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Does a director have the capacity to make independent judgments without undue influence from management of the company? This is the billion-dollar question and is not easily answerable from the information presented shareholders. However, we can glean from the proxy statement some indications as to whether a director is sufficiently independent from management so that she might act in the best interests of shareholders.
The debate has raged for many years as to what defines an "independent" director. While governance experts will undoubtedly argue this question for sometime, the standard that has emerged is one promulgated by the NYSE. The NYSE identifies a director as independent if he or she has no more than one non-trivial relationship with the company. That one relationship is the directorship. Any more relationships with the corporation and his or her independence is called into question.
Here are the other relationships that call into question a directors lack of independence:
- Was the director previously employed with the company or an affiliate;
- Was the director previously employed or previously employed by the auditor of the company in the last five years;
- Was the director previously employed by a consultant to the company;
- Was the director previously employed by a customer or supplier of the company with a non-trivial relationship;
- Was the director previously employed by a college or foundation receiving grants or endowments from the company;
- Is the director related to an executive or director of the company;
- Is the director an officer of another company on which the company's chair or CEO serves as a board member.
NYSE listed companies will disclose this information in their proxy statements. A quick glance at the document will give you a sense of the directors' independence in accordance with this standard.
However, this bright-line test does not catch all of the possible problems with director independence.
Robert Monks and Nell Minow describe the problem of assessing whether directors are independent in their book, Corporate Governance. They make the important point that there are two ways of looking at director independence. Is a director "resume independent" or is the director "independent in spirit." This is an important distinction.
The NYSE standard follows the "resume independence" standard. However, this may fail to account for more subtle issues related to a director's independence. For instance, when a director is handsomely compensated as a director, gets credit cards to use for himself and his family, socializes with the CEO and has other undisclosed ties with the company or its officers, is he capable of acting in the interests of shareholders or the executives? Herein lies the problem with the cookie cutter approach used in measuring independence today.
At a recent conference in 2010, Charles M. Elson, director at HealthSouth and director of the John L. Weinberg Center for Corporate Governance at the University of Delaware made an interesting observation about the qualification of directors, to wit: "Someone may look fantastic with a million different qualifications, but when you meet them, they may be very, very different than their qualifications suggest. And there are folks who have qualifications that might not be so terrific, but, frankly, when you see them in action, they do an amazing job. In other words, I don't think that someone's qualifications on paper necessarily present the greatest picture of them."
While shareholders may never know the more subtle factors that would make a director less than independent in spirit, outcomes at the board level may be telling. One gross example of this is the recent announcement that JP Morgan Chase is awarding more than $27 billion in bonuses to its employees stemming from their performance in 2009. The public outcry will likely have repercussions for many years to come. While the company's CEO, James Dimon is front and center on this debate, nary a peep has been heard from the Board's Compensation Committee. Interestingly, the committee is composed of four current or former CEOs of major public companies and the committee's chair is none other than Lee Raymond, the former CEO of ExxonMobil.
It's not too difficult for me to see where four current and former CEOs of major companies stand when it comes to paying one of their own.
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