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The real impact of corporate governance isn't about compliance or structure or policies, it's about the conditions that impact decision-making. Sound-Up Governance features fresh perspectives to help boards and executives to be a bit better tomorrow than they were yesterday.
When a corporation does something really bad or fails to do important basic things to keep itself alive – making money, paying employees, being generally nice to people, etc. – one of the first things that happens is people start looking really closely at the board. “Why didn’t the board do something to keep the corporation from being crappy?” is usually a popular question among stakeholders, journalists, and Twitter users when a corporation becomes, well, crappy. One thing people really like to zoom in on is the “independence” of directors. Independence refers to a lot of different things, but in the most general sense it’s just about conflicts of interest.
Because there’s no such thing as a board without conflicts of interest, most people find it helpful to identify what types of conflicts might be most important. A lot of stock exchanges, for example, are mostly interested in making sure that directors’ interests are more aligned with shareholders than they are with the CEO. Some people call this “independence from management.”
How does independence from management work in real life? CEOs are usually super smart, but even smart people are completely wrong a lot of the time. Also, everyone is self-interested in some ways. For instance, one way that CEOs tend to be self-interested is that they want and like to get paid loooooots of money – the more the better. On the other hand, shareholders are generally interested in not paying the CEO more than they have to. It is helpful for at least some directors to be independent from management so that they feel comfortable speaking up in the boardroom if they think the CEO might not be behaving in the best interests of shareholders and other stakeholders.
So, when a corporation does something really bad, directors who aren’t independent from management get the super stink eye from stakeholders because of suspicion that they might have been helping out the CEO instead of taking care of the corporation. Some ways to make sure a director is independent from management are 1) asking if they get any pay from the corporation other than their normal director compensation, 2) Making sure they don’t owe the CEO a lot of money, 3) Making sure the CEO doesn’t owe them a lot of money, 4) any other stuff about money? 5) Checking if they might be the CEO’s mom, 6) etc.
There are other important types of independence, especially because independence from management doesn’t guarantee that a director will actually BEHAVE independently from management.
Imagine you’re a director for a company that designs fusion reactors (futuristic!) and you don’t know anything about nuclear fusion. The CEO – who is an expert in nuclear fusion – might come into the boardroom and share a bunch of numbers and charts. Then they tell you that valve #234335---0000X1 on the ExtraFuturyFusionTron2x reactor isn’t working properly and make a recommendation about what the corporation should do next. If you’re like most people, you’re probably going to trust the CEO’s judgment because they are smart and they probably want what’s best for the corporation. Plus, what do you know about valve #234335---0000X1? Precisely nothing! In other words, your lack of confidence in your own smartness might keep you from asking good questions and challenging the CEO’s recommendations. So, you’re not independent from management, but it’s just because you don’t have enough knowledge and information. This happens *all* the time. It might have even happened to you today. It’s cool. Don’t worry about it too much. But we can clearly see how normal and innocent circumstances might create independence problems in boardrooms.
Some people like to say that “independent mindedness” is more important than independence from management. In other words, it’s more important for you to be willing to disagree with or question people than it is to make sure you’re not the CEO’s mom.