The role of independent directors lies at the center of the current movement aimed at enhancing corporate governance among U.S. public companies. Indeed, there is broad consensus regarding the importance of actively engaged independent directors. But, independence does not lend itself to precise definition. It is in large part dependent on the particular governance function being performed by the director.
A corporate director's role includes two principal functions: a decision-making function and an oversight function. The decision-making function involves action taken at a particular point in time, while the oversight function involves ongoing monitoring over a period of time.
In the context of the board's decision-making function, the independence question necessarily requires a case-by-case evaluation based on the facts and circumstances surrounding the particular subject before the board. Generally, the analysis focuses on whether the director is able to base his or her decision on the corporate merits of the subject rather than extraneous considerations or influences. Thus, in In re Oracle Corp. Derivative Litigation, 824 A.2d 917 (Del. Ch. 2003), the Delaware Court of Chancery found a lack of independence with respect to two directors who appeared unquestionably independent under applicable stock exchange listing standards but who nevertheless had significant ties to persons who were the subject of their special committee investigation.
In the context of the board's oversight function, the independence question focuses on independence from management, namely whether the director is beholden to or dominated by management. This can happen, for example, when management is in a position to control a director's continuing receipt of a material financial benefit, such as a consulting arrangement. The more independent a director is from management, the less likely the director will "look the other way" in the course of monitoring management's conduct or "pull punches" in the course of evaluating management's performance.
The latest stock exchange listing requirements regarding director independence seek to enhance board oversight and, therefore, focus on independence from management. This emphasis helps to explain why neither the NYSE nor Nasdaq view ownership of even a significant amount of stock, by itself, to preclude a finding of independence. After all, the need for board oversight arises out of the separation of corporate ownership (stockholders) from corporate management (officers) - to wit, the board serves at the election of stockholders to monitor and oversee management but, importantly, not to manage.
This focus on independence from management also helps to explain the accelerating movement toward having an independent chairman or lead director. The purpose of an independent chairman or lead director is not to add another layer of power, but to facilitate the execution of critical independent director functions, such as overseeing management, by providing for some form of leadership among the independent directors. Without leadership, independent directors may perform sub-optimally due to the difficulties inherent in group dynamics.
Those who represent boards are well advised to maintain a constant vigil regarding the independence of the directors they counsel. But, despite the proliferation of various definitions of independence involving bright line tests, the issue of independence must always begin with the threshold questions: Independent from whom? Independent for what purpose?