GLOCOM Platform
Debates Media Reviews Tech Reviews Special Topics Books & Journals
Summary Page
Search with Google
Home > Debates Last Updated: 14:32 03/09/2007
Debate: Commentary (June 23, 2003)

Corporate Governance Revisited: Is Board Member Independence Key?

Daniel P. Dolan (Principal, Communication Japan)

Corporate governance has been one of the hottest business topics of the past few years, particularly as mushrooms sprout from the former sites of large U.S. companies such as Enron. Perhaps the most visible of corporate governance issues is the relative independence of board directors, partly because the oversight functions of boards can (in theory) impact all areas of corporate governance and partly because board member independence is easily quantifiable. "Independent" directors have no business or personal ties to the company and are not employees.

Current corporate governance reform activities have been energized by the 2002 Sarbanes-Oxley Act, an effort by the U.S. government to counter business fraud and bankruptcies. The Act covers corporate and criminal fraud accountability, enhanced financial disclosure, corporate responsibility, analyst conflict of interest and auditor independence. U.S. companies need to be in compliance with the Act by their first shareholders meeting after January 1, 2004.

Push for Director Independence
The independence of board directors is commonly believed to be positively associated with company performance, and some studies lend support to this theory. Accelerated efforts by large companies around the world to increase the independence of company boards reflects this belief. But is there another story here, or at least another angle?

Glen Fukushima wrote an insightful essay in this forum in April 2002 in which he describes differences in conceptions and practices of corporate governance between Japan and the United States. He cites the Global Corporate Governance Indicators 2002 survey by Davis Global Advisors, which included ratings of Board Independence among major industrialized countries. On that measure using a scale of 0-10, the U.S. scored 7 and Japan scored 0. Other scores included the United Kingdom 4, France 3, Germany 2, Belgium 2, Netherlands 1and Portugal 0.

But Fukushima questions the rush by many observers in both the U.S. and Japan to grow U.S.- style corporate governance practices in Japan, including an increase in the numbers of independent board directors. He concludes that corporate governance differences between the U.S. and Japan are simply indications of the range of forms of capitalism.

Study Findings are Mixed
There have been studies since the early 1990s suggesting that greater board member independence is related to better financial performance. For example, in the essay described above Fukushima cites a survey of 450 Japanese companies conducted in 2001 by Keio University and the Japan Corporate Governance Forum. According to Fukushima, the studies found that "companies in which outside directors participate in corporate decisionmaking reported higher growth in sales and pretax profit over the past four years than those that did not." In addition, a Yale School of Management review of empirical studies of company data from 1991 through 1995 found that "corporations with active and independent boards appear to have performed much better in the 1990s than those with passive boards."

But some more recent research contradicts this conventional wisdom. A study published in 2000 of almost 1,000 of the largest U.S. companies found "evidence that firms suffering from low profitability respond by increasing the independence of their board of directors, but no evidence that this strategy works - that firms with more independent boards achieve improved profitability" (emphasis added).

Board Director Involvement Most Critical
Harvard Business School professor Paul Gompers argues that it is not enough simply to place independent directors on company boards. In fact, he believes that board directors-independent or not-have had little real impact on company performance and culture "because they largely have been unwilling to change that culture." Gompers calls for more active involvement by board members instead of myopic attention to degree of board member independence. This debate is likely to continue until more evidence is in.

Copyright © Japanese Institute of Global Communications