Independent Directors and Controlling Shareholders
165 University of Pennsylvania Law Review, Issue 6 (May 2017).
52 Pages Posted: 7 Mar 2016 Last revised: 26 Oct 2017
Date Written: April 1, 2017
Independent directors are an important feature of modern corporate law. Courts and lawmakers around the world increasingly rely on these directors to protect investors from controlling shareholder opportunism. In this Article, we argue 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.
Note: Some earlier versions of this paper were circulated under the title “Making Independent Directors Work.”
Keywords: Controlling Shareholders, Corporate Control, Independent Directors, Corporate Governance, Agency Problems, Conflict of Interest, Self-Dealing, Controller Opportunism, Tunneling, Boards of Directors
JEL Classification: D21, G32, G34, G35, G38, K22
Suggested Citation: Suggested Citation