Saturday, March 26, 2011
The Uneasy Case for the Inside Director, by Lisa M. Fairfax, George Washington University - Law School, was recently posted on SSRN. Here is the abstract:
In the wake of recent scandals and the economic meltdown, there is nearly universal support for the notion that corporations must have independent directors. Conventional wisdom insists that independent directors can more effectively monitor the corporation and prevent or otherwise better detect wrongdoing. As the movement to increase director independence has gained traction, inside directors have become an endangered species, relegated to holding a minimal number of seats on the corporate board. This Article questions the popular trend away from inside directors by critiquing the rationales in favor of director independence, and assessing the potential advantages of inside directors. This Article argues that the value of independent directors has been overstated, while the value of inside directors has been under-appreciated and under-examined. This argument rests on three critical points. First, independent directors are constrained in their ability to perform their monitoring functions, and many of these constraints may be insurmountable – particularly as we increase independent directors’ responsibilities. Second, inside directors can make valuable, and often overlooked, contributions to board governance. Third, reliance on independent directors as a substitute for external regulation is inappropriate and potentially costly. To this end, this Article suggests that inside directors may serve an important signaling function, underscoring the need for enhanced regulation, while ensuring that corporate monitors are subject to appropriate liability and therefore have increased incentives to perform their responsibilities.
To be sure, the case for the inside director is not an easy one, particularly given that any benefits such directors bring to the board come with costs, including the potential for self-dealing and overreaching. However, before we render inside directors extinct, we first should determine whether their costs are outweighed by their benefits.