Board Gatekeepers

In September of 2016, news broke that employees at Wells Fargo had been moving customers’ funds into newly created fake accounts—without customer consent—in order to boost their sales figures. For outsiders, the aftermath was shocking; regulators fined Wells Fargo $3 billion and Wells Fargo fired 5,300 employees. But for the board of directors, the now-infamous scandal must have been like watching a slow-moving freight train for years. The Office of the Comptroller of the Currency found that the Wells Fargo board had known about fudged sales numbers for eleven years before the scandal broke. And while four directors resigned in the aftermath of the scandal as a result of their lack of oversight, a central question remained: what had caused the board of a reputable, established, highly regulated enterprise to overlook a scandal in the making for over a decade? In other words, investors and regulators alike pondered: “[w]here were the Independent Directors?”

But the issues with Wells Fargo’s board went beyond the rank-and-file directors serving on the board. Wells Fargo’s board included a Lead Independent Director (LID) who was meant to serve as gatekeeper, limiting management’s influence over the boardroom and further solidifying the board’s independence. But, as the Wells Fargo scandal demonstrates, having a designated LID does not necessarily effectuate true independence. In fact, the Federal Reserve has placed direct blame on Wells Fargo’s LID, stating in a letter that “you did not appear to lead the independent directors in pressing firm management for more information and action, even after you were aware of the seriousness of the problems” and that “[a] lead independent director is appointed to… provide an alternative view of, and (when necessary) check on, executive directors of the board and the management of the firm. Your performance in that role is an example of ineffective oversight.”

Indeed, as director independence became a mainstay of modern corporate governance, courts, regulators, investors, and companies themselves have all increasingly emphasized the need for independent directors to take on key leadership positions as a means to safeguard corporate boards’ ability to serve as a robust check on management’s power. Investors have started to push boards not only to maintain a sufficient number of independent directors on their boards, but also to ensure that the power structure and dynamic in the boardroom is not skewed such that the board, as a group, is unable to act independently of management. This push has focused on diluting the structural power the CEO has in the boardroom. Recognizing the imbalance in power between the management representative on the board and the independent directors, investors have begun asking boards to break that power through the introduction of two key independent leadership roles within the boardroom—an Independent Chair of the board and a LID. As a result, a vast majority of public companies’ boards are now led by an Independent Chair, or alternatively, include a LID. Indeed, the Independent Chair and LID have become focal points of investors demands over the last decade. Today, most companies have either an Independent Chair or LID (or both) on their boards to satisfy investors’ expectation of independence, or at least the appearance thereof.

This paper terms these emerging leaders as Board Gatekeepers. In the corporate context, the term gatekeepers has developed to reflect the ability of outside professionals such as lawyers and auditors to monitor and curb corporate misconduct. The LID and the Independent Chair are similarly meant to provide this corporate gatekeeping function within the boardroom, by serving as the “independent counter-balance to the CEO” and by signaling, and ensuring, the existence of proper monitoring of management by the board.

In theory, the emergence of Board Gatekeepers—who provide a second layer of protection to the independence of the board—should have cemented board independence in what one can term its functional role. Board Gatekeepers are meant to be even more empowered and detached from management compared to the rest of the independent board. This allows them to serve an independent gatekeeping function—a necessary guardrail against management’s ability to exert undue control over the boardroom.

However, herein lies the puzzle. Despite the significant rise in the percentage of independent directors on companies’ boards and the emergence of the independent board gatekeepers—who are meant to “guard the guards”—the overall ability of boards to effectively monitor management may not have shifted as much as companies’ self-proclamations suggested and as investors may have assumed. The Wells Fargo scandal and other recent corporate scandals have shown that Board Gatekeepers are not a panacea to a board’s inability to be independent.

How can one reconcile the parade of recent scandals—and the ensuing surprise of regulators and investors—with the emergence of the new Board Gatekeepers on which they have relied? This paper is the first to provide detailed and critical account of the emergence of Board Gatekeepers and in doing so it shows that these failures may not be so puzzling once one looks beyond the mere façade of the boardroom.

A closer look at Board Gatekeepers paints a different reality. Through a hand-collected dataset and interviews with directors and general counsels, this paper reveals, for the first time, that installing Board Gatekeepers is not the cure-all it seems. Instead, Board Gatekeepers are often deprived of the powers necessary to rebalance the boardroom dynamic and, in many cases, their own independence is questionable at best—and recognizing them as such has numerous theoretical and practical implications.

More specifically, using a first of its kind hand-collected and hand-coded dataset of Board Gatekeepers’ independence and powers in 900 publicly traded companies, this paper shifts the focus to the functional independence of Board Gatekeepers and shows that their failures could be explained, at least in part, by their lack of functional independence. Indeed, in many cases, Board Gatekeepers, although purported to be independent, are tightly connected to the companies where they serve in ways that cast doubt on their willingness to truly act independently.

But it is not only the willingness to act that might curtail Board Gatekeepers’ effectiveness. It is also about the powers at their disposal. Indeed, the sharp divide between the ceremonial presence of independent gatekeepers and their functional independence extends beyond concerns regarding their own personal independence, as manifested in their willingness to act. It also centers around the lack of concrete tools at their disposal to exert independent monitoring, even if they so desired. This paper provides the first empirical analysis of the powers given to LIDs and Independent Chairs of boards, examining the frequency, type and strength of the powers afforded to Board Gatekeepers, finding that in many cases, these crucial gatekeepers are granted nothing but a mere title rather than substantive powers. This second facet of functional independence spotlights the concerns regarding Board Gatekeepers’ power to truly act independently even if they are willing.

The concern regarding gatekeepers’ explicit powers is further affirmed through a series of original interviews with directors and general counsels, including LIDs, who identified the concrete ways through which enumerated gatekeepers’ powers can affect the board. Enumerated powers were seen as particularly important in preventing discord in the board, in empowering the LID to take actions even when a potential discord may arise, and in setting clear expectations of the LID’s role for both the board and investors.

Equally important, the powers given to Board Gatekeepers are imperative not only in allowing gatekeepers to exert independence ex-ante. They also provide a central mechanism of accountability ex-post, allowing regulators and investors to specifically point to a lack of action by these gatekeepers, despite the explicit power to do so. This was the case in the Wells Fargo scandal where regulators pointed to the LID’s lack of inquiry and lack of demand for additional information despite the specific powers that were given to the LID in the firm’s Corporate Governance Guidelines.

Finally, board gatekeepers are predominantly white men, and gender and racially diverse directors are shunned from these leadership roles in many companies. Out of the 900 companies sampled only six companies had a female serving as Independent Chair and only six percent of all LIDs included within this analysis were female. Recent studies have shown that more diverse boards generally make better decisions and are more apt to prevent misconduct. This lack of diversity may further hinder gatekeepers’ functional independence.

Recognizing the gap between board gatekeepers’ ceremonial and functional independence, the paper proceeds to argue that the blind championing of Board Gatekeepers by investors and companies alike may not only undermine the credibility of director independence but may also render the role entirely counterproductive. Therefore, this paper posits, it is important to safeguard gatekeepers’ functional independence through a combination of heightened independence standards, improved disclosures, and the grant of specific and common enumerated powers.

The full paper can be downloaded here.