The Rise of Independent Directors in the United States, 1950-2005: Of Shareholder Value and Stock Market Prices

Abstract

Between 1950 and 2005, the composition of large public company boards dramatically shifted towards independent directors, from approximately 20% independents to 75% independents. The standards for independence also became increasingly rigorous over the period. The available empirical provides no convincing explanation for this change. This Article explains the trend in terms of two interrelated developments in U.S. political economy: first, the shift to shareholder value as the primary corporate objective; second, the greater informativeness of stock market prices. The overriding effect is to commit the firm to a shareholder wealth maximizing strategy as best measured by stock price performance. In this environment, independent directors are more valuable than insiders. They are less committed to management and its vision. Instead, they look to outside performance signals and are less captured by the internal perspective, which, as stock prices become more informative, becomes less valuable. More controversially, independent directors may supply a useful friction in the operation of control markets. Independent directors can also be more readily mobilized by legal standards to help provide the public goods of more accurate disclosure (which improves stock price informativeness) and better compliance with law. In the United States, independent directors have become a complementary institution to an economy of firms directed to maximize shareholder value. Thus, the rise of independent directors and the associated corporate governance paradigm should be evaluated in terms of this overall conception of how to maximize social welfare.