OP-ED: The Value of Independent or Outside Directors
It is considered a "best practice" to have "independent" or "outside" directors on a corporate board. Companies listed on the NYSE and NASDAQ are required to have a majority of directors be independent. Also, public companies' audit committees are required to be independent. Why? What value does "independence" provide to corporate boards and, in particular, to a closely held business or family business board?
First, there is independence. For publicly traded companies, that means that the director has "no material relationship with the company," or "a relationship that … would interfere with the exercise of independent judgment in carrying out the responsibilities of a director." In other words, the director does not have a material or pecuniary relationship with the company, other than sitting on the board, holding some shares and collecting board fees. "Independence" means free of conflicts of interest, free from management influence, and free of incentives that influence decisions.
Second, an outside director can bring different expertise and a fresh viewpoint to the company. This diversity of perspective can enhance a company's ability to make strategic and operational business decisions that maximize value. An independent director can share ideas, tools and experiences used in different businesses and industries that may result in a new outlook or a fresh way of looking at an old problem. This way, the board can take advantage of lessons learned at other companies and/or best practices that can add value.
Third, these directors usually act as directors on other boards and have extensive experience in corporate governance, risk management and other best practices. Since a board's main obligation is oversight, independent directors can improve the board's ability to provide proper accountability of management and enterprise risk. However, to attract outside directors, the board must function in a professional manner. These directors want to make a positive impact on the company, and if their time is not valued or the board meetings do not run efficiently and effectively, these directors will not continue to serve.
Fourth, an independent director can act as a mentor to management or to other board members and can spearhead an educational process on the proper functioning of a board and the best practices in board management.
Fifth, outside directors provide an element of discipline and the benefit of protection to all directors from claims that they violated fiduciary duties or had conflicts of interest. Most corporate state laws provide that if action is approved by a majority of the directors "who have no direct or indirect interest in the transaction," then the transaction is not voidable. Independent directors often constructively challenge management in an effort to make better decisions for the company.
Sixth, as "outsiders," these directors have a different network of industry and personal contacts, and they can make introductions and provide advice ranging from managerial talent to product development.
Seventh, effective outside directors are not insiders, so they take management out of operational aspects and instead direct managers to focus on key strategic direction and challenges.
And lastly, in a closely held or family business, independence helps when the family or management has lost objectivity. Outside directors can help clarify goals and roles. They can help take the emotion out of a decision and require that objective facts and perspectives be presented in order to come to a business decision. This is particularly important in a family business where hiring, firing, promoting and compensating family members and succession or transition planning are key decisions. It is also invaluable when a family manager is in need of disciplinary action.
In conclusion, independent directors can add great value to a business, but only if they are allowed to play the role of outside director and the right outside director is selected.
Originally published in the Daily Journal of Commerce on October 13, 2015