Academic journal article Journal of Corporation Law

Beyond Beholden

Academic journal article Journal of Corporation Law

Beyond Beholden

Article excerpt

I. INTRODUCTION                                                     516 II. INDEPENDENT DIRECTORS IN CONTROLLED COMPANIES: THE STANDARD     520       ACCOUNT       A. Independent Directors as Monitors                          521       B. Who is Independent?                                        523           1. Past and Ongoing Relationships                         523           2. The Controller's Power over Director Retention and     525              Termination           3. "Boardroom Atmosphere" and Psychological Factors       527           4. Risk to Reputation                                     528 III. INDEPENDENT DIRECTOR REALITIES                                 531       A. Data Sources and Methodology                               531       B. Controller-Independent Director Ties                       534       C. Creating a Taxonomy of Controlling Shareholders            542           1. Base                                                   543           2. Concentration                                          546              a. Decisional Allocation                               546              b. Spheres of Influence                                548 IV. DOCTRINAL AND THEORETICAL IMPLICATIONS                          551       A. Enhanced Scrutiny for Powerful Controllers                 551       B. A Harder Look at Post-Transaction Relationships            553       C. Understanding Freezeouts as Presenting an Asymmetric       555          Final Period Problem V. CONCLUSION                                                       557 


Independent directors have long been a core part of corporate law's answer to the agency problem that arises in controlled companies. The presence of a controlling shareholder produces the potential for private benefits: the controlling shareholder can extract benefits from the corporation at the expense of other shareholders. (1) To contain this risk of opportunism, courts and policymakers have promoted the engagement of independent directors to vet contracts between companies and their controllers. (2) As Guhan Subramanian observes, the move to independent directors is now "standard practice" in controlled firms. (3)

The conventional notion of independence translates roughly into the absence of substantial prior or ongoing relationships to the controlling shareholder. (4) This definition reflects corporate law's persistent preoccupation with "beholdenness" as the main threat to independence. (5) The paradigmatic concern is that a director with lucrative ties to the controlling shareholder may be subtly pressured by the fact that the controller can cut off those ties or even unseat her from the board. (6) This diagnosis, in turn, has prompted calls to insulate nominally independent directors from the controlling shareholder's ire. (7)

Corporate governance scholarship focuses extensively on the incentives generated by the controlling shareholder's ability to retaliate against insubordinate directors. What the literature overlooks, however, is that directors may also be influenced by the prospect of reward. What happens when the controlling shareholder is not angered but instead pleased?

The result, it turns out, is often new opportunities or future benefits from the controlling shareholder to the favored directors. Controlling shareholders can direct their resources or those owned by the controlled company in ways that reward friends. For instance, Charles Dolan, whose family controlled Cablevision Systems until 2016, invested his own money with a fund founded by one of Cablevision's former "independent" directors. (8) Some controllers have substantial influence over other companies as well. When the controlling shareholder of M & F Worldwide, Ronald Perelman, sought to "freeze out" (9) the company's minority shareholders, the company formed a special committee of four "independent" directors to negotiate with Perelman over the terms of his acquisition. …

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