Independent directors are an important feature of modern corporate law and courts and lawmakers around the world increasingly rely on these directors to protect investors from controlling shareholder opportunism. In our Article, Independent Directors and Controlling Shareholders, forthcoming in the University of Pennsylvania Law Review, we examine this reliance. We show that the existing director-election regime significantly undermines the ability of independent directors to effectively perform their oversight role.
Both the election and retention of independent directors normally depend on the controlling shareholders. As a result, these directors have incentives to go along with controllers’ wishes, or, at least, inadequate incentives to protect public investors.
To induce independent directors to perform their oversight role, we argue, some independent directors should be accountable to public investors. This can be achieved by empowering investors to determine or at least substantially influence the election or retention of these directors. These “enhanced-independence” directors should play a key role in vetting “conflicted decisions,” where the interests of the controller and public investors substantially diverge, but not have a special role with respect to other corporate issues. Enhancing the independence of some directors would substantially improve the protection of public investors without undermining the ability of the controller to set the firm’s strategy.
We explain how the Delaware courts, as well as other lawmakers in the United States and around the world, can introduce or encourage enhanced-independence arrangements. Our analysis offers a framework of director election rules that allows policymakers to produce the precise balance of power between controlling shareholders and public investors that they find appropriate. We also analyze the proper role of enhanced-independence directors as well as respond to objections to their use. Overall, we show that relying on enhanced-independence directors, rather than independent directors whose election fully depend on the controller, can provide a better foundation for investor protection in controlled companies.
We do not argue that independent directors should play a key role in protecting public investors at controlled companies. Some may believe that market forces can discourage controller opportunism. Others may find other measures—such as public enforcement or approval by minority shareholders—to be necessary or effective in enhancing investor protection. We take as a given that corporate law has long substantially relied on independent directors in controlled companies to protect public investors in cases of controller conflicts. Given this pervasive reliance on independent directors, our contribution is twofold. First, we show that, by itself, approval by independent directors who serve at the pleasure of the controller cannot serve as an effective device for vetting conflicted decisions. Second, we analyze how to turn independent directors into more effective guardians of the interests of public investors in conflicted decisions.
Below we outline in more detail the analysis of the Article:
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