From an interview of Strine at Directors & Boards:
We have a lot of unrealistic expectations for independent directors, and I think it would be better to rebalance boards a little bit. We need folks who are genuinely independent directors, but we also need directors with expertise, and we need directors who were active in business and who understand the industry. And some of the rules and incentives can get so tight that we actually discourage people with the right kind of qualities from serving on boards.
It doesn’t really matter if you’re independent if you don’t have expertise. But can you be independent and also have the expertise and the knowledge? I’m sure you can.
We just independent directorized the world. We went from having a bare majority of them to having a supermajority of them. We don’t actually empower them. We take away their ability to think long term because we put in place Say on Pay. We don’t do Say on Pay every four years or five years, where you would really have a long-term pay plan, we do it every year as a vote on generalized outrage.
Independent directors are not like trustees at universities, who usually have prior affiliations with the university and the community in which it exists, and that they care deeply about. Independent directors are weather vanes for the market. Not to denigrate them, but let’s think about the definition of an independent director. They tend to have no prior affiliation or current association with the company, and thus they really have no reason to deeply care about it or any aspect of it. Now you can say that’s independence, but it’s also a blank slate.
There’s great competition to be an independent director. Independent director pay has gone up. The typical pay just to be on one company board is higher than my judges in our judiciary. If you’re on three boards, you’re often making more than a half million dollars a year just as a director.
The old concern was that directors had to be popular with management to stay on boards, but now you have to stay popular with the institutional investor community and with the proxy advisers, and therefore these directors are highly responsive to market sentiment.
Maybe my lack of popularity with the self-appointed shareholder spokesmen who run ISS and its ilk, not to mention institutional investors generally explains my lack of board seats?
Anyway, the usually board-bashing/activist-loving folks at The Corporate Counsel observe that:
It’s refreshing to hear somebody with influence in the corporate governance debate finally say something like this. As I’ve blogged previously, my guess is that in 50 years people may really wonder why we thought it was a good idea to demand that the boards of the world’s largest corporations be comprised overwhelmingly of people with no ties to or experience with the company. Who knows? Maybe Chief Justice Strine’s remarks are a signal that we won’t have to wait 50 years for people to start asking that question.
I've been a sharp critic of independent director mandates going back to one of my first articles, see Independent Directors and the ALI Corporate Governance Project, 61 Geo. Wash. L. Rev. 1034 (1992). In my book Corporate Governance after the Financial Crisis
... the board of directors has three basic functions. First, while boards rarely are involved in day-to-day operational decision making, most boards have at least some managerial functions. Second, the board provides networking and other services. Finally, the board monitors and disciplines top management.
Independence is potentially relevant to all three board functions. As to the former two, outside directors provide both their own expertise and interlocks with diverse contact networks. As to the latter, at least according to conventional wisdom, board independence is an important device for constraining agency costs. On close examination, however, neither rationale for board independence justifies the sort of one size fits all mandate adopted by the exchanges at the behest of Congress and the SEC.
After a lengthy review of the evidence on director independence, I concluded that "the empirical evidence on the merits of board independence is mixed." I then observed that:
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.
Oliver Williamson suggests that one of the board’s functions is to “safeguard the contractual relation between the firm and its management.”[1] Insider board representation may be necessary to carry out that function. Many adverse firm outcomes are beyond management’s control. If the board is limited to monitoring management, and especially if it is limited to objective measures of performance, however, the board may be unable to differentiate between acts of god, bad luck, ineptitude, and self-dealing. As a result, risk averse managers may demand a higher return to compensate them for the risk that the board will be unable to make such distinctions. Alternatively, managers may reduce the extent of their investments in firm-specific human capital, so as to minimize nondiversifiable employment risk. Insider representation on the board may avoid those problems by providing better information and insight into the causes of adverse outcomes.
Insider representation on the board also will encourage learned trust between insiders and outsiders. Insider representation on the board thus provides the board with a credible source of information necessary to accurate subjective assessment of managerial performance. In addition, however, it also serves as a bond between the firm and the top management team. Insider directors presumably will look out for their own interests and those of their fellow managers. Board representation thus offers some protection against dismissal for adverse outcomes outside management’s control.
Such considerations likely explain the finding by Klein of a positive correlation between the presence of insiders on board committees and firm performance.[2] They also help explain the finding by Wagner et al. that increasing the number of insiders on the board is positively correlated with firm performance.[3]
The fetish for independence cost us these potential benefits from insider representation. Congress’ refusal to permit private ordering means that those firms where those costs are highest are unable to opt out of the one size fits all straightjacket.
[1]Oliver E. Williamson, The Economic Institutions of Capitalism 298 (1985).
[2]See April Klein, Firm Performance and Board Committee Structure, 41 J. L. & Econ. 275 (1998).
[3]See John A. Wagner et al., Board Composition and Organizational Performance: Two Studies of Insider/Outsider Effects, 35 J. Mgmt. Stud. 655 (1998).
