The Fetishization of Independence

According to conventional wisdom, a supermajority independent board of directors is the ideal corporate governance structure. Debate nevertheless continues: empirical evidence suggests that independent boards do not improve firm performance. Independence proponents respond that past studies reflect a flawed definition of independence. Remarkably, neither side in the independence debate has looked to Delaware, the preeminent state source for corporate law. Comparing Delaware's notions of independence with those of Sarbanes-Oxley and its attendant reforms reveals two fundamentally different conceptions of independence. Sarbanes-Oxley equates independence with outsider status. An independent director is one who lacks financial ties to the corporation and is not a close relative of management. Delaware's approach to independence, in contrast, is situational. As different conflicts arise in different contexts, the focus of concern--the influence from which we wish to insulate directors--varies as well. There are at least two lessons for corporate reformers. First, the definition of independence should be refined to address the conflict at hand. For example, if the area of concern is executive compensation, the question is not merely whether the director lacks financial ties to the corporation and familial ties to corporate executives, but also whether the director lacks financial ties to the executives being compensated. Current independence rules overlook this obvious hole. Second, and more fundamentally, independent directors are useful only in situations where a conflict exists. An independent director--a part-timer whose contact with the corporation is necessarily limited--is not inherently better suited to further the interests of shareholders than an inside director. Current rules thus over-rely on independence, transforming an essentially negative quality--lack of ties to the corporation--into an end in itself, and thereby fetishizing independence. I. INTRODUCTION II. THE DOMINANCE OF INDEPENDENCE A. The Conventional Definition: Independence as Status B. The State of the Independence Debate III. WHY REVISIT INDEPENDENCE? A. Lack of Candidates and Increasing Cost of Independents B. The Value of Outside Independent Directors C. Empirical Evidence That Independence Does Not Matter D. Resisting the Fetishization of Independence IV. "INDEPENDENCE" UNDER DELAWARE LAW A. Distinguishing Between Independence and Interest B. Conflicting Interest Transactions and Self-Dealing 1. Delaware's Exploration of the Nuances of "Interest" 2. Section 144: Another Example of Delaware's Flexibility 3. Interest Summarized C. Derivative Suits 1. A Brief Review of Derivative Suits' Procedural Posture: Suing to Make the Corporation Sue 2. Interest 3. Independence D. Takeovers 1. Freezeout Mergers 2. Defensive Measures Against Hostile Takeovers E. Independence Summarized V. LESSONS LEARNED A. Refining the Definition: The Executive Compensation Case Study B. The Ends of Independence and Revisiting the Fetishization of the Proxy VI. POTENTIAL OBJECTIONS TO GENERALIZING FROM DELAWARE'S INDEPENDENCE TO CORPORATE GOVERNANCE A. Apples and Oranges B. The Interest Group Objection C. Apples and Oranges Redux: The Public/Private Divide D. A False Dichotomy E. Administrability VII. CONCLUSION I. INTRODUCTION Consider a hypothetical major U.S. corporation that presents a textbook example of good corporate governance. Two highly knowledgeable insiders (the CEO and CFO) sit on the board, as does the former CEO. Also on the board are seven independent (1) directors who have no management role, thus forming a strong supermajority bloc of wholly independent board members. (2) Further illustrating corporate governance best practices, the board's chairwoman is one of the independent directors, carefully chosen to take the helm in conjunction with the ouster of the corporation's former CEO. …