1.1 Prologue

The importance of board independence was stressed by The High Level Group of Company Law Experts (hereafter: High Level Group), which regarded the lack of monitoring by independent directors as a major cause of the corporate scandals at the start of the twenty-first century (Winter et al. 2002: 60). A survey among investors in Asia-Pacific, Europe and North-America by Institutional Shareholders Services (ISS) confirms the importance: forty per cent of institutional investors rank board independence in the top three of most important governance issues (ISS 2011: 3). The attributed importance can also be derived from the fact that the level of board independence has increased in the United States as well as in Europe over the last decades (Hopt and Leyens 2004: 135; Gordon 2007: 1472-1476).

The rationale behind independence lies primarily in the agency theory. The agency theory is concerned with the separation of ownership and control (Jensen and Meckling 1976), in which respect the owners of the company act as principals by delegating executive tasks to managers (agents). Both principals and agents are rational human beings and pursue utility maximisation and personal economic gain maximisation, creating a divergence of interests (agency problem). The principals can establish – among other measures – monitoring by independent directors to keep the agent from acting on his own behalf (Jensen and Meckling 1976: 308). Agency theorists prescribe high levels of board independence, because this is associated with high monitoring and accordingly with high company performance (Muth and Donaldson 1998: 5, 9; Nicholson and Kiel 2007: 587-588).

The independent directors in the previous paragraph are independent NEDs in a unitary board structure or independent SDs in a dual board structure. In the remainder of this study the term supervisor will be used if both NEDs and SDs are meant. NEDs have the task to ‘constructively challenge and help develop proposals on strategy’, according to principle A.4 of the UK Corporate Governance Code (Financial Reporting Council 2010: 11). SDs in a supervisory board should ‘supervise the policies of the management board and the general affairs of the company and its affiliated enterprise, as well as [to] assist the management board by providing advice’, according to principle III.3 of the Dutch Corporate Governance Code (Corporate Governance Code Monitoring Committee 2008: 22). The independence requirement for these supervisors is a way to avoid conflicts of interest and a lack of loyalty in the execution of their tasks (Hopt 2006: 458). Furthermore, independence allows supervisors to speak their minds in the boardroom uninhibited and should also take away the psychological pressure to avoid debate and dissent when under group pressure (Harvard Law Review Note 2004: 2185-2187). This leads to better board processes, consequently to better corporate governance and is expected to lead to better financial performance of the company (Bhagat and Bolton 2008: 271). Besides better performance, monitoring by independent supervisors in areas concerning the auditing of the company’s financial results and the remuneration and nomination of directors is expected to decrease the likelihood of corporate scandals (Winter et al. 2002: 60).

An economic theory with an opposite view on board independence is stewardship theory. In contrast to agency theory, stewardship theory assumes that a manager is a good steward for the company’s resources and assets (Donaldson and Davis 1991: 51). The most important assumptions underlying the stewardship theory are firstly that managers are naturally trustworthy and, secondly, that agency costs are automatically minimised, because it is unlikely that managers harm shareholders’ interests for fear of damage to their reputation (Nicholson and Kiel 2007: 588). Consequently, monitoring by independent supervisors – prescribed by agency theory proponents – is less necessary in a stewardship theory framework. Since information held by executive directors is superior to that of independent NEDs (Baysinger and Hoskisson 1990: 74), a high level of executive directors on a unitary board leads to the availability of high-quality information, which results in high-quality decisions and is associated with high corporate performance (Nicholson and Kiel 2007: 588-589).

These different views from economic theories on whether a company should or should not have high levels of board independence does not explain why the levels of board independence differ. In order to address this issue, international studies with a predominant focus on the United States have investigated determinants and reasons of board independence from different research perspectives. One group of scholars explains the level of board independence by means of company characteristics (e.g. Lehn et al. 2005; Boone et al. 2007; Linck et al. 2008), other scholars use the national culture as explanatory variable (e.g. Li and Harrison 2008a; 2008b), and other scholars have conducted research on the relationship between legal and political factors and the level of independence (Li and Harrison 2008b: 382).

In the second half of the previous century, based on the agency theory, board independence was considered to be the apex stone of corporate governance (Hopt 2006: 458-459). This belief in the important role resulted in higher levels of board independence (Hopt and Leyens 2004: 135; Gordon 2007: 1472-1476). Notwithstanding large accounting scandals in the twenty-first century, literature still defends exactly the same line of reasoning as regards board independence with renewed vigour (Harvard Law Review Note 2004: 2181-2182; Hopt 2006: 458-459). In line with this tendency towards more focus on independence, the European Commission published a plan of how to move forward with company law and corporate governance in Europe (Commission of the European Communities 2003). The European Commission’s plan resulted in a Recommendation that required having a sufficient number of independent NEDs in a unitary board structure and independent SDs in a dual board structure to ‘ensure that any material conflict of interest involving directors will be properly dealt with’ (Commission of the European Communities 2003: 15; European Commission 2005). In addition, the European Commission published criteria to determine the independence of supervisors. In the United States a similar movement took place. The Sarbanes-Oxley Act and the NYSE and NASDAQ Listing Rules provided that a majority of the unitary board should comprise independent NEDs and in addition the definition of independence was clarified and sharpened (Harvard Law Review Note 2004: 2187-2189).

Scholars cast doubt on the efficacy of the new regulations and guidelines on director and board independence. For the United States, Romano disputes the efficacy of the corporate board regulations of the Sarbanes-Oxley Act and claims that there was no expected improvement of audit quality and investor protection at the time of adoption of the bill (2005: 1585-1591).4 Elson and Gyves argue that increased board independence is only effective if it is combined with equity ownership of those independent directors (2003: 883-884). For Europe, and in particular for the Netherlands, Kroeze contests the stringency of the board independence requirements and doubts whether the aim for better supervision will be achieved by requiring more directors to be independent (2005: 274). Van Ginneken (2012) addressed the subject of independence in his inaugural lecture and he questions the lack of debate about independence requirements for the Netherlands.

Because of all the value attributed to board independence, scholars have tried to prove this value by investigating the impact of board independence on financial company performance and board behaviour (e.g. Baysinger and Butler 1985; Dalton et al. 1998; Klein 1998; Bhagat and Black 1999; 2001; 2002; Anderson et al. 2004; Ajinkya et al. 2005; Patelli and Prencipe 2007; Bhagat and Bolton 2008; Coles et al. 2008). However, the results of these studies are inconclusive and not very convincing.5 Hence, the claim of the agency theory about the positive impact of board independence on financial performance is not supported beyond doubt by empirical studies.

Notwithstanding the attention of policymakers and the discussion about independence in economic literature, there is still no clear and consistent definition of independence. The fact that independence is used to indicate ‘different things at different times for different reasons’ is a reason for this (Harvard Law Review Note 2006: 1555). Langevoort defines independence as ‘a subjective concept that connotes a willingness to bring a high degree of rigor and sceptical objectivity to the evaluation of company management and its plans and proposals’ (2001: 798). Brudney summarises a number of definitions that range from the trivial requirement of having no direct financial interest in a transaction or not being a party to it, to a definition based on which more affiliations (including family) are considered to be a hindrance for the exercise of independent judgement (1982: 601). Brudney notes in this respect that it is frequently unclear whether these definitions are applied to current relationships or also to past relationships.