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September 26, 2003
Identifying the Effects of Interlocking Directorships on Board Independence
    by William Baue

A new report from The Corporate Library uncovers ways interlocking directorships impede board independence, though shareowner activists could leverage this interlock to push corporate governance reform.

Director independence is seen by many as a panacea to the corporate governance rot that has been revealed over the last few years. The New York Stock Exchange (NYSE) and NASDAQ have proposed new listing standards requiring a majority of independent outside directors on boards. However, the exchanges' definition of independence does not prevent certain director relationships and dynamics that can undermine independence. So says a report released earlier this week by The Corporate Library (TCL), an independent provider of corporate governance research and analysis. The tools used to produce the report may help shareowner activists to advocate for greater board independence.

The report, entitled Corporate and Director Interlocks in the USA: 2003, analyzed director interrelationships at 1,727 of the largest corporations in the US using TCL's Interlocks Tool, which it launched in November 2002. The study, which covers the period up to December 2002, analyzed 16, 406 directorships held by 12,794 individuals. The study particularly looks at multiple different types of interlock, or the overlap of directors serving on multiple boards, which can create conflicts of interest.

"The biggest companies perform the best on board independence [as defined by NYSE and NASDAQ], probably because they've got more seats to allocate to outsiders, but this kind of independence seems to accompany less independence in other respects," said Jackie Cook, the senior research associate with TCL who authored the report. "Looking at the number of independent outsiders does not go nearly far enough."

Consider the combination of chief executive officer (CEO) and board chair positions, a practice widely considered anathema to effective corporate governance.

"You'd think bigger boards would have enough seats to appoint a chairperson who's separate from the CEO, but strangely, this is not the case," Ms. Cook told

The report finds that 84 percent of companies in the largest market capitalization category (greater than $10.2 billion) had combined CEO and Board Chair positions. Meanwhile, 62 percent of the boards of companies in the smallest market capitalization category (up to $183 million) have joint CEO-Chairs.

"Boards with higher independence [according to NYSE-NASDAQ definition] also have more outside CEOs serving on them as non-executive directors," said Ms. Cook. "Not only that, boards that are headed by CEO-Chairs also tend to have more outside CEOs on the compensation committee."

"I can't see these outside CEOs having any incentive to pioneer challenging performance-related pay packages, because it would come back to bite them on their own boards," she continued.

The report cites the example of Augustus Busch, chair and CEO (until June 2002) of Anheuser-Busch (ticker: BUD), Edward Whitacre, chair and CEO of SBC Communications (SBC), and Charles Knight, chair and CEO (until 2000) of Emerson Electric (EMR). All three are considered independent outsiders on each other's boards.

"While these designations are technically correct, it is hard to imagine that one can be entirely unbiased by a co-membership relationship [among these three CEOs] spanning at least 17 years, with a combined 27 full board meetings in the last year, not counting committee meetings," wrote Ms. Cook in the report.

Ms. Cook sees the potential for demand for TCL's Interlocks Tool from the social investment sector, as shareowner activists could use it to identify directors and boards with both best- and worst-practice.

"On the one hand, they can leverage these methodologies to individualize responsibility for board decision-making and identify decisions, or non-decisions, that have led to environmental destruction or violation of human rights," Ms. Cook said.

"On the other hand, shareowner activists could identify and support directors who are catalysts for change," she continued. "Board practices spread through this director network, so it's definitely good to have these individuals plugged into it, especially considering the studies showing that directors who are proactive in initiating change tend to get sidelined in both the informal and formal networks."

The report ends by weighing in on the director election process, as the Securities and Exchange Commission (SEC) is currently considering proposed changes.

"It would be an excellent move to open up the nomination process to shareholders, but we would have to watch out for new patterns of relationships that emerge after that," Ms. Cook concluded.


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