The Conference Board Governance Center Blog

Sep
14
2010

Guest Contributor: Dodd-Frank Act Should Address Interlocking Directors

GUEST CONTRIBUTOR POST: C. Warren Neel is executive director of the University of Tennessee’s Corporate Governance Center and a director on several public company boards. Having sat on nine boards in his career, he experienced, several years ago, the interlocking directorship issues and reflects that understanding on the boards he now serves. This post is exclusive to The Conference Board Governance Center.

By C. Warren Neel

We’ve all served as corporate directors and participated in identifying new board members. Search firms are important participants, but we also rely on fellow members for recommendations. A couple of decades, ago this was a simpler process. Now independence is a defined requirement with more shareholder involvement in defining the term.

In the late 90s, before passage of the Sarbanes-Oxley Act (SOX) in 2002, the independence issue was a theme for the public media. One of the more interesting news items was Disney’s Chairman/CEO Michael Eisner. Certain directors of that board had business relationships with Eisner that compromised their decision regarding Eisner’s compensation. Some members were buddies of fellow board members, and performance evaluations were tempered by tight friendships. Shareholders were very upset.

Then Enron occurred, SOX became law and the issue of board independence was addressed. Or, was it?

In April the Wall Street Journal published an article, “Board Ties Begin to Trip Up Companies.” [Registration required.] It was reported that Sears Holding Corp. had been sued by shareholders charging that board member independence was not being followed. Some directors were on other boards of companies considered to be competitors. Sears took exception to the suit noting that its directors had met the regulatory requirements of independence.  Shortly later, however, some members of the board announced they would not seek re-election.

The WSJ article tends to suggest interlocking directors could compromise independence regardless of whether regulatory requirements are met. The article captured my thoughts about the history of such boards begging and prompted the question: How should the issue of independence be considered beyond meeting legal requirements?

Since the article appeared, the Dodd-Frank Act became law and expanded the requirements of independence.  Choosing a board chair was but one item addressed. There was also an increased emphasis on the requirements for membership on the board itself with a greater emphasis on the membership of the audit and compensation committees.

Designing these new regulations is an important step. But they don’t answer the question: Is this all there is to solving issues regarding board member independence?

Even when indepence compliance is met, interlocking directorates should still remain a consideration for board members. If such exist a board’s performance might still be compromised even if independence standards are met. Directors who are on several boards together and yet meet the independence requirements could be very close friends who have faced issues together. Interlocking directors are more likely to take a similar position on critical issues facing the company. In their social setting position they will have discussed the company’s issue and even reflected on the position they took together on another board. The result could be a consistent “block vote” rather that the necessary independence in their decision. The expertise for which a member was recruited could therefore be compromised.

Admittedly, social friendship is not assurance that the board cannot function appropriately. Nor is it a guarantee that any issue coming before directors will necessarily be solved. It should, however, be a consideration when searching for talent.

Boards today can meet the regulatory requirements yet have interlocking members. The requirement of independence will be met but social independence will be present. The expertise an independent member is to bring, if this social relationship is highly valued by those who serve on other boards together, could be at risk. Such friendship can limit the true value of independence. Those cases are very likely to affect the needed “chemistry” of a board and its role in a company’s future.

The role of a Corporate Governance Committee, if it is responsible for board evaluations and recruitment of members, should be to consider the interlocking issue beyond just compliance. Researching the expertise of a candidate to fill the expertise needs defined by the board is not enough. The candidate’s career, the relationships that he or she has with other current members on other boards and any social relationship, should be a central part of the due diligence.

The Dodd-Frank Act addresses the issue of independence but potential new members who have interlocking relationships yet meet the regulation requirements should also meet social independence standards necessary for representing the interest of shareholders.



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