Let’s Hear It for the Inside Director
from March/April 2003
by Kenneth Kamen
The governance reforms mandated by the Sarbanes-Oxley Act are certainly long overdue. Companies are already rethinking any practice that might give Wall Street reason to worry about their reported financial results.
But there is a dangerous downside to this caution. Irrational conservatism might be just as detrimental to your company as irrational exuberance. A board’s determination to be perceived as ultracompliant could conceivably come at the expense of the very decision-making process that made the company successful in the first place.
This could be particularly true for smaller outfits. While outside directors constitute the majority of the board at most larger companies, that’s not the case at their mid- and small-cap counterparts, where boards often comprise—or are dominated by—the individuals who participate in the daily management and growth of the company, the insiders.
Even before Sarbanes-Oxley became law, other reforms were pushing these companies to get more outsiders on their boards. Some increased the size of their boards by adding outsiders; others replaced inside directors with outsiders.
Much of this is all about appearances, of course, and sometimes that pays off—particularly if the shift in a board’s makeup attracts new investors or keeps current ones from leaving. Your stock price will reflect this.
But if your company has a history of playing it straight with its shareholders and employees, a bunch of new outside directors may not provide much additional benefit and in fact might even hurt your competitive advantage. One danger is that too many board meetings will be bogged down in bringing these newcomers up to speed on the company and its place in its industry. In contrast, insiders know the company and its positioning well. Some of the more senior directors—those who might be the most likely to be replaced—are your corporate historians. The loss of their gray hair in the boardroom might leave the company likelier to repeat past mistakes.
Inside directors are also the ones whose eyes and ears are constantly trained on your particular marketplace, and they are in the best position to bring industry trends into the boardroom. Their advice helps the board and the CEO reach informed decisions, and can be invaluable. They have also taken the measure of the capabilities and limitations of the company’s top executives and can provide good counsel about them.
None of this removes the necessity of having qualified outsiders on the board. Their diverse business experience can be one of the most valuable tools an effective board of directors has at its disposal. Sarbanes-Oxley’s requirement that outside directors sit on the audit committee is an excellent innovation. But let’s be careful. A company’s determination to be perceived as the corporate equivalent of a choirboy should not come at the expense of a vital asset: its inside board members.
Kenneth Kamen is the president of Mercadien Capital LLC.
