The Myth of an Independent System for Nominating Directors (and Another Reason Why Shareholder Access Is Necessary) (Part 1)

The central problem of corporate governance is the need to ensure that officers and directors manage in a manner that benefits shareholders. 

To address this issue, companies put in place various safeguards designed to ensure that the interests of shareholders at the board level are adequately protected.  Independent directors represent the main device for doing so.  Independent directors, so the theory goes, will not be beholden to the CEO or other executive officer and will decide issues not in the best interest of management but the best interest of shareholders.

Whatever the merits of the approach, it only works if directors are truly independent.  As we have noted often on this Blog, the rules of the stock exchange and the interpretations of the Delaware courts do not ensure that directors labeled independent are in fact independent.  Neither definitions, for example, adequately screen for friendship and both essentially exclude fees paid to directors from the independence analysis.  Thus, directors can earn "total compensation" of more than $1 million a year  (Apple, for example) yet be treated as if this amount does not matter and will not be taken into account when deciding issues that affect the CEO.  Many of these issues are discussed in Disloyalty Without Limits: 'Independent' Directors and the Elimination of the Duty of Loyalty. 

But the weakest link in the system of "independent" directors is likely the process for selecting members to the board.  This is done by the board itself, a body that always includes the CEO. Not only is the CEO always on the board, but in one study of the 100 largest companies, he/she was the only non-independent director in 44 of the companies.

Thus, the CEO is in a good position to influence the nomination process.  In recognition of this, the exchanges have in place requirements that listed companies have a nominating committee that includes only independent directors.  See 303A.04 Nominating/Corporate Governance Committee.  In other words, the CEO cannot sit on that committee. 

We will discuss these requirements in the next post.