Abstract
This Essay tackles a pervasive misperception on the part of regulators that director independence significantly increases the efficacy of corporate boards. In this Essay, I assert that such “cosmetic independence” is not enough to remedy the corporate failures of recent years. Cosmetic independence is independence that takes into account only a corporate director’s relationship with the corporation and not the tools a director needs to achieve substantive independence. These tools include time, information, and knowledge, all of which have been recognized as critical to effective decision-making processes in organizational behavior literature.
This Essay is critical of regulatory reforms intended to improve board monitoring. Regulators have consistently responded to each new wave of corporate failure by requiring greater board independence without much regard to the organizational process necessary for boards to function effectively. These regulations are designed to enhance board performance by changing the composition and structure of the board through increasing the number of directors that meet a superficial definition of independence and creating a more detailed and independent committee structure. The changes assume that stricter definitions of director independence necessarily lead to boards more effectively monitoring corporate management. There are numerous, well-known examples of this shift toward increasing director independence, which started in the 1970s and has continued through major legislative overhauls such as the Sarbanes-Oxley Act. Examples include changes in stock-exchange listing standards post-Enron, the federal government’s involvement in corporate boards following the 2008 financial crisis, and most recently, several of the corporate governance provisions in the Dodd-Frank Act.
These reforms have implemented little more than a cosmetic independence, which is both static and decontextualized. Cosmetic independence does not provide the board with the substantive components that are necessary for successful, informed decision-making and form the foundation of the board’s monitoring role. I therefore challenge the conventional wisdom that increasing director independence, by itself, can meaningfully reduce agency costs or the likelihood of repeated corporate failure when a substantive approach to selecting directors is needed. I submit that we should be skeptical of cosmetic independence as the principal criteria for board membership. In order to reduce managerial influence in the boardroom, the basis on which directors are selected must be broadened to include time, information, and knowledge.
This Essay is critical of regulatory reforms intended to improve board monitoring. Regulators have consistently responded to each new wave of corporate failure by requiring greater board independence without much regard to the organizational process necessary for boards to function effectively. These regulations are designed to enhance board performance by changing the composition and structure of the board through increasing the number of directors that meet a superficial definition of independence and creating a more detailed and independent committee structure. The changes assume that stricter definitions of director independence necessarily lead to boards more effectively monitoring corporate management. There are numerous, well-known examples of this shift toward increasing director independence, which started in the 1970s and has continued through major legislative overhauls such as the Sarbanes-Oxley Act. Examples include changes in stock-exchange listing standards post-Enron, the federal government’s involvement in corporate boards following the 2008 financial crisis, and most recently, several of the corporate governance provisions in the Dodd-Frank Act.
These reforms have implemented little more than a cosmetic independence, which is both static and decontextualized. Cosmetic independence does not provide the board with the substantive components that are necessary for successful, informed decision-making and form the foundation of the board’s monitoring role. I therefore challenge the conventional wisdom that increasing director independence, by itself, can meaningfully reduce agency costs or the likelihood of repeated corporate failure when a substantive approach to selecting directors is needed. I submit that we should be skeptical of cosmetic independence as the principal criteria for board membership. In order to reduce managerial influence in the boardroom, the basis on which directors are selected must be broadened to include time, information, and knowledge.
Original language | English (US) |
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Pages (from-to) | 1435-1456 |
Number of pages | 22 |
Journal | Seattle University Law Review |
Volume | 34 |
Issue number | 4 |
State | Published - 2011 |
Keywords
- Corporations
- Board of directors
- Organizational behavior
- director independence
- Agency theory
- decision making
- knowledge
- information