The Fetishization of Independence

I. INTRODUCTION

Consider a hypothetical major U.S. corporation that presents a textbook example of good corporate governance. Two highly knowledgeable insiders (the CEO and CFO) sit on the board, as does the former CEO. Also on the board are seven independent 1 directors who have no management role, thus forming a strong supermajority bloc of wholly independent board members.2 Further illustrating corporate governance best practices, the board's chairwoman is one of the independent directors, carefully chosen to take the helm in conjunction with the ouster of the corporation's former CEO. A sophisticated and seasoned financial executive, the chairwoman has studied books on governance, attended directors' workshops, and hired consultants to update the board's handbooks. With this independent board in place-meticulously selected to right the mistakes of the recent past-the corporation's stock has soared. But then, within the course of a month, the tapestry of success unravels.3 One independent director, a flashy, risk-loving Silicon Valley mogul,4 clashes repeatedly with the chairwoman. Allegations of board leaks, potential criminal behavior, and internecine conflict between board members lead to the chair's resignation and scandal for the entire corporation.

This corporation, as it turns out, is not a hypothetical firm, but in fact is Hewlett Packard (HP), the 14th largest corporation in the United States.5 Regardless of the blame that may ultimately be assigned to the various individuals on the board, the HP story illustrates the perils of relying on "best practices" corporate governance-such as a supermajority independent board-alone. Nevertheless, a student of corporate governance discourse over the past 40 years could easily conclude that independent boards are an essential-indeed, a natural-part of good corporate governance.6 It is now conventional wisdom that independent boards must run companies, so obvious that it does not even warrant discussion.7

Even so, in some corners of academia, debate about the value of independent directors persists.8 Empirical studies have shown that a majority independent board does not improve firm performance-that is, firms with a majority of independent directors do not perform better for shareholders than those with a minority of independents.9 In response, proponents urge ever-stricter definitions of independence. Surprisingly, however, participants in this debate have failed to examine the role of independence in Delaware, the preeminent source of corporate law in the United States.10 This omission is particularly notable because Delaware's theory of independence differs radically from the conventional approach. Although practitioners have parsed Delaware's independence requirements in specific areas,11 there has been no systematic examination of the role that independent directors play in Delaware, nor has anyone compared that role with the recommendations of independence-minded corporate governance activists.

This Article uses Delaware's approach to independence to question both the means and ends of director independence as currently conceived.12 By "means," I refer to the way that independence is defined. The Sarbanes-Oxley Act of 200213 (SOX) and self-regulatory organizations (SROs) such as the NASDAQ and the New York Stock Exchange (NYSE) define independence by way of status: "independence" means outsider status. The hallmark of the independent director, so conceived, is an absence of ties to those in control of the corporation. SOX and the SROs gauge this lack of ties through the use of two metrics: (1) lack of financial ties to the corporation, and (2) lack of familial ties to the managers of the corporation. For example, under the NYSE rules, directors are not independent if they have received more than $100,000 in non-director fees, or are a close relative of executive management. Delaware, by contrast, takes a more contextual approach. Under Delaware law, one cannot determine independent status ex ante, before a conflict arises. Once a conflict triggers the need for an inquiry, Delaware looks to the specifics of the situation in order to determine independence. As a result, a person not related to an executive and who has never taken compensation from the corporation nonetheless may be deemed to lack independence for reasons of past obligation,14 or even friendship with key managerial personnel.15

Delaware's approach provides a lesson for the SROs and corporate reformers 16 generally: a genuine concern about board-member independence requires focus on the conflict at hand. Both SOX and the SROs' definitional approaches suffer from the same deficiency: they address financial conflicts with the corporation and familial conflicts with corporate managers, but overlook f...

If you are already a vLex customer, Access Here