Research Handbooks in Law and Economics series
Edited by Claire A. Hill and Brett H. McDonnell
Chapter 10: The Elusive Quest for Director Independence
1 Lisa M. Fairfax 1. INTRODUCTION The inside director – a director currently employed with the corporation on whose board she serves – is a dying breed. Although the inside director once dominated corporate boards, today the inside director has been painted as biased, untrustworthy, and generally antithetical to the best interests of shareholders and the corporation. As a result, inside directors have been banished altogether from many board committees and reduced to holding a minimal number of seats on the board as a whole (Bhagat & Black 1999, 2002; Chandler 1999; Millstein 1993). This virtual elimination of inside directors’ role on corporate boards is inextricably linked to the overwhelming consensus that boards should be dominated by ‘independent’ directors. Such consensus stems from a belief that independent directors are better equipped to monitor the corporation, detect fraud, and protect shareholders’ interests. However, the evidence accumulated from our increased experience with independent directors calls into question such a belief. Surveying that evidence, this chapter argues that the independent director’s value has been vastly overstated, while the inside director has been under-appreciated and under-examined. This has important implications for corporate governance and our system of external regulation. The second part of this chapter reveals the manner in which the corporate landscape has shifted to exclude inside directors from the board, and the rationale for that shift. The following sections pinpoint the limits of independent directors’ ability to be truly independent and to effectively perform their monitoring role, while highlighting the difficulties associated with overcoming those...
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