In working up a revised draft of the chapter on independent directors for my forthcoming book Corporate Governance After the Crises, I came across a very interesting report by Grant Kirkpatrick, which contains evidence from which I infer that the post-Sarbanes-Oxley fetish for board of director independence may have contributed to the financial crisis of 2007-2008.
The strict conflict of interest rules embedded in the new definitions of independence made it difficult for financial institutions to find independent directors with expertise in their industry. A survey of eight US major financial institutions, for example, found that two thirds of directors had no banking experience. Given the inherent information asymmetries between insiders and outsiders, the lack of board expertise significantly compounded the inability of financial institution boards to effectively monitor their firms during the pre-crisis period. More expert boards could have done more with the information made available to them and, moreover, would have been better equipped to identify gaps therein that needed filling.
In addition, the need to find independent directors put an emphasis on avoiding conflicted interests at the expense of competence. In other words, the problem was not just that the new definition of independence excluded many candidates with industry expertise, it was also that the emphasis on objective indicia of conflicts dominated the selection process to the exclusion of indicia of basic competence and good judgment. The financial crisis thus appears, in part, to have been an unintended consequence of SOX.