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Independent Directors and Controlling Shareholders

52 Pages Posted: 7 Mar 2016 Last revised: 2 May 2017

Lucian A. Bebchuk

Harvard Law School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR) and European Corporate Governance Institute (ECGI)

Assaf Hamdani

Hebrew University - Faculty of Law

Date Written: April 2017

Abstract

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.

Notes: 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

Bebchuk, Lucian A. and Hamdani, Assaf, Independent Directors and Controlling Shareholders (April 2017). Available at SSRN: https://ssrn.com/abstract=2741738

Lucian A. Bebchuk (Contact Author)

Harvard Law School ( email )

Cambridge, MA 02138
United States
617-495-3138 (Phone)
617-812-0554 (Fax)

HOME PAGE: http://www.law.harvard.edu/faculty/bebchuk/

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) and European Corporate Governance Institute (ECGI)

Assaf Hamdani

Hebrew University - Faculty of Law ( email )

Mount Scopus, 91905
Israel

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