Country Year Requirements Regarding Independent Directors
A. The Advisory and Monitoring Roles of Boards
Corporate boards of directors are at the apex of corporate internal control systems and are responsible for final corporate decisions.15The boards not only advise management on corporate strategy but also monitor management. The advisory and monitoring roles of boards sometimes
14The preeminence of Delaware corporate law among U.S. state corporate laws is well-recognized among scholars and practitioners. More than 50 percent of all public-listed companies in the U.S., including 63 percent of the Fortune 500, are incorporated in the state of Delaware. In recent years, the expansion of federal law in internal corporate governance of public companies has intruded the traditional domain of state corporate law and has drawn scholarly discussion about the future of Delaware state corporate law. The competition of corporate law has morphed from state-to-state competition to state-to-federal competition. For the classic statement of state
competition, seeWilliam Cary, Federalism and Corporate Law: Reflection upon Delaware, 83 YALE L.J. 663, 663-670 (1974).For recent discussion about the intrusion of federal law to state corporate law,seeMark J. Roe,
Delaware's Competition, 117 Harv. L. Rev. 588 (2003) [hereinafter Roe Delaware’s Competition];William B.
Chandler III & Leo E. Strine, Jr., The New Federalism of the American Corporate Governance System: Preliminary Reflections of Two Residents of One Small State, 152 U.PA.L.REV. 953 (2003); Renee M. Jones, Rethinking Corporate Federalism in the Era of Corporate Reform, 29 IOWA J.CORP.L. 625, 627-29 (2004); Larry E. Ribstein, Market vs. Regulatory Responses to Corporate Fraud: A Critique of the Sarbanes-Oxley Act of 2002, 28IOWA J.
CORP.L. 1, 57-59 (2002); Mark J. Roe, Delaware's Politics, 118 HARV.L.REV. 2491 (2005);Mark J. Roe,A Spatial Representation of Delaware-Washington Interaction in Corporate Lawmaking, 2012 COLUM.BUS.L.REV. 553 (2012) ;Mark J. Roe, The Shareholder Vote and Its Political Economy, in Delaware and in Washington, 2 HARV.BUS. L.REV.1 (2012).
15Eugene Fama& Michael Jensen, Separation of Ownership and Control, 26 J.L.&ECON.301, 311 (1983).
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overlap.16Boards seeking to give effective advice to management rely on management to first provide them with accurate information. On the one hand, boards will advise management more effectively if management provides it with more sound information. But on the other hand, providing more information to boards exposes management to more effective monitoring.17
In theory, shareholders want CEOs to share sufficient sound information with boards so that boards can give sound recommendations to management and effectively monitor management. In practice, however, CEOs face a trade-off in sharing reliable information with their respective boards. Assuming a moral hazard problem presents itself and that CEOs’ preferred projects are different from shareholders’, CEOs would be hesitant to share firm-specific information with their own boards if those boards are independent and intensely monitoring their own CEOs. As a result, the advisory and monitoring roles of boards may conflict with each other.18 Economic theories suggest that it maybe optimal for shareholders to choose a friendly board that does not monitor too intensely and with whom the CEO is willing to share information.19
In his 2011 article, Faleye provides empirical evidence showing that advisory and monitoring roles do conflict.20The study classified board committees as either monitoring committees or advising committees and categorized audit, compensation, and nomination committees as monitoring committees. The study defined directors as monitoring-intensive if they served on at least two of the three principal monitoring committees and defined boards as
16 Donald C. Langevroot, Commentary: Puzzles About Corporate Boards and Board Diversity, 89N.C.L.REV. 841, 842-845 (2011); Amy L. Hillman & Thomas Dalziel, Boards of Directors and Firm Performance: Integrating Agency and Resource Dependence Perspectives, 28 ACAD.MGMT.REV. 383, 384-88 (2003);
17 For a literature review on boards function in practice, see generallyRenee Adams et al., The Role of Boards of Directors in Corporate Governance: A Conceptual Framework & Survey, 48 J.ECON.LIT.58 (2010).
18Renee B. Adam and Daniel Ferreira, A Theory of Friendly Boards, 62 J.FIN.217, 217-220 (2007).
19Id., at 229-231. See also Andres Almazan and Javier Suarez, Entrenchment and Severance Pay in Optimal Governance Structures, 58J.FIN 519 (2003); Donald C. Langevoort, Resetting the Corporate Thermostat: Lessons
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monitoring-intensive if a majority of their members were monitoring-intensive directors. In addressing the quality of board-advising functions, the study used acquisition performance and corporate investments in innovation as proxies of innovation. A major finding was that firms with monitoring-intensive boards exhibited worse acquisition performance and less innovation than did firms with weakly monitoring boards, implying that intense monitoring could compromise board-advisory functions.21
The question that then presents itself is whether boards with intense monitoring and weak advising functions would be most likely to strengthen or to weaken firm value.22Faleye found that monitoring-intensive boards are associated with a statistically significant reduction of 12.1 percentage points in Tobin’s q, a proxy for firm value.23 There are many possible explanations for the loss in firm value. Because of time constraints, increases in directors’ time spent monitoring management could reduce the time available to the directors for advising management. In addition, monitoring-intensive directors would perceive themselves as corporate monitors rather than advisors and thus are reluctant to provide strategic advice. On the other hand, CEOs tend to share less information with monitoring-intensive boards, and this could result in poorer board advice.24
Empirical research supports the theoretical hypothesis that the advisory and monitoring roles of boards are sometimes in conflict with each other. In general, research suggests that the net effect of increased monitoring is negative, especially in larger firms where the firms’ needs
21Id.
22James D. Westphal, Board Games: How CEOs Adapt to Increases in Structural Board Independence from Management, 43 ADMIN.SCI.Q. 511, 512-13 (1998); Benjamin Hermalin& Michael Weisbach, Endogenously Chosen Boards of Directors and Their Monitoring of the CEO, 88 AM.ECON.REV.96, 96-97 (1998).
23 Tobin's q is defined as total assets minus the book value of equity plus the market value of equity, divided by the book value of assets. Id., at 175 Table 7.
24Id., at 175.
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on board advising is greater than smaller firms because their operations are more complex, or when firms are in need of their own board’s advice on specific value-creating activities, such as corporate acquisitions and R&D investments.25