Bernard S. Sharfman & Steven J. Toll[*]
In today’s world of corporate governance, the board of directors of a publicly held firm (public company) will almost certainly be made up of a majority of independent directors. For example, both the New York Stock Exchange and the NASDAQ require that a public company’s board have a majority of independent directors and that the major corporate board committees—audit, compensation, and nominating—be composed entirely of independent members. Moreover, both stock exchanges require that directors meet certain subjective and objective criteria before they can be considered independent. In addition, proxy advisory companies, those companies that help shareholders decide how to vote on company matters, have their own enhanced independence guidelines. This movement toward increased board independence began during the 1990s but was given a big boost by the Enron scandal. It is also a reflection of society’s evolving understanding of how a public company is to be governed. As so well expressed by Professors Margaret Blair and Lynn Stout, “[t]he notion that responsibility for governing a publicly held corporation ultimately rests in the hands of its directors is a defining feature of American corporate law; indeed, in a sense, an independent board is what makes a public corporation a public corporation.” As discussed below, it allows the board of a public company to act as a “mediating hierarchy;” that is, as an arbiter of disputes between the various stakeholders that constitutes a public company. Moreover, many believe that independent boards can better monitor managerial opportunism and enhance firm performance relative to management dominated boards.
If independence is critical, then one option to ensure board independence is to require that a board be composed solely of independent directors. However, this is problematic because an all independent board would lack the insights, knowledge, and understanding of those who know the company best. This would cause more harm than good in board decision-making. Therefore, a corporate board composed of a majority but not entirely of independent directors appears preferable.
But having a majority of independent directors means nothing unless these independent directors also exercise “independence of mind.” They must be able to make independent judgments without being overly influenced by inside directors and executive management. This, of course, is easier said than done. Moreover, “independence does not consider how the directors will contribute to the board’s understanding of the firm’s core capabilities” and thereby help optimize firm performance. Thus, independence in itself provides little in the way of guidance on how independent board members are to be selected.