Will the Independent Director Institution Work in China?(1)


Sibao Shen


I. INTRODUCTION
In recent years, China has joined the corporate governance debate and introduced the independent director institution to improve the corporate governance of listed corporations.[1] On August 6, 2001, the China Securities Regulatory Commission (CSRC) issued the Guiding Opinion on Establishing the Independent Director Institution in Listed Corporations ("the Opinion").[2] This landmark document formally established the independent director institution in China under which a minimum of one-third of each listed corporation,s board members shall be independent directors.[3] Despite insufficient practical and theoretical bases, many people--including the regulators—hope the independent director institution will be a panacea to the corporate governance problems entangling Chinese listed corporations.[4]
The concept of independent director carries no clear meaning, even among its proponents.[5] Several terms, such as independent director, outside director, and non-executive director, are used interchangeably, though the terms have different meanings. Outside directors and non-executive directors are similar in that they are not involved in the day-to-day operations of a corporation. Neither position, however, guarantees independence. Some individuals appear to be outsiders, but are in fact insiders, such as former employees, outside counsel providing financial or legal services, or close families of senior management members.[6] In terms of their relationship with management or controlling shareholders, outside directors further divide into affiliated directors and unaffiliated directors.[7] Only the unaffiliated, outside directors are independent directors.[8] In China, an independent director does not assume any position other than director in a corporation, and who has no relationship with the corporation or its controlling shareholders that might affect his or her independent, objective judgment.[9] #p#分页标题#e#
Independent directors first appeared in the United States to cure the corporate governance problems of public corporations, which have widely dispersed shareholders.[10] Independent directors were created to monitor the integrity and performance of management in order to make public corporations a more effective wealth-maximizing instrument for shareholders, and a more socially responsible instrument for the public.[11] The rationale behind the independent director institution in China differs from that in the United States: the institution in China primarily targets controlling shareholders, rather than management.[12] Instead of dispersed share ownership, the ownership structure of listed corporations in China is highly concentrated.[13] The major corporate governance problem is that controlling shareholders use their advantageous positions to expropriate the assets of listed corporations to the detriment of minority shareholders.[14] Therefore, the introduction of the independent director institution into China reflects the spirit of the U.S. independent director institution-its purpose is to prevent controlling shareholders from using their advantageous positions to the detriment of both the corporation and of minority shareholders.[15]
This Article argues that the importation of the independent director institution to China is an important step toward improving corporate governance. Unfortunately, it is unrealistic to count on independent directors to completely prevent exploitation by controlling shareholders and management, especially when listed corporations have not yet solved their share structuring problems, and China has yet to formulate a sound legal environment. Under these circumstances, the independent director institution in China cannot avoid the same defects existing in the independent director institution in the United States-namely, an inability to monitor and a lack of independence and incentive to remain objective.[16] Even in the United States, where the legal and social environment is far better for independent directors to function properly, the effectiveness of the independent director institution is highly disputed.[17] Thus, it is doubtful whether independent directors can meet their expectations in China. #p#分页标题#e#
This Article discusses the defects of the independent director institution and provides some suggestions for its improvement in China. Particularly, this Article discusses whether and how independent directors and the supervisory board can co-exist in China,s corporate governance structure. China, with civil law traditions, has a similar model to that of civil law countries where a supervisory board is established in corporate governance law.[18] Because of many drawbacks, the supervisory board institution does not function well in China.[19] Since both supervisors and independent directors serve as monitors, the functions of independent directors and supervisors overlap.[20] Some critics argue that it is more cost-effective for a corporation to choose between the two institutions.[21] This Article, however, suggests that the supervisory board institution, after improving its power and structure, would be a good supplementary institution to alleviate the defects of the independent director institution.
Part I briefly outlines the debates in the United States on independent directors. Part II analyzes their importation into China. Part III discusses the defects of the independent director institution and provides suggestions to improve the institution in China. Part IV discusses the issue of co-existence of independent directors and the supervisory board in China,s corporate governance structure. Part V concludes that the independent director institution is only one among many measures China needs to take in order to improve the corporate governance of its listed corporations.
II. AMERICAN DEBATE
The concept of the independent director was first seen in the United States in the early 20th century.[22] The U.S. economy is characterized by highly developed capital markets, which has led to highly decentralized share ownership.[23] The dispersed shareholding structure weakens the control that the shareholders maintain over the board of directors and management.[24] Due to this dispersed shareholding structure, with the consequence of divorce between ownership and control, the inherent agency problems in the corporate context are highlighted: managers of corporations were "tempted to shirk and to steal, ,[consuming] excess leisure, perquisites and in general [being] less dedicated to the goal of wealth maximization than they would be if they were not simply agents.,"[25] Under these circumstances, independent directors ensure that the board of directors functions as a faithful delegate of the shareholders; independent directors also perform two major monitoring functions: "goad managers to perform adequately their wealth-maximizing task, in both long-run and short-run terms; and . . . ensure managers, integrity in dividing corporate assets between themselves and stockholders." [26] The addition of independent directors to corporate boards is also expected to solve the problem of corporate social responsibility, although scholars have never agreed on how much social responsibility is sufficient.[27] #p#分页标题#e#
The independent director institution has been accepted within a surprisingly short time in the United States, particularly after the 1970s, in response to the increasing criticism of the evils attributed to the exercise of unbridled corporate power uncovered in the Watergate investigation and foreign bribery cases.[28] Although neither state law nor federal law makes any provision for the composition of the board (except that the Investment Corporation Act requires that no more than 60% of the directors of a registered investment corporation be "interested persons"), the independent director institution is firmly followed in practice.[29] The U.S. Securities Exchange Commission (SEC) has actively promoted the structuring of corporate governance in order to forestall the abuse of power by major corporations. As early as 1977, with the SEC,s approval, the New York Stock Exchange (NYSE) introduced a stipulation that all listed corporations establish and maintain an auditing committee composed entirely of independent directors.[30] In 2002, in response to the well- published corporate scandals, the NYSE tightened its listing standards to require that each listed corporation have a majority of independent directors and three committees-nomination, compensation, and audit-composed exclusively of independent directors.[31] The National Association of Securities Dealers Automated Quotations (NASDAQ) has similar changes in its listing rules.[32] The American Law Institute also recommends that "the board of every large publicly held corporation should have a majority of directors who are free of any significant relationship with the corporation,s senior executives."[33] Today, most U.S. public corporation boards consist of a majority of independent directors, and an increasing number have only one or two inside directors.[34]
Despite its wide acceptance, whether independent directors improve the corporate governance of U.S. public corporations is disputed.[35] Some commentators argue that independent directors have played important roles in improving corporate governance.[36] For example, a 1998 study of 154 U.S. public corporations discovered that corporations with an active and independent board of directors were more successful in business than those corporations with a passive board of directors that lacked independence.[37] Another study, conducted in 2000, showed that corporations whose board contained a high percentage of independent directors were relatively more comprehensive in financial disclosure.[38] #p#分页标题#e#
Other commentators, however, have raised questions about the effectiveness of independent directors: a study of independent special litigation committees, for example, found that almost all special litigation committees ruled in favor of defendant-directors and concluded that this could only have been attributed to the bias of the independent directors.[39] Empirical research on independent directors of 934 American public corporations from 1983 to 1993-including such names as General Motors, IBM, Kodak, Chrysler, and Westinghouse--concluded that large, American, public corporations could not improve their corporate governance efficiency and raise their performance by absorbing an increasing number of independent directors.[40] A recent 2002 empirical study revealed that low profitability corporations responded by increasing the independence of boards; however, corporations with more independent boards often did not improve profitability, andthere was some indication that these companies performed worse.[41] In every recent headlining boardroom scandal, beginning with Texas Gulf Sulfur, there was a preponderance of outsiders on the board at the time of the scandal.[42] For example, the inside/outside balance was two to ten at Texas Gulf Sulfur (insider trading violation), five to twelve at Lockheed (illegal political contributions), four to eighteen at Penn Central (financial disaster), three to six at Northrup, six to eleven at W.T. Grant (bankruptcy), three to nine at Gulf Oil (both involving bribes to foreign officials), and two to fifteen at Enron (accounting irregularities).[43]
There have been several criticisms of the independent director institution. First, critics claim that independence does not really exist because management has significant control over selection of independent directors, and independent directors are not socially independent no matter how tight the criteria for independence. Second, independent directors do not possess adequate incentive to actively monitor management because they do not have a genuine interest in the corporation. Finally, even truly independent and diligent directors lack information and resources to effectively monitor management. #p#分页标题#e#
Therefore, despite the wide acceptance of the independent director institution in the United States, many critics remain unconvinced and have presented persuasive arguments that the institution contains insurmountable defects, and may even be futile. If independent directors are not effective directors, why are they so well-accepted among U.S. public corporations? As some critics point out, one reason is, ironically, insiders of public corporations welcome independent directors because they shield management from the aura of impartiality and legal liability.[44] For example, the board can often prevent a shareholder,s derivative action by appointing a "disinterested" committee.[45] The committee is supposed to determine whether continuing the action is in the corporation,s "best interests," which, not surprisingly, rarely occurs.[46] The American Bar Association also counsels that a nominating committee is good for self-protection: "The existence of a properly constituted Nominating Committee should be an important factor in securing judicial acceptance of the overall fairness of the decision-making process." [47]



【Exprss】
[1]See Minkang Gu, Will an Independent Director Institution Perform Better then a Supervisor? Comments on the Newly Created Independent Director System in the People’s Republic of China, 6 J.CHINESE & L. 59, 59 (2003) (surveying independent director theory in Chinese corporate governance).
[2]See CHINA SEC. REGULATORY COMM’N, GUIDELINES FOR INTRODUCING INDEP. DIRS. TO THE BD. OF LISTED COS., Zhengjianfa No.102(2001), available at http://www.csrc.gov.cn/en/jsp/detail.jsp?infoid=1061947864200&type=CMS.STD[hereinafter GUIDELINES FOR INTRODUCING DIRECTORS].
[3]Id.
[4]Gu, supra note 1, at 59.
[5]Victor Brudney, The Independent Director- Heavenly City Or Potemkin Village?, 95 HARV. L REV. 597,599(1982)(arguing for the importance of regulatory controls in corporate governance in view of the inadequacy of “independent directors.”). #p#分页标题#e#
[6]See BRENT A. OLSEN, PUBLICLY TRADED CORPORATIONS: GOVERNANCE & REGULATION, §2:26(2d ed. 2004); see also Donald E. Pease, Outside Directors: Their Importance to the Corporation and Protection from Liability, 12 DEL. J CORP. L. 25, 29(1987).
[7]OLSEN, supra note 6.
[8]See id.
[9]Tong Lu, Development of System Of Independent Directors and the Chinese Experience, in CORPORATE GOVERNANCE REFORM: CHINA AND WORLD (2002), available at Ctr for Int’l Private Enter., http://www. cipe. org/china/cg_book.htm.
[10]See Betty M. Ho, Restructuring the Boards of Directors of Public Companies in Hong Kong: Barking Up the Wrong Tree, 1 SING. J. INT’L & COMP. L. 507, 507(1997).
[11]Brudney, supra note 5, at 602.
[12]See Gu, supra note 1, at 60.
[13]See id.
[14]See Cindy A. Schipani & Junhai Liu, Corporate Governance in China: Then and Now, 2002 COLUM. BUS. L. REV. 1, 27.36-37 (2002).
[15]See Gu, supra note 1, at 70; see also Danhan Huang, Problems Concerning Independent Directors Institution and Its Legal Environment, in CORPORATE GOVERNANCE REFORM: CHINA AND WORLD (2002), available at Ctr for Int'l Private Enter., http://www.cipe.org/china/cg book.htm.
[16]See Ho, supra note 10, at 518-21.
[17]See id. at 518.
[18]See Gu, supra note 1, at 74.
[19]Id.
[20]Id. at 74-75.
[21]See id.
[22]Id. at 61.
[23]ADOLF A. BERLE, JR. & GARDINER C. MEANS, THE MODERN CORPORATION AND PRIVATE PROPERTY 127, 135 (1933) (observing that the corporate mechanism has evolved into one where there are many shareholders).
[24]Lu, supra note 9.
[25]Ho, supra note 10, at 508-09 (quoting Daniel R. Fischel, The Corporate Governance Movement, 35 VAND. m. REV. 1259, 1262 (1982)).
[26] Brudney, supra note 5, at 602.
[27]Id. at 605.
[28]See id.; see also Richard Guo, Disinterested? Or Uninterested? Some Thoughts on the CSRC's Independent Directors Guiding Opinion, CHINA L. & PRAC., Oct. 2001, at 71, reprinted in 3 PERSP. 5 (2002), at http://www.oycf, org/Perspectives/law.htm (June 30, 2002). #p#分页标题#e#
[29]A.L.I, PRINCIPLES OF CORPORATE GOVERNANCE: ANALYSIS AND RECOMMENDATIONS § 3A.01 (Proposed Final Draft 1992) [hereinafter PRINCIPLES].
[30]Lu, supra note 9.
[31]HAROLD S. BLOOMENTHAL & SAMUEL WOLFF, SECURITIES AND FEDERAL CORPORATE LAW ~ 1:195 (2d ed. 2004).
[32]Id.
[33]PRINCIPLES, supra note 29, at ~ 3A.01.
[34]Sanjai Bhagat & Bernard Black, The Non-Correlation Between Board Independence and Long-term Firm Performance, 27 J. CORP. L. 231,232 (2002).
[35]Lu, supra hole 9.
[36]Id.; see Ira M. Millstein & Paul W. MacAvoy, The Active Board of Directors and Performance off the Largest Pubficly Traded Corporation, 98 COLUM. L. REV. 1283, 1298 (1998).
[37]Lu, supra note 9.
[38]Id.
[39]Ho, supra note 10, at 523.
[40]Lu , supra note9.
[41]Bhagat & Black,supra note 34, at 233.
[42]OLSON, supra note6,at§2:26.
[43]See id.
[44]See Pease,supra note 6,at35-40.
[45]OLSON supra note 6,at§2:26.
[46]Id.
[47]Id.