Independent Director Theory

1361 Words6 Pages
It is therefore evident that the theoretical underpinnings of the monitoring board and the independent director concept emanate from the agency cost theory that relates primarily to the manager-shareholder agency problem. Acknowledgement of the majority-minority agency problem in the literature is sparse because academics were not confronted with the issue at all as they were primarily dealing with outsider systems of corporate governance. Emergence of Independent Directors in U.S. Corporate Practice Apart from repeated allusions in theory to the concept of independent directors as an answer to the manager-shareholder problem, the emergence of the independent director in practice can be attributed to that very same problem as well. American…show more content…
It is worth pausing for a moment to briefly reflect on what caused that corporate governance crisis. At the outset, boards did have a role (or failure thereof) to play in precipitating the corporate governance crisis. The 1990s witnessed a shift in executive compensation from cash payments to stock-based compensation (including in the form of stock options). This created perverse incentives to company managers as it enabled them to boost the short- term stock performance of the company and then encash the options at a high price.39 As Professor Gordon notes: ―Boards had simply failed to appreciate and protect against some of the moral hazards that stock- based compensation created, in particular, the special temptations to misreport financial results.‖40 All these clearly indicate a failure of boards to monitor managers that led to serious misstatements in books of accounts. This was the manager-shareholder agency problem manifested at its best. Stock options to managers promoted short-termism that prompted…show more content…
While the managers benefited, shareholders suffered, and the board seemed to be waiting in the side lines. It is indeed the manager-shareholder agency problem that triggered one of the most extensive and rapid set of reforms in American corporate history. The independent director, as we shall see, was proffered as the solution to that problem. 1.4. Emergence of Independent Directors in U.K. Corporate Practice The history of the independent director institution is comparatively short in the U.K., with its life span being less than 20 years. Apart from that, the literature on the role of independent directors in U.K. companies is limited compared to that in U.S. companies. Nevertheless, there is a great amount of similarity in corporate governance practices between the U.S. and the U.K. Of course, there exist some areas of divergence, but the similarities far outweigh the differences, at least on matters of principle (as opposed to matters of detail).41 Even where there are differences, they have a bearing largely in terms of ―degree rather than kind.‖42 Hence, my effort in this section is to briefly discuss the emergence of the independent director concept in the U.K., with greater emphasis on those areas where U.K. has followed a different trajectory from that of the
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