This is the third post in my effort to clarify corporate governance terms that now seem misleading to me. We all know what these words mean in a literal sense but in the context of governance, of business and of our post-crash world do they still mean the same thing?
I look forward to your comments.
Independence & Legal Independence
Effective governance of corporations requires that the board include individuals and committees independent of the management. Under the current system, in which boards of directors are essentially self perpetuating, it strains credulity that any individual board member could be considered to be “independent” of the board and the CEO. Directors chosen and endorsed by management inherently have a conflict of interest. Those entrusted with auditing and compensating management cannot be dependent on the favor of management without destroying the legitimacy of the process.
The criteria for independence is defined according to the charter of each corporation, state incorporation statutes and the various Stock Exchanges. In his recent essay on the HLS Corporate Governance Forum, Martin Lipton recently wrote: “friends can and should be independent directors. There is absolutely no basis for second-guessing a board’s reasonable determination that a friend of the CEO, or a friend of another director, is independent” (Corporate Governance Adrift). Plainly, there is such a thing as legal independence but is it what we want or does it operate so as to legitimate a management based power structure?
Legal independence is a construction that exists outside reality. A legally independent director may or not be independent-minded. People want to be directors, it is a coveted position. If an individual is “gifted” a directorship it seems naïve to believe that he will be independent of the person who offers him the position. The only way to characterize an individual as truly independent is to have him nominated from outside the present power system – for example, as the SEC has recently proposed.
Specific criteria of independence are often painfully wrought, but does compliance with them assure quality independence – “real” independence -- essential for a system of effective governance? Can the corporate system flourish in reliance on “legally independent” compensation committees, audit committees and their creatures?
#1 – Is a system based on “legal independence” at best a charade and at worst a deception?
#2 – Can shareholders have assurance that any person selected according to the prevailing system of board self perpetuation is actually independent?
#3 – Or, is it therefore necessary that some interested parties – a percentage of long term shareholders - outside of the incumbent board and management choose those individuals whose independence is essential to the integrity of the corporate governance?