Governance Matters
To reign in excessive CEO compensation, US law began requiring listed companies to disclose information on executive pay with the Securities Act of 1933 and have required ever more detailed information since.
This has had the opposite of the intended effect.
Boards of directors typically use "peer benchmarking" to decide on CEO compensation and the ever-greater disclosure requirements have increasingly allowed boards to see exactly how much CEOs of peer companies earn.
With that information in hand, the board debate is usually whether to pay their CEO in line with the 50th, 75th, or 90th percentile of what similar companies pay.
You may see where this is going: Using the 50th percentile as a lower bound mathematically guarantees that CEO pay will inexorably rise.
Of course, not many companies use the 50th percentile. Doing so would be a concession that a board had agreed to hire an average CEO and, like the parents of Lake Wobegon, all boards think their CEOs are above average.
The result is that rising disclosure requirements lead to higher, not lower, pay for CEOs.
That unintended consequence (detailed in a study here) is an example of how complicated the issue of corporate governance is.
Governance of for-profit corporations is hard: There is no law, SEC rule, or FINRA guideline that can guarantee corporations are governed equitably.
Governance of nonprofit corporations is even harder: An academic paper found that non-profit governance “is generally abysmal, worse than that of for-profit corporations.”
But governance of for-profit non-profits appears to be the hardest: OpenAI’s attempt to govern a for-profit entity with a non-profit board has failed spectacularly. And because OpenAI’s structure was an attempt to safely develop artificial intelligence, the consequences are far higher than CEOs being egregiously overpaid.
Thanks to OpenAI, corporate governance is now an existential issue.
Corleone negotiating tactics
With this morning’s news that Sam Altman is joining Microsoft with dozens and maybe hundreds of his ex-work colleagues likely to follow, the OpenAI board of directors appears to have made a possibly fatal blunder.
They have, however, acted well within their mandate.
The board that fired Altman oversees the nonprofit parent that controls the organization's for-profit subsidiary — all of which have a stated mission of creating an artificial general intelligence that is broadly beneficial to humanity.
To keep the board's interests aligned with humanity — rather than OpenAI’s investors — the majority of directors are independent and none hold equity in OpenAI.
Similarly, Open AI’s investors were encouraged to view their investment “in the spirit of a donation.”
We don’t yet have all the details but the board appears to have fired Altman because, with Altman as CEO, OpenAI was developing towards artificial general intelligence too quickly and the board — consistent with its mandate — wanted to slow things down.
The unintended consequence of the firing, however, is that they have likely sped things up.
If so, it’s at least in part because OpenAI’s corporate structure was misaligned with its stated mission.
Governing a for-profit business with a non-profit board is untenable: No set of written rules can force profit-minded investors to behave as if they were charitable donors.
Instead, OpenAI became aligned with the interests of its most important stakeholder, Microsoft.
Microsoft's investment of $10 billion consisted mostly of Azure credits, without which OpenAI could not pursue its mission.
In return, Microsoft was given perpetual rights to all of OpenAI’s IP — and now they have the people who developed the IP, too.
Firing Altman was the board’s attempt to wrest back control but the result, according to Ben Thompson, is that Microsoft has effectively acquired OpenAI for $0.
As in The Godfather, it was an offer OpenAI couldn’t refuse.
Good-vibes governance
Crypto types may find this turn of events less surprising than TradFi types.
“Alignment” has been a notable buzzword and subject of debate in crypto this year and, as crypto lacks anything that resembles a board of directors, the debate has revolved around vibes, memes, and the soft power of charismatic leaders.
Bitcoin, for example, is aligned with Satoshi’s original vision of internet-native payments, but also the store-of-value vision of its most enthusiastic HODLERs.
Ethereum is aligned with Vitalik’s ethos of community governance, but also with the ultra-sound money meme.
Solana is so far aligned with Anatoly’s vision of ultra-low fees, but may also become aligned with the profit-minded holders who bought in because of Van Eck’s $3,000 price target.
The idea of aligning interests via memes and vibes of course sounds flakey.
But the OpenAI drama may demonstrate that for all of the carefully written rules around corporate governance, the unwritten rules of crypto could turn out to be the most effective type.
You can’t make this stuff up
Boards of directors, intended to solve the principal-agent problem inherent to publicly listed companies, are more independent than ever before — but governance problems abound.
Boards may be captured by management (Enron), may operate in their own interests (Tesla), may be negligent (Lehman Brothers), or insufficiently inquisitive (Theranos).
Some may be all of the above: The board of directors for the Nasdaq-listed investment company Fog Cutter Capital Group once approved a retention bonus for a CEO serving a 14-month term in prison.
(After his release, the CEO’s probation officer allowed him to work for Fog Cutter during the day while reporting to a halfway house in the evening.)
But the OpenAI board drama is possibly unprecedented in corporate history — extensive Google searching returned no comparable CEO firings.
(Extensive ChatGPT prompting returned several plausible-sounding but entirely fabricated ones.)
Comparisons are being made to the firing of Steve Jobs, but Apple was in dire straits at the time while OpenAI is (was) the world’s hottest startup.
For a close parallel, we have to resort to fiction: The OpenAI board firing its co-founder CEO seems most analogous to Norman Osborn being fired by the board of Oscorp Industries in the first Spider-Man movie.
The movie the OpenAI board really needed to watch, however, was Star Wars: In striking down Sam Altman, OpenAI has created an unimaginably powerful rival.
The rest of us — hoping only that this isn’t all a prelude to The Terminator — have learned a lesson in the existential importance of corporate governance.
