Some Boards can be too Independent, Research Says

Recent scandals including Wells Fargo’s bogus accounts fiasco have put the spotlight on board independence. But companies thinking they can ward off bad behavior by appointing fewer company insiders as directors could be making a big mistake.

Some 73% of companies in the S&P 1,500 currently boast of having their CEO as the only insider board member, up from 41% in 2000, according to researchers at Arizona State University.

The thinking is that these “home alone” CEOs will be able to bring adequate inside information to board meetings, allowing oversight to mostly be conducted at arms length by the independent directors.

The problem, the research found, is that these companies were 27% more likely to engage in financial misconduct. They also generated 10% lower net income, on average, than those with more than one inside director, while their top executives received much larger pay packets.

“It appears that lone-insider boards do not function as intended and firms should reconsider whether the push toward loan-insider boards is actually in shareholders’ best interests,” the researchers concluded in the paper, which is scheduled to appear in the Strategic Management Journal.

An issue facing lone-insider boards is that other directors will be reliant on inside information provided by only one person, who may or may not be as forthcoming about company workings as hoped.

Corroboration among other executives at board meetings could at least provide a check on CEO’s opinions, including on succession planning, the authors suggested.

In the wake of high-profile corporate collapses such as Enron, U.S. companies are now required by law to have a majority of independent directors.

Few studies, however, appear to show a direct link between board independence and strong company financial performance. To the contrary, a paper published back in 2000 by professors at the University of Colorado and Stanford Law School hinted that increased board independence could actually hurt a company’s financial performance.

“Inside directors are conflicted but well informed,” the authors concluded. “Independent directors are not conflicted, but are relatively ignorant about the company.”

They added: “Perhaps independent directors will be quicker to act if something goes wrong, but more likely, in their ignorance, to do the wrong thing, especially if their deliberations are not leavened by the information available to fellow inside directors.”