Beruflich Dokumente
Kultur Dokumente
Wolf-Georg Ringe*
1. Introduction............................................................................................ 402
2. Independent directors and the financial crisis ........................................ 403
2.1 The regulatory and quasi-regulatory push ............................................. 405
2.2 A question mark behind independence .................................................. 407
3. Why do we have independent directors? ............................................... 408
3.1 Improving the boards performance ....................................................... 408
3.2 Criteria of independence ........................................................................ 410
4. Challenges to independence ................................................................... 412
4.1 Matching independence with industry and ownership structure ............ 413
4.2 Empirical evidence ................................................................................ 415
4.3 Incentive problems ................................................................................. 417
4.4 Substitutes for independence ................................................................. 418
5. Towards a functional understanding of board independence ................. 420
5.1 Improving independence ........................................................................ 420
5.2 Combining independence with dependence ........................................... 421
6. Conclusion ............................................................................................. 424
Abstract
This paper re-evaluates the corporate governance concept of board independence
against the disappointing experiences during the 2007-08 financial crisis. Inde-
pendent or outside directors had long been seen as an essential tool to improve the
monitoring role of the board. Yet the crisis revealed that they did not prevent firms
excessive risk taking; further, these directors sometimes showed serious deficits in
understanding the business they were supposed to control, and remained passive in
addressing structural problems.
A closer look reveals that under the surface of seemingly unanimous consensus
about board independence in Western jurisdictions, a surprising disharmony
prevails about the justification, extent and purpose of independence requirements.
These considerations lead me to question the benefits of the current system. Instead,
this paper proposes a new, functional concept of board independence. It would
redefine independence to include those directors that are independent of the firms
controller, but, at the same time, it would require them to be more accountable to
(minority) shareholders.
1. INTRODUCTION
1 In this contribution we speak of the board, largely for simplicity reasons knowing that
some countries use a two-tier board system. In these two-tier jurisdictions, we would refer to the
supervisory board.
2 See recent empirical contributions, for example, R. Adams, Governance and the Financial
Crisis, 12 International Review of Finance (2012) p. 7; A. Beltratti and R. Stulz, The Credit
Crisis Around the Globe: Why Did Some Banks Perform Better?, 105 Journal of Financial
Economics (2012) p. 1; D. Erkens, M. Hung and P. Matos, Corporate Governance in the 2007-
2008 Financial Crisis: Evidence from Financial Institutions Worldwide, 18 Journal of Corporate
Finance (2012) p. 389.
Independent Directors After the Crisis 403
The concept of board independence has originated in the United States. US case
law has long encouraged independent and non-employee directors, while US ex-
change rules require that company boards include a majority of independent direc-
tors and that key committees be composed of a majority, or entirely, of independent
directors.
Regulation is often scandal-driven or responds to economic crises. In response
to a number of major corporate and accounting scandals, including those affecting
Enron and WorldCom, the Sarbanes-Oxley Act reformed large parts of US corpo-
rate law and capital market regulation. This included a strengthening of board
independence: inter alia, the Sarbanes-Oxley Act required publicly traded compa-
nies to have wholly independent audit committees with the power and the duty to
select outside auditors.3
In a similar way, the global financial crisis of 2007-08 re-opened the debate
around corporate governance and risk management.4 Again, independent directors
were partly blamed for the major failures of checks and balances.5 The account that
the financial crisis was, if not caused, at least facilitated by idiosyncratic and institu-
tional deficits in board-level corporate governance has become ever more popular in
the financial press.6 But also, a number of academic papers seek to confirm the
account that boards not only failed, but failed in a way that contributed to or exacer-
3 E.M. Fogel and A.M. Geier, Strangers in the House: Rethinking Sarbanes-Oxley and the
Independent Board of Directors, 32 Delaware Journal of Corporate Law (2007) p. 33; K.J.
Hopt, Comparative Corporate Governance: The State of the Art and International Regulation,
59 American Journal of Comparative Law (2011) p. 1, at p. 25.
4 Numerous publications on this subject have already been published. See, for example,
S. Bainbridge, Corporate Governance After the Financial Crisis (Oxford, OUP 2012); C. Mayer,
Firm Commitment: Why the Corporation Is Failing Us and How to Restore Trust in It (Oxford,
OUP 2013); OECD, Corporate Governance and the Financial Crisis: Key Findings and Main
Messages (June 2009).
5 The iconic American investor Carl Icahn claims that the financial crisis was caused by the
failure of a significant set of checks and balances ultimately ending with the boards of directors.
See C. Icahn, Corporate Boards That Do Their Job, Washington Post, 16 February 2009, A 15.
6 J. Schnatter, Where Were the Boards? Accountability Shouldnt End with the CEO, The
Wall Street Journal 25 October 2008, A 11; D. Goldman, Goodbye and Good Riddance AIG
Directors!, cnnmoney.com, 30 June 2009, available at: <http://money.cnn.com/2009/06/30/news/
companies/aig_shareholder_meeting/index.htm>; J.R. Finlay, Outrage of the Week: Leadership
Fiddles While Bear Stearns Burns (blog entry, 14 March 2008), available at: <http://finlayon
governance.com/?p=423>.
404 Wolf-Georg Ringe EBOR 14 (2013)
bated the financial crisis and the resulting losses at banks and in the real economy.7
Most frequently, this line of scholarship suggests that boards of banks failed to
conduct proper risk oversight at their institutions in the years leading up to the finan-
cial crisis.8 Similarly, other scholars have noted that boards made poor decisions with
respect to compensation, operations and investment at financial institutions.9 In sum,
these accounts view the financial crisis and poor bank performance as a function of
corporate governance failure, particularly of monitoring boards.10
As might be expected, this stream of the literature has led to deeper critiques of
board performance, particularly the performance of independent directors. For
those who think that independent directors are of questionable value anyhow, this
may provide confirmation. But those who believe independent directors can play a
significant role in the management of general firm performance have sought to
rehabilitate these directors by pointing to their remediable deficits. According to
them, directors failed, for example, at risk management because they lacked appro-
priate incentives, expertise or information.11 Alternatively, they did not have the
power, tools or advisers to properly supervise and assess risk. As for any bad
decisions, again this was largely due to informational failures and asymmetries,
failed incentives or other fixable deficits at director level.12 Often, these critiques
revert to the argument that had boards been even more independent of management
they might have been more questioning of executives and successful in both their
monitoring role and depending on the legal system their managerial role.13
7 Boards of directors in general are said to have played an abysmal role. See L.L. Dallas,
Financial Crisis, 9 Journal of Corporate Law Studies (2009) p. 1; R. Sprague and A.J. Lyttle,
Shareholder Primacy and the Business Judgment Rule: Arguments for Expanded Corporate
Democracy, 16 Stanford Journal of Law, Business and Finance (2010) p. 1, at pp. 31-32.
10 The narrative finds mixed support in the available empirical evidence. See B.R. Cheffins,
Did Corporate Governance Fail During the 2008 Stock Market Meltdown? The Case of the
S&P 500, 65 Business Lawyer (2009) p. 1; see also R. Stulz and R. Fahlenbrach, Bank CEO
Incentives and the Credit Crisis, 99 Journal of Financial Economics (2011) p. 11.
11 E.J. Pan, Rethinking the Boards Duty to Monitor: A Critical Assessment of the Delaware
Doctrine, 38 Florida State University Law Review (2011) p. 209, at pp. 225-231;
L.A. Cunningham, Rediscovering Board Expertise: Legal Implications of the Empirical Litera-
ture, 77 Cincinnati Law Review (2008) p. 465; R.M. Jones and M. Welsh, Toward a Public
Enforcement Model for Directors Duty of Oversight, 45 Vanderbilt Journal of Transnational
Law (2012) p. 343.
12 See N.F. Sharpe, Rethinking Board Function in the Wake of the 2008 Financial Crisis, 5
Journal of Business and Technology Law (2010) p. 99, at p. 110; see also L.A. Bebchuk and
H. Spamann, Regulating Bankers Pay, 98 Georgetown Law Journal (2010) p. 247.
13 See, e.g., J. Manns, Building Better Bailouts: The Case for a Long-Term Investment Ap-
The most critical need is for an environment in which effective challenge of the
executive is expected and achieved in the boardroom before decisions are taken
on major risk and strategic issues. For this to be achieved will require close at-
tention to board composition to ensure the right mix of both financial industry
capability and critical perspective from high-level experience in other major
business. It will also require a materially increased time commitment from non-
executive directors (NEDs), from whom a combination of financial industry ex-
perience and independence of mind will be much more relevant than a combina-
tion of lesser experience and formal independence. In all of this, the role of the
chairman is paramount, calling for both exceptional board leadership skills and
ability to get confidently and competently to grips with major strategic issues.
With so substantial an expectation and obligation, the chairmans role will in-
volve a priority of commitment that will leave little time for other business ac-
tivity.19
Oversight Obligations, 45 University of Michigan Journal of Law Reform (2011) p. 55, at p. 66.
These board-centred responses form the lions share of reform proposals outside the realm of
enhanced prudential regulation.
18 Sir David Walker, A Review of Corporate Governance in UK Banks and Other Financial
at p. 136.
Independent Directors After the Crisis 407
There are only few who question the entire concept of independence. Some observ-
ers, however, acknowledge that in some instances the question of independent
directors might have been pushed too far.32 OECD research suggests that inde-
pendence has mainly been implemented by setting up negative lists of undesirable
criteria and that this might have led to qualifications (i.e., a positive list) or suit-
ability being only of secondary importance.33 To this end, the OECD recommends
that such a negative list should usefully be complemented by positive examples of
director qualities that would increase independence.34 Moreover, they note that the
issue is not just independence and objectivity but also capabilities.35 Other re-
searchers emphasise that regulation itself has possibly contributed to the failure of
independent directors.36 That is, independence criteria in regulation often exclude
those very people that used to work at the firm, thus excluding key experts on the
subject matter of the firms business.37 In this vein, empirical studies that predomi-
nantly focus on the special case of banks have suggested that board independence is
28 Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub.L. No. 111-203, H.R.
4173, 165.
29 Ibid., 952.
30 See, e.g., Sarbanes-Oxley Act of 2002, Pub.L. No. 107-204, 116 Stat. 745, 301 (requiring
audit committees comprised of independent directors); Dodd-Frank Act, supra n. 28, 165(h)
(requiring certain public financial companies and bank holding companies to have risk commit-
tees comprised of independent directors).
31 See P. Rose, Regulating Risk by Strengthening Corporate Governance, 17 Connecticut
<http://www.oecd.org/corporate/ca/corporategovernanceprinciples/31557724.pdf>.
35 Ibid.
36 J. Winter, The Financial Crisis: Does Good Corporate Governance Matter and How to
Achieve it?, in E. Wymeersch, K.J. Hopt and G. Ferrarini, Financial Regulation and Supervi-
sion: A Post-Crisis Analysis (Oxford, OUP 2012) p. 368, at p. 376, at 12.15.
37 Winter, ibid.
408 Wolf-Georg Ringe EBOR 14 (2013)
positively related to bank bailouts.38 The reason for increasingly independent boards
of banks could well be due to country-specific regulation.39
However, the overwhelming and uncritical support for independence is by no
means a global standard. Consider the example of Japan, where until recently no
independence at all was required for board members. In the wake of the accounting
scandal at Olympus, the Japanese optics and imaging company, the government
planned to require firms to appoint at least one independent director.40 However, for
conservative business circles, even this minimum step was too much; in the end,
legislation could only be passed in a version which had been watered down signifi-
cantly in favour of a mere comply-or-explain approach.41
In what follows, this question mark behind independence will be developed fur-
ther. The next section explores the roots of board independence, after which four
fundamental challenges to the concept are discussed. This then leads us to our more
functional account of board independence, overcoming the ostensible weaknesses.
In order to understand the conclusions we can draw from the crisis, we need to go
back to the roots of the concept of directors independence. In order to establish
whether anything has failed or should be modified, we need to understand why
independence was seen as desirable in the first place.
(2012) p. 7; B. Minton, J. Taillard and R. Williamson, Financial Expertise of the Board, Risk
Taking and Performance: Evidence from Bank Holding Companies, Journal of Financial and
Quantitative Analysis (forthcoming 2013).
39 D. Ferreira, T. Kirchmaier and D. Metzger, Boards of Banks, ECGI Finance Working
Kingdom: Non-Executive Directors Following the Higgs Report, in J. Armour and J. McCahery,
eds., After Enron: Improving Corporate Law and Modernising Securities Regulation in Europe
and the US (Oxford, Hart Publishing 2006) p. 367.
Independent Directors After the Crisis 409
This rationale is confirmed by the fact that the importance of independence has
been emphasised in particular areas within the board where such conflicts of inter-
ests are potentially most salient. In this sense, most regulatory initiatives over the
past decades that have refined the concept put special emphasis on independence
for board committees, such as the remuneration committee, the nomination commit-
tee and the audit committee. In these fields, potential conflicts are exacerbated: for
example, the audit committee is the key body evaluating the performance of the
management. Here, the temptation will be great to let personal connections prevail
over objective criteria. To this end, most regulators worldwide establish reinforced
independence criteria for these or similar committees.
Our initial sense of policy is supported by a brief survey of justifications usually
cited. For example, the requirements of the New York Stock Exchange state that
[r]equiring a majority of independent directors will increase the quality of board
oversight and lessen the possibility of damaging conflicts of interest.43
Academic scholarship has refined the theoretical underpinnings for independence
in various ways. One of the classic academic articles dealing with the problem em-
phasises that independent directors act as shareholder surrogates to assure that the
company is run in the long-term best interests of its owners. This quote incidentally
sounds as if it is part of the current debate around short-termism in company law;
yet it comes from a 1991 article by Ronald J. Gilson and Reinier Kraakman.44 The
important implication (and extension to the basic monitoring role) is that independ-
ence ultimately has the goal of furthering the interests of the shareholders, and that it
is not an end in itself.45 From this perspective, independent directors are seen as a
trustee for shareholders, to mitigate managerial agency costs.46
But independent directors have been considered as a tool with much wider ob-
jectives; one may even say as a panacea to mitigate almost every problem of com-
pany law. Thus, independent directors are said to prevent self-dealing by examining
conflict of interest transactions; they should monitor management to detect and
prevent managerial fraud; further, independent directors are supposed to examine
corporate affairs and thus to prevent managerial mismanagement. Some even go as
far as to say that independent directors serve the interests not just of the sharehold-
ers, but of all stakeholders, if not of society as a whole.47
pendent directors effectively carry out their role. See ibid., at pp. 873-874.
46 L. Enriques, H. Hansmann and R. Kraakman, The Basic Governance Structure: The Inter-
ests of Shareholders as a Class, in R. Kraakman, et al., The Anatomy of Corporate Law, 2nd edn.
(Oxford, OUP 2009) p. 64 (trusteeship strategy).
47 On this discussion, see P. Beleya, et al., Independent Directors and Stakeholders Protec-
tion: A Case of Sime Darby, 2 International Journal of Academic Research in Business and
Social Sciences (2012) p. 422.
410 Wolf-Georg Ringe EBOR 14 (2013)
Jeffrey Gordon, in a 2007 article, advanced the idea of a connection between the
role of independent directors and the development of the stock market, in particular
addressing the problem of directors who are less informed and familiar with the
company.48 His argument is that increasingly sophisticated and efficient stock
markets permit companies to retain more independent directors, since the more
informative share price serves as a signal for them and makes up for the lack of
business understanding.49 Thus, Gordon argues, independent directors are more
valuable than insiders since they are less captured by the management. The more
developed and informed the stock market is, the easier it is for independent direc-
tors to monitor the management and, consequently, the more functional it is to have
independent directors on the board, avoiding reliance on explicit expertise.
These theoretical accounts give a comprehensive picture and provide ample justifi-
cation for having independent directors on the board. Yet it is surprisingly unclear
what the precise criteria are for determining whether a director is truly independ-
ent.50
Some regulators try to define independence by providing an abstract, general
description. This strategy has predominantly been used by international bodies that
try to combine approaches applicable across jurisdictions. Thus, for example, the
Basel Committee finds that the key characteristic of independence is the ability to
exercise objective, independent judgment after fair consideration of all relevant
information and views without undue influence from executives or from inappro-
priate external parties or interests.51
At the national level, many regulatory instruments give a list of criteria which
attempt to describe what does not constitute independence. For example, both the
UK Corporate Governance Code 52 and the NYSE Listed Company Manual 53 pro-
. .
vide a relatively similar negative catalogue of criteria that would normally exclude
a specific directors independence, such as where the director
48 J. Gordon, The Rise of Independent Directors in the United States, 1950-2005: Of Share-
holder Value and Stock Market Prices, 59 Stanford Law Review (2007) p. 1465.
49 Ibid., at pp. 1541-1563. See, for criticism, Bainbridge, supra n. 4, at pp. 99-100.
50 For a recent overview, see P. Davies and K.J. Hopt, Corporate Boards in Europe Ac-
countability and Convergence, 61 American Journal of Comparative Law (2013) p. 301, at pp.
317-326; M. Roth, Unabhngige Aufsichtsratsmitglieder, 175 Zeitschrift fr das gesamte
Handels- und Wirtschaftsrecht (ZHR) (2011) p. 605.
51 Basel Committee, supra n. 23, para. 38.
52 Financial Reporting Council, The UK Corporate Governance Code (September 2012),
has been an employee of the company or connected entity within the past years;
is or has been connected with the companys auditors, advisers, directors or
senior employees;
has received additional remuneration from the company apart from the direc-
tors remuneration;
has had a material business relationship with the company; or
represents a significant shareholder (UK only).
Some jurisdictions have gone further by increasing the level of detail and the
complexity of such lists, thus making them very complex to apply.54
An example of a compromise solution may be found in the German Corporate
Governance Code.55 The German Code provides a (short) list of criteria, but quali-
fies them in the following way: a director is not deemed independent if he/she has
personal or business relations with the company, its executive bodies, a controlling
shareholder or an enterprise associated with the latter which may cause a substan-
tial and not merely temporary conflict of interests [emphasis added].56 This ap-
pears to be a middle ground between the two extreme models described above: first
providing a list of substantial criteria which, however, only count if there is a
substantial, long-term conflict of interests.
The EU Recommendation of 2005 on this subject 57 almost resignedly states that
.
54 See, for example, the Danish Corporate Governance Code, May 2013, section 3.2, avail-
governance-code.de/eng/kodex/index.html>.
56 Ibid., section 5.4.2.
57 European Commission, Recommendation of 15 February 2005 on the role of non-
executive or supervisory directors of listed companies and on the committees of the (supervisory)
board, OJ 2005 L 52/51.
58 Ibid., Annex II.
59 See, in more detail, Enriques, et al., supra n. 46, at p. 66, in particular footnote 60.
412 Wolf-Georg Ringe EBOR 14 (2013)
Germany introduced this criterion only recently, but will only consider it relevant if
it involves a substantial and long-term conflict of interests.60 Another area of diver-
gence is the situation of employee representatives on the board, where Germany
differs from most other legal systems, due to its system of co-determination.61 More
generally, the various instruments presented here do not just differ in regulatory
style or substance, but also, and fundamentally, in who ultimately determines if the
board members of a particular company fulfil the independence criteria or not.62 To
illustrate, the US approach is mandatory in the sense that the NYSE listing author-
ity will scrutinise their own criteria objectively. By contrast, many other jurisdic-
tions leave the final decision on what constitutes independence to the board itself.
This is the case not only under the EU Recommendation, but also in the UK, where
the board determines whether each director is independent in character and judg-
ment.63 The above-mentioned criteria are then only non-binding guidelines for the
board, which is free to deviate under the well-known comply or explain principle.
This approach ultimately leaves the question to the market to judge.
In summary, it appears that a closer look at the legal systems of Western
economies testifies to a large divergence in the understanding of independence of
board members. This is true for both the regulatory justification of the concept and
the precise criteria that are relevant for determining independence.
4. CHALLENGES TO INDEPENDENCE
The starting point for this paper has been the unequalled triumph of the concept of
director independence in Western corporate governance over the past decades.
Following this, we have seen that the notion of independence is ambiguous and is
60 The 2012 revision of the German Corporate Governance Code included the criterion of
personal or business relationship with a controlling shareholder in the list in section 5.4.2. See on
this in detail, T. Florstedt, Die Unabhngigkeit des Aufsichtsratsmitglieds vom kontrollierenden
Aktionr, Zeitschrift fr Wirtschaftsrecht (ZIP) (2013) p. 337. A first court case concerning
Thyssen Krupp AG is now pending at the courts, see D. Fockenbrock, Strengers Kampf fr
Unabhngigkeit, Handelsblatt, 22 February 2013, p. 22.
61 K.J. Hopt, Corporate Governance of Banks after the Financial Crisis, in Wymeersch,
the annual report each non-executive director it considers to be independent. The board should
determine whether the director is independent in character and judgement and whether there are
relationships or circumstances which are likely to affect, or could appear to affect, the directors
judgement. The board should state its reasons if it determines that a director is independent
notwithstanding the existence of relationships or circumstances which may appear relevant to its
determination, including.
Independent Directors After the Crisis 413
67 On this change, see H.M. Ringleb, et al., Die Kodex-nderungen vom Mai 2012, Neue
Comparative Advantage (Oxford, OUP 2001); W. Carlin and C. Mayer, Finance, Investment and
Growth, 69 Journal of Financial Economics (2003) p. 191; M. Blair and L. Stout, A Team
Production Theory of Corporate Law, 85 Virginia Law Review (1999) p. 247.
70 See supra n. 48 and accompanying text.
71 On data supporting these different factors for industry structures, see Carlin and Mayer,
as a global principle of corporate governance. However, they insist that the practical meaning
differs across jurisdictions.
73 See, e.g., for a sceptical account of harmonisation attempts in corporate law L. Enriques,
EC Company Law Directives and Regulations: How Trivial Are They?, 27 University of
Pennsylvania Journal of International Economic Law (2006) p. 1.
Independent Directors After the Crisis 415
The second challenge to independence is the mixed empirical support it has re-
ceived in recent years. Essentially, scholars have tried to evaluate whether inde-
pendent directors improve firm performance, and have come up with overall mixed
results.76 As a consequence, there is uncertainty about the merits of the entire
concept of independence.
For example, in two ground-breaking studies, American scholars Bhagat and
Black come to the conclusion that the number of independent directors on the board
is negatively correlated with firm performance.77 A European study arrives at
code. See Weil, Gotshal & Manges LLP, Comparative Study of Corporate Governance Codes
Relevant to the European Union and Its Member States: Final Report (2002), available at:
<http://ec.europa.eu/internal_market/company/docs/corpgov/corp-gov-codes-rpt-part1_en.pdf>
(and <part2_en.pdf>), at pp. 81-83.
75 OECD Principles of Corporate Governance (2004), supra n. 34, section VI.E.
76 For recent overviews, see L.A. Bebchuk and M.S. Weisbach, The State of Corporate Gov-
ernance Research, 23 Review of Financial Studies (2010) p. 939, at pp. 943-945; R. Adams, The
Role of Boards of Directors in Corporate Governance: A Conceptual Framework and Survey, 48
Journal of Economic Literature (2010) p. 58, at pp. 80-86.
77 S. Bhagat and B. Black, The Uncertain Relationship Between Board Composition and
Firm Performance, 54 Business Lawyer (1999) p. 921; S. Bhagat and B. Black, The Non-
Correlation Between Board Independence and Long-Term Firm Performance, 27 Journal of
Corporation Law (2002) p. 232.
416 Wolf-Georg Ringe EBOR 14 (2013)
78 N. Fernandes, EC: Board Compensation and Firm Performance: The Role of Independ-
3.1.6: it can be noted that the role played by (independent) directors in the crisis period has
not necessarily been convincing and that sometimes even a certain level of distrust in independent
directors and their level of knowledge relevant to the company of which they are a director, can
be identified, available at: <http://ec.europa.eu/internal_market/company/docs/modern/reflection
group_report_en.pdf>.
81 Ibid., at pp. 50-51.
82 The Report was discussed at a public conference in Brussels on 16 and 17 May 2011. The
Commission then launched a public consultation to seek views from all stakeholders on European
company law from 2012 onwards. See Consultation on the Future of European Company Law,
at: <http://ec.europa.eu/internal_market/consultations/docs/2012/companylaw/questionnaire_en.
pdf>. The feedback statement is available at: <http://ec.europa.eu/internal_market/consultations/
docs/2012/companylaw/feedback_statement_en.pdf>. See also European Commission, Green
Paper: The EU Corporate Governance Framework, supra n. 25, section 2.7.2 and Q22.
83 D. Nordberg, Corporate Governance and the Board in S.O. Idowu and C. Louche, eds.,
Theory and Practice of Corporate Social Responsibility (Springer 2011) p. 39, at p. 51; see also
Lau Hansen, supra n. 54, at p. 79.
84 G. Kirkpatrick, The Corporate Governance Lessons from the Financial Crisis, 96 OECD
independent board members who lacked financial expertise performed worst during
the crisis.88
These accounts all have far-reaching implications for the benefits associated
with board independence. Taken together, the empirical studies show that board
independence will at least not always be helpful in improving company perform-
ance. This raises the question of why regulators (and, indeed, companies them-
selves) continue adding ever more independence criteria. It is conceivable that
diminishing marginal returns mean that the optimal number of independent direc-
tors, at least for US companies, may already have been well exceeded.
Another problem might be that independence in itself is not enough; scholars have
recently been focusing increasingly on the proper incentive structure for independ-
ent directors. This intuitively makes sense, given the numerous tasks we assign to
independent directors and the almost superhuman results we expect from them:
they are supposed to guard against self-dealing by examining conflict of interest
transactions; we expect them to actively oversee management and to detect and
prevent fraud; further, independent directors are supposed to examine corporate
affairs and thus prevent managerial mismanagement.89
In short: we ask a lot of them. In particular, we expect independent directors to
speak out and to take a proactive role in monitoring. What, other than possibly
reputational or moral constraints, can incentivise them to take up this challenge?
What, as some have described it, can encourage them to fight the battle rather
than enjoy an easy life by taking a laid-back approach to monitoring?90
Consider the recent Olympus scandal in Japan, mentioned above.91 Given the
scarcity of independent board members in Japan, Olympus stood out amongst
Japanese firms by actually having three independent members on its board. How-
ever, none of them intervened or prevented the management from misbehaving.
Opponents to more independence on Japanese boards use this as an argument to
support their claim that (the lack of.) independence was not the problem, nor will
increasing independence help solve the problem.92 Rather, it seems that the inde-
pendent directors did not dare speak out: former Olympus president Michael Wood-
ford described them as acting like children in a classroom when they were asked
88 Ferreira, Kirchmaier and Metzger, supra n. 39. See also H. Hau and M.P. Thum, Sub-
prime Crisis and Board (In-)Competence: Private versus Public Banks in Germany, 24 Economic
Policy (2009) p. 701.
89 See above section 3.
90 P.L. Davies and S. Worthington, Gower and Davies Principles of Modern Company Law,
to consider ousting the chairman at the time.93 Also, it seems doubtful that reputa-
tional constraints really work.94
Lawmakers have suggested the obvious solutions, for example, to strengthen
liability standards or to incentivise directors financially. Whatever the approach, it
is positive that this aspect of the debate to consider the incentives side has now
reached the mainstream policy discussion. It has too often been neglected in the
traditional debate.
Independence as a regulatory tool may not be the only mechanism for achieving
the particular objective for a specific situation; indeed, it may well be that lawmak-
ers prefer alternative means or substitute mechanisms. This aspect is frequently
overlooked in the policy debate. However, it is fundamental to any meaningful
legal comparison. For example, in a transnational comparison, observers frequently
note the notable absence of independent directors in Japanese companies, as already
noted above.95 Such superficial analysis does however not take into account that
Japanese law has strict independence requirements for statutory auditors, at least
half of whom must be independent.96 They may fulfil some of the objectives that
independent directors do in other jurisdictions.
Germany is another example of a country with a certain reluctance to introduce
far-reaching independence requirements. This certainly has to do with the specific
German issue of worker representation on the (supervisory) board of large compa-
nies, as well as with the concentrated shareholder environment. Following our
rationale developed above, we would expect independent directors, as necessary
counterweight, to voice the concerns of minority shareholders.97 And yet, as de-
plored by the European Commission,98 German law does not specify strict inde-
pendence standards and only vaguely requires the supervisory board to include
what it considers an adequate number of independent members.99 However, any
criticism of this vagueness does not take into account the substitutes for minority
protection offered by German statutory law. Above all, there is the well-known
group law (Konzernrecht), providing for a statutory system of compensation or
damages payments for minority shareholders in group situations.100 Another substi-
tute for protecting monitory shareholders might be the very strict understanding of
shareholder equality in German law 101 and the far-reaching possibility to chal-
.
100 Aktiengesetz 15-18 and 291-317. See L. Enriques, G. Hertig and H. Kanda, Related-
Party Transactions, in Kraakman, et al., supra n. 46, at pp. 176-178; P. Hommelhoff, Protection
of Minority Shareholders, Investors and Creditors: The Strengths and Weaknesses of German
Corporate Group Law, 2 European Business Organization Law Review (EBOR) (2001) p. 61;
Forum Europaeum Corporate Group Law, Corporate Group Law for Europe, 1 EBOR (2000) p.
165.
101 Aktiengesetz 53a. See L. Enriques, H. Hansmann and R. Kraakman, The Basic Gov-
107 See above section 4.1. Note, however, that the distinction between concentrated and
108 The 2012 amendment of the German Corporate Governance Code revised its section 5.4.2
documenti/english/laws/fr_decree58_1998.htm>.
422 Wolf-Georg Ringe EBOR 14 (2013)
companies are required to reserve at least one board seat for candidates drawn
from slates submitted by minority shareholders; consequently, even investors
holding a comparatively small block of shares can have access to the board.113 It is
encouraging that the European Commission, in its latest Green Paper on Corporate
Governance, mentions the Italian system as a good example of making the board
more accountable to minority shareholders.114 Another example is the well-known
and much-discussed German system of employee representation on the board.
Similarly to how the Italian law protects minority shareholders, the German law
takes care of employees. It is important to note, however, that these appointed
directors have duties and liabilities like any other director, including in particular
the duty to protect the interests of the company as a whole. Nevertheless, their
position as appointed representatives of a certain group facilitates information flows
between the company or management and the represented group (in both direc-
tions), and helps ensure that the concerns of this group are at least heard and con-
sidered at board level, thus raising awareness of their positions and encouraging
discussions. All of this would be very much in line with the strand of research that
has become known as the theory of the board as a mediating hierarch, in the sense
that the board as an institution brokers the relationship between the various differ-
ent constituencies affected by the company.115
Transferring this line of reasoning to the US/UK context of corporate govern-
ance, where ownership is more dispersed, independent directors should not just be
independent of management, but, to some extent, be accountable to the sharehold-
ers as well. This has been advocated already some time ago, but is not reflected in
the current legislative framework.116 Indeed, some argue that boards should be more
accountable to shareholders, relying on empirical data from the financial crisis.117
Moreover, improving the representation of shareholders or minority groups on
the board would have positive side effects. Looking at the weaknesses of the typical
current independent director as discussed above,118 there is a good chance that, for
113 See on this, B. Espen Eckbo, et al., Efficiency of Share-Voting Systems: Report on Italy,
Board, 79 Washington University Law Quarterly (2001) p. 403; and M. Blair and L. Stout, A
Team Production Theory of Corporate Law, 85 Virginia Law Review (1999) p. 247.
116 Gilson and Kraakman, supra n. 44, at p. 865.
117 See B. Francis, I. Hasan and Q. Wu, Do Corporate Boards Affect Firm Performance?
New Evidence from the Financial Crisis, Bank of Finland Research Discussion Paper No.
11/2012, at p. 35, available at: <http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelu
aloitteet/Documents/BoF_DP_1211.pdf>.
118 See above section 4.
Independent Directors After the Crisis 423
example, group representatives would have better expertise simply because the
minority group would make sure they put forward a candidate who best represents
their interests in a sophisticated manner. Similarly, we can expect that the incentive
problem will be mitigated: directors who directly represent a specific group will
have a much stronger incentive to pursue a certain agenda than the empty, disin-
terested standard director. It may be hoped that this will result in an open, fresh
dialogue: the ultimate goal would be for representative directors to present new
arguments and possible strategies to their fellow independent directors and argue
for certain ways forward, informing and inspiring the entire board and ultimately
benefiting the entire company.
On the other hand (nothing in excess). It would have fatal conse-
quences were the board only composed of representatives of certain interest groups.
This could lead to overprotection and overrepresentation of (potentially different)
minority groups and activists, blocking an effective organisation of and decision
making by the board. The consequence would be trench warfare and deadlock in
decision making. It is moreover beneficial to have a proportion of truly independent
outsiders on the board, as they can overcome groupthink and bring in new, fresh
ideas. A good balance is essential and a mixture of all of these groups is desirable.
The ultimate tenet must be the one from the former Combined Code,119 which
insists that an appropriate balance of directors is essential such that no individ-
ual or small group of individuals can dominate the boards decision taking.120
These simple words aptly describe the objective of board composition, better than
many lengthy articles.
In sum, this paper supports the idea to combine board independence with a cer-
tain, balanced dependence on (or accountability towards) certain constituencies and
stakeholders. We have seen that the following benefits are to be expected. First,
having a representative on the board will be a direct tool to voice the concerns of
the protected group (minority shareholders, for example) and to raise awareness for
their positions. Secondly, certain weaknesses that independent directors have
shown during the financial crisis may be overcome, notably expertise deficits and
incentive problems. Having appointed representatives with a clear agenda on the
board will ensure that these individuals are better incentivised and experienced.
Thirdly, an indirect impact may be expected on the incentives of the other, non-
appointed directors. Being exposed to new, clearly formulated arguments and
(sometimes contrasting) positions within the board dialogue will stimulate more
controversial thinking, improve the quality of the dialogue and raise the general
standard of discussions. This will enhance the standard of board activity overall, to
the benefit of the company as a whole. Fourthly, representative board members
119 The Combined Code of Corporate Governance is the predecessor of todays UK Corpo-
stand to improve information flows beyond the board even if they cannot always
force through their position, they can at least raise awareness of the views of minor-
ity groups. Conversely, they can also improve the information stream by reporting
back to their principals about deliberations in the board and thus contribute to more
transparency within the company.
6. CONCLUSION
The dismal performance of many companies during the financial crisis has re-
opened the debate on board corporate governance, and in particular on the long-
established element of director independence. Many current initiatives and policy
discussions seem to suggest that they aim to strengthen independence, thus a clear
more of the same. By contrast, this paper calls for a reflection on the inherent
purpose of director independence and develops a functional notion of director
independence, overcoming its deficiencies.
This is against the background that independence is often used in an undiffer-
entiated way, lacking a clear, unambiguous definition. This complicates in particu-
lar cross-border comparisons. This paper suggests that it is necessary to perform an
analysis not only of the notion of independence, but also of the concept. Thus,
independent directors are understood as a means to better control the management
and to mitigate agency costs by protecting minority groups. The specific role that
independent directors have to play depends on the specific jurisdiction, in particular
on the business environment, shareholder structure and industry characteristics. It is
therefore crucial to determine of whom the director should be independent.
But, this paper argues, independence as such is not enough. The second step is
that independence should be carefully balanced with a certain amount of depend-
ence. This refers to accountability of directors to certain minority groups which
they should protect. Strengthening the accountability of directors promises to
overcome certain weaknesses that they have displayed over the past years, most
notably expertise and incentive problems. Minority shareholder appointment rights
in Italy are an example of a useful concept in a concentrated ownership environ-
ment. The corresponding tool for a more dispersed ownership scenario would be a
director directly appointed by the shareholders.
Overall, the challenge is to find the right balance between independence and de-
pendence. Independence from the controller (management and/or majority share-
holder) should be guaranteed, but a certain accountability to the underrepresented
group would be an equally important component in motivating and stimulating the
board to perform a meaningful role.
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