All Independent, All the Time?

By Cydney Posner

"The Case Against Too Much Independence on the Board," in The New York Times, , argues that board "independence, like innovation itself, can be too much of a good thing."

The author, the NYT's DealProfessor, recalls that, in decades past, corporate boards were populated primarily by CEOs and their handpicked friends and colleagues. Not so today, when "the independent director, an outside director who is not beholden to the chief, dominates the corporate board." According to a Columbia professor cited in the column, in 1950, only 20% of directors of large public companies were independent, but, by 2005, this number was 75%. Now, the CEO is often the only non-independent director on the board. The question, as they say at CNN, is whether this is a good thing or bad thing? (http://www.thedailyshow.com/watch/tue-october-29-2013/good-badfellas (language alert))

According to the DealBook column, in the 1980s, a number of papers found that boards with independent directors were better at making certain decisions, checking CEO hubris and providing better oversight. Increases in the number of large institutional investors led to an emphasis on "shareholder value as the goal for companies. Institutional investors embraced control over the chief executive through independent directors as a way to better monitor executives while also allowing the investors a voice at the table." Following the Enron and WorldCom scandals, Congress and regulators, through SOX and related rules, imposed requirements for independent directors on boards and board committees. Now, while the CEO is often the only insider, shareholders have continued to push for more independence, submitting proposals to separate the offices of CEO and board chair.

Interestingly, though, while the presence of independent directors has been widely viewed as favorable to shareholders, the author contends that "studies have been unable to find that their presence results in better returns for shareholders. …[Recent studies] largely find that the good effects from majority independent boards disappear with ‘super independent' boards. Such companies are less profitable. At least one study has found that the more oversight a board provides, the better monitoring that results but the worse the performance, regardless of whether it is independent or not." The evidence for separation of the board chair and CEO positions "is also scant to support this move for all companies despite more than 30 studies over the decades. Anecdotally, independent directors have not had a great track record of late. Failed banks like Lehman Brothers and Bear Stearns had boards with a supermajority of independent directors. While executives also seemed to fail to spot the financial crisis, boards didn't do much better….Not only that, but at least one study has found that since the financial crisis, directors of banks were not penalized. Before the crisis they had a 0.6 percent chance of being removed for poor performance. After 2008, that increased to only a 1 percent chance. If directors are not even being disciplined for poor performance, why do we expect them to do better and keep giving them more power?"

The author observes that those favoring a greater proportion of insiders on boards assert that "independent directors often are simply not up to the task of knowing the company as well as the executives…..[W]hen you remove insiders from the board, the outside directors lack the knowledge and experience to steer the company appropriately. After all, are the outside directors of [an investment bank] going to start crunching numbers on the bank's risk-management spreadsheet to fully understand the bank's risk?" [One might, however, ask the same question about the banks' other executives who, in an alternate scenario, could be board members.] <br> <br>The author then presents the conundrum: "While the evidence is mixed at best about independent directors, the push for independent directors has transformed into a quest for super independence. Why is this the case?"

Experts are apparently divided. Some argue that independent directors lead to better disclosure, better-run and more legally compliant companies, resulting in aggregate stock price increases. Others, the author suggests, "argue that the independent director is simply a handy political tool. It may be that adoption of the independent director staves off more vigorous regulation. Alternatively, for institutional investors and pension funds that are trying to exert more control over the companies they own, independent directors may be less likely to challenge them. It may be that it shows that these shareholders care about things like corporate governance even if it does not do anything. This is also why legislators and regulators love the independent director." (You might recall that the author also took issue with internal pay equity disclosure, which he similarly viewed as an instance of "cheap regulation." See my email of 8/29/13.)

According to the DealProfessor, the "quest for super independence… means that boards are losing the inside expertise they may need to properly run the company. Independent directors may be good in some measure, and no one wants to go back to the old days of crony boards. But perhaps it is time to temper the enthusiasm for all independent directors, all the time."

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