The Cosmetic Independence of Corporate Boards

24 Pages Posted: 3 Jun 2011 Last revised: 18 Oct 2011

See all articles by Nicola F. Sharpe

Nicola F. Sharpe

University of Illinois College of Law

Date Written: June 1, 2011

Abstract

This Essay tackles a pervasive misperception on the part of regulators that director independence significantly increases the efficacy of corporate boards. In this Essay, I assert that such “cosmetic independence” is not enough to remedy the corporate failures of recent years. Cosmetic independence is independence that takes into account only a corporate director’s relationship with the corporation and not the tools a director needs to achieve substantive independence. These tools include time, information, and knowledge, all of which have been recognized as critical to effective decision-making processes in organizational behavior literature. This Essay is critical of regulatory reforms intended to improve board monitoring. Regulators have consistently responded to each new wave of corporate failure by requiring greater board independence without much regard to the organizational process necessary for boards to function effectively. These regulations are designed to enhance board performance by changing the composition and structure of the board through increasing the number of directors that meet a superficial definition of independence and creating a more detailed and independent committee structure. The changes assume that stricter definitions of director independence necessarily lead to boards more effectively monitoring corporate management. These reforms have implemented little more than a cosmetic independence, which is both static and decontextualized. I challenge the conventional wisdom that increasing director independence, by itself, can meaningfully reduce agency costs or the likelihood of repeated corporate failure when a substantive approach to selecting directors is needed. The aim of the Essay is two-fold. First, like other critics of independent directors, it highlights the inadequacies inherent in the current definition of independence in corporate governance reforms. By identifying better criteria for board membership and better processes for board decision-making, the Essay suggests that these attributes are more accurate indicators of an effective board than cosmetic independence. Second, the Essay goes beyond the frequently discussed flaws of independence and suggests that the attention paid to the independent director/inside director distinction is misplaced. Instead, the Essay encourages scholars to turn to the organizational behavior literature on group decision-making to identify the attributes of effective teams, which include time, information, and knowledge. These attributes go beyond cosmetic independence and help fill in the gaps left by the conventional regulatory approach. In this regard, an organizational behavior approach is consistent with the tenets of agency theory but, as compared to conventional prescriptions for board reform, it takes a deeper look at the factors that enable corporate boards to make sound decisions. Using these factors to identify strong candidates for board membership does not require that we eliminate independence as a criterion for board membership; it means that we must recognize that independence without the underlying attributes of time, information, and knowledge is not enough. The Essay argues that these three attributes should be the driving force behind director selection, not cosmetic independence.

Keywords: Corporations, Board of Directors, Organizational Behavior, Director Independence, Agency Theory, Decision Making, Knowledge, Information

JEL Classification: K22, L20, L21, M10, M20

Suggested Citation

Sharpe, Nicola F., The Cosmetic Independence of Corporate Boards (June 1, 2011). Seattle University Law Review, Vol. 34, pp. 1435-1456, 2011; Illinois Program in Law, Behavior and Social Science Paper No. LBSS11-23; Illinois Public Law Research Paper No. 10-36. Available at SSRN: https://ssrn.com/abstract=1856698

Nicola F. Sharpe (Contact Author)

University of Illinois College of Law ( email )

504 E. Pennsylvania Avenue
Champaign, IL 61820
United States

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