Arguably, the objections to proxy access have less traction with respect to BSPs than with respect to individual directors. As one of us has elsewhere articulated them, those objections come in two gen- eral flavors.227 One is that proxy access inefficiently shifts the locus of decisionmaking about board composition to shareholders, who have an infor- mational disadvantage about the proper qualifications and fit of board mem- bers.228 The other is that electing a minority of directors will lead to factions on the board representing different shareholder interests, thus impeding board functioning and decisionmaking.229 Although the BSP model still suffers to some extent from the first problem, we think it is likely that shareholders will have better information about BSPs than individual board candidates, especial- ly if publicly held BSPs arise and the market can price their skill set. The BSP model arguably does even more to reduce the magnitude of the second objec- tion, because it reduces the potential mischief of dissident directors elected off a short slate, while still using competition and shareholder voice to improve governance. B. Increasing Managerial Power The flexibility of our proposal is demonstrated by the fact that one could alternatively tweak the appointment and election rules to go not in the direction of shareholder empowerment but rather towards what one of us has elsewhere referred to as director primacy.230 To encourage an even more robust form of director primacy while simultaneously reducing the potential for shareholder disenfranchisement or abuse, one could imagine, say, fixed, five-year board terms for BSPs with no removal during that period (except for cause), but with mandatory rotation.231 This idea builds off a proposal by Martin Lipton and Steven Rosenblum for a quinquennial election for board members to give firm governance the time and insulation from the pressures of short-term investors to focus on creating long-term shareholder value.232 Combining this insulation with the idea of mandatory rotation might look something like this: a company would nominate at least two BSPs to stand for election. Shareholders would elect one to serve a set, say, five-year, term. During that five-year term, the BSP would have all the powers enumerated by Lipton and Rosenblum, as well as the limitations they proposed. For instance, the board could not be removed except for conduct that was illegal or amounted to gross malfeasance of duty. As such, the board would have the power to resist any hostile takeovers, since its control of the corporation for that period would be nearly absolute. Then, at the end of the five-year term, the incumbent BSP would have to rotate off and a new BSP would be elected. There is an analogy here to the mandatory rotation of auditors. After the accounting scandals of the late 1990s to early 2000s, the idea of mandatory ro- tation of auditors became a live issue. As of this writing, the Public Company Accounting Oversight Board (PCAOB) is considering mandatory rotation of auditors, such that an audit firm would serve a maximum number of years be- fore it would have to be replaced by another firm.233 One can imagine adopting this approach for BSPs, either alone or in combination with other governance arrangements. For instance, a firm could put in its charter or the legislature could require a mandatory rotation of BSPs after a set number of years. The ar- guments here for and against such a requirement are straightforward and are similar to those now being debated by the PCAOB with respect to account- ants.234 Mandatory rotation has the benefits of reducing capture by managers, bringing new ideas, and reducing agency costs. On the downside, any rule will be both overinclusive-forcing out competent boards-and underinclusive- allowing incompetent boards to remain in place longer than they deserve. One might think that a company would have the proper incentives to optimize how long a board stayed in place, thus making any mandatory rule unnecessary. While we think there are reasons to doubt companies' incentives are perfect, in the absence of some significant experimentation, it is far too early to propose a set time period as optimal, assuming one exists across many firms. The chief advantage of combining our idea with that of Lipton and Rosenblum is that the virtues of BSPs help reduce the potential objections to their quinquennial election proposal. BSPs would be more accountable, more agile and able, and more transparent in terms of performance, thus reducing the risks of giving them free rein for a period of five years. If courts impose strong- er fiduciary duties on BSPs (as we expect), boards are staffed with more capa- ble individuals, board performance in terms of governance is measured by the market, and BSPs have large reputational capital, there is less reason to suspect that reducing shareholder oversight to once every five years would result in more managerial slack or self-serving behavior. There are undoubtedly countless other ways in which the board services model could be used to achieve corporate governance improvements or chang- es. We leave these to future articles and the market for corporate governance to determine. VI. OBJECTIONS In this Part, we briefly address two significant objections to our proposal. Some may argue that our burden is a heavy one because the limitation of eligi- bility to serve as a corporate director to natural persons is ubiquitous and longstanding. We have shown a strong affirmative case for BSPs, however, and in this Part we show that the case against them is surprisingly weak. A. Limited Liability One objection to our proposal is the potential mischief arising from allow- ing board services to be provided behind a cloak of limited liability. Although commentators generally agree that fiduciary duties are an imperfect mechanism for policing corporate decisionmaking, the concern would be that legalizing BSPs would further undermine whatever work the duties of care and loyalty are now doing. As mentioned above, there are two countervailing impacts of lim- ited liability for directors. On the one hand, limited liability could be thought to decrease the incentives for the directors to take care, since its owners will not be liable beyond their capital contribution. On the other hand, there are well- known benefits of limited liability, which make it widely accepted for the pro- vision of all types of goods and services. Limited liability may make judgments against corporate entities more likely because judgments against limited liabil- ity firms may be more acceptable to courts. Limited liability also encourages shareholder investment, since investors need not worry about their private wealth being endangered and do not have to worry about monitoring each other to reduce the risks of joint and several liability. We've addressed much of this concern above, showing how the use of cor- porations as boards is likely to increase legal and nonlegal constraints on board misconduct. For instance, large BSPs will be composed of numerous individu- als with human capital and reputational assets in the firm, and these will be lost if the BSP fails. This reputation multiplier has been shown to do significant work in reducing opportunism by firms. So here we will take on another related objection-the infinite regress problem. A firm serving as the board of another firm, and so on through many layers, could result in liability being dissipated completely in corporate shells. We can think of the problem as suggesting the need for some individual to ultimately be liable for the conduct of any firm. This is, however, an objection about limited liability generally, as it would equally apply to the current rules allowing the general partner of a limited part- nership to incorporate, not about limited liability in the context of BSPs. In all cases in which limited liability is used, moreover, there are mecha- nisms in place to help reduce the chance that the corporate fiction is used to de- liberately shield misconduct. First, private ordering could ameliorate this prob- lem. There is nothing that prevents companies that hire BSPs from requiring these firms be well capitalized, have insurance or post a bond, or agree to be bound by fiduciary duties that run to the owners of the BSP. Reputation can al- so play a complementary role, since both the hiring firm and the BSP are likely repeat players with incentives not to cheat. It is the combination of contract and monitoring by investors and consumers that provides the primary mechanism for reducing the downside of limited liability in other areas, and it can do some work here too. Second, there are legal tools available to catch those cases in which private ordering and market mechanisms fail to prevent fraud and abuse enabled by limited liability. Piercing the corporate veil, for example, is available to hold the owners of a firm personally liable in cases in which the courts determine the use of a corporate form is effectively just a fraud designed to externalize costs onto others.235 Piercing could be used in the case of BSPs, as it is used when firms provide other products and services. If a BSP met the test that justified piercing-for example, it is thinly capitalized, disregards corporate formalities, etc.-then holding owners liable would be possible. Thus, if a BSP were merely designed to reduce liability in an individual case without any of the offsetting benefits, the firm would be disregarded and the individual owners of the firm would be liable. Consider, for instance, a group of ten directors that formed a corporation solely for the purpose of avoiding liability. Assuming a company would hire them to provide board services without any guarantees, the BSP could, without veil piercing, lead to a worse outcome. But if the directors put no capital into the firm and did not respect the legal difference between the firm and the indi- viduals, courts would have no trouble holding the individual directors liable.236 Delaware precedents support this argument. In cases in which entities serve in roles similar to boards, the courts will disregard the entity when necessary to avoid allowing the entity to serve merely as a way of externalizing harm or reaping private benefits for those behind the entity. For instance, in In re USACafes, L.P. Litigation, the court looked through a partnership entity serving in a quasi-director role to individuals behind the entity.237 In that case, the lim- ited partners of USACafes, L.P. sued the directors of USACafes General Part- ner, Inc., its corporate general partner, for breach of fiduciary duty. The direc- tors of the general partner held 47% of the limited partnership interests and owned 100% of the stock of the corporate general partner. In the challenged transaction, the partnership sold its assets to a third party, which made a $15 million side payment to the directors of the general partner, which was alleged- ly a breach of duty to the limited partners. The defendants argued that while the general partner owed fiduciary duties to the limited partners, the members of the board of the corporate general partner owed no duties to the limited part- ners.238 The court rejected this argument, extending fiduciary duties to the in- dividuals behind the legal entity serving as the manager of the partnership. The court deployed the equitable tradition of looking to where control actually re- sided and noted that "[w]hen control over corporate property was recognized to be in the hands of shareholders who controlled the enterprise, the fiduciary ob- ligation was found to extend to such persons as well."239 This was necessary to avoid allowing a manager, like a general partner or BSP, to engage in a self-dealing transaction at whim. The court described it this way: Consider, for example, a classic self-dealing transaction: assume that a majori- ty of the board of the corporate general partner formed a new entity and then caused the general partner to sell partnership assets to the new entity at an un- fairly small price, injuring the partnership and its limited partners. Can it be imagined that such persons have not breached a duty to the partnership itself? And does it not make perfect sense to say that the gist of the offense is a breach of the equitable duty of loyalty that is placed upon a fiduciary?240 The USACafes doctrine has been extended to other analogous situations, such as the managers of LLCs and statutory trusts.241 The key point to recognize is that the arguments for limited liability for most businesses translate well to the provision of director services. If one be- lieves the virtues of limited liability outweigh the costs for regular business ac- tivities, like oil refining, pharmaceutical design, and air travel, then this calcu- lus should have the same bite for the provision of director services. Directors acting through a corporate entity are akin to the shareholders protected by lim- ited liability: they could worry less about risk, would not have to monitor each other, and so on. Limited liability thus serves as a rough analogue to risk pool- ing, which is a key benefit of our proposal. B. Sticky Equilibria Another objection is that firms are risk averse when it comes to governance innovations,242 and therefore even if legislators permitted non-natural persons to serve as directors, the current model might be quite resilient, even if not op- timal. As a practical matter, we know of no company that has challenged this requirement or lobbied to try to change it. This is not necessarily an indication that some firms might not benefit from such a change. Any firm that wanted to change the rule would have to bear all of the costs of lobbying or litigation, as well as the uncertainty in the market as the innovations were tried out, but would not be able to capture all of the upside relative to its competitors, who, after all, could simply adopt the new approach once it was accepted.243 So alt- hough we are not certain there would be demand for board services provided by firms as opposed to individuals, we do not think the absence of them is evi- dence of the lack of demand. The current equilibrium may be a suboptimal one and not the only possible one. The sticky equilibrium issue may be especially problematic, however, for two reasons. First, many of the benefits from the Boards-R-Us model of gov- ernance may be only available, or especially available, if large BSPs exist and are competing in a robust market for board services. There are many vested in- terests whose fortunes are tied to the current arrangement, and we expect they will resist upsetting the current equilibrium. As with the creation of any new market or industry out of existing ones, there will be transition costs, given the increase in uncertainty and need for experimentation and learning in the short run. Second, in jurisdictions in which corporate entities have been permitted to serve as boards or in board-like roles, BSPs did not arise naturally. For in- stance, in Hong Kong, unlisted private companies unaffiliated with listed com- panies were until recently able to have corporate directors. The experience in Hong Kong was not a good one. According to a report by the Standing Com- mittee on Company Law Reform, which proposed eliminating incorporated di- rectors, the use of corporate directors had two problems: the corporation serv- ing as director changed with frequency, "making it very difficult to know who was responsible for the conduct of the business of a company," and the lack of a person as a director made attaching liability to the director more difficult.244 For reasons discussed above, these concerns are not significant in a world with BSPs, but the creation of a market for governance is important to reducing their potential negative impact. We are confident that the robust activism of U.S. capital markets and the prominent role played today by investors and stake- holders in governance sufficiently distinguishes the United States from Hong Kong and the other jurisdictions in which corporate directorships (of a variety) have been tried. While our goal in this Article is not to plot the precise way forward as a practical matter, we think there is significant potential for vertical integration of the board services industry to generate profitable opportunities for BSPs. In ad- dition, the current existence of firms in this space-serving as consultants and advisors to existing sole-proprietor board members-means that the costs of vertical integration are lower than if new firms had to be created to start the in- dustry from scratch. The current corporate governance space is replete with ac- tivist shareholders, investors, good governance advocates, and pension funds, all of which may have an incentive to experiment with the BSP model, either by creating a BSP or by pushing companies to adopt them. If this is insuffi- cient, some encouragement or experimentation might be warranted. There is a literature on point,245 and we will not repeat the arguments here. We've argued for BSPs, both as a matter of theory and practice, and therefore think the case for them is strong enough to support steps to make them a reality. One mechanism for achieving some movement in the direction of a robust market for BSPs is the possibility that a court could hold managers of a particu- lar firm liable for failing to consider, if not hire, a BSP.246 If we are correct that hiring a BSP could bring substantial governance improvements, then for an un- derperforming company with an entrenched board, the failure to open the board up to competition from a BSP or a move to shut out a BSP from competing for control of the board could be viewed as a violation of managers' and board members' fiduciary duties. C. Special Interest Representatives One may object that the use of a BSP would make it more difficult for par- ticular individuals to serve on corporate boards. We noted above how the BSP model could accommodate the hiring of individuals with valuable connections, be they political, personal, financial, managerial, or otherwise.247 If a particular individual, say, the daughter of a political leader, would make a valuable addi- tion to the board of a particular firm, that same person could be hired by the BSP to work on the team serving the board function for that particular firm. This is true regardless of what value a particular individual is providing. Here, however, we address a particular objection, which is that institutional investors occasionally nominate board members in order to influence govern- ance of the firm.248 Although it is contestable whether such special interest di- rectors add value,249 assuming that they do, one could read our proposal as ef- fectively stripping investors of the ability to nominate board members, and therefore the board of its ability to directly represent a diverse set of interests. If one believes that the board serves an intermediating function for heterogeneous shareholder preferences, then this could be a significant cost of a move to BSPs. Even if special interest directors are not always positive for firms, they may be in some cases, and the hiring of a BSP could lead to the flight of institu- tional capital, especially where it would serve as a valuable constraint on man- agement failures. There are several responses. First, this is just one cost that must be weighed against the benefits of the BSP model. It may be, for instance, that the gains from increased competition for board seats are sufficient that the need for spe- cial institutional shareholder board seats is reduced or eliminated. After all, if institutional shareholders seek board representation solely as a mechanism for disciplining bad boards, an overall improvement in boards through the use of BSPs may obviate the need for special representation. Further, we would ex- pect these decisions of costs and benefits to be made by firms in the market for investor capital. If firms internalize the costs of governance, which we have every reason to believe they will, then they have the right incentives to maxim- ize this tradeoff. Second, special access to board processes for important firm stakeholders, be they investors or unions or the government, can be achieved by contract. If an institutional investor wants to access information or to be able to monitor management, it could contract with the company for this right, much as credi- tors contract with firms using various covenants that give them access to infor- mation or types of control. Alternatively, investors could intermediate their ac- cess or monitoring role through the BSP, by contracting for the information or monitoring function to be fulfilled by the BSP. Third, if contracting with either the firm or the BSP is costly or impossible, the investor could sponsor his own BSP to compete against the current board for the board services function. In a world in which the costs of changing or improving firm governance are lowered dramatically by this option, the value of special interest access to the board is greatly diminished. D. The Value of Personal Leadership There is also a Burkean objection that we've alluded to above: that is, the longstanding tradition of individual directors may suggest a deep wisdom about personal service that would be lost in the move to the BSP model. The objec- tion would go something like this: not only have boards since the days of the Dutch East India Company been composed of individual sole proprietorships, but also board members may simply be another category of leader that we think of as necessarily being individuals. For instance, the Constitution requires the President to be an individual person, and it would seem strange to suggest that we hire Presidents-R-Us to be President, even though many of the arguments advanced above could apply to that situation as well. The same could be said about a variety of leaders, from mayors to law school deans. One response is that our proposal is about corporate directors, not political leaders, and the cost-benefit calculation may be quite different in those cases. For instance, firms have to compete in various markets, and markets provide discipline for bad governance choices in ways that political leaders do not feel as intensely. We pick a President every four years, whereas the governance of Microsoft is priced every second. Another response is that boards are different than the President or a law school dean because of the nature of the role they play. While it might make sense to hire a firm to be a dean or President, there is something personal about leadership in these cases that is not as true in the board context. Individuals feel invested in the personal connection with political leaders for reasons deep in the human psyche, but it is difficult to imagine that any corporate stakehold- er-be it an employee, customer, or investor-feels this way about a particular board member or the board as a whole. It is possible that some CEOs serve this function, and that this may make the use of a firm to provide CEO services more problematic, but it is hard to see this value for the board. As noted above, the board provides a variety of functions, none of which concerns the kind of personal leadership that we commonly associate with individual leaders. A final response is to point out that the use of boards is largely a product of historical path dependency, and that the reasons for their initial use no longer seem as strong as they once did. Franklin Gevurtz traced the origin of corporate boards back to medieval guilds and towns, concluding that corporate board an- tecedents were "a reflection of political practices and ideas widespread in Western Europe in the late Middle Ages."250 Gevurtz's detailed historical ac- count concludes that the reason corporate boards developed was in order to give "political legitimacy" to corporate activity.251 While his article concludes with a sop to modern defenders of boards and greater shareholder participation in corporate affairs, there is nothing about our idea that would upset the idea of "consent through elected representatives" continuing as part of the corporate tradition.252 In fact, our proposal is likely to increase the political legitimacy of corporate boards by opening up possibilities for more transparent and active participation of shareholders in deciding who will represent their interests in supervising corporate management. E. Other Objections A couple of other potential objections are worth mentioning briefly. First, one may argue that for the BSP model to work well, BSPs will have to provide services to more than one company, and this will create conflicts of interest. While this is obviously true, it is not an insurmountable problem. Other service firms, such as those providing accounting, legal, and consulting services, have access to proprietary information and have significant power to influence cor- porate behavior in ways that could raise significant conflict problems if they are serving rival firms. These firms nevertheless have developed tools and proce- dures that enable them to convince their clients that they are able to minimize the potential losses from any conflicts. We would expect BSPs to do so as well, perhaps simply parroting the tried-and-true techniques used by law firms and the like for years. BSPs who do this well will thrive, and those who do not will die off. In addition, there are existing laws that will do work here, such as those banning certain informed trades by insiders or constructive insiders. These have been used against board members, most famously in the recent case of Rajat Gupta, who used his position as a board member at Goldman Sachs to enrich himself and others based on private information.253 Reputational sanctions will do work here as well. Professionalism may too, since, as noted above, the crea- tion of BSPs may create a new class of professional directors. If this happens, a professional organization, akin to those found in other areas like law, account- ing, and brokerage services, may arise to enforce soft-law norms of conduct in this area.254 Second, there is the possibility that BSPs may complicate the takeover market. On the one hand, a more independent BSP would be expected to be more amenable to a valuable takeover offer, and the transparency of a large corporation would make any kind of side deal less likely. On the other hand, the potential loss of business to a particular BSP from a merger-for example, if the acquirer wants to install its own BSP or board-could mean a BSP might oppose a merger that would increase shareholder value. While this is possible, this is also true of current boards. Moreover, insofar as a BSP would have in- creased financial incentives tied to the value of the underlying company, this conflict could be reduced relative to the current board model. In addition, BSPs that develop reputations for opposing valuable mergers may find their brand diminished in what we expect will be a vigorous market for board control. Fi- nally, there are existing legal mechanisms, such as fiduciary duty suits common today in mergers, to police egregious board reluctance or entrenchment in the face of a valuable acquisition offer. Finally, one might argue that there is value in independent deliberation by individual board members, and this will be lost if those providing board ser- vices are all working for a single firm that has hiring and firing authority over them. Like other objections, however, this is just a cost to be weighed against the benefits of BSPs. There is also reason to believe this concern is overblown. The current board model puts enormous authority over directors in the hands of a single individual-the CEO-and it is not obvious why this mechanism for eliciting independent judgment and deliberation is a superior to having those doing the deciding work for a single firm instead. Moreover, if it is valuable to have independence in this way, there are solutions within the BSP model. BSPs can organize as partnerships or limited liability partnerships and thus replicate the board deliberation model at the top of the BSP. Deliberation and independ- ent judgment could also be built into the way in which BSPs staff projects, and, as noted above, one would expect this to be a dimension on which BSPs would try to differentiate their services. BSPs that can best replicate the value, if any, that exists in the current board model will thrive and be able to charge more for their services. One last point is worth making. The value of independence and individual deliberation may be situational and something that a BSP could buy in the spot market for particular transactions. This would be an analogy to boards' current use of special committees of independent directors in final- period transactions, like mergers. If in a particular transaction or for a particular firm there is a need for independent deliberation by individuals unaffiliated with the company or the BSP, such individuals could be hired by the BSP to provide this value on an ad hoc basis. CONCLUSION Professional director services are statutorily required to be obtained through personal service contracts. This is extremely odd, yet widely accepted by corporations and corporate observers. We know of no other service provided for corporations that is obligated by law to be performed by a sole proprietor- ship, and for good reason. Lawyers, consultants, accountants, doctors, and so on all associate with each other to form corporate entities to provide their ser- vices for a host of well-understood reasons. Business associations allow for risk sharing, for investments in training and information, for capturing economies of scale, and for increased accountability through greater reputational stakes and better judicial supervision. If the state-law requirement that board members be natural persons were amended to permit all legal persons, including partner- ships, LLCs, and corporations to provide board services, we believe the market for directors and for governance could be fundamentally improved. A market for corporate governance, separate and distinct from the market for corporate control, could arise that would have the power to make boards the true fulcrum of corporate governance that the law presumes they are or should be. Board services could become a true market, with competition bringing the expected benefits of better services at lower cost. Our proposal is consistent with the spirit of state corporate law as a set of default rules that merely enable firms to create their own governance arrange- ments designed to generate local maxima. Mandatory rules are the exception, not the norm, and should be based on clear and convincing evidence that free- dom of contract would be unlikely to lead to social welfare improvements. We believe such a case is not made in this context, and, in fact, the opposite is true. In addition, there are a variety of contexts in which law, including state and federal law, already tolerates corporate entities serving in a board or board-like role. Partnerships, for instance, can have any legal person serving in the board- like role of general partner. Extending this right to corporations seems like a logical next step. This is not to argue that all firms should hire other firms to provide their board services. We doubt one-size-fits-all arguments generally and are confi- dent that such a rule here would be hopelessly overbroad. Firms should merely have a choice, subject to the constraints of the market and judicial review for opportunism, in the use of corporations to provide these services. As we've shown, the Boards-R-Us idea is one that could be used to achieve a host of governance ends, ranging from increased shareholder power to better director primacy over corporations. In either case, and all those in between, what our proposal does is increase the transparency and competition for board services in a way that should increase confidence that firm choices about the role of the board are ones that are in the interests of shareholders and society in general, rather than based on a hidden agenda. 1. ROBERT A.G. MONKS & NELL MINOW, CORPORATE GOVERNANCE 256 (5th ed. 2011). 2. See generally ADOLF A. BERLE, JR. & GARDINER C. MEANS, THE MODERN CORPORATION AND PRIVATE PROPERTY 84-89 (1932) (discussing separation of ownership and control in public corporations). 3. See, e.g., Ramirez de Arellano v. Weinberger, 745 F.2d 1500, 1558 (D.C. Cir. 1984) (en banc) (Scalia, J., dissenting) (noting "the efficiencies generated by the separation of ownership and control which account for much of the success and popularity of the corpo- rate form"), vacated, 471 U.S. 1113 (1985); Eugene F. Fama, Agency Problems and the The- ory of the Firm, 88 J. POL. ECON. 288, 289 (1980) ("[S]eparation of security ownership and control can be explained as an efficient form of economic organization."). 4. See BERLE & MEANS, supra note 2, at 6 ("The separation of ownership from con- trol produces a condition where the interests of owner and of ultimate manager may, and of- ten do, diverge, and where many of the checks which formerly operated to limit the use of power disappear."). 5. State law mandates that "[t]he business and affairs of every corporation . . . be managed by or under the direction of a board of directors." DEL. CODE ANN. tit. 8, § 141(a) (2014); see also MODEL BUS. CORP. ACT ANN. § 8.01 annot. (2013) (providing a summary of comparable state corporation code provisions). In turn, state law provides that the board shall be elected by shareholders. See id. § 8.03(c) (providing for directors to be elected at the an- nual shareholder meeting). As such, "corporate law provides for a separation of control and ownership." Malone v. Brincat, 722 A.2d 5, 9 (Del. 1998). 6. See infra Part I.A (discussing the board's management function). 7. Managerial decisions, like whether to sell particular products or enter particular markets, are thought to be difficult and costly for courts to scrutinize ex post, as well as ade- quately policed by market forces. Board decisions, on the other hand, present opportunities for expropriation of corporate assets or opportunities by particular firm stakeholders, and courts are thought to be able to police these with greater accuracy and less cost. 8. See Seinfeld v. Verizon Commc'ns, Inc., 909 A.2d 117, 119 (Del. 2006) ("Dela- ware corporate law provides for a separation of legal control and ownership. . . . The com- mon law imposes fiduciary duties upon the directors of Delaware corporations to constrain their conduct when discharging that statutory responsibility."). 9. Jill E. Fisch, The Peculiar Role of the Delaware Courts in the Competition for Corporate Charters, 68 U. CIN. L. REV. 1061, 1074 (2000) ("[T]he majority of Delaware's important legal rules are the result of judicial decisions."). 10. One of us has elsewhere examined at book length recent legislative efforts to in- fluence corporate governance. See STEPHEN M. BAINBRIDGE, CORPORATE GOVERNANCE AFTER THE FINANCIAL CRISIS (2012). 11. Pub. L. No. 107-204, § 301, 116 Stat. 745, 775-77 (codified as amended at 15 U.S.C. § 78j-1 (2012)). 12. Pub. L. No. 111-203, §§ 951-953, 124 Stat. 1376, 1899-904 (2010) (codified as amended at 15 U.S.C. §§ 78j-3, 78l, 78n to 78n-1). 13. See BAINBRIDGE, supra note 10, at 256 ("Today, ISS services some 1700 institu- tional investor clients, which collectively manage some $25 trillion in equity securities."). 14. See Stephen Choi et al., The Power of Proxy Advisors: Myth or Reality?, 59 EMORY L.J. 869, 869 (2010) (concluding that "popular accounts substantially overstate the influence of ISS" and that "the impact of an ISS recommendation is reduced greatly once company- and firm-specific factors important to investors are taken into consideration" (ital- ics omitted)). 15. See Harrah's Entm't, Inc. v. JCC Holding Co., 802 A.2d 294, 311 n.39 (Del. Ch. 2002) ("[T]he election of directors may be the most . . . important action[] that shareholders can take." (second and third alterations in original)). 16. See, e.g., Kelli A. Alces, Beyond the Board of Directors, 46 WAKE FOREST L. REV. 783, 785 (2011) ("Numerous corporate law scholars have critically examined the structure and functions of the board of directors and have evaluated the relative success of various board compositions." (footnote omitted)); John Haberstroh, Activist Institutional Investors, Shareholder Primacy, and the HP-Compaq Merger, 24 HAMLINE J. PUB. L. & POL'Y 65, 81 (2002) ("[S]ince the mid-1970s corporate law academics and shareholder activists have ef- fectively lobbied to refashion boards of directors."); Thomas W. Joo, Corporate Governance and the "D-Word," 63 WASH. & LEE L. REV. 1579, 1579 (2006) ("[M]ost corporate law aca- demics have come to agree with Berle and Means' famous descriptive argument that corpo- rate decisionmaking power is denied to shareholders and is instead heavily concentrated in the board of directors and upper management."). 17. See, e.g., Barry D. Baysinger & Henry N. Butler, Corporate Governance and the Board of Directors: Performance Effects of Changes in Board Composition, 1 J.L. ECON. & ORG. 101, 102 (1985) (noting that corporate board reform proposals typically emphasize changes to board composition and independence); Usha Rodrigues, The Fetishization of In- dependence, 33 J. CORP. L. 447, 452 (2008) ("Corporate governance reformers generally presume (1) that outside independent boards are better than non-independent boards, and (2) that the more independent a board is, the better."). 18. See, e.g., Stephen M. Bainbridge, Director Primacy and Shareholder Disempow- erment, 119 HARV. L. REV. 1735 (2006) (arguing for limits on shareholder power); Lucian Arye Bebchuk, The Case for Increasing Shareholder Power, 118 HARV. L. REV. 833 (2005) (arguing in favor of greater shareholder empowerment); Leo E. Strine, Jr., Toward a True Corporate Republic: A Traditionalist Response to Bebchuk's Solution for Improving Corpo- rate America, 119 HARV. L. REV. 1759 (2006) (arguing for limits on shareholder power). 19. See generally J.W. Verret, Pandora's Ballot Box, or a Proxy with Moxie? Majority Voting, Corporate Ballot Access, and the Legend of Martin Lipton Re-Examined, 62 BUS. LAW. 1007, 1021-29 (2007) (providing a brief history of the "tug of war between managers and shareholders"). 20. See, e.g., MELVIN A. EISENBERG, THE STRUCTURE OF THE CORPORATION: A LEGAL ANALYSIS 170-85 (1976) (arguing that board reforms focused on director independence would improve monitoring of management); Lisa M. Fairfax, Sarbanes-Oxley, Corporate Federalism, and the Declining Significance of Federal Reforms on State Director Independ- ence Standards, 31 OHIO N.U. L. REV. 381, 387 (2005) (noting that the Sarbanes-Oxley Act, for example, "focus[ed] on director independence" and sought to "eliminate those ties that hindered directors [sic] ability to objectively monitor corporate officers"). 21. See infra Part IV. 22. As discussed in Part I.A below, boards fulfill a variety of functions, which vary somewhat from firm to firm. 23. One of us has elsewhere described U.S. corporate governance as a system of direc- tor primacy. See Stephen M. Bainbridge, Director Primacy: The Means and Ends of Corpo- rate Governance, 97 NW. U. L. REV. 547, 605 (2003) ("[T]he board of directors is not a mere agent of the shareholders, but rather is a sort of Platonic guardian serving as the nexus of the various contracts making up the corporation."). Nothing in our proposal would change that conclusion. 24. Delaware, for instance, allows corporations to modify the role of the board of di- rectors, including not having a board, but mandates that boards consist solely of natural per- sons. See infra Part IV. 25. See id. 26. See id. 27. See infra Part V. 28. We say "in part" here because it is possible to imagine individual board members serving alongside a BSP. For instance, inside directors, important investors, representatives of creditors, and even the government are possibilities. For simplicity, we largely leave the details of this issue to another day. 29. Although freedom of contract as an organizing principle of corporate law is con- tested both as a descriptive and normative matter, we assume it herein without digressing to defend it. For a discussion of the mandatory-versus-enabling debate, see Stephen M. Bain- bridge, Community and Statism: A Conservative Contractarian Critique of Progressive Cor- porate Law Scholarship, 82 CORNELL L. REV. 856, 860-61 (1997) (book review). 30. DEL. CODE ANN. tit. 8, § 141(a) (2014). The law of almost all other states contains similar provisions. See MODEL BUS. CORP. ACT ANN. § 8.01 annot. (2013) (reviewing stat- utes). 31. See Rosenblatt v. Getty Oil Co., 493 A.2d 929, 943 (Del. 1985) ("The realities of modern corporate life are such that directors cannot be expected to manage the day-to-day activities of a company."). 32. See Jonathan L. Johnson et al., Boards of Directors: A Review and Research Agenda, 22 J. MGMT. 409, 411 (1996) (describing the board's roles as "control, service, and resource dependence"); see also Lynne L. Dallas, Proposals for Reform of Corporate Boards of Directors: The Dual Board and Board Ombudsperson, 54 WASH. & LEE L. REV. 91, 98- 104 (1997) (distinguishing between the board's monitoring and "relational" roles). 33. See FRANKLIN A. GEVURTZ, GLOBAL ISSUES IN CORPORATE LAW 68 (2006) (stating that many commentators believe the board's primary role is "to monitor management, rather than actually to manage the corporation"). 34. For a detailed overview of board functions, on which this discussion draws in part, see BAINBRIDGE, supra note 10, at 44-50. 35. Besides generally allocating the conduct of the corporation's business and affairs to the board, corporation statutes include many specific mandates that only the board can fulfill. Approval by the board of directors is a statutory prerequisite, for example, to mergers, see MODEL BUS. CORP. ACT ANN. § 11.04(a) ("The plan of merger or share exchange must be adopted by the board of directors."), and related transactions such as sales of all or sub- stantially all corporate assets, see id. § 12.02(b) ("A disposition [of assets that would leave the corporation without a significant continuing business activity] shall be initiated by a resolution by the board of directors authorizing the disposition."), issuance of stock, see id. § 6.21(b) ("The board of directors may authorize shares to be issued for consideration con- sisting of any tangible or intangible property or benefit to the corporation, including cash, promissory notes, services performed, contracts for services to be performed, or other securi- ties of the corporation."), distribution of dividends, see id. § 6.40(a) ("A board of directors may authorize and the corporation may make distributions to its shareholders . . . ."), and amendments to the articles of incorporation, see id. § 10.03(a) ("The proposed amendment must be adopted by the board of directors."). In addition to those duties explicitly assigned by statute to the board, courts have held that some other decisions are so important that the board of directors must make them. See, e.g., Lee v. Jenkins Bros., 268 F.2d 357, 365-66 (2d Cir. 1959) (explaining that officers have no apparent authority with respect to extraordinary matters, which are reserved to the board). 36. See Jeffrey N. Gordon, The Rise of Independent Directors in the United States, 1950-2005: Of Shareholder Value and Stock Market Prices, 59 STAN. L. REV. 1465, 1471 (2007) ("[T]he fraction of independent directors for large public firms has shifted from ap- proximately 20% in the 1950s to approximately 75% by the mid-2000s."). 37. See Grimes v. Donald, No. CIV. A. 13358, 1995 WL 54441, at *8 (Del. Ch. Jan. 11, 1995) (observing that "modern, multi-function business corporations" are "large, com- plex organizations" and that modern boards are comprised mainly "of persons dedicating less than all of their attention to that role"), aff'd, 673 A.2d 1207 (Del. 1996), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del. 2000). 38. See id. (explaining that directors "satisfy their obligations by thoughtfully appoint- ing officers, establishing or approving goals and plans and monitoring performance"). 39. See William T. Allen, Independent Directors in MBO Transactions: Are They Fact or Fantasy?, 45 BUS. LAW. 2055, 2057 (1990) ("[B]usinessmen or women will view their roles as directors in the same way that they probably wish outside directors on the board of their own companies to view their role-as a source of expert advice and judgment, on call to the CEO but not to be officiously interjected."). 40. See Edward B. Rock, The Logic and (Uncertain) Significance of Institutional Shareholder Activism, 79 GEO. L.J. 445, 494 (1991) (opining that outside board members can "serve as a sounding board for the CEO, and may, if asked, be able to contribute a differ- ing perspective or alternative solutions"). 41. BERLE & MEANS, supra note 2, at 6. 42. See Michael P. Dooley, Controlling Giant Corporations: The Question of Legiti- macy, in CORPORATE GOVERNANCE: PAST & FUTURE 28, 38 (Henry G. Manne ed., 1982) (discussing "the limited governance role assigned to shareholders"). 43. See OLIVER E. WILLIAMSON, THE ECONOMIC INSTITUTIONS OF CAPITALISM: FIRMS, MARKETS, RELATIONAL CONTRACTING 306 (1985) (arguing that the board of directors "arises endogenously, as a means by which to safeguard the investments" of shareholders). 44. For a more detailed account of the board's changing roles and the forces that drove those changes, see BAINBRIDGE, supra note 10, at 50-58. 45. See Renée B. Adams et al., The Role of Boards of Directors in Corporate Govern- ance: A Conceptual Framework and Survey, 48 J. ECON. LITERATURE 58, 64-65 (2010). 46. See Renee M. Jones & Michelle Welsh, Toward a Public Enforcement Model for Directors' Duty of Oversight, 45 VAND. J. TRANSNAT'L L. 343, 346 (2012) ("The monitoring model forms the basis of the Sarbanes-Oxley reforms that sought to strengthen the hand of independent directors vis-à-vis corporate management."). 47. Id. at 398 n.279. 48. Gordon, supra note 36, at 1518 (footnotes omitted). By 1997, Melvin Eisenberg thus was able to declare that "key structural elements of the monitoring model-including a board that has at least a majority of independent directors, and audit, nominating, and com- pensation committees-[were] already well-established." Melvin A. Eisenberg, The Board of Directors and Internal Control, 19 CARDOZO L. REV. 237, 239 (1997). 49. See BAINBRIDGE, supra note 10, at 50-51 (discussing the history of criticism of boards of directors). 50. ADAM SMITH, AN INQUIRY INTO THE NATURE AND CAUSES OF THE WEALTH OF NATIONS 700 (Edwin Cannan ed., Random House, Inc. 1937) (1776) (complaining that one could not expect that the directors of a joint stock company, "being the managers rather of other people's money than of their own, . . . should watch over it with the same anxious vigi- lance with which the partners in a private copartnery frequently watch over their own"). 51. Douglas complained that there were too many boards whose members did "not di- rect." See William O. Douglas, Directors Who Do Not Direct, 47 HARV. L. REV. 1305, 1305- 07 (1934). Douglas also dismissed directors as "business colonels of the honorary type- honorary colonels who are ornamental in parade but fairly useless in battle." William O. Douglas, Chairman, Sec. & Exch. Comm'n, Address at a Luncheon of the Fort Worth Clear- ing House Association (Jan. 8, 1939), in DEMOCRACY AND FINANCE: THE ADDRESSES AND PUBLIC STATEMENTS OF WILLIAM O. DOUGLAS 46, 46 (James Allen ed., 1940). 52. Facilitating Shareholder Director Nominations, Securities Act Release No. 9046, Exchange Act Release No. 60,089, Investment Company Act Release No. 28,765, 74 Fed. Reg. 29,024 (proposed June 18, 2009) (observing that the financial crisis had "led many to raise serious concerns about the accountability and responsiveness of some companies and boards of directors"). 53. RALPH NADER ET AL., TAMING THE GIANT CORPORATION 64 (1976). 54. See BAINBRIDGE, supra note 10, at 65-67 (summarizing such evidence). 55. See id. at 167-69 (discussing evidence of board failures with respect to risk man- agement). 56. Lucian Bebchuk and Jesse Fried, for example, have argued that "directors have been influenced by management, sympathetic to executives, insufficiently motivated to bar- gain over compensation, or simply ineffectual in overseeing compensation." LUCIAN BEBCHUK & JESSE FRIED, PAY WITHOUT PERFORMANCE: THE UNFULFILLED PROMISE OF EXECUTIVE COMPENSATION 4 (2004). As a result, they claim, executive pay has greatly ex- ceeded the levels that would prevail if directors loyal to shareholder interests actually bar- gained with managers at arm's length. See id. at 2 (arguing that "the pay-setting process in publicly traded companies has strayed far from the arm's-length model" because "manageri- al power has played a key role in shaping managers' pay arrangements"). Many other com- mentators have leveled similar criticisms at boards. See Michael B. Dorff, Confident Uncer- tainty, Excessive Compensation & the Obama Plan, 85 IND. L.J. 491, 493 n.7 (2010) (citing both critics of the current system and defenders of the market's fundamental efficiency). 57. See BAINBRIDGE, supra note 10, at 81-86 (discussing the impact of evolving stock exchange listing standards on the composition of public corporation boards of directors). As to the impact of corporate reformers, see, for example, Donald C. Clarke, Three Concepts of the Independent Director, 32 DEL. J. CORP. L. 73, 73 (2007) ("Independent directors have long been viewed as a solution to many corporate governance problems."); Melvin A. Eisen- berg, Corporate Law and Social Norms, 99 COLUM. L. REV. 1253, 1278 (1999) (arguing that the monitoring model "requires that the board consist of at least a majority of directors who are independent of the senior executives, and that the board have audit, nominating, and compensation committees composed exclusively of such independent directors"); and Laura Lin, The Effectiveness of Outside Directors as a Corporate Governance Mechanism: Theo- ries and Evidence, 90 NW. U. L. REV. 898, 899-900 (1996) (explaining that some reformers have identified independent directors as a key element of good corporate governance). 58. See Gordon, supra note 36, at 1473-76 (compiling multiple studies to show that the percentage of independent directors on boards of U.S. public companies increased from approximately twenty percent in 1950 to approximately seventy-five percent in 2005). 59. See COLIN B. CARTER & JAY W. LORSCH, BACK TO THE DRAWING BOARD: DESIGNING CORPORATE BOARDS FOR A COMPLEX WORLD 22 (2004) (observing that "most directors today . . . are very part-time"). 60. Cf. id. (noting that this trend has continued in the more recent past, as "part-time directors don't spend much time together"). 61. JEREMY BACON, MEMBERSHIP AND ORGANIZATION OF CORPORATE BOARDS 25 (1990). 62. Cf. Roberta S. Karmel, Realizing the Dream of William O. Douglas-The Securi- ties and Exchange Commission Takes Charge of Corporate Governance, 30 DEL. J. CORP. L. 79, 131-33 (2005) (arguing that the complexity of financial reporting to comply with the Sarbanes-Oxley Act could pull company officers and directors away from their core duties of business decisionmaking, problem solving, and strategic thinking). 63. See BAINBRIDGE, supra note 10, at 59-60 (discussing how the Sarbanes-Oxley and Dodd-Frank Acts codified the monitoring model). 64. Peter J. Wallison, Capital Punishment, WALL ST. J. (Nov. 4, 2006, 12:01 AM ET), http://online.wsj.com/news/articles/SB116260306089713296. 65. Id. (internal quotation mark omitted) (quoting an Ernst & Young survey of inde- pendent directors). 66. See, e.g., Michael P. Dooley & E. Norman Veasey, The Role of the Board in De- rivative Litigation: Delaware Law and the Current ALI Proposals Compared, 44 BUS. LAW. 503, 533 (1989) (making the point that, as part-time outsiders, independent directors inher- ently have less information and take longer to persuade than full-time insiders). 67. RALPH D. WARD, SAVING THE CORPORATE BOARD: WHY BOARDS FAIL AND HOW TO FIX THEM 1 (2003). 68. Id. 69. Id. at 123. 70. See Bainbridge, supra note 10, at 87-88 (noting that employees who "make signif- icant investments in firm-specific human capital" are "likely to make better decisions for the firm than an outsider, even assuming equal levels of information relating to the decision at hand"). 71. See CARTER & LORSCH, supra note 59, at 53 ("Directors are the archetypal general- ists in a world that values and needs specialization."). 72. Nicola Faith Sharpe, Rethinking Board Function in the Wake of the 2008 Financial Crisis, 5 J. BUS. & TECH. L. 99, 109 (2010). 73. CARTER & LORSCH, supra note 59, at 45. 74. Id. 75. Id. 76. See id. at 49 (discussing the relationship between service length and interpersonal relations). 77. Id. 78. For an application outside the common practice, see M. Todd Henderson & Fred- erick Tung, Pay for Regulator Performance, 85 S. CAL. L. Rev. 1003 (2012). 79. Charles M. Elson, Director Compensation and the Management-Captured Board-The History of a Symptom and a Cure, 50 SMU L. REV. 127, 162-64 (1996). 80. Id. at 165. 81. Id. 82. CARTER & LORSCH, supra note 59, at 48 (noting the conflict of interest faced by managers and directors "loaded up with stock and options"). 83. Id. 84. See id. (noting the link between increasing stock ownership and loss of "some as- pects of [the director's] independence"). 85. We imagine that if firms providing board services were legal, there would arise a competitive market for the provision of these services, just as there is for legal, accounting, and consultancy services for companies. In fact, we can imagine many of the firms that cur- rently provide these services offering board services. The specialty BSPs we imagine could be in competition with BCG (a consultancy), Sidley Austin LLP (a law firm), Towers Wat- son (a compensation consultancy), Aon (an insurer of directors), and KPMG (an accountan- cy), each of which could expand its operations to include providing director services. Many of these firms already provide strategic and management advice to large corporations, a role that used to be provided by boards. Many of them also serve compliance and monitoring functions as a complement to or substitute for board actions. Our proposal is simply a natural extension of these activities to a full recognition of statutory board functions provided by outside firms. 86. See DEL. CODE ANN. tit. 8, §§ 107-108 (2014). 87. See id. § 211(b) (providing that an annual meeting of stockholders shall be held for the election of directors on a date and at a time designated by or in the manner provided in the bylaws). 88. See, e.g., NYSE LISTED COMPANY MANUAL § 303A.04(a) (2013). 89. Until recently, state law merely required a plurality shareholder vote. Section 216(3) of the Delaware General Corporation Law formerly provided, for example, that: "Directors shall be elected by a plurality of the votes of the shares present in person or repre- sented by proxy at the meeting and entitled to vote on the election of directors." STEPHEN M. BAINBRIDGE, MERGERS AND ACQUISITIONS 153 (3d ed. 2012) (internal quotation marks omit- ted). Today, however, state law permits-but does not require-firms to adopt various schemes having the effect of requiring director candidates to receive a majority of the votes cast in order to serve. See id. at 154-57 (discussing state-law developments). 90. See, e.g., Rosenfeld v. Fairchild Engine & Airplane Corp., 128 N.E.2d 291, 292-93 (N.Y. 1955) (describing reimbursement rules for proxy contests). 91. BAINBRIDGE, supra note 89, at 177 (discussing the rarity of proxy contests and rea- sons therefor). 92. See infra Part V.A. 93. Consider, for instance, the board of Walmart. As of April 2014, it had sixteen members, twelve of whom are not otherwise affiliated with Walmart. These include two business professors, three former CEOs, three current CEOs, the former head of an account- ing firm, the former head of an advertising firm, the former head of the Small Business Ad- ministration, and the general partner of an investment fund. See Board of Directors, WALMART, http://corporate.walmart.com/our-story/leadership/board-of-directors (last visited Apr. 26, 2014). 94. For instance, the board of The Walt Disney Company, which infamously paid Mi- chael Ovitz over $140 million for one year of work, consisted of several personal friends of Disney CEO Michael Eisner, including actor Sidney Poitier, the principal of the elementary school Eisner's children attended, and the architect who designed one of Eisner's homes. See In re Walt Disney Co. Derivative Litig., 907 A.2d 693, 760 (Del. Ch. 2005) ("Eisner stacked his . . . board of directors with friends and other acquaintances who, though not necessarily beholden to him in a legal sense, were certainly more willing to accede to his wishes and support him unconditionally than truly independent directors."), aff'd, 906 A.2d 27 (Del. 2006); Charles M. Yablon, Bonus Questions-Executive Compensation in the Era of Pay for Performance, 75 NOTRE DAME L. REV. 271, 282, 291 n.55 (1999) (listing board members with "personal or financial ties to Eisner or the company"). Such cronyism may be difficult to unpack from appointments that are in the interest of shareholders. For instance, media conglomerate IAC recently appointed thirty-one-year-old graduate student Chelsea Clinton to the board. Brett Pulley, Chelsea Clinton to Join Board of Directors at Diller's IAC/InterActiveCorp, BLOOMBERG (Sept. 26, 2011, 2:29 PM PT), http://www.bloomberg.com/news/2011-09-26/chelsea-clinton-joins-board-of-directors-at- iac-interactivecorp-.html. Perhaps this made business sense, since political connections are (unfortunately) valuable for firms. But it also was a way for IAC's chairman, Barry Diller, to maximize his utility, as opposed to that of IAC's shareholders; Diller is a big donor to the Democrats, and helping Ms. Clinton is an obvious way to continue that practice. There is reason to suspect the latter, since former board members of IAC include Diller's wife, the fashion designer Diane von Furstenberg, and General Norman Schwarzkopf, and since the current board also includes von Furstenberg's son, Alex. IAC/InterActiveCorp, SOURCEWATCH, http://www.sourcewatch.org/index.php/IAC/InterActiveCorp (last modified Feb. 20, 2013). 95. The analogy to law firms and accounting firms is imperfect. For one, a BSP would, at least in theory, have vastly more power than an accounting firm or law firm, since the lat- ter render only advice. In practice, however, the analogy may be fairly tight. While account- ing firms and law firms are generally under the authority of other decisionmakers in the firm, this is not true for certain classes of extraordinary firm actions. Accountants and lawyers are bound by professional responsibility rules and statutes to bind their clients in certain ways that cannot be overridden or to withdraw from representation in ways that raise costs for their clients. The same could be true of BSPs-the bulk of their work could be analogized to providing a professional service to the CEO and the firm generally, while in some extraordi- nary cases, like approving a merger, the BSP would have significant powers. 96. As discussed in Part III.B, below, we envision Boards-R-Us as a board services consulting firm containing experts from multiple disciplines, whose expertise would com- bine as necessary to make decisions for client corporations. 97. Our approach does not prevent the use of mixed boards. Consistent with our em- phasis on providing enabling rather than default rules, we believe that companies should have the ability to have a BSP serve as part of a larger board that also includes individuals chosen via the traditional model. The most obvious case for a mixed board would be where the firm wished to continue having inside directors (i.e., current or recently retired employ- ees, especially the CEO) serve on the board. On the desirability of having inside directors serving on the board, see Stephen M. Bainbridge, A Critique of the NYSE's Director Inde- pendence Listing Standards, 30 SEC. REG. L.J. 370 (2002). Large shareholders may demand a board seat as well. Indeed, investors with large stakes in particular firms often seek influ- ence over firm policies by nominating (either directly or with the consent of management) directors to represent their interests. See CHRIS CERNICH ET AL., IRRC INST., EFFECTIVENESS OF HYBRID BOARDS 7-11 (2009), available at http://www.irrcinstitute.org/pdf/IRRC_05_09_ EffectiveHybridBoards.pdf (discussing the efforts of hedge funds to obtain representation on portfolio company boards of directors so as to effect changes in top management team com- position or corporate strategy). The government also occasionally asserts its interest in particular firms through the appointment of a board member. See, e.g., Anton Troianovski et al., Wary of China, U.S. Steps into Sprint's Board, WALL ST. J. (May 22, 2013, 9:40 PM ET), http://online.wsj.com/news/articles/SB10001424127887323336104578499651225020178. If valuable in a particular case, this tactic could continue to be used, either by convincing the BSP (through management) to add a particular individual to the team for a particular firm, or by expanding the board to include individual members in addition to a BSP's role. 98. Some additional contracting might be necessary to form coherent firms out of a changing mix of individuals, but this is a rather small cost. 99. If having the relatively inexperienced daughter of a former President and Secretary of State on the board will improve governance for a particular firm, then a BSP would have an incentive to hire that person to be part of a board services team. This "value" could in- clude reasons that aren't about shareholder or firm value, such as pleasing the individual or group making the decision of which BSP to hire. 100. One might conclude that appointing board members is a fringe benefit of the CEO, in which case the move toward a BSP that makes idiosyncratic appointments less likely might require compensating the CEO, either with additional remuneration of some kind or with some other power. There are, however, reasons to doubt the importance of the work done by our proposal in this regard. CEOs are already less closely involved in board ap- pointments, given the rise of the independent nominating committee, now required by law for public companies. Insofar as it remains an issue for CEOs, the move to a BSP may make this issue less salient and less important. In other words, once CEOs no longer think about board seats as theirs to fill and instead think about firms to hire to provide services to the company, the importance of this power will likely be lower. 101. See infra notes 134-37 and accompanying text (discussing the evolution of director compensation practices). 102. See infra notes 137-42 and accompanying text (discussing incentive effects of di- rector stock ownership). 103. Although some professional services firms historically did not take equity stakes in their clients, in recent years consultancies, law firms, and other service providers have in- creasingly done so. See, e.g., David Leonhardt, Consultants Are Putting a New Price on Advice, N.Y. TIMES (Jan. 19, 2000), http://www.nytimes.com/2000/01/19/business/ management-consultants-are-putting-a-new-price-on-advice.html. 104. See, e.g., Michael Bobelian, Dewey's Downfall Exposes the Demise of Partner- ships, FORBES (June 7, 2012, 10:49 AM), http://www.forbes.com/sites/michaelbobelian/ 2012/06/07/deweys-downfall-exposes-the-demise-of-partnerships (tracing the transition away from the partnership model to the change in about forty states in the mid-1990s that allowed law firms to organize themselves as limited liability partnerships). 105. See, e.g., Reena Aggarwal, Demutualization and Corporate Governance of Stock Exchanges, J. APPLIED CORP. FIN., Spring 2002, at 105, 105-06 (listing numerous examples of stock exchanges around the world demutualizing since 1993 and discussing implications). 106. See supra Part I.C. 107. PAUL MILGROM & JOHN ROBERTS, ECONOMICS, ORGANIZATION AND MANAGEMENT 106 (1992) ("By definition, economies of scale in production allow a firm to reduce its costs compared to small-scale production . . . ."). 108. For a discussion of economies of scale in different industries, see THE STRUCTURE OF AMERICAN INDUSTRY (James Brock ed., 12th ed. 2009) (examining the structure of the agriculture, petroleum, electricity, cigarette, beer, automobile, music recording, telecommu- nications, airline, banking, health care, public accounting, and college sports industries). See also Joaquim Silvestre, Economies and Diseconomies of Scale, in 2 THE NEW PALGRAVE: A DICTIONARY OF ECONOMICS 80, 80-84 (John Eatwell et al. eds., 1987). 109. See THE STRUCTURE OF AMERICAN INDUSTRY, supra note 108. 110. The Big Four accounting firms dominate the accounting industry, and extremely large firms are present in consulting (e.g., Accenture, Bain & Company, Booz Allen Hamil- ton, Deloitte Consulting, and IBM Global Services). The top fifty consulting companies, however, account for less than thirty percent of industry revenue. Consulting Services Indus- try Profile, FIRST RES., http://www.firstresearch.com/Industry-Research/Consulting- Services.html (last updated Mar. 31, 2014). 111. Legal Services Industry Profile, FIRST RES., http://www.firstresearch.com/ Industry-Research/Legal-Services.html (last updated Mar. 10, 2014). 112. Id. 113. Jennifer Smith, DLA Piper Climbs to Top of Heap with 2012 Revenues of $2.4 Bil- lion, WALL ST. J. L. BLOG (Apr. 25, 2013, 7:04 PM ET), http://blogs.wsj.com/law/2013/ 04/25/dla-piper-climbs-to-top-of-heap-with-2012-revenues-of-2-4-billion; Staci Zaretsky, Bow Before the Global 100, the Top-Grossing Law Firms on the Planet, ABOVE THE LAW (Oct. 1, 2013, 11:55 AM), http://abovethelaw.com/2013/10/bow-before-the-global-100-the- top-grossing-law-firms-on-the-planet (presenting highlights of the 2013 Am Law 100). 114. Zaretsky, supra note 113. 115. MILGROM & ROBERTS, supra note 107, at 106. 116. Cf. Stephen M. Bainbridge, Corporate Lawyers as Gatekeepers, UCLA J. SCHOLARLY PERSP., Fall 2012, at 5, 13 ("[I]n many of the recent corporate scandals, the mis- conduct was committed by a small group of senior managers who took considerable pains to conceal their actions from outside advisors, such as legal counsel."). 117. SPENCER STUART, SPENCER STUART BOARD INDEX 14 (2012), available at http://content.spencerstuart.com/sswebsite/pdf/lib/Spencer-Stuart-US-Board-Index- 2012_06Nov2012.pdf. 118. Id. at 19. 119. 15 U.S.C. § 78j-3 (2012). 120. Id. 121. Id. § 78j-1. 122. Id. 123. See R.H. Coase, The Nature of the Firm, 4 ECONOMICA 386 (1937). 124. Id. at 389. For a discussion of these issues in a related area, see M. Todd Hender- son & Frederick Tung, Reverse Regulatory Arbitrage: An Auction Approach to Regulatory Assignments, 98 IOWA L. REV. 1895 (2013) (applying the Coasean insight to the question of how bank examiners are allocated to their regulatory assignments). 125. Coase, supra note 123, at 390-91, 394. 126. Id. at 395. 127. The precise title of these individuals varies depending on which form of business organization they have chosen to adopt, running from shareholders (corporation) and manag- ers or members (LLC) to partners (partnerships and limited partnerships). Unless otherwise indicated, we use manager herein as a generic term for all of these alternatives. 128. Management consultants, for instance, use their large firm size to invest heavily in training consultants, to produce knowledge and expertise, to allow specialization, and to permit deployment of talent at the optimal point across time and space. For an account of how the industry works through the lens of one of its most successful firms, see DUFF MCDONALD, THE FIRM: THE STORY OF MCKINSEY AND ITS SECRET INFLUENCE ON AMERICAN BUSINESS (2013). These firms have hundreds if not thousands of professionals, some of whom provide front-line services, but many of whom provide those employees on the front line with research, expertise, support services, technology, and so on. Having front-line pro- fessionals under the same corporate umbrella as these ancillary functions allows services to be provided at lower cost because of the ability to allocate them across a wider asset base. This allows specialization and cost savings from shared services. 129. See, e.g., William A. Birdthistle & M. Todd Henderson, Becoming a Fifth Branch, 99 CORNELL L. REV. 1, 8-12 (2013) (describing self-regulation of professional stock bro- kers). 130. Ronald J. Gilson & Reinier Kraakman, Reinventing the Outside Director: An Agenda for Institutional Investors, 43 STAN. L. REV. 863 (1991). 131. Id. at 865. 132. Id. at 886. 133. Id. at 886-87. 134. See, e.g., STUART, supra note 117, at 11. 135. Microsoft Corp., Definitive Proxy Statement (Schedule 14A) 20-21 (Oct. 9, 2012). Board members were required to hold stock equal to three times their annual retainer of $100,000. In addition, directors received additional payments of $15,000 for service on vari- ous committees. Id. at 20. 136. See Lucian A. Bebchuk & Jesse M. Fried, Tackling the Managerial Power Prob- lem: The Key to Improving Executive Compensation, PATHWAYS, Summer 2010, at 9, 11-12. 137. The optimal work structure and incentives needed to achieve the most efficient form of governance are far beyond our scope, and, in any event, are likely not knowable in advance without experimentation and market-provided information and discipline. They likely will vary widely over time and across firms and industries. For purposes of proving our model feasible, we note, however, that there is nothing obviously problematic about moving toward an entity model of board services. The key point is simply that the purposes of the current board compensation structure can easily be achieved in the professional ser- vices firm setting. 138. For instance, professional services firms, like consultancies or restructuring firms, typically pay executives two components: a "salary" based on work performed, and a "bo- nus" tied to the overall profitability of the firm. The former is based on work done on specif- ic projects, successful pitches, and any management or supervisory work; the latter is based on a share of the residual based on overall value to the firm. For lower-level employees, a mix of salary, performance-based incentives, stock ownership, and other forms of compensa- tion are used depending on the firm and the situation. 139. See George W. Dent, Jr., Stakeholder Governance: A Bad Idea Getting Worse, 58 CASE W. RES. L. REV. 1107, 1142-43 (2008) ("The proliferation of private equity stems in large part from the benefits of avoiding the agency costs of the separation of ownership and control characteristic of public companies."). 140. See Robert C. Illig, The Promise of Hedge Fund Governance: How Incentive Compensation Can Enhance Institutional Investor Monitoring, 60 ALA. L. REV. 41, 73-74 (2008) (explaining that private equity fund managers often hold significant ownership stakes in their funds, which improves their incentives). 141. On April 26, 2014, Microsoft's market capitalization was $329.7 billion. Microsoft Corporation (MSFT), YAHOO! FIN., http://finance.yahoo.com/q/ks?s=MSFT (last visited Apr. 26, 2014). 142. Such an equity stake would also compensate the BSP for any additional liability risk to which it is exposed relative to natural person directors, which would reduce the risk that switching to a BSP would result in significantly higher total director fees. 143. This estimate is based on confidential interview with an executive at a leading D&O insurance provider. See generally ZURICH AM. INS. CO., EVALUATING HOW MUCH D&O INSURANCE TO PURCHASE (2011), available at http://www.zurichna.com/internet/ zna/SiteCollectionDocuments/en/Products/financialinstitutions/Zurich-DO-limits.pdf; Chris- tine Kang, Directors' and Officers' Insurance: Ordinary Corporate Expense or Valuable Sig- naling Device? (May 11, 2011) (unpublished A.B. thesis, Stanford University), available at https://economics.stanford.edu/files/Kang_HThesis2011.pdf. 144. Amended and Restated Articles of Incorporation of Microsoft Corporation, MICROSOFT, http://www.microsoft.com/investor/CorporateGovernance/PoliciesAndGuide lines/articlesincorp.aspx (last updated Nov. 24, 2009). 145. See BELVERD E. NEEDLES, JR. & MARIAN POWERS, FINANCIAL ACCOUNTING 15 (11th ed. 2010) (stating that there are "about 15,000 [corporations in the United States that] have stock that is publicly bought and sold"). 146. See, e.g., TAMAR FRANKEL, TRUST AND HONESTY: AMERICA'S BUSINESS CULTURE AT A CROSSROAD 183-84 (2006) ("There are some departures from the historical strong pro- tection of corporate boards. For example, in the past two decades, the Delaware courts . . . were reluctant to make corporate directors liable for the wrongs committed by their corpora- tions. The courts respected the directors' business judgment and, with a few notable excep- tions, shielded the directors from the claims of shareholders."); Lisa M. Fairfax, Spare the Rod, Spoil the Director? Revitalizing Directors' Fiduciary Duty Through Legal Liability, 42 HOUS. L. REV. 393, 409 (2005) ("[T]he tremendous deference courts grant to board decisions means that courts hold directors liable for only the most egregious examples of director mis- conduct."). 147. See, e.g., Jonathan R. Macey & Geoffrey P. Miller, Trans Union Reconsidered, 98 YALE L.J. 127, 131 (1988) ("Delaware courts have rejected a number of challenges to board deliberations that seemed no more careful than the actions deemed inadequate in Trans Un- ion."). 148. For a general discussion of the incentive effects of insurance on corporate conduct, see TOM BAKER & SEAN J. GRIFFITH, ENSURING CORPORATE MISCONDUCT: HOW LIABILITY INSURANCE UNDERMINES SHAREHOLDER LITIGATION (2010). 149. Cf. Ronald J. Gilson & Robert H. Mnookin, Sharing Among the Human Capital- ists: An Economic Inquiry into the Corporate Law Firm and How Partners Split Profits, 37 STAN. L. REV. 313, 391 (1985) (making a related argument to explain partnerships, noting that the lack of perfect skill correlation across special areas of knowledge or expertise pro- vides a type of insurance for partners). 150. See BAKER & GRIFFITH, supra note 148, at 109 (explaining that "D&O insurers do almost nothing to monitor the public corporations they insure"). 151. See Tom Baker & Sean J. Griffith, The Missing Monitor in Corporate Govern- ance: The Directors' & Officers' Liability Insurer, 95 GEO. L.J. 1795, 1808-14 (2007) (dis- cussing why the D&O insurance market currently does not effectively monitor board and corporate performance). 152. See BAKER & GRIFFITH, supra note 148, at 98 (discussing how D&O insurers fail to accurately price policies). 153. See David A. Skeel, Jr., Shaming in Corporate Law, 149 U. PA. L. REV. 1811, 1812 & n.3 (2001) (quoting corporate governance expert Nell Minow to the effect that pub- lic corporation directors are "the most reputationally sensitive people in the world" (internal quotation marks omitted)). 154. See John C. Coffee, Jr., Understanding the Plaintiff's Attorney: The Implications of Economic Theory for Private Enforcement of Law Through Class and Derivative Actions, 86 COLUM. L. REV. 669, 718 (1986) (noting that reputation is impacted by litigation, even if settled). 155. According to The 2011 U.S. Director Compensation and Board Practices Report, around seventy percent of directors in manufacturing and nonfinancial services were also the director of at least one other for-profit enterprise. MATTEO TONELLO & JUDIT TOROK, THE CONFERENCE BD., RESEARCH REPORT R-1486-11-RR, THE 2011 U.S. DIRECTOR COMPENSATION AND BOARD PRACTICES REPORT 52 (2011), available at http://ssrn.com/abstract=2032229. 156. See, e.g., Jayne W. Barnard, Reintegrative Shaming in Corporate Sentencing, 72 S. CAL. L. REV. 959, 966-68 (1999) (describing the importance of reputation for directors). 157. See Enron Corp., Definitive Proxy Statement (Schedule 14A) 3-6 (Mar. 27, 2001) (listing biographical information for Enron directors). 158. An example of the reputational cost is shown by the way Enron's failure has trailed economist and columnist Paul Krugman, a former advisory board member. See James Taranto, Happy Enroniversary, WALL ST. J. (Jan. 27, 2012), http://online.wsj.com/article/ SB10001424052970204573704577187081831886976.html. 159. See Eisenberg, supra note 57, at 1265 (claiming directors respond more to social norms than the threat of liability); see also Frank H. Easterbrook & Daniel R. Fischel, Man- datory Disclosure and the Protection of Investors, 70 VA. L. REV. 669, 675 (1984) (discuss- ing the reputational concerns of managers); David M. Phillips, Principles of Corporate Gov- ernance: A Critique of Part IV, 52 GEO. WASH. L. REV. 653, 673, 682 (1984) (arguing that reputational concerns can displace the need for legal sanctions). 160. See, e.g., Yaniv Grinstein, Complementary Perspectives on "Efficient Capital Markets, Corporate Disclosure and Enron," 89 CORNELL L. REV. 503, 505 (2004) ("Enron's board members had lots of reputation at stake, but concern for reputation and legal punish- ment failed to provide adequate incentives for board members of Enron to demand explana- tions for questionable deals."). 161. Edward M. Iacobucci, Reputational Economies of Scale, with Application to Law Firms, 14 AM. L. & ECON. REV. 302, 303 (2012). 162. Id. at 319. 163. Id. at 303. 164. Although individuals currently providing board services to companies undoubtedly value their reputations and act in ways to preserve them, this theory suggests that, all else being equal, the total reputation at stake in any transaction would be significantly higher if the individual were part of a larger firm. In that case, when the director made a decision, say to approve a merger or not, the decision would be betting not only the reputation of the indi- vidual director, but also that of all other employees of the board services firm. So, no matter how much an individual values her reputation, additional reputational bonding can be achieved through association with other individuals. 165. See Larry E. Ribstein, Ethical Rules, Agency Costs, and Law Firm Structure, 84 VA. L. REV. 1707, 1707-08 (1998). 166. Id. at 1718-19. 167. Id. at 1719. 168. Iacobucci, supra note 161, at 304. 169. Id. at 305. 170. Id. at 313. 171. Id. at 320-21. 172. Id. at 327. 173. See S.S. Samuelson & L.J. Jaffe, A Statistical Analysis of Law Firm Profitability, 70 B.U. L. REV. 185, 204 (1990). 174. Marc Galanter & William Henderson, The Elastic Tournament: A Second Trans- formation of the Big Law Firm, 60 STAN. L. REV. 1867, 1908 (2008). 175. William D. Henderson, An Empirical Study of Single-Tier Versus Two-Tier Part- nerships in the Am Law 200, 84 N.C. L. REV. 1691, 1696 (2006). 176. Iacobucci, supra note 161, at 324. 177. We should be clear that we do not believe this means there will be no governance failures or even the optimal number of such failures. This is also not to say that we agree with those scholars who believe that reputation alone is or, under our model, would be suffi- cient to provide optimal incentives for directors. Our more modest claim is that there are im- provements to be had in corporate governance from the deployment of the reputational assets of large BSPs. And this additional benefit of BSPs supports permitting companies to hire boards that are not natural persons. On the other hand, we acknowledge that a BSP could have incentives to pursue a par- ticular course for a company not because it is the right decision for that company, but be- cause of the BSP's need to develop a favorable reputation. For example, a BSP might con- sent to certain governance reforms, not because the reforms are right for a particular company, but because it needs to build a reputation of being concerned with governance in order to win board appointments. The question is not whether a BSP eliminates agency costs, however, but whether it reduces them relative to natural person directors. For the reasons discussed in this Subpart, we think the net reputational effect will be beneficial. 178. Gilson & Kraakman, supra note 130, at 875. 179. Steven N. Kaplan & David Reishus, Outside Directorships and Corporate Perfor- mance, 27 J. FIN. ECON. 389 (1990). 180. Id. at 409-10. 181. Id. at 390. For similar data, see Stuart C. Gilson, Bankruptcy, Boards, Banks, and Blockholders: Evidence on Changes in Corporate Ownership and Control when Firms De- fault, 27 J. FIN. ECON. 355, 356 (1990). 182. See, e.g., BEBCHUK & FRIED, supra note 56, at 4 (describing the power managers have over board members). 183. See Stephen M. Bainbridge, Why a Board? Group Decisionmaking in Corporate Governance, 55 VAND. L. REV. 1, 12-41 (2002) (discussing theory and empirical evidence about group decisionmaking). To be sure, all groups are vulnerable to certain systematic er- rors. See id. at 31-32 (discussing groupthink and other group biases). The BSP model cannot solve that problem so long as it depends on team production. 184. We think in practice a mixed board is likely to be used rarely, since the BSP will, under current law, be held jointly and severally liable for all board decisions, and therefore will be reluctant to share power with individuals with much less wealth. 185. See MICHAEL C. EHRHARDT & EUGENE F. BRIGHAM, FINANCIAL MANAGEMENT: THEORY AND PRACTICE 804 (13th ed. 2011) (discussing investment banks' matchmaking function in bringing clients together for mergers and acquisitions). 186. Bainbridge, supra note 183, at 36 ("Within a production team, for example, mutual monitoring and peer pressure provide a coercive backstop for a set of interpersonal relation- ships founded on trust and other noncontractual social norms."). 187. Some critics of our proposal may argue that we are simply doubling the agency problem. In the client firm, there is a problem that the directors may not adequately monitor the corporation's employees. If the client appoints a BSP to serve as its board, and the BSP appoints an employee (or many) to accomplish that work, you arguably have two agency problems where in the traditional mode we only had one. But this objection applies equally to any situation in which a firm is providing a service. That is, it applies equally to any entity (such as a law firm or consultancy or accountancy) where there is a separation of ownership and control. A system of legal rules, best practices, contracts, and compensation structures has evolved to address the double agency problem in those settings, resulting in a net de- crease in costs. We see no reason to think that the BSP would be different. 188. DEL. CODE ANN. tit. 8, § 141(b) (2014). 189. MODEL BUS. CORP. ACT ANN. § 8.03 (2013). 190. Id. § 1.40(13). 191. This requirement is not unique to U.S. corporate law. In the European Union, only natural persons can be members of the board of a Societas Privata Europaea. Rolandino Guidotti, The European Private Company: The Current Situation, 13 GER. L.J. 331, 341 (2012). 192. NYSE LISTED COMPANY MANUAL § 303A.01 (2013). 193. Id. § 303A.02(a)(i). 194. See id. § 303A.04-.06. 195. Id. § 303A.02 cmt. 196. See, e.g., 17 C.F.R. § 240.10A-3(b)(1) (2013) ("In order to be considered to be in- dependent for purposes of this [section], a member of an audit committee of a listed issuer that is an investment company may not, other than in his or her capacity as a member of the audit committee [have a material relationship with the company]." (emphasis added)). 197. Pub. L. 111-203, § 952, 124 Stat. 1376, 1900-03 (codified as amended at 15 U.S.C. § 78j-3 (2012)). 198. Although changing state law, federal law, and stock exchange listing rules may seem like a daunting task, the linkages between these rules make the case more straightfor- ward. If state laws were amended to allow firms to serve as directors, the change would cas- cade through the rest of the various corporate governance rules at the state, federal, and pri- vate-regulator levels. State law sets the baseline from which all of these other statutes and rules, both private and public, operate. For instance, independence requirements of federal law and the exchanges could be met simply by ensuring that the company and the BSP were not under common control. Some tweaks might be required here and there, but it would not require much beyond amending the underlying state corporate law. 199. See FRANK H. EASTERBROOK & DANIEL R. FISCHEL, THE ECONOMIC STRUCTURE OF CORPORATE LAW 14-15 (1991); Larry E. Ribstein, The Mandatory Nature of the ALI Code, 61 GEO. WASH. L. REV. 984, 989-91 (1993). 200. See EASTERBROOK & FISCHEL, supra note 199, at 2 ("[E]nabling statute[s] allow[] managers and investors to write their own tickets, to establish systems of governance without substantive scrutiny from a regulator."). 201. DEL. CODE ANN. tit. 8, § 141(a) (2014). 202. See Larry E. Ribstein, An Applied Theory of Limited Partnership, 37 EMORY L.J. 835, 868-71 (1988) (discussing incorporated general partners). The Delaware Limited Part- nership Act defines a "general partner" as "a person who is named as a general partner in the certificate of limited partnership," DEL. CODE ANN. tit. 6, § 17-101(5), and then "person" as "a natural person, partnership . . . , limited liability company, . . . corporation, . . . or any oth- er individual or entity," id. § 17-101(14). See generally Robert W. Hamilton, Corporate General Partners of Limited Partnerships, 1 J. SMALL & EMERGING BUS. L. 73 (1997) (not- ing the availability of corporate general partners). 203. See DEL. CODE ANN. tit. 6, § 17-1101(c) ("It is the policy of this chapter to give maximum effect to the principle of freedom of contract and to the enforceability of partner- ship agreements."); MARTIN I. LUBAROFF & PAUL M. ALTMAN, LUBAROFF & ALTMAN ON DELAWARE LIMITED PARTNERSHIPS § 1.2 (2013) ("The choice of the appropriate business organization in any situation varies depending upon the particular facts of each case and con- sideration of both tax and nontax factors."). One of the key reasons for the use of this ar- rangement in the unincorporated context is to provide managers with limited liability. It is important to note that while reducing individual liability (through risk pooling) is a key fea- ture of our proposal for BSPs, there are other advantages of our proposal for BSPs for corpo- rations, especially large, publicly traded corporations, that are not obtained in the case of un- incorporated entities, like LLCs or partnerships. These are discussed further below. These additional benefits make the case for BSPs for corporations stronger than for unincorporated entities. 204. See, e.g., Frigidaire Sales Corp. v. Union Props., Inc., 562 P.2d 244, 247 (Wash. 1977) (holding that the incorporated general partner was entitled to limited liability such that its shareholders could not be held liable for partnership debts). 205. See Elf Atochem N. Am., Inc. v. Jaffari, 727 A.2d 286, 290 (Del. 1999) ("The Delaware [Limited Liability Company] Act has been modeled on the popular Delaware LP Act."); Feeley v. NHAOCG, LLC, 62 A.3d 649, 669 (Del. Ch. 2012) ("Other Delaware al- ternative entity statutes, including the LLC Act and the Delaware Statutory Trusts Act, are modeled on the LP Act . . . ."). 206. See Feeley, 62 A.3d at 669 ("[T]he LLC Act and the Delaware Statutory Trusts Act . . . permit entities to serve in managerial roles . . . ."). 207. 15 U.S.C. § 80a-2 (2012). 208. 301 F.2d 458, 460-61 (2d Cir. 1962). 209. In reaching its conclusion that Empire had all the powers of a typical director, the court considered the following: Empire is responsible for the entire management of the fund, except the purchase and sale of the portfolio securities. Empire is empowered "to do all acts, take all proceedings and exer- cise all such rights and privileges relating to any property at any time held by it as Trustee as could be done, taken or exercised by the absolute owner thereof, except as expressly restrict- ed herein." (Trust Agreement § 8.5.) "At any time the Trustee may take such action as it in good faith may believe to be required for the benefit of the trust property." (§ 8.8) Empire is charged with responsibility for selecting a successor investment advisor (§ 10.2) and must consent to the creation of any new series of shares (§ 11.1). It is unnecessary to describe in detail all of the many aspects of authority granted to Empire by the instrument. It is clear that the functions exercised by it as trustee are "similar" to those exercised by a director; indeed they are identical in many respects. Id. at 460. 210. 368 U.S. 403, 410 (1962) ("Lehman Brothers would be a 'director' of Tide Water, if as petitioner's complaint charged Lehman actually functioned as a director through Thom- as, who had been deputized by Lehman to perform a director's duties not for himself but for Lehman."). 211. Feder v. Martin Marietta Corp., 406 F.2d 260, 263 (2d Cir. 1969) (citing Blau, 368 U.S. at 408-09). 212. 1 EDWARD P. WELCH ET AL., FOLK ON THE DELAWARE GENERAL CORPORATION LAW § 141.03 (6th ed. 2013). 213. Id. 214. MODEL BUS. CORP. ACT ANN. § 8.03 (2013). Only five states currently mandate multimember boards. Id. § 8.03 annot. 215. Id. § 8.03 cmt. 216. 11 U.S.C. § 704 (2012). 217. Id. § 321. 218. J. Harold Mulherin & Annette B. Poulsen, Proxy Contests and Corporate Change: Implications for Shareholder Wealth, 47 J. FIN. ECON. 279 (1998) (describing the motivation for and results of a study of the effect of proxy contests on shareholder wealth). 219. See Lucian Arye Bebchuk & Marcel Kahan, A Framework for Analyzing Legal Policy Towards Proxy Contests, 78 CALIF. L. REV. 1071 (1990) (arguing that proxy contests and the threat thereof can be an important constraint on agency costs). Note that the proxy access proposals discussed below typically would not provide a mechanism for removing the entire board in one election cycle. A proxy access proposal put forward by the SEC, for ex- ample, would have limited shareholders to putting forward a short slate and made the mech- anism available only to those shareholders who expressly disavowed intent to obtain control of the firm. See BAINBRIDGE, supra note 89, at 185 (describing the proposal). 220. See BAINBRIDGE, supra note 89, at 177 (noting the rarity of proxy contests even though they have become somewhat more common in recent years). 221. See, e.g., Lucian A. Bebchuk & Scott Hirst, Private Ordering and the Proxy Ac- cess Debate, 65 BUS. LAW. 329, 331 (2010) ("[T]he adoption of a federal proxy access re- gime has received significant support from shareholder groups and those who work with them."); Lisa M. Fairfax, The Model Business Corporation Act at Sixty: Shareholders and Their Influence, 74 LAW & CONTEMP. PROBS. 19, 28 (2011) (noting "the important weight that shareholders have placed on the proxy-access issue"). 222. See BAINBRIDGE, supra note 10, at 224-28 (discussing various versions of proxy access proposals). For instance, Eisenberg proposed allowing large shareholders (e.g., great- er than five percent of outstanding stock) to nominate directors. EISENBERG, supra note 20, at 117-21. Similarly, Louis Lowenstein suggested shareholders have an exclusive right to nom- inate a defined portion of the board, such as one-fifth to one-quarter of the seats. LOUIS LOWENSTEIN, WHAT'S WRONG WITH WALL STREET: SHORT-TERM GAIN AND THE ABSENTEE SHAREHOLDER 209-11 (1988). Most expansively, George Dent proposed turning the entire board election process over to a committee of the corporation's ten or twenty largest share- holders. George W. Dent, Jr., Toward Unifying Ownership and Control in the Public Corpo- ration, 1989 WIS. L. REV. 881, 907-08. Bebchuk has built a cottage industry supporting shareholder access to the proxy. He has authored numerous academic publications and en- gaged in shareholder advocacy trying to achieve, through legal and firm-based reforms, more competitive elections. See, e.g., Lucian A. Bebchuk, The Myth of the Shareholder Franchise, 93 VA. L. REV. 675 (2007). 223. See, e.g., Bo Becker et al., Does Shareholder Proxy Access Improve Firm Value? Evidence from the Business Roundtable's Challenge, 56 J.L. & ECON. 127 (2013) (finding negative stock price reaction to SEC and court actions derailing efforts to give shareholders access to the proxy for those firms most vulnerable to shareholder challenges). 224. Section 971 of the Dodd-Frank Act permits the SEC to adopt rules that will allow shareholders access to a public company's proxy solicitation materials for purposes of nomi- nating their own directors. Pub. L. No. 111-203, § 971, 124 Stat. 1376, 1915 (2010) (codi- fied as amended at 15 U.S.C. § 78n (2012)). 225. See Bus. Roundtable v. SEC, 647 F.3d 1144, 1147 (D.C. Cir. 2011) (describing the rule). 226. Id. at 1148 ("We agree with the petitioners and hold the Commission acted arbi- trarily and capriciously for having failed once again . . . adequately to assess the economic effects of a new rule."). 227. See BAINBRIDGE, supra note 10, at 233-55 (assessing arguments for and against shareholder empowerment). 228. See id. at 240-41 (arguing that maintaining limits on shareholder participation en- hances the efficiency of corporate decisionmaking). 229. See id. at 230 (arguing that "because the effect of proxy access will be to increase the number of short slates, albeit to an uncertain extent, its impact on corporate governance likely will be analogous to that of cumulative voting," which has deleterious effects on board decisionmaking). 230. See supra note 23 (discussing director primacy model). 231. Of course, the term need not be five years, and one can imagine competition among firms in their corporate charters with respect to the optimal amount of insulation needed. 232. Martin Lipton & Steven A. Rosenblum, A New System of Corporate Governance: The Quinquennial Election of Directors, 58 U. CHI. L. REV. 187, 189-90 (1991) (arguing for a system of corporate governance that "encourage[s] the ordering of [constituents'] relation- ships and interests around the long-term operating success of the corporation" and proposing measures that include "replac[ing] annual elections of directors with quinquennial elec- tions"). 233. See Dena Aubin, PCAOB's Debate over Auditor Rotation Moves to Congress, REUTERS TAX BREAK (Mar. 29, 2012), http://blogs.reuters.com/taxbreak/2012/03/29/pcaobs- debate-over-auditor-rotation-moves-to-congress. 234. See Dena Aubin, US Chamber Challenges Auditor Watchdog on Rotation, REUTERS (Mar. 27, 2012, 3:32 PM EDT), http://www.reuters.com/article/2012/03/27/ chamber-rotation-idUSL2E8EQ7DN20120327. 235. See Robert B. Thompson, Piercing the Corporate Veil: An Empirical Study, 76 CORNELL L. REV. 1036, 1036, 1041 (1991). 236. Id. at 1038 (finding that "the likelihood of piercing increases as the number of shareholders decreases" and with factors "such as misrepresentation and undercapitaliza- tion"). 237. 600 A.2d 43, 56 (Del. Ch. 1991) (finding that plaintiffs had adequately pled "a wrongful diversion from the Partnership"). 238. Id. at 45-47. 239. Id. at 48. 240. Id. at 49, quoted in Feeley v. NHAOCG, LLC, 62 A.3d 649, 670 (Del. Ch. 2012). 241. See, e.g., Paige Capital Mgmt., LLC v. Lerner Master Fund, LLC, No. 5502-CS, 2011 WL 3505355, at *30 (Del. Ch. Aug. 8, 2011) (imposing fiduciary liability on individu- al who was the managing member of the LLC that acted as the general partner for a limited partnership); Gelfman v. Weeden Investors, L.P., 792 A.2d 977, 992 n.24 (Del. Ch. 2001) (applying the doctrine to the directors and officers of a corporate general partner). 242. See Michael Abramowicz, Speeding Up the Crawl to the Top, 20 YALE J. ON REG. 139, 154-56 (2003). 243. Cf. id. at 194-200 (describing how a hypothetical sui generis intellectual property regime might encourage greater corporate law innovation). 244. FIN. SERVS. & THE TREASURY BUREAU (H.K.), CO REWRITE: REWRITE OF THE COMPANIES ORDINANCE 21 (2008), available at http://www.gov.hk/en/residents/government/ publication/consultation/docs/2008/2ndPCCOR.pdf. 245. See, e.g., John Stuckey & David White, When and When Not to Vertically Inte- grate, MIT SLOAN MGMT. REV., Spring 1993, at 71, 72 (claiming that vertical integration is warranted when "[t]he market is young and the company must forward integrate to develop a market"). 246. Thanks to Peter Oh for suggesting this possibility. 247. See supra Part II.B.2. 248. As with the private equity example mentioned above, there is a sliding scale in which the number of nominated board members could scale roughly with the ownership stake of particular investors. 249. For an argument that activism is valuable, see Alon Brav et al., Hedge Fund Activ- ism, Corporate Governance, and Firm Performance, 63 J. FIN. 1729, 1732 (2008) (finding benefits of increased CEO turnover and decreased CEO pay when activist investors target a firm). 250. Franklin A. Gevurtz, The Historical and Political Origins of the Corporate Board of Directors, 33 HOFSTRA L. REV. 89, 129 (2004). 251. Id. at 170-73. 252. Id. at 172-73. 253. See, e.g., Anita Raghavan, Rajat Gupta's Lust for Zeros, N.Y. TIMES (May 17, 2013), http://www.nytimes.com/2013/05/19/magazine/rajat-guptas-lust-for-zeros.html? pagewanted=all. 254. For a discussion of this type of self-regulation in the brokerage context, see Birdthistle & Henderson, supra note 129. Stephen M. Bainbridge* & M. Todd Henderson** * William D. Warren Distinguished Professor of Law, UCLA School of Law. ** Professor of Law and Aaron Director Teaching Scholar, University of Chicago Law School. We thank the workshop participants at the University of Chicago Law School and UCLA School of Law for their helpful suggestions. Thank you to Kelli Alces, Jennifer Arlen, Peter Oh, James Park, and Mark Ramseyer for their comments as well. (c) 2014 Stanford University, Stanford Law School |