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Entrepreneur and Fellow at the Centre for Risk Studies, University of Cambridge Judge Business School on the negative aspects of independent directors and what alternatives are available 

Recent regulation assumes that independent directors provide objective, shareholder-minded monitoring and that increasing their presence reduces agency problems and improves firm performance.

Research, however, has demonstrated that in reality the effect of independent directors on firm value is either insignificant or negative. Despite this, it is widely agreed that independent directors who are powerful elevate shareholder wealth. Unfortunately, more often than not, independent directors are not powerful enough to achieve this duty.

After the Global Financial Crisis, the criticism of independent directors turned to their lack of specialized experience, particularly in relation to the banking industry. As a result, more regulations were introduced in the US which required independent directors of listed companies to disclose qualifications, skills and experience, and in the UK a new code required boards to balance the chosen directors’ skills, experience and knowledge of the company with director independence. These regulations are fiddling at the margins. The central focus should be on the culture of the board and its ability to perform its risk oversight function.

The February 2015 report by McKinsey & Company records “Boards aren’t working.” Only 14% of the 692 directors and executives surveyed selected “a reputation for independent thinking” as one of the key criteria that public company boards consider when appointing a new director, whereas independence and the ability to “question herd decision making” are one of the most important characteristics of a director.

Independent thinking has been lost on boards in part because of the systemic failure of both the selection process and the board culture.

Inquiries have shown that some of the worst corporate disasters have occurred due to an inability of the board to question and investigate. Too often people are overconfident about their forecasts and risk assessments and consequently assess the range of possible outcomes too narrowly. They extrapolate too heavily from history, and this is exacerbated by confirmation bias, which means they lean toward a one-sided position and suppress conflicting information. When events unfold that are different from those they expect, it leads to even more irrational commitment and suppression of contradictory evidence. Objective risk management is an anathema to such groups; it is beyond their institutional capacity.

The Alternative: Contrarian Directors

An alternative to the current process is the introduction of a “Contrarian Director” to institutionalize the ability to stand outside the tide of groupthink and effectively warn and caution the board. This director should have an express duty to consider a complete range of outcomes (including pre-conceived “extreme” scenarios), question herd decision making, fully investigate issues without bias and recommend a course of action that is truly independent and impartial.

This director would have the duty, in respect of every recommendation of substance to the board to give careful consideration to possible opposing arguments and prepare a written report for the board.

The Contrarian Director’s appointment and role is designed to protect and encourage independent thinking and questioning and also to promote the same by others on the board and in senior management.

Siobhan C. Sweeney was a participant at the Salzburg Global Program Corporate Governance in the Global Economy: The Changing Role of Directors. The session was hosted in partnership with BNY Mellon, Goldman Sachs, and Shearman & Sterling LLP and was sponsored by Barclays, LIXIL, Mars, Potter Anderson & Corroon LLP, the state of Delaware, and Warburg Pincus. More information on the session can be found here: http://www.salzburgglobal.org/go/550