The Downside to Full
In recent years, there’s been a marked trend toward corporate boards on which the
only insider is the CEO. But there’s a problem with that kind of board independence:
New research finds it’s associated with poorer financial performance.
BY OLUBUNMI FALEYE
HIGH-PROFILE ACCOUNTING and corporate
governance scandals have resulted in significant changes in the structure of corporate
boards of directors, especially the move to
(nearly) fully independent boards — that is,
boards on which the CEO is the only employee director. According to data from the
proxy advisory firm Institutional Shareholder Services, 36% of S&P 500 companies
had no other employee director besides their
CEOs in 1999. The percentage of such companies has increased steadily since then,
reaching an astonishing 75% in 2015. This
dramatic trend raises the important question of whether board effectiveness improves
or suffers with fully independent boards.
The Benefits of Full
The potential benefits of an independent
board are well known. Independent directors
are usually leaders with few reasons to be
beholden to the CEO. Boards dominated by
independent directors are better able to oversee the CEO and protect the interests of
shareholders and other stakeholders. Increasing their number can foster better board
performance by enhancing a company’s access to external resources and connections.
A larger number of independent directors
The Disadvantages of
also allows a board to ensure that its members
are not overburdened with oversight re-
sponsibilities to the detriment of strategic
counseling. A fully independent board
enables a company to reap these benefits
without enlarging its board, thereby avoiding
the potential disadvantages of a large board.
However, full board independence is not
without its costs. First, research has shown
that the quality of managerial oversight and
strategic advising by independent directors
depends significantly on the quality and
completeness of information they receive.
Senior executives other than the CEO often
have unique insights into different aspects of
the company’s operations. While such
insights can be transmitted to the board via
the CEO, this can introduce systematic noise
(or deliberate bias on the part of the CEO)
that reduces the value of such information.
Further, inviting non-director executives to
board meetings on an ad hoc basis does not
facilitate the ongoing information exchange
between independent directors and execu-
tives that comes naturally with board
membership. A fully independent board
may thus become less effective because it
works with relatively poorer information.
Second, a major responsibility of corporate boards is to replace the CEO when
needed. Because no senior executives other
than the current CEO are members of a
fully independent board, independent
directors on such boards do not regularly
interact with, observe, and evaluate them as
they contribute to important strategy development and execution decisions. A fully
independent board thus may evaluate internal candidates for the CEO position less
accurately due to less familiarity with them.
The board may appoint an external candidate when an internal candidate would be
the better choice. Even if it does choose
an internal successor, a fully independent
board’s reduced firsthand information on
senior executives may mean that the candidate is not the best fit.
Finally, senior executives traditionally
perfect their company-specific strategy