As some of you may know, my earlier terminology plea (thanks for solid assistance on that front, by the way) related to my work-in-progress: comparing the role of independent directors under Delaware law with their role under general corporate governance principles. I hope to offer a new gloss on the empirical data that more independent directors don’t lead to better firm performance (generally Sanjai Bhagat and Bernie Black’s work, updated by Roberta Romano) on the road to figuring out what independence means in the corporate world and why it matters.
Enter Jeffrey Gordon, who posted this article on SSRN. No, don’t worry, I haven’t been SSRENded just yet, but certainly it gives me pause. Gordon argues that there’s a reason that there are proportionately more independent directors on corporate boards now than there were in the 1950s (from 20% to approximately 75%), and it’s not just Delaware takeover opinions or governance reformers that caused the sea change.
Instead, it’s because the rules of the game have changed so that independent directors can be more useful than before. Because corporations now disclose more information, stock prices more accurately reflect the worth of the company. This information gives an inside director relatively less advantage over an outside director compared to 50 years ago. Said differently, outside directors now have the tools to monitor credibly. Furthermore, Gordon says that the benefits of all those independent directors are systematic, so that you can’t compare across firms—the benefit is widespread.
I obviously haven’t done justice to Gordon’s work in this blog post, and I encourage you to read it yourself. But I still am not convinced that independent directors have spent the past 15 years acting on any new-found comparative advantage that they have gained. Sure, after the corporate governance scandals broke, there has been evidence of greater board empowerment—the relatively recent uptick in boards replacing CEOs is one example. But supermajority independent directors pre-dated—and some say caused—the Enron-Worldcom era scandals.
This is a provocative piece for me, and the most thoughtful defense of independent directors I’ve seen in a while. Certainly it complicates my analysis. Thanks, Jeffrey Gordon!
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1. Posted by Jeff Lipshaw on October 10, 2006 @ 12:53 | Permalink
"They are less committed to management and its vision. Instead, they look to outside performance signals and are less captured by the internal perspective, which, as stock prices become more informative, becomes less valuable."
I haven't read the article, but juxtapose this with the "efficient markets" approach to insider trading (i.e., because markets are efficient, the view from the inside, at least in the longer run, is no different than the view from the outside, and the prohibitions against insider trading are unnecessary and, indeed, counterproductive).
Your skepticism about what the directors actually do for firm performance seems warranted. In the old paradigm, they merely followed management's lead; in the new, they are doing what an efficient market would do anyway.
Great directors don't make for innovation or create value or provide differentiation. They do something else, but I'd argue the relationship between the something and the value of the firm is attenuated. Maybe the constant between then and now is that firm performance (wow, what an insight!) has to do with products and services, none of which the directors create.