The Case Against Too Much Independence on the Board; While crony-filled boards are gone, Steven M. Davidoff argues there is no evidence that a supermajority of independent directors does any better

NOVEMBER 11, 2013, 10:42 AM

The Case Against Too Much Independence on the Board


Regulators and institutional investors keep pushing the independent directors as the cure-all for what ails America’s corporations. Yet that independence, like innovation itself, can be too much of a good thing. Decades ago, the boards of corporate America were occupied by the C.E.O. and the C.E.O.’s handpicked friends and colleagues. Today the independent director, an outside director who is not beholden to the chief, dominates the corporate board.In 1950, only 20 percent of directors of large public companies were independent, according to Prof. Jeffrey Gordon at Columbia University School of Law. By 2005, this number had risen to 75 percent. The independent director rules, but unfortunately there is a problem. They may do more harm than good, especially in abundance.

In the 1980s, a number of papers found that boards with independent directors were better at making certain decisions. Studies found that boards with a majority of independent directors were more likely to fire the C.E.O. or engage in destructive acquisitions. The emergence of large institutional shareholders also led to the embrace of 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.

Congress and regulators also gave impetus to the independent director over the last 10 years. The catalysts were the Enron and WorldCom scandals. As a result of the Sarbanes-Oxley Act in 2002 and new rules adopted by the stock exchanges at the behest of the Securities and Exchange Commission, regulations were put in place requiring that the majority of directors on public company boards be independent.

Audit and nominating committees were also required to be composed solely of independent directors. The move was embraced more fully by the Dodd-Frank Act, which requires that members of a board’s compensation committees be independent. Large financial institutions were also required to have separate risk committees composed solely of independent directors.

Now, not only do we have boards that are populated by independent directors, but often, the C.E.O. is the sole nonindependent director on the board.

Independent directors have been championed as being good for shareholders, but studies have been unable to find that their presence results in better returns for shareholders. Instead, the evidence in favor of independent directors is confined to some studies mostly from the 1980s, which found that these directors might check C.E.O. hubris and spur better oversight.

The pendulum today has swung toward boards of almost all independent directors. But these situations are not ideal either, according to studies. They 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.

EVEN if the chief is the sole insider, shareholders have still pushed for further independence. A case in point is efforts to push for the separation of the roles of chairman and C.E.O. We saw this unfold this year in the failed movement to replace Jamie Dimon as the chairman of JPMorgan Chase. The move failed, but Mr. Dimon is still the lone nonindependent director out of the bank’s board of 10.

For those who advocate a separation of the chairman and C.E.O. positions in favor of further empowering directors, the evidence 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. The two banks that survived the crisis best, Goldman Sachs and JPMorgan, did so because of strong executive leadership.

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?

Those in favor of more insiders assert that independent directors often are simply not up to the task of knowing the company as well as the executives.

No one is going back to the days when O. J. Simpson was a director on the board of Infinity Broadcasting. But when 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 Goldman Sachs going to start crunching numbers on the bank’s risk-management spreadsheet to fully understand the bank’s risk?

So we have a dichotomy: 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 remain divided about the right mix of independent and inside directors. Professor Gordon of Columbia has argued that independent directors resulted in better disclosure and better-run companies that complied more fully with the law. This has resulted in aggregate stock price increases and validated the use of independent directors.

Others 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.

The quest for super independence, though, 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.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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