Independent Directors: Not Useful?

Much of the US corporate governance scheme relies on the sagacity of independent directors, directors not beholden to management or major ownership’s interests and thus able to guide the company fairly on behalf of all shareholders.  Certainly for larger and public companies generally,  the need for independent directors is not only a mantra but also the law: public companies must have independent directors making up the comp and audit committees and a majority of independents overall; and under Delaware law, a vote of independent directors removes the stigma of self interest from many kinds of transactions wherein management and interested directors are dealing with the company and risk exists of unfairness to the minority.

Then you look at the defining corporate governance failure of our generation, the 2008 meltdown, and you see that independent boards were involved in some of the most spectacular failures of the era.  How can that be?

Recent research, building on seminal studies by Professor Jay Lorch at HBS, suggests that the failure was not the lack of independence in fact, but the lack of domain experience, that rendered independence irrelevant.

The board of Lehman Brothers, the bank which failed and triggered the collapse of financial markets, is a case in point.  The board was made up of smart accomplished independents, including ex-CEOs of IBM, SmithGlaxoKline, Haliburton, Telemundo and Sotheby’s.  But contemporary records confirm that none of them had domain experience in the financial markets in which Lehman played, let alone the sub-prime mortgage market.

The question arises, in a world of complex business, how DO you get directors who are independent of a company, not tied to a competitor, deeply knowledgeable in your business verticals (of which there may be several that are material), and not over the hill?  One suggestions is to get directors from industries that are at least analogous in terms of scale and business issues and target markets, if not spot on.

Another suggestion is to train directors to know what they need to know.  That would take a seismic shift in practice.  First, directors may be quite busy with their own companies or, alternately if retired, sitting on several boards.  Second, these senior people are not used to going to school, even if dedicated to doing a credible job as director.  Third, midst criticism of the high comp for public directors, one reply is that being a public director takes a huge amount of time if done correctly, and thus how do you increase the director work-load without increasing the compensation paid to the directors.

Every company and directorship experience is different.  Wise directors can find people inside or outside their companies upon whom to rely for risk-reward analysis.  But with directors of major corporations making hundreds of strategic decisions every month with potentially huge impact on companies or sectors or the whole economy, it doesn’t take more than a few failures of judgment  before you have the mini-depression of 2007-10 all over again.

Leave a Reply

Your email address will not be published. Required fields are marked *