David F. Larcker is the James Irvin Miller Professor of Accounting at Stanford Graduate School of Business and Brian Tayan is a Researcher with the Corporate Governance Research Initiative at Stanford Graduate School of Business. This post is based on their recent paper.
Introduction
We recently published a paper on SSRN, The First Outside Director, that examines the individual chosen by private and public companies as their first outside director.
Little is known about the process by which pre-IPO companies select independent, outside board members—directors unaffiliated with the founder or investor groups. Private companies are not required to disclose their selection criteria or process. They are also not subject to public listing requirements that stipulate independence standards or impose specific monitoring obligations through committees and executive sessions. Instead, board choices are driven largely by company insiders (such as the founder, management, and investors) in consultation with advisors and affiliates to address specific strategic, leadership, or operational issues facing the company. Even the timing of when to invite an external director to the board tends to be discretionary. The result is that a startup company goes from having a closely controlled board comprised entirely of shareholder representatives, to one with unaffiliated outside directors who have equal and independent voting rights, with no standard road map for making this transition.
Here, we look at when, why, and how private companies add their first independent, outside director to the board.
