Steven Davidoff challenges the conventional wisdom that more independence is always better when it comes to corporate boards of directors:
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. ...
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.
Go read the whole thing--it's a great analysis. But you might also want to read Chapter 3 of my book Corporate Governance after the Financial Crisis
The post-SOX regulatory environment rests on the conventional wisdom that board independence is an unalloyed good. As the preceding sections demonstrated, however, the empirical evidence on the merits of board independence is mixed. Accordingly, even though there is some reason to think independent board members are finally becoming properly incentivized and, as a result, more effective, the clearest take-home lesson from the preceding analysis is still that one size does not fit all.
This result should not be surprising. On one side of the equation, firms do not have uniform needs for managerial accountability mechanisms. The need for accountability is determined by the likelihood of shirking, which in turn is determined by management’s tastes, which in turn is determined by each firm’s unique culture, traditions, and competitive environment. We all know managers whose preferences include a penchant for hard, faithful work. Firms where that sort of manager dominates the corporate culture have less need for outside accountability mechanisms.
On the other side of the equation, firms have a wide range of accountability mechanisms from which to choose. Independent directors are not the sole mechanism by which management’s performance is monitored. Rather, a variety of forces work together to constrain management’s incentive to shirk: the capital and product markets within which the firm functions; the internal and external markets for managerial services; the market for corporate control; incentive compensation systems; auditing by outside accountants; and many others. The importance of the independent directors’ monitoring role in a given firm depends in large measure on the extent to which these other forces are allowed to function. For example, managers of a firm with strong takeover defenses are less subject to the constraining influence of the market for corporate control than are those of a firm with no takeover defenses. The former needs a strong independent board more than the latter does.
The critical mass of independent directors needed to provide optimal levels of accountability also will vary depending upon the types of outsiders chosen. Strong, active independent directors with little tolerance for negligence or culpable conduct do exist. A board having a few such directors is more likely to act as a faithful monitor than is a board having many nominally independent directors who shirk their monitoring obligations.
The post-SOX standards, however, strap all listed companies into a single model of corporate governance. By establishing a highly restrictive definition of director independence and mandating that such directors dominate both the board and its required committees, the new rules fail to take into account the diversity and variance among firms. The new rules thus satisfy our definition of quack corporate governance. The one size fits all model they mandate should be scrapped in favor of allowing each firm to develop the particular mix of monitoring and management that best suits its individual needs. Unfortunately, as we will see throughout our review of the post-crisis federal regulatory scheme, neither Congress nor the SEC has given any deference to the principle of private ordering.
What Have we Lost?
The fetish for board independence has costs. Two are already on the table; namely, those associated with the information asymmetry between outsiders and insiders and those occasioned by the need to incent outsiders to perform. A third is the lost value of insider representation.
