Corporate Governance

Independent Directors and the Russian Capital Markets

By J. Robert Brown

Another student wrote about independent directors on the boards of Russian companies.  The data casts some interesting insights into the use of these directors in the United States.  There has been considerable debate over the value of independent directors on the boards of US companies.  Much of the analysis ignores the fact that directors treated as independent in fact are not.  This goes to problems with the definition.  Under both state law and the NYSE, the definition does not screen for personal relationships, account for structural bias, or take into consideration the fees paid to officers and directors. 

Jeffery Gordon at Columbia notes that one explanation for the lack of evidence may be that "most of the empirical evidence assesses incremental changes in board independence in firms where there is already substantial independence and after the cultural entrenchment of norms of independent director behavior."  Jeffrey N. Gordon, The Rise of Independent Directors in the United States, 1950-2005:  Of Shareholder Value and Stock Market Prices, 59 Stan. L. Rev. 1465, 1505 (2007).  In this context, the benefits likely to to the "early adopters."  Id.  at 1506. 

Consistent with that, a 2006report byHeidrick & Struggles, an international head hunting firm, noted data provided by McKinsey & Co. indicated that "western investors are likley to pay 38% more for shares in Russian Companies with a well developed system of corporate governance."  The report further noted that 90% of Russian companies listed in overseas markets have independent directors, typically one-third to one half of the board, with 57% of the independent directors foreign nationals.  The use of foreign nationals likely sends a signal to the market that the company is serious about independence and not just meeting a technical definition. 

The data supports Gordon's hypothesis.  In countries where independent directors are not common, their use can result in an appreciable benefit.  In the US, where the stock exchanges already require as a condition of listing, that companies have a majority of independent directors on the board, any increase in the number of independent directors is incremental and takes place in an environment already saturated with them.  It would not be a surprise to learn that share prices do not necessarily go up in response.

Part of the reason for this is also that the definition of independent used by the stock exchanges does not ensure independence (it does not screen for friendship or take into account the often exorbitant fees paid to directors).  Moreover, the CEO, who typically sits on the board and acts as the chairman, invariably plays a role in director selection.  The interesting issue to study in the US would be boards with truly independent directors.  Had shareholders been allowed access by the Commission and been able occasionally to elect their own directors, it might have been possible to study the phenomena. 

Full post as published by The Race to the Bottom on January 10, 2008 (boomark / email).