Outside Directors

QUITE SIMPLY, outside directors are those members of a company's board of directors without executive responsibilities, and who often face information asymmetry about the company. They are usually appointed to the board of directors for their contribution to the expansion of the enterprise's strategy and to provide important knowledge not otherwise available to management. Outside directors, like inside directors, have two main roles: to ensure that the company delivers returns to shareholders (the performance function) and to ensure it acts in accordance with laws and regulations (the accountability function).

However, given the distance of their day-to-day operations, outside directors have more of a role to play in terms of the accountability function than in terms of the performance function. Outside directors are beneficial to an enterprise provided the company does not employ them in any other manner, including consulting contracts.

Outside directors provide access to valuable resources and information, but several corporate governance analysts insist on tighter rules of independence including a restriction on the number of directorships a single individual can hold, investor participation in the selection and appointment of outsiders, and mandated meetings with significant shareholders.

In the early 2000s, firms made significant changes to their programs, plans, and policies for members of their boards of directors. A struggle continues between the growing need for qualified persons and the reluctance by some candidates to join boards. This reluctance can be attributed to increased time requirements, and potential reputation and financial risk.

The result is increased competition for qualified board members, especially standing chief executive officers and candidates with substantial financial experience. This, in turn, impacts outside-director [Page 596]compensation. If outside directors are to provide meaningful protection for investors, they must be in a position to challenge the executive management and draw attention to dubious practices, even in apparently successful companies.

While independence is, above all, concerned with the integrity of the individual in question, it is not unreasonable to suggest that financial ties, whether personal, business, political or philanthropic, threaten the independence of outside directors and therefore their motivation to actively challenge management. But, rather than simply meeting some checklist of independence criteria, analysts say it is imperative that outsiders are able, in practice not just in theory, to express views to the board that are different from those of the chief executive officer. They must also be confident that, provided this is done in a considered way, they will not suffer reprisals.

Several proposals intend to set limits on how much money can be exchanged between the company for which an individual is a director, and another company for which she is an executive or employee. For example, the New York Stock Exchange (NYSE) proposed that if a director received fees in excess of $100,000 a year in direct payment from a company, then she should be presumed not to be independent until five years after such fees stop being received. Some proposals extend the scope of such fees to include nonemployment based compensation, such as executive consultancy work.

The collapse of Enron Corporation triggered corporate governance analysts to question whether outside directors should be accountable for, or simply be more aware of, a company's complex finances. In the United States, there are specific rules that aim to ensure that outside directors are independent, but in the light of financial high-profile events in the early 2000s, it is questionable whether these rules have had any real impact on the effectiveness of audit committees.

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