The discussion on the previous pages has evaluated the role the board of directors, both as individuals and as agents for the firm, however how important is the board to the firm? To answer this, a comparison of Babcock and Brown to a firm without a board needs to be made.
Without a board of directors, Babcock and Brown would not have been set up in the controversial manner of a shell company separated from an operating company. Under a pure owner/manager style of company, it is very likely the two would have been one in the same and the shareholder’s invested money would have been used by B&B to directly invest in it’s assets. However, without the board, the strong and high-risk growth strategy of leveraging invested money to attain higher levels of debt to increase their asset holding would not have existed. While the level of debt attained is questionable, the notion of borrowing money to make money is a sound concept that has proven to work for individuals and firms alike.
Also, without the board, it could be perceived that no risk identification and management would have occurred, resulting in faster, and even greater fail rates than the one experienced. There is no doubt that, left to his own devices, Phil Green would have worked on extracting as much money as possible to build and retain the company’s asset base to ensure trading continued, while leaving profitability at very low levels. This was evident in his strategy for trying to work B&B out of insolvency. Phil Green was pushing for a sell off to Terrafirma for a value that would ensure the assets are retained, though shareholders would walk away with nothing.
Thirdly, without a board a firm is subject to acting unethically in the commercial environment. Admittedly with a board this is also bound to happen in some instances, such as in Babcock and Brown, however when the firm only relies on the management team or founder to make these decisions, one person’s view is not always the correct view.
Finally, and most importantly, without a board the firm is subject to high levels of agency costs. This arises from the original framework set-out in this discussion that states there is a disconnect between the demands of the shareholders and the actions of the management team. The size of the disconnect is directly attributable to a cost, whether it be financial or otherwise. In the case of Babcock and Brown it was clear that despite their being a board of directors, the board was too strongly influenced by management, being the CEO. This resulted in the company model being based on the maintenance of a shell company used to raise public funds to feed a privately owned firm. Shareholders were disconnected with the actions of management, as they were not made aware of the use of their invested money. Without a board in place, this is an extreme example of agency costs that can be incurred if there is no impartial and unbiased entity that stands between the shareholders and the management team.
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