Corporate Governance & Independent Directors IMP

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15 SAcLJ Corporate Governance and Independent Directors 355
CORPORATE GOVERNANCE AND INDEPENDENT

DIRECTORS
A Introduction
1 The company is today the most widely used business vehicle, far
outstripping associations of persons in partnership. In the developed
countries of the common law world, for example, only the professions
and sundry small businesses generally use the partnership vehicle. Where
the professions are concerned, this is largely due to the perception that
professional persons should be held to a higher standard and be subject
to the prospect of unlimited liability. However, the requirement for
professionals to engage in their profession only through the partnership
vehicle, and with the prospect of unlimited liability for all partners, is
being rapidly eroded. One of the main advantages of incorporation is that
investors in the enterprise are not personally liable, in the absence of any
direct assumption of responsibility on their part, for the debts and other
liabilities of the company.' It is becoming increasingly accepted that
professional practices are also essentially business enterprises that ought
to be allowed the benefit of limited liability afforded by the corporate
vehicle. In addition, as the number of professional negligence suits has
increased, the professions have also lobbied vigorously for such
protection. It is often argued by the professions that the potential liability
each professional person bears is out of all proportion to the fees charged
for their professional services, thereby shifting risk unfairly to them. It is
also often said that as professional indemnity schemes are common,
indeed sometimes compulsory, the professions are the ones ultimately
insuring losses caused to third parties even where there are other parties
(usually uninsured) involved. Today, as a result of these views, many
jurisdictions allow associations of professionals to carry on business
Unless the court engages in what is known as 'lifting' or 'piercing' the corporate veil,
a process by which the court looks beyond the company to the shareholders of the
company for liability, see generally PL Davies, Gower's Principles of Modern
Company Law (London, Sweet & Maxwell, 6 th ed., 1997), Chapter 6; Schmitthoff,
"Salomon in the Shadow" [1976] Journal of Business Law 305; M Whincup,
"'Inequitable Incorporation' - the Abuse of Privilege" (1981) 2 Company Lawyer
158; P Carteaux, "Louisiana Adopts a Balancing Test for Piercing the Corporate
Veil" (1984) Tulane Law Review 1089; F Easterbrook and D Fischel, "Limited
Liability and the Corporation" (1985) 52 University of Chicago Law Review 89; A
Domanski, "Piercing the Corporate Veil - A New Direction?" (1986) 103 South
African Law Journal224; S Ottolenghi, "From Peeping Behind the Corporate Veil to
Ignoring it Completely" (1990) 58 Modern Law Review 338; Tan CH, "Piercing the
Separate Personality of the Company: A Matter of Policy?" [1999] SJLS 531-551.
356 Singapore Academy of Law Journal (2003)
through a corporate vehicle.2 Some also allow limited liability

partnerships, 3 which are common in Europe4 but never really took off in
the common law world.
2 Although a company in the eyes of the law is a different creature
from a partnership, where small or closely held companies are
concerned, the operation and management of such companies may be
little different from a partnership. Indeed, many small or closely held
companies may have previously been partnerships that later adopted the
corporate form. Such companies are often referred to as "quasi-
partnerships" ' although the term is of course misleading.6 In such
companies, there may be virtually no difference between ownership and
management. Many of the shareholders of such companies will be
involved in the management of these companies. Even where they are
not directly involved, the often-informal nature of such associations will
usually mean that their views will be taken into consideration, or that
they will be consulted on important matters.
3 In the case of large companies whose shares are listed on a stock
exchange, the fact of the listing will usually mean that the shareholder
spread is diverse. In publicly listed companies, there is usually some
dichotomy between ownership and management. In a famous work,
attention was called to the prevalence in the United States of widely held
companies where ownership is dispersed among small shareholders, with
control vested in managers who have small or non-existent equity
interests. In such companies there is a clear separation of ownership and
2 For example, Singapore amended its Legal Profession Act (Cap. 161) in 2000 (see
Legal Profession Amendment Act 2000), which introduced a new Part VIA that
allows advocates and solicitors to practise through a "law corporation" and not only
as a firm.
3 In England, for example, any two or more persons (individuals or companies) may
form a limited liability partnership. Such partnerships are not limited to the
professions. Notwithstanding its name, this vehicle is in effect a modified form of
private company and not a partnership with limited liability, as it is in some other
jurisdictions, see G Morse, PartnershipLaw (London, Blackstone Press, 5th ed.,
2001), Chapter 9. Singapore is also considering the introduction of limited liability
partnerships, although it is not clear yet whether Singapore will choose limited
liability partnerships similar to the English model, or partnerships with limited
liability. The former seems more likely although this author considers it a retrograde
step.
4 See RCI Banks, Lindley & Banks on Partnership,(London, Sweet & Maxwell, 18 th
ed., 2002), 33.
5 See e.g., Ebrahimi v Westbourne GalleriesLtd [1973] AC 360; Re Central Realty Co
(Pte)Ltd [1999] 1 SLR 559; Wu Fu Ping v Ong Beng Seng [2001] 2 SLR 40.
6 Ebrahimi v Westbourne GalleriesLtd, ibid, 379.
control.7 However, such a clear dichotomy does not exist in all

companies. In some companies, where a particular shareholder or group
of shareholders own a significant percentage of the company's shares,
such percentage may be sufficient, even when not a majority interest, to
give these shareholders effective control over the company due to the
diffused nature of the company's shareholders. Such shareholders who
hold a significant interest will often be part of the management. As a
general rule, though, most shareholders in public listed companies will
have a relatively small number of shares in the company and not be
involved in management. Even where shareholders or groups of
shareholders have a relatively large percentage of the company's shares,
they may in some cases prefer not to be directly involved in management
but to entrust that to the care of professional managers. Thus, the
distinctive feature of publicly listed companies is that a diverse group of
shareholders will entrust the management of the company to agents,
some of whom themselves may be large shareholders
B An excursion into history
4 From a historical standpoint,9 it will be seen that even without

anything resembling a public listing today, wherever business enterprises
7 See A Berle and G Means, The Modern Corporation and Private Property (New
York, Harcourt, Brace & World Inc, 1932, revised edition, 1967).
R La Porta, et al, "Corporate Ownership Around the World" (1999) 54 Journal of
Finance 471, find that the Berle and Means widely held corporation is only a
common organizational form for large firms in the richest common law countries. As
one looks outside the United States, particularly at countries with poor shareholder
protection, even the largest firms tend to have controlling shareholders. Sometimes
that shareholder is the State; but more often it is a family, usually the founder of the
firm or his descendants.
For further reading, see Gower's Principles of Modern Company Law, supra note 1,
chapters 2 and 3; W Holdsworth, A History of English Law (London, Methuen and
Sweet & Maxwell, 1966), Volume VIII, 192-222; TB Napier, "The History of Joint
Stock and Limited Liability Companies" in A Century of Law Reform: Twelve
Lectures on the Changes in the Law of England During the Nineteenth Century
(London, Macmillan, 1901), Chapter XII; BC Hunt, The Development of the Business
Corporation in England: 1800 - 1867 (Cambridge, Massachusetts, Harvard
University Press, 1936); CA Cooke, Corporation Trust and Company: An Essay in
Legal History (Manchester, Manchester University Press, 1950); A Chayes, "The
Modem Corporation and the Rule of Law" in ES Mason (ed), The Corporation in
Modern Society (Cambridge, Massachusetts, Harvard University Press, 1966), 25,
32-7; JW Hurst, The Legitimacy of the Business Corporationin the Law of the United
States: 1780 - 1970 (Charlottesville, The University Press of Virginia, 1970); LM
Friedman, A History of American Law (New York, Simon and Schuster, 1973), Part
III, Chapter VIII; WR Cornish and GN Clark, Law and Society in England: 1750 -
[continued next page]
were of a large and complex nature, the need for risk takers (shareholders
today) to delegate management to agents became necessary. The modem
company can be traced back to medieval times where it was used by
ecclesiastical bodies and boroughs. In the commercial sphere, it was also
used by guilds of merchants and craftsmen. The principal function of
these bodies was to regulate the affairs of its members. Corporate status
was obtained by royal charter." This secured for the borough territorial
self-government from feudal lords. For the guilds, it secured a monopoly
over a trade that could be practised only by members of the guild.
Members carried on the trade on their own account or with others subject
to the rules and regulations of the guild. The guild itself as an entity was
not engaged in the trade and was principally an administrative and self-
regulating organisation for that particular trade.
5 The next stage of the development of the 'company' saw it
evolve from one principally interested in internal administration to one
engaged in external trade. In the sixteenth and seventeenth centuries, the
crown's desire to expand foreign trade led to charters being granted to
entities that pursued commercial gain in overseas territories. Initially,
these entities were not much different from the guild associations.
Membership of the company allowed each member, subject to the rules
of the company, to pursue the overseas trade in question either on the
member's own account, or in joint account with other members. The
royal charter was intended to grant the company, and therefore its
members, a monopoly over a particular aspect of foreign trade. It was
also a means by which the crown enlisted private resources to the king's
business. Incorporators would venture their own funds for the state's
ends, in effect paying for the privilege.11 The company therefore had a
strong political dimension. As Holdsworth puts it: "It was from the point
of view of trade organization and the foreign policy of the state, rather
than from the point of the interests of the persons composing the
company - from the point of view of public rather than commercial law
- that the corporate form was valued."12
1950 (London, Sweet & Maxwell, 1989), 246-62; F Evans, "The Evolution of the
English Joint Stock Limited Trading Company" (1908) 8 Columbia Law Review 339;
M Schmitthoff, "The Origin of the Joint-Stock Company" (1939) 3 University of
Toronto Law Journal 74; W Horrwitz, "Historical Development of Company Law"
(1946) 62 Law QuarterlyReview 375.
10 In later times Parliament secured power to grant its own charters.
11 Chayes, supra note 9, 34.
12 Supra note 9, 202.
15 SAcLJ Corporate Governance and Independent Directors
6 However, over time the mode of engaging in business changed.

This was hardly surprising. Overseas ventures required more in the way
of capital and expertise. The risks were greater and each endeavour took
a much longer time. Merchants could not expect their wares to arrive in
the marketplace within a relatively short time. Ships could be away at
sea for months and be subject to all the attendant risks then present of sea
travel. It became impractical for all but the wealthiest merchants to
continue to trade on their own account. Gradually, more and more began
to trade on joint account and with a joint stock in trade. 13Eventually, this
became the only means of trading through the company.14
7 We see in this gradual development many of the features of the
modem publicly listed company. The medieval entity had evolved into a
body that traded for the benefit of its members rather than one that
merely regulated the affairs of its members in the pursuit of a foreign
commercial enterprise. The company had a permanent joint stock that
resembled the capital subscribed for in modem companies. As private
trading became forbidden, the company itself was the vehicle for the
pursuit of the monopolistic commercial enterprise. Most importantly, this
in turn saw the rise of professional management, a relatively select group
of persons who in effect managed the company. Yet it should be borne in
mind that in many respects these 'companies' were very different from
modem companies. One particularly important difference was that many
of these joint stock companies were not incorporated companies with a
separate personality but unincorporated partnerships. Legal ingenuity
enabled many of these unincorporated associations to have many of the
advantages of incorporation by the use of trusts. The company would be
formed under a 'deed of settlement' under which the subscribers would
agree to be associated in an enterprise with a prescribed joint stock
divided into a specified number of shares. The trust deed would specify
many of the terms on which the members would associate, including the
delegation of management to a committee of directors, the vesting of the
company's property with a separate body of trustees, and how the
provisions of the deed could be varied." When additional capital was
needed, it was raised by levies on the existing members. The important
advantage of limited liability conferred only by incorporation does not
appear to have been fully appreciated. 6 However, what is important to
note was that by the end of the seventeenth century, the idea of
13 From where the term 'joint stock company' originates.

14 See e.g., the evolution of the East India Company, Cooke, supra note 9, 58-9.
15 Gower 's Principlesof Modern Company Law, supra note 1, 29.
16 Ibid, 21-2.
combining capital with entrepreneurship was appreciated. So too was the

need to entrust management to professional agents.
8 In the first two decades of the eighteenth century, there was a
speculative fervour that led to a bursting of the bubble in 1720. One of
the most speculative enterprises, the South Sea Company, saw its stock
price collapse precipitously. Many other companies failed completely
and this led to public confidence in joint stock companies being
destroyed to the extent that it was three quarters of a century before there
was a comparable boom. Following upon this crisis, relatively few
charters were given in subsequent years as the Law Officers of the
Crown were reluctant to advise the grant of charters and insisted on
restrictive conditions when any were granted.1 7 It was only towards the
end of the century that Parliament granted more statutory incorporations
with the growth of canal building."8
9 The events of the early eighteenth century hold an important
lesson. For companies to be effective vehicles for trade, and indeed for
commerce itself to flourish, public confidence is important. The law
must ensure sufficient safeguards for all those who would have dealings
with companies, whether they are the investing members of the public,
or those who would trade with the companies themselves. To this
realisation is owed many of the features of modem company law such as
prospectus requirements in the case of public offerings of securities,
continuing disclosure requirements, accounting obligations, restrictions
and obligations placed on management, a collective insolvency regime
and the pari passu principle of insolvency law, just to name a few.
Investors in companies must have confidence that the companies are well
managed before they will invest in a venture that they do not have any
real control over. Investing in such companies after all requires an act of
faith. Those investing often do not have personal knowledge of those in
management. At best, they know some of those in management by
reputation, or from the media. Yet they are asked, and are willing, to risk
their capital in the enterprise. Such acts of faith may to some extent be
facilitated by faith in the process, namely that the general system of
corporate governance constitutes a check on the ability of management
to abuse the discretion vested in them. 19
17 Gower's Principlesof Modern Company Law, supra note 1, 27-8.

18 Ibid.
19 FH Easterbrook and DR Fischel, "The Corporate Contract" (1989) 89 Columbia Law
Review 1416, 1419-21.
C Corporate governance
10 In the case of small companies in many Commonwealth

jurisdictions, many of the safeguards required for large publicly listed
companies with a diffuse shareholder base are unnecessary. The
members themselves, being intimately involved in the enterprise, are
well able to look after their own interests. Where these interests are
threatened, the law provides two important safeguards.
11 The first is that where these members are also directors, as they
often will be, the law allows them the right, in their capacity as directors,
to inspect the accounting records of the company.2" Access to
information is thus an important tool by which such shareholders can
protect themselves. The second is the unfair prejudice or oppression
remedy enshrined in the companies' legislation of many common law
countries.21 This enables a shareholder who has been oppressed or
unfairly discriminated against to bring an action against the offending
shareholders or directors. If the court is satisfied that there is oppression
or unfair discrimination, the court may make such order as it thinks fit
for giving relief in respect of the matters complained of,22 or remedying
the matters complained of.23
12 The two important safeguards available to shareholders in small

companies are usually not significant in publicly listed companies. Most
shareholders will not be directors and cannot therefore have recourse to
the company's accounting records. As for the unfair prejudice or
oppression remedy, while it potentially applies to all companies, 24 it will
be highly difficult to persuade a court to apply it in respect of public
listed companies. In part, this is because the courts will find it difficult,
20 See the English Companies Act 1985, s. 222. It has been suggested that s. 222 gives
directors a statutory right to an order for inspection of the accounting records of the
company, see DD Prentice, "A Director's Right of Access to Corporate Books of
Account" (1978) 94 Law Quarterly Review 184 and Berlei Hestia (NZ) Ltd v
Fernyhough [1980] 2 NZLR 150. The position in Singapore is governed by s. 199(5)
of the Singapore Companies Act (Cap. 50), which explicitly states that "[t]he Court
may in any particular case order that the accounting and other records of a company
be open to inspection by an approved company auditor acting for a director, but only
upon an undertaking in writing given to the Court that information acquired by the
auditor during his inspection shall not be disclosed by him except to that director";
see also Wuu Khek Chiang George v ECRC Land Pte Ltd [1999] 3 SLR 65.
21 See e.g., s. 459 of the English Companies Act 1985, and s. 216 of the Singapore
Companies Act.
22 English Companies Act 1985, s. 461(1).
23 Singapore Companies Act, s. 216(2).
24 Re a Company (No. 00314 of 1989) [1991] BCLC 154.
in the case of a publicly listed company, to give effect to any legitimate

expectations that an individual investor, or a group of investors, may
have. Such expectations are more readily given effect to in quasi-
partnership companies. In the case of a public listed company, any
understanding or agreement that has given rise to the expectation will not
generally be known to other investors. 5 Investors in public listed
companies must have confidence that the companies' affairs will be
conducted in accordance with its constitution and not be affected by
extraneous equitable considerations and constraints. 26 In addition,
shareholders in public listed companies know that there is a ready market
for the shares of such companies, and that if they are unhappy, their
normal remedy is to exit the company by selling their shares, a route not
available to shareholders of unlisted companies.
13 Accordingly, two of the most widely used forms of protection

for shareholders of large publicly listed companies are corporate
governance rules and disclosure requirements. 27 The former ensures (at
least in theory) that management power is subject to safeguards, and the
latter ensures that shareholders have sufficient information on which to
make informed decisions on their investments; and indeed on whether to
invest, which in turn acts as a check on management. In a sense, the duty
of disclosure may be seen as an aspect of corporate governance as it
generally has to be discharged by management and is intended to provide
a degree of transparency to management actions. This paper does not
intend to discuss all these aspects of corporate governance. Its role is
more modest; the focus will be on the role of independent directors as
one of the most widely advocated and used mechanisms
28
to strengthen
corporate governance in widely held companies.
25 Re Blue Arrow plc [1987] BCLC 585; Re Tottenham Hotspur plc [1994] 1 BCLC
655.
26 Re Astec (BSR) plc [1998] 2 BCLC 556, 589, where the court also expressed the view
that the concept of legitimate expectations should have no place in the context of
public listed companies. See also E Ferran, Company Law and Corporate Finance
(Oxford, Oxford University Press, 1999), 239-40.
27 Including auditing requirements. In this regard, Singapore's Monetary Authority of
Singapore announced on 13 March 2002 that all banks in Singapore will be required
to change their auditors after 5 years. This may well presage a move to require all
publicly listed companies in Singapore to do the same. An editorial in The
Economist, "Unresolved Conflicts", 18 October 2003, 14, supports auditor rotation
on the basis that it will go a long way toward making auditors genuinely independent.
Although this may be a step in the right direction, more will have to be done to
ensure that auditors perform their role adequately.
28 Although some mention will be made of auditors, as they play a crucial role in
enabling independent directors to discharge the functions expected of them.
D Directors' fiduciary duties
14 Before considering the role of independent directors of publicly

listed companies, it will be useful to digress a little and consider the
fiduciary duties that all directors owe their companies. In all companies
where there is a delegation of management to agents and risk bearing by
capital contributors, there is good reason to believe that the agents will
not always act in the best interests of their principals. The principal can
limit divergences from his interest by establishing appropriate incentives
for the agent and by incurring monitoring costs designed to limit the
aberrant activities of the agent. In addition in some instances it will pay
the agent to expend resources (bonding costs) to guarantee that he will
not take certain actions to harm the principal. Even so, there will be
some divergence between the agent's decisions and those decisions that
would maximize the welfare of the principal. This is also a cost of the
agency relationship and is referred to as the "residual loss". The
monitoring expenditures incurred by the principal, the bonding
expenditures by the agent and the residual loss are referred to as agency
costs.29
15 Under common law, directors are said to be under a fiduciary

duty of loyalty and good faith to the company. In applying this duty to
directors, a number of rules have emerged of which the two most
important are: (1) that directors must act in good faith in what they
believe to be the best interests of the company; and (2) that, without the
informed consent of the company, they must not place themselves in a
position where their interests and those of the company are likely to be in
conflict."
16 Non-common law jurisdictions, while not having the concept of
fiduciary duties, have rules that fulfil a similar function. For example, the
People's Republic of China's (PRC) Company Law (Revised)31
legislation contains provisions that are similar to those found at common
law. Thus, for example, Article 59 of the PRC Company Law (Revised)
provides that the directors, supervisors and manager shall "faithfully
29 MC Jensen and WH Meckling, "Theory of the Firm: Managerial Behavior, Agency

Costs and Ownership Structure", in RA Posner and KE Scott (eds), Economics of
CorporationLaw and Securities Regulation (Boston, Little, Brown, 1980), 39, 39-40.
30 See Gower's Principlesof Modern Company Law, supra note 1, 599-601.
31 Adopted by the 5th Session of the Standing Committee of the
8 th National People's
Congress on 29 December 1993, which became effective on 1 July 1994.

perform their duties and protect the interests of the company. ' 32 Article
61 states that the directors and manager "may not engage in the same
type of business as their company, whether for their own account or that
of others, nor may they engage in activities which are harmful to the
interest of their company. If a director or the manager engages in such
business or activities, the revenue so obtained shall belong to the
company. ' 33 What is unclear though, in the absence of provisions dealing
with derivative actions, is how such a claim may be brought if the
wrongdoers are themselves in control of the company. Similarly,
Indonesia's law on limited liability companies,31 Awhich came into force
on 7 March 1996, provides at Articles 85 and 98 respectively that the
Board of Directors and the Commissioners of a company are obliged to
perform their duties "with good faith and a sense of responsibility.. .to
further the interests and business of the company."
17 Such duties imposed by the law on directors may be understood
as a means to reduce agency costs by subjecting directors to strict duties
with appropriate penalties for the breach of such duties. The fiduciary
duties act as a counterweight to the natural instinct of agents to prefer
their own interests. They play a useful role in defining the role of
directors, and the duties that they owe. In addition, such duties, insofar as
they also play a role in deterrence, serve a purpose not unlike that of the
criminal law.
E Independent directors
18 It has been mentioned above that one way of managing the

divergence of interests between the providers of capital and management
is to incur monitoring costs. One of the roles of independent directors,
indeed perhaps their main role, is to monitor management.34 On the face
32 This English translation is taken from China Law Reference Service, Volume 2
(Hong Kong, Asia Law & Practice, 1996), 14-5.
33 Other relevant articles are Articles 60, 62 and 63.
31A Undang Undang Tentang Perseroan Terbatas. The translation is taken from BS
Tabalujan, Indonesia Company Law - A Translation and Commentary (Singapore,

Sweet & Maxwell Asia, 1997).
34 Another possible important role for independent directors may be to provide the full-
time executives with advice and counsel on matters of corporate policy and strategy,
see BR Cheffins, Company Law: Theory Structure and Operation (Oxford,
Clarendon Press, 1997), 604-5. Obviously, the ability of independent directors to play
this role meaningfully varies from person to person and on the industry that the
company operates in. Independent directors no doubt offer advice on matters of
corporate policy and strategy but it is debatable how significant their advice is,
of it, there is much to commend this idea. Independent directors are

directors who are not affiliated to executive or inside directors. In
addition, independent directors should also generally be persons who do
not have a business or other relationship with the company or with other
senior officers of the company.
19 Having independent directors, at least in theory, minimises the
danger of management abusing their power.3" As such directors are not
directly involved in management, they do not have the same
opportunities as management to use their positions as directors to their
own advantage rather than to the advantage of the company and
shareholders. The role of independent directors is to monitor the actions
of management and to do this they must themselves be independent of
management.3 6 In the United States, many publicly listed (or traded)
companies have a majority of independent directors.37 This phenomenon
is rare in Asia. In part, this is because many publicly listed companies in
particularly where they do not have the relevant industry experience. As Rogers CJ
put it in AWA Ltd v Daniels (1992) 7 ACSR 759, 832: "Foremost among [the
difficulties that arise in the allocation of liability] is the failure to recognise and admit
that many companies today are too big to be supervised the administered by a board
of directors except in relation to matters of high policy. The true oversight of the]
activities of such companies resides with the corporate bureaucracy. Senior
management and, in the case of mammoth corporations, even persons lower down the
corporate ladder exercise substantial control over the activities of such corporations
involving important decisions and much money. It is something of an anachronism to
expect non-executive directors, meeting once a month, to contribute anything much
more than decisions on questions of policy and, in the case of really large
corporations, only major policy. This necessarily means that, in the execution of
policy, senior management is in the true sense of the word exercising the powers of
decision and of management which in less complex days used to be reserved for the
board of directors." Later in the judgement, at 865, Rogers CJ expressed the view that
as "conglomerates get larger and more complex it becomes almost impossible for the
non-executive director to discharge directorial duties in any detailed and
knowledgeable manner."
35 Although there may be other mechanisms that already constrain managerial abuse of
their discretion, see R Romano, "Corporate Law and Corporate Governance", in GR
Carroll and DJ Teece (eds), Firms, Markets, and Hierarchies:the Transaction Cost
Economics Perspective (New York, Oxford University Press, 1999), 365, 419; BR
Cheffins, ibid, 607-9, 614-7.
36 See e.g., MA Eisenberg, The Structure of the Corporation -A Legal Analysis
(Boston, Little, Brown and Company, 1976), 156-68; 0 Williamson, "Corporate
Governance" (1984) 93 Yale Law Journal 1197; BR Cheffms, ibid, 605-6; EF Fama
and MC Jensen, "Separation of Ownership and Control" (1983) 26 Journal of Law
andEconomics 301, 312-5.
37 S Bhagat and B Black, "The Relationship Between Board Composition and Firm
Performance", in KJ Hopt, et al. (eds), Comparative Corporate Governance: The
State of the Art and Emerging Research (Oxford, Clarendon Press, 1998), 281-2.
Asia have dominant shareholders 38 who essentially control the company 39

and have little incentive to weaken their control by appointing a majority
of independent directors. In addition, the market pressures that may
provide incentives for such companies to improve (or at least to appear
to do so) their systems of corporate governance, e.g. by appointing a
majority of independent directors, largely do not exist.40 Even so, to the
extent that independent directors have access to information and
management, attend Board meetings and presentations, they can
potentially exercise a monitoring function even though they may not
constitute a majority on the Board of directors.41
20 While the theory seems intuitively correct, most of the studies
that have been conducted do not appear to bear it out. Bhagat and Black,
for example, after surveying much of the4 2literature and conducting their
own re-examination, conclude as follows:
"There remains no convincing evidence that the composition of
the Board of directors affects overall firm performance.
Bhagat/Black (1997) find evidence that the proportion of inside
38 In many cases, the company is controlled by a family, often the children and/or
grandchildren of the founding shareholder. Over time, this nexus is likely to weaken
as it already has in some companies but family dominated publicly listed companies
still fairly common. See also S Claessens, et al, "The separation of ownership and
control in East Asian Corporations" (2000) 58 Journalof FinancialEconomics 81; R
La Porta, et al, "Investor protection and corporate governance" (2000) 58 Journalof
FinancialEconomics 3, 14-5; La Porta, et al, supranote 8.
39 The position in many other countries appears similar. Where this is the case, there is
a problem of separation of ownership and control, though not of the type described
by Berle and Means. These companies are run not by professional managers without
equity ownership who are not accountable to shareholders but by controlling
shareholders. These controlling shareholders are ideally placed to monitor the
management, and in fact are usually part of the management together with other
family members, but at the same time they have the power to expropriate the
minority shareholders as well as the interest in so doing. Cash flow ownership by the
controlling shareholder mitigates this incentive for expropriation, but does not
eliminate it, see La Porta, et al, supra note 8, 511.
40 For example, large institutional investors, effective takeover mechanisms, media and
market pressure, and sufficient viable alternative investment opportunities. It is of
course debatable how effective these mechanisms are in the first place.
41 The Singapore Code of Corporate Governance (available at
<http://www.mof.gov.sg/cor/doc/cgcfinalrpt.doc>) provides in clause 2.1 that
independent directors should make up at least one-third of the Board. In England, the
Combined Code of Corporate Governance provides in clauses A.3.1
and A.3.2 that non-executive directors should comprise not less than one-third of
the Board of which a majority should be independent. (available at
<http://www.ecgi.org/codes/country documents/uk/combined code.pdf>)
42 Supra note 37, 299-300.
directors on the Board correlates with improved performance,

but this evidence is stronger for recent past than for near-term
future performance. They find that the proportion of independent
directors correlates with slower recent past growth, but not with
future performance. A null result, of course, can never be
proved. But, pending the results of additional tests..., the burden
of proof should perhaps shift to those who support the
conventional wisdom that ever greater Board independence is an
important element of improved corporate governance."
21 Similarly, Romano, who also surveys the literature, states that

the bulk of the results of various studies find insignificant associations
between Board composition and firm performance.43 Her conclusion is
that Board composition does not matter for overall performance.' An
Australian study also found no solid evidence supporting the proposition
that independent directors add value.4"
22 However, Romano draws a distinction between what she terms
the "strong" and "weak" forms of a monitoring Board.4 6 Under the
"strong" form, a monitoring Board would be expected to enhance
performance on an ordinary day-to-day basis, or over some longer
period, compared to non-monitoring (insider-dominated) Boards. Under
the "weak" form, the most effective functioning of a monitoring Board
will occur upon the appearance of significant difficulties in the firm's
performance or other extraordinary events.
23 From an intuitive point of view, it would be difficult for most
independent directors to monitor management on a day-to-day basis, or
to directly enhance performance over a longer period. Independent
directors are non-executive and cannot, in the main, devote the greater
part of their time or energies monitoring management performance.
Furthermore, independent directors do not generally have the same
degree of knowledge and expertise about the business compared to
management. It will be difficult for independent directors to make the
same assessments of specific transactions that management can.
Accordingly, it is difficult for independent directors to 'second-guess'
management. The reality is that independent directors will, to a large
43 R Romano, supra note 35, 375.

44 As opposed to extraordinary times such as during financial distress and takeovers,
ibid, 419.
45 J Lawrence and G Stapledon, Do Independent Directors Add Value?, (Melbourne,
Centre for Corporate Law and Securities Regulation, 1999).

extent, have to be guided by the advice of management. They will be

reluctant to interfere with the views of management that are honestly
held unless those views are obviously untenable or unrealistic.
24 On the other hand, as Romano points out, 47 outsiders should be
able to recognise and react to gross failures of strategy and performance,
as opposed to identifying nuances of differences in the performance of
day-to-day operations. Romano surmises that under the "weak" form
hypothesis of Board impact, a positive correlation between Board
composition and performance could be expected only in times of
distress. Romano states 48 that although the interaction between Board
composition and specific events is at times ambiguous, the data are most
consistent with a monitoring interpretation, i.e. that outsider Boards take
greater charge in extraordinary events or crisis situations and enhance
share value. This, however, is hardly a strong vindication of outsider
Boards.49 It would be the height of negligence if such Boards did not
exercise greater oversight in extraordinary events or crisis situations. In
such instances the issues will usually be more clearly defined, thereby
making it easier for independent directors to manage the situation. What
is called for is oversight of a type that can minimise the prospect of
companies (or at least the shareholders of companies) finding themselves
all too suddenly in a crisis situation.
25 There are several possible reasons for the non-correlation
between the proportion of independent directors and corporate
performance. First, although independent directors are intended to
protect the interests of shareholders through their monitoring function,
they may to a greater or lesser extent owe their appointment to
management, or feel beholden to management in some way."° This is a
41 Ibid.
48 Ibid, 384.
49 Cf Romano, ibid, 385, where the point is made that there is no evidence that
investors are losing something in ordinary governance by having outsiders rather than
insiders on board who will prove useful in the event of a crisis. Rather, it only
highlights the need to fashion adequate incentives for outside directors to do their
job.
50 IM Millstein and PW MacAvoy, "The Active Board of Directors and Performance of
the Large Publicly Traded Corporation" [1998] Columbia Law Review 1283, 1284,
state that after the mid-twentieth century, when the separation of corporate ownership
from managerial control was virtually complete, professional managers began
dominating their Boards of Directors in addition to daily corporate decision making.
In practice Board members were chosen from among its own ranks of large-company
executives and from among its professional associates in law and finance. Board
service was largely viewed as an honorific and responsive to management concerns.
particular reality in companies where the Chief Executive Officer (or the
Managing Director) is also the controlling shareholder. Even where this
is not the case, senior management are likely at least to be consulted on
Board appointments and indeed, the Chief Executive Officer may be
proactive in suggesting persons that he considers to be suitable for
appointment to the Board. This raises the fundamental issue of how
independent such directors are. Furthermore, to the extent that
management has influence over the appointment of directors, they will
be inclined to encourage the appointment of directors whom they feel
would be unlikely to interfere overly with management decisions. In the
final analysis, all these factors make it very difficult to expect that
independent directors will exercise meaningful oversight of
management. Indeed, it is said that the unwillingness to challenge
management by asking tough questions is one of the shortcomings of
Boards across corporate America. 1 This also appears to be the case in
Singapore. It has been said that the general culture in Singapore is one
where persons are too polite to ask the hard questions. Independent
directors may just try to please the chairman and the Chief Executive
Officer and not ask difficult questions. 2
26 It is perhaps hardly surprising that there should be reluctance on

the part of independent directors to challenge management. While this
may be particularly true where the independent directors are in some
way beholden to management, it is unlikely to be limited to such
instances. In the ultimate analysis, the Board of Directors is a body
where the members are generally engaged in a common enterprise. Some
degree of collegiality is therefore regarded as a necessity. 3 In addition,
the dynamics within a Board will usually ensure a high degree of
Instead of an arms-length relationship, there was a collegial relationship between the

Board and management. See also Eisenberg, supra note 36, 171-2; JD Cox and HL
Munsinger, "Bias in the Boardroom: Psychological Foundations and Legal
Implications of Corporate Cohesion" (1985) 48 Law and Contemporary Problems
83; GW Dent, "The Revolution in Corporate Governance, the Monitoring Board, and
the Director's Duty of Care" (1981) 61 Boston UniversityLaw Review 623, 626-7.
51 See ML Mace, "Directors: Myth and Reality - Ten Years Later" (1979) 32 Rutgers
Law Review 293, 295-6; "Enron's Board Gives Black Eye to Efforts Aimed at
Improving Corporate Governance" in Knowledge@ Wharton, available at
<http://knowledge.wharton.upenn.edu/category.cfm?catid 2>.
52 Remarks made by Singapore's Ambassador-at-Large, Professor Tommy Koh, see
Lee Su-Shyan, "Ask hard questions and know your companies well", Straits Times,
13 July 2002, A18.
53 See also JE Parkinson, CorporatePower and Responsibility: Issues in the Theory of
Company Law (Oxford, Clarendon Press, 1993), 194-5; BR Cheffins, supra note 32,
609-10.
conformity among its members. As Cox and Munsinger point out, 4

conformity and cohesion within a group increase with the value each
member places on membership in the group. In the case of a directorship
of a public corporation, this value is extremely high. Individuals learning
of their nomination to the Board think of the prestige, the influence, and
the pleasure of associating with other successful people with whom they
will share the challenges of being a director. Those who serve as
directors look forward to serving with others they admire, with whom
they wish to become better acquainted, and with whom they wish to
work on important matters. These preferences are a manifestation of the
inherent drive for affiliation and companionship that motivates people
throughout life to seek self-identity in a group. Through attachment to a
group, individuals satisfy their needs to validate their self-worth.
Membership on the Board of a public company confers the additional
reward of increased status derived from the overall high prestige of the
other board members. The very high personal value that directors place
on membership of the Board, the enhanced self-esteem that is derived
from being singled out for membership in a select group, and the
increased attention associated with continued group membership all tend
to multiply the overall cohesion of the group. Furthermore, many outside
directors of companies are themselves top managers of other companies.
This interlocking directorate has been seen as an instrument for
cementing ties between firms. Another reason has been to enable
companies to ensure that their managers remain full abreast of the
changing corporate environment and practices of other companies."5
Accordingly, in the circumstances, it is extremely likely that there will
be a great reluctance to adopt an approach that may be construed or
perceived as confrontational.
27 Secondly, many independent directors are appointed to add
lustre and prestige to the Board. They tend to be busy, successful
individuals who already hold a number of other similar positions. The
amount of time that they can bring to bear on the company's affairs will
be limited. This problem is compounded where the companies in
question are engaged in highly technical industries that the independent
directors may have very little knowledge of. In such a situation, it will be
extremely difficult for the independent directors to play a useful role in
Board deliberations. Often, the independent directors will have little
54 Supra note 50, 91-9.

55 M Useem, "Business and politics in the United States and United Kingdom" in S
Zukin and P DiMaggio (eds), Structures of capital: The social organization of the
economy (Cambridge, Cambridge University Press, 1990), 263, 268-71.
choice but to rely on the judgement of management. 6 After all, statistics

and information can only take a Board so far, assuming in the first place
that there has been complete disclosure of all relevant facts. At the end of
the day, when important strategic decisions have to be taken, judgement
must be exercised. Without the background or experience that comes
from many years in a particular field or industry, the best that can
probably be expected of independent directors insofar as the decision-
making process is concerned is that they may prevent extremely poorly
conceived ideas. 7
28 A third reason is offered by Bhagat and Black. 8 They suggest
that different companies benefit from different Board structures. For
example, slowly growing companies may need a high proportion of
independent directors to control management's tendency to reinvest the
company's cash flow even when there are few if any reinvestment
opportunities. Optimal Board composition could also vary according to
the principal industry that the company is engaged in.
29 A fourth possibility, also offered by Bhagat and Black, is that
independent directors can add value, but only if they are embedded in an
appropriate committee structure. 9 This would let independent directors
perform the monitoring function. However, most large companies
already have such committee structures, and another study finds little
evidence that the principal outsider-dominated 'monitoring' committees
affect performance."
30 The fifth possibility has already been alluded to above, namely
the imbalance in knowledge and expertise relative to the company and its
various businesses places a significant advantage in the hands of
management. 1 In addition, management has at its disposal the entire
56 See also BR Cheffins, supra note 32, 610-11.
57 SC Vance, "Corporate Governance: Assessing Corporate Performance by Boardroom
Attributes" (1978) 6 Journal of Business Research 203, finds that the technical
expertise of directors in a company's industry correlates with firm performance. In
highly successful firms, about one-fifth of the directorate dimension consists of
technical expertise. This is a significant finding. If this finding is correct, it should
perhaps cause us to be more realistic about what we can expect of independent
directors. At the same time, it may well point towards the importance of Boards
having a higher proportion of directors with relevant industry experience.
59 Ibid, 300.
60 A Klein, "Firm Performance and Board Committee Structure" (1998) 41 Journal of
Law and Economics 137.
61 See also Williamson, supra note 36, 1219; Dent, supra note 50, 627-8; Eisenberg,
supra note 36, 172.
administrative machinery of the company. Accordingly, independent

directors cannot help but be dependent on management. Independent
directors have little choice in general but to proceed on the basis that
management is acting in good faith and to act on the basis of such
information as is provided to them by management. If management does
not so act, independent directors will be handicapped and unable to fulfil
their monitoring function effectively. In this regard, the Australian case
of A WA Ltd v Daniels6 2 provides a useful case study.
31 In A WA, the plaintiff company purchased foreign currency

contracts to cover its exposure to foreign currency fluctuations that arose
in relation to the contracts it had in place for goods it imported.
However, its foreign exchange (FX) dealings developed beyond risk
management so that in the 1986-87 financial year, 25% of its profit was
budgeted to come from its managed hedging activities. In 1985 Koval,
an employee of the plaintiff was appointed its FX manager and he
appeared to be very successful. The reported profit for the 8 months of
the financial year to February 1987 apparently exceeded budget by
400%. Koval was permitted by the plaintiffs management to operate
without effective control and supervision. There was a general absence
of a proper system of books and records and other internal controls, and
no effective dealing limits. Unfortunately, Koval had generally disclosed
the contracts showing a profit only. Loss-making contracts were not
disclosed and the plaintiff claimed that Koval's activities in fact led to a
loss of AUD$49.8 million from its FX transactions. In a suit brought
against the auditors for negligence, the auditors claimed contributory
negligence alleging, inter alia, that the directors were themselves
negligent.
32 Rogers CJ held that the non-executive directors were not

negligent.13 The loss arose through the incompetent implementation by
senior management of the project for risk management. The non-
executive directors were entitled to rely on management whose
trustworthiness they had no reason to doubt. Management had not
complied with the Board's general direction that the FX activities were
to be related to the plaintiffs underlying exposure to foreign currency
fluctuations and not for speculative purposes. The non-executive
directors were also not advised by senior management on a number of
important matters such as the deficiencies in internal controls and
accounting systems. There was no evidence to suggest that the non-
62 Supra note 34.

63 Affirmed on appeal, see DanielsvAnderson (1995) 16 ACSR 607.
executive directors ever became aware, or should have become aware, of

the deficiencies in internal controls and books of account. They had no
reason to believe that their policy of no risk and of management of
hedges related to underlying exposures was not being observed
rigorously. They relied and were entitled to rely on management and the
auditors. When particularly large profits on the FX activities was
realized, the non-executive directors were understandably concerned but
had been assured by the auditors that the profits reported were genuine.
Having regard to the limited knowledge that the non-executive directors
had because of the concealment of management, it could not be said that
they were negligent.
33 The A WA case provides a salutary example of how difficult it
will be for independent directors to perform their monitoring function if
management is not honest and open with them. At the same time, it also
showed a certain timidity on the part of the Board in the pursuit of
matters of concern that may be typical of many other Boards. On appeal,
Clarke and Shellar JJA opined that a puzzling feature of the case was
that a logical explanation for the huge increase in profits would be that
there was a high level of trading in FX. It seemed natural that the
directors should know of or suspect this.' Although both judges went on
to say that the other surrounding circumstances absolved the non-
executive directors from blame, it would not be unreasonable to think
that the non-executive directors were somewhat lacking in this aspect of
their monitoring function.
34 It is suggested that to a large extent the inadequacy, in practice,
of the monitoring function that independent directors are supposed to
play, is attributable to the evolution of the basic structure of corporate
governance. From a historical perspective, it is clear that corporate law
long ago favoured business arrangements that centralized decision-
making.65 In England, this was certainly evident from early company law
cases that held that where the articles have vested the power of
management in the Board of Directors, shareholders could not overrule
management decisions made by the Board.66 This position was arrived at
' Ibid, at 674.

65 JW Hurst, supra note 9, 25.
66 Automatic Self-Cleansing Filter Syndicate Co v Cuninghame [1906] 2 Ch 34; Quin
& Axtens v Salmon [1909] 1 Ch 311; [1909] AC 442; Gramophone and Typewriter
Ltd v Stanley [1908] 2 KB 89; Shaw & Sons (Salford) Ltd v Shaw [1935] 2 KB 113;
Scott v Scott [1943] 1 All ER 582; Black White and Grey Cabs Ltd v Fox [1969]
NZLR 824; Bamford v Bamford [1970] Ch 212. The position in the United States is
notwithstanding even earlier authority that suggested otherwise.67 Thus in

Shaw & Sons (Salford) Ltd v Shaw, Greer U succinctly expressed the
point as follows:6"
"A company is an entity distinct alike from its shareholders and
its directors. Some of its powers may, according to its articles, be
exercised by directors, certain other powers may be reserved for
the shareholders in general meeting. If powers of management
are vested in the directors, they and they alone can exercise these
powers. The only way in which the general body of the
shareholders can control the exercise of the powers vested by the
articles in the directors is by altering their articles, or, if
opportunity arises under the articles, by refusing to re-elect the
directors of whose actions they disapprove. They cannot
themselves usurp the powers which by the articles are vested in
the directors any more than the directors can usurp the powers
vested by the articles in the body of shareholders."
35 What is significant about these cases is that the conclusion

arrived at appears to be contrary to the language of the articles in
question. In the English cases, the articles that vested the power of
management in the Board used language similar to that found in versions
of Table A prior to the English Companies Act 1985.69 The relevant
provision in Table A provided that the business of the company would be
managed by the directors but that this would be "subject nevertheless to
any regulation of these articles, to the provisions of the Act and to such
regulations, being not inconsistent with the aforesaid regulations or
provisions, as may be prescribed by the company in general meeting".
similar, see Continental Securities Co v Belmont, 99 N.E. 138 (N.Y. 1912);

Associated Grocers ofAlabama, Inc v Willingham, 77 F. Supp. 990 (N.D. Ala. 1948);
Amdur v Meyer, 224 N.Y.S.2d 440 (App. Div. 1962). In ContinentalSecurities Co v
Belmont, Chase J said at 142: "It is provided by statute in this state that the affairs of
every corporation shall be managed by its board of directors. The directors are not
ordinary agents in the immediate control of the stockholders. The directors hold their
office charged with the duty to act for the corporation according to their best
judgment, and in so doing they cannot be controlled in the reasonable exercise and
performance of such duty .... They are trustees clothed with the power of controlling
the property and managing the affairs of a corporation without let or hindrance... .The
claim by the appellants that the body of stockholders has some immediate or direct
authority to act for the corporation or to control the board of directors in the matters
set forth in the complaint is based upon an erroneous conception of the duties and
powers of the body of stockholders in this state."
67 See, e.g. Isle of Wight Railway v Tahourdin (1883) 25 ChD 320.
69 See e.g., Companies Act 1948, article 80.
36 A literal interpretation of the relevant Table A article, and indeed

of the clauses in the cases discussed, points strongly to the conclusion
that the "regulations" that "may be prescribed by the company in general
meeting", are a reference to ordinary resolutions passed by the
shareholders in general meeting. As such, these "regulations" that are
prescribed by the shareholders could not be inconsistent with "any
regulation of these articles", which would have necessitated a special
resolution to alter.7" This interpretation was in fact arrived at in the
Singapore decision of Credit Development v IMO.71 It is submitted that
as an exercise in interpretation, the result in Credit Development v IMO
cannot be faulted. Ultimately, it is suggested that the courts in England
arrived at a different conclusion because of a conscious preference for a
policy of strong centralised management within companies.72 Although
approached at as a matter of interpretation, it would appear that only
very explicit language in the articles that would admit of no ambiguity
whatsoever would lead the courts to conclude that the body of
shareholders in general meeting is the organ within the company that is
superior to the Board of Directors.73 As Buckley LJ put it in Gramophone
and Typewriter Ltd v Stanley:74
"This court decided not long since, in Automatic Self-Cleansing

Filter Syndicate Co. Ltd. v. Cuninghame [1906] 2 Ch. 34, that
even a resolution of a numerical majority at a general meeting of
the company cannot impose its will upon the directors when the
articles have confided to them the control of the company's
affairs. The directors are not servants to obey directions given by
the shareholders as individuals; they are not agents appointed by
and bound to serve the shareholders as their principals. They are
persons who may by the regulations be entrusted with the control
of the business, and if so entrusted they can be dispossessed
from that control only by the statutory majority which can alter
the articles. Directors are not, I think, bound to comply with the
directions even of all the corporators acting as individuals."
70 See also GD Goldberg, "Article 80 of Table A of the Companies Act 1948" (1970)
33 Modern Law Review 177; MS Blackman, "Article 59 and the Distribution of
Powers in a Company" (1975) 92 South African Law Journal286; GR Sullivan, "The
Relationship Between the Board of Directors and the General Meeting in Limited
Companies" (1977) 93 Law QuarterlyReview 569.
71 [1993] 2 SLR 370. The relevant provisions in the Singapore Companies Act have
since been amended, see s. 157A and Table A, regulation 73.
72 See also Blackman, supra note 70, 290.
73 See e.g., Companies Clauses Consolidation Act 1845, s. 90.
74 Supra note 66, 105-6.
37 Not only did Company Law favour centralised decision-making,

it also allowed the Board of Directors to delegate authority to designated
officers of the company, or to sub-committees of the Board. Although
agency law generally prohibits delegation of authority, this was
justifiable on the organic theory of company law, which regards the
Board as an organ of the company and not merely an agent.75 From the
outset, the company was an instrument 7to 6
provide firm central direction
for the enterprising use of pooled assets.
38 With the centralization of corporate decision-making, it was

inevitable that as companies grew in size and scope, the greater influence
would eventually repose in the managers of the company as opposed to
the Board as a whole. Although companies were seen as analogous to the
state,77 and were structured along democratic lines,78 what has instead
75 Gower's Principlesof Modern Company Law, supra note 1, 14-17.

76 Hurst, supra note 9, 26.
77 In the speech by the then President of the Board of Trade, Robert Lowe, to the House
of Commons when he introduced the Companies Bill, 1856, he referred to companies
as "little republics", see Hansard CXL, 138. See also A Frazer, "The Corporation as a
Body Politic" (1983) 57 Telos 5; E Enlow, "The Corporate Conception of the State
and the Origins of Limited Constitutional Government" (2001) 6 Washington
University JournalofLaw & Policy 1; Chayes, supra note 9, 39.
78 With the shareholders as the electorate and the Board of Directors as the legislature,
see E Latham, "The Body Politic of the Corporation", in ES Mason (ed), The
Corporation in Modern Society, supra note 9, 224; A Pound, "The Rise of the
Political Model of Corporate Governance and Corporate Control" (1993) 68 New
York University Law Review 1003, 1012-3. It may also be possible to see the
shareholders as analogous to the legislature and the Board as the executive, Gower's
Principlesof Modern Company Law, supra note 1, 14-17. The view that a company
is analogous to a state may provide a further insight into the preference for strong
centralised decision-making. It is consistent with the view in political theory that
once the citizens of a state have elected a government, they must allow the
government substantial autonomy to govern as it sees fit, without subjecting every
decision to a potential referendum. If the citizens are dissatisfied with the
government, they may exercise their votes at the next election to bring another party
into office. JA Schumpeter put it this way in his classic work, Capitalism, Socialism
and Democracy (London, George Allen & Unwin Ltd, 4 th ed., 1952), 272: "in making
it the primary function of the electorate to produce a government (directly or through
an intermediate body) I intended to include in the phrase also the function of evicting
it... .since electorates normally do not control their political leaders in any way except
by refusing to reelect them or the parliamentary majorities that support them, it seems
well to reduce our ideas about this control". Later at 286, he states that "[v]oters do
not decide issues... In all normal cases the initiative lies with the candidate who
makes a bid for the office of member of parliament and such local leadership as that
may imply. Voters confine themselves to accepting this bid in preference to others or
refusing to accept it"; cf S Bottomley, "From Contractualism to Constitutionalism: A
Framework for Corporate Governance"(1 997) 19 Sydney Law Review 277, 302-4.
occurred has been the transfer of the leadership function from owners
(and it might be added, the Board as a whole) to executive directors and
other salaried managers.79 With directors generally not being subject to
shareholder control save for the (often) theoretical right to deny re-
election, it is unsurprising that directors, whether executive or not, feel
only a tenuous connection with the shareholder body. In turn, the Board
itself has declined as an active and independent decision-making body.8
One commentator has gone so far as to say that the claim that the
separation of corporate management and power would guard against
untrammelled power has managed to facilitate the opposite result. As
corporations come to resemble large-scale bureaucracies more than
commercial entrepreneurs, corporate managers begin to maximise their
own utility and not the company's profits; they are as much the
scriptwriters of the economic drama as the actors in its unscripted
performance.81 This has led to calls from time to time for a strengthening
of the political process and shareholder democracy within companies.82
39 Accordingly, in the final analysis, and herein lies the paradox,
with the leadership function firmly entrenched with management, in the
absence of an overhaul of the system, independent directors can
discharge their monitoring functions effectively only if management
itself is committed to the role of such directors. This is particularly the
case where companies do not have Boards with a majority of
79 If indeed the analogy between companies and the state is a valid one, the decline of
the Board as the legislature in companies is mirrored by developments in
parliamentary democracies based on the Westminster model where the executive has
become more powerful at the expense of the legislature, see e.g. Thio Li-ann, "The
Post-Colonial Constitutional Evolution of the Singapore Legislature: A Case Study"
[1993] SingaporeJournalof Legal Studies 80, 84-7.
80 Latham, supra, note 78, 230. See also BC Hunt, supra note 9, 135-6. In A WA Ltd v
Daniels, supra note 34, 878, Rogers CJ opined that "the commercial reality of the
matter is that, in these days of conglomerates and perhaps transnational
conglomerates at that, the opportunity for non-executive directors to exercise
meaningful control over management is as slight as the ability of ministers to control
a vast bureaucracy."
A Hutchinson, "Mice Under a Chair: Democracy, Courts and the Administrative
State" (1990) 40 University of Toronto Law Journal374, 381.
12 See e.g., Pound, supra note 78; cf Chayes, supra note 9, 39-41. As is pointed out by
DD Prentice, "Some Aspects of the Corporate Governance Debate" in DD Prentice
and PRJ Holland (eds), Contemporary Issues in Corporate Governance (Oxford,
Clarendon Press, 1993), 25, 31, two assumptions underlie proposals for board
restructuring. One of the assumptions is that shareholders play a muted role in the
governance of companies. No doubt shareholders will still have to elect the Board,
but in most cases this is a mere formality and there is little evidence, at least in the
UK, of widespread shareholder activism with respect to the election or removal of
directors. Thus non-executive directors will operate in lieu of shareholders voice.
independent directors. Even where Boards with a majority of

independent directors appear to add value to the company, Romano
concedes that the observed effect of Board composition could be
spurious because such performance could be a function of the quality of
management itself. If high quality managers are more likely to place
outsiders on Boards than poor quality managers who do not want to be
monitored, a finding that shareholders are better served by outsider-
dominated Boards is simply an illustration of the better management of
these companies.8 3 To this it should be added that high quality managers
appreciate the valuable role of independent directors and will take steps
to allow them to play their role effectively.84 As Fama and Jensen point
out, internal managers can use their knowledge of the organization to
nominate outside Board members with relevant complementary
knowledge: for example, outsiders with expertise in capital markets,
corporate law, or relevant technology who provide an important support
function to the top managers in dealing with specialized decision
problems.8"
40 The importance of this cannot be overstated. There is a tendency

to think that simply having independent directors improves corporate
governance. The reality is sometimes the opposite. Unless there are
independent directors who are truly independent, and have the strength
of character and ability to perform an effective monitoring function, the
presence of independent directors acts as a smokescreen and a snare for
the unwary investor who may pay a higher price for equity on the basis
of a supposedly better corporate governance structure.86 Good corporate
governance is not about having a certain number of independent
directors, of the number of Board meetings in a year, or even about
whether there are Board committees that have a majority of independent

14 See, e.g. "Bank of China - Cleaning Up", Economist, 9 March 2002, 70-1.
85 Supra note 36, 313-4.
86 Interestingly, Lord Young of Graffham, as outgoing president of the English Institute
of Directors, reportedly shocked an audience in April 2002 by suggesting that non-
executive directors can do more harm than good and should be abolished. Lord
Young is reported to have said that it was "dangerous nonsense" to assume that part-
time non-executive directors could know enough about what was going on inside
their companies to spot problems. It was wrong to assume that external directors
could ever have the information or time to supervise executive directors and this
should be left to investors, see D Roberts, "Non-exec role under scrutiny", Financial
Times, 25 April 2002 (reproduced in Independent Director at
<http://www.independentdirector.co.uk/Non-exec underScrutiny.htm>). See also CS
Axworthy, "Corporate Directors - Who Needs Them?" (1988) 51 Modern Law
Review 273.
directors. These tell us only about structures and while relevant, does not
provide the more important information about how the independent
directors or the Board really operate.
41 One study purports to show that independent directors can make
a difference where the Board is truly independent, has adopted a
professional culture, and is therefore a well-governing Board. In their
article,87 Millstein and MacAvoy assert that while management used to
dominate Boards, in the 1990s Boards of Directors of large publicly
traded companies have begun to address their passivity and dependence.
This appears to have arisen largely due to efforts to address or avoid
serious performance problems associated with managerial entrenchment.
Members of Boards responded to increasing pressures from various
quarters including institutional investors, active investors, judicial
intervenors, and media attacks. The latter caused directors to be
concerned about their reputations and these have all led to directors
monitoring management more actively. 8
42 Millstein and MacAvoy go on to say that many Boards of large
companies operate in a different mode than they did a few short years
ago. For most large, publicly traded corporations, a majority of directors
are not members of management. For trend-setting corporations, new
independent directors are selected in consultation with management by a
wholly independent Board committee such as the "nominating" or
"governance" committee. Most important, Board participation in agenda
setting and in determining information flow is more active. There are
also executive sessions of independent directors, separate from
management, to evaluate management. Although few Boards have gone
so far as to embrace the separation of the roles of the Chairman of the
Board and the Chief Executive Officer, some companies have created a
leader of the independent directors (a "lead director") or some other non-
management Board leadership position, or have designated a "special-
purpose" lead director for a specific task. According to Millstein and
MacAvoy, this change in the role of the Board means that a search for
proof that good governance improves performance based on data from
the 1970s and 1980s cannot lead to the conclusion that Boards cannot be
relied upon to motivate management to improve corporate performance.89
43 Having set out their essential premise, both authors go on to
identify certain acceptable surrogates (short of being present at all Board
17 Millstein and MacAvoy, supranote 50, 1285-6.
88 Ibid, 1284-8.
89 Ibid, 1294.
meetings to observe and record the Board proceedings) that are

indicative of professional Boards that recognise their unique function
distinct from management and that assert control over processes to
maintain independence.9" These acceptable surrogates include
independent Board leadership, periodic meetings of the independent
directors without management present, and formal rules or guidelines for
the relationship between the Board and management. These surrogates
have structural characteristics, but to the authors, they more directly
indicate Board behaviour from which can be inferred Board
independence. Each of these surrogates is a departure from the
traditional system that allows the Board to be dominated by
management. The presence of all or even any one of these surrogates is,
to the authors, indicative that traditional Board culture has been
displaced in favour of an independent and professional approach in
Board decisions.
44 Millstein and MacAvoy conclude that their studies of companies
in the first half of the 1990s showed a statistically significant relationship
between an active independent Board and superior corporate
performance as measured by earnings in excess of costs of capital over
the industry average. 91 They assert that this research demonstrates a
substantial and statistically significant correlation between an active,
independent Board and superior corporate performance. They believe
that such superior performance is a result of activist corporate
governance.
45 The views expressed by Millstein and MacAvoy appear
somewhat over-optimistic. While market pressures may certainly give
independent directors greater incentive to take their monitoring roles
seriously, it has already been mentioned in an earlier part of this article
the considerable difficulties that independent directors face in
discharging such a role adequately. 92 The existence of lead directors (or
even the separation of the roles of Chairman and Chief Executive
Officer), separate meetings without management being present, or rules
and guidelines that regulate the relationship between the Board and
management, cannot adequately address the real difficulties that Boards
face in the monitoring of management. The existence of such
"surrogates" or structural mechanisms may be an indication of the good
90 Ibid, 1298-9.
91 Ibid, 1381.
92 It is also doubtful if market forces provide sufficient pressure on companies to
introduce strong safeguards for good corporate governance, see Parkinson, supra
note 53, 185-8; GW Dent, supranote 50, 635-8.
intentions of the Board. Whether these good intentions have been turned
into reality is a completely different proposition. While it is difficult to
fault the view that independent directors can make a difference where the
Board is truly independent, has adopted a professional culture, and is
therefore a well-governing Board, the slew of corporate scandals that
engulfed the United States in the last two years casts considerable doubt
on Millstein and MacAvoy's central premise that there has been a
fundamental shift in corporate governance in the 1990s. Instead, it is
widely perceived today that Chief Executive Officers may have become
too powerful in the 1990s and it is necessary to strengthen the role of
independent directors. To this difficult issue the article now turns.
F Strengthening the role of independent directors
46 In light of the corporate difficulties in the United States, the

issue of good corporate governance has once again been brought to the
forefront. 93 In the United States, the New York Stock Exchange
("NYSE") Corporate Accountability and Listing Standards Committee94
submitted a report to the NYSE's Board of Directors on 6 June 2002.
The report made recommendations to amend the NYSE's listing
standards with the goal of enhancing the accountability, integrity and
transparency of the NYSE's listed companies and was accepted by
NYSE Board of Directors on 1 August 2002. 9' In England, Mr Derek
Higgs was asked to lead an independent review of the role and
effectiveness of non-executive directors. In Mr Higgs' consultation paper
dated 7 June 2002,96 he stated that the preferred starting point would be
an approach based on best practice rather than regulation or legislation. 97
On its part, Singapore has established a Council on Disclosure and
Corporate Governance that will be an independent body overseeing
corporate governance rules and accounting standards.
93 See, e.g. "Designed by Committee", Economist, 15 June 2002, 70 (Special Report on

Corporate Governance).
94 The report is available at
<http://www.nyse.com/abouthome.html?query /about/report.html>.
95 The Press Release to this effect is also available at
<http://www.nyse.com/abouthome.html?query /about/report.html>.
96 The consultation paper is available at
<http://www.independentdirector.co.uk/consultation doc.pdf>.
97 See paragraph 3 of the consultation paper. The Higgs report was issued in January
2003 and is available at
http://www.dti.gov.uk/cld/non-exec review/pdfs/higgsreport.pdf.
47 It is suggested that if independent directors are still to be

considered an important aspect of good corporate governance,9" two
crucial elements are necessary. First, there is a need to ensure that
independent directors are truly independent. Secondly, it is crucial that
the company's external 'independent' auditors perform their supporting
roles.99
48 In theory, directors are elected by shareholders. However, in
practice, the right of shareholders to elect directors is not meaningful. It
is unrealistic to expect the vast majority of shareholders who have small
stakes in the publicly listed company to take steps to propose directors
for election at a general meeting. Nor, unlike the state, is there an
alternative slate of directors that may be a potential government in
waiting. The ostensible democratic process built into the corporate
structure is thus characterised by both apathy and a complete lack of any
alternative. What happens in practice is that management, or the Board
itself (or the Nominating Committee of the Board), will put forward
candidates for election or re-election as a director. This coupled with
control of the proxy voting mechanism, makes such election or re-
election a mere formality. 100
The process bears no meaningful semblance to
any concept of democracy.
49 As indicated earlier, this manner in which directors are elected
casts some presumptive doubt on how independent non-executive
98 Bearing in mind that the various studies mentioned earlier on the whole were unable
to arrive at a conclusion that independent directors added value to their companies.
This author must confess some sympathy for the views of Lord Young, supra note
86. As has been pointed out above, there are significant practical difficulties in the
way of independent directors properly performing their monitoring function. To
meaningfully strengthen their ability to play this role, it is suggested that radical
surgery is required that may significantly change the way in which Boards operate.
This may be unpalatable to companies and stock exchanges. The latter is often a
business organization in its own right. Part of its role is to attract companies to be
listed on its trading platform. It therefore has to strike a balance between its
regulatory role, and being sensitive to the fact that entrepreneurs must find it
attractive to list their shares on it. Such an inherent conflict may make it difficult to
set the best possible standards even after recognising that rational investors prefer
markets with more safeguards and that this should, in a perfect market, translate into
a higher premium for capital issued in such markets. The latter has to be balanced
against managements that are only too ready to allege that new standards will unduly
hinder their ability to manage their companies effectively when in reality, what they
are against is more accountability.
99 Even though independent directors may find it difficult to second-guess management
proposals, independent directors can realistically play a more significant role in
ensuring the integrity of the company's financial accounts.
100 See also E Latham, supranote 78, 223-5.
directors are. It cannot be doubted that management is materially

involved in the process for selection of many of the persons whose
names are put forward for nomination as directors at general meetings.
To strengthen director independence, the NYSE report of 6 June 2002
has recommended tightening the definition of "independent" director." 1
Such directors should have "no material relationship with the listed
company (either directly or as a partner, shareholder or officer of an
organization that has a relationship with the company)." Specific cases
where directors will not be considered independent include a person who
is a former employee of the listed company until five years after the
employment has ended, and a person who is, or in the past five years has
been, affiliated with or employed by a present of former auditor of the
company (or of an affiliate) until five10 years after the end of either the
affiliation or the auditing relationship. 2
50 In similar vein, on 30 July 2002, President George W Bush
signed into law the Sarbanes-Oxley Act of 2002.113 Section 301 of the
Act amends section 10A of the Securities Exchange Act of 1934 to set
out standards relating to audit committees. It provides, inter alia, that
each member of the audit committee shall be independent and that to be
considered independent, the member may not accept any consulting,
advisory or other compensatory fee from the company, or be an affiliated
person of the company or any subsidiary thereof. In addition, each audit
committee shall have the authority to appoint independent counsel and
other advisers that it determines are necessary for it to carry out its
duties. The company shall provide appropriate funding, as determined by
the audit committee, to pay the fees of such advisers, as well as the fees
of the accounting firm rendering the audit. The auditors shall report in a
timely fashion to the audit committee all critical accounting policies and
practices to be used; all alternative treatments of financial information
within generally accepted accounting principles that have been discussed
with management, ramifications of the use of such alternatives, and the
101 See Recommendation 2.

102 Other instances arise where the director is, or in the past five years has been, part of
an interlocking directorate in which an executive officer of the listed company serves
on the compensation committee of another company that employs the director. In
addition, directors with immediate family members in the foregoing categories must
likewise be subject to the five-year "cooling-off' provisions for purposes of
determining independence.
103 The Act is available at
<http://news.findlaw.com/hdocs/docs/gwbush/sarbanesoxleyO72302.pdf>.
treatment preferred by the auditors; and any material written

communications between the auditors and management.104
51 In England, the Combined Code" 5 states that non-executive
directors should comprise not less than one-third of the Board. The
majority of non-executive directors should be independent of
management and free from any business or other relationship that could
materially interfere with the exercise of their independent judgment. In
Singapore, its Code of Corporate Governance. 6 provides that there
should be a strong and independent element on the Board, with
independent directors making up at least one-third of the Board. An
"independent" director is one who has no relationship with the company,
its related companies or its officers that could interfere, or be reasonably
perceived to interfere, with the exercise of the director's independent
business judgement with a view to the best interests of the company.
Examples of such relationships, which would deem a director not to be
independent, include a director that has been employed by the company
or any of its related companies for the current or any of the past three
financial years; a director who has an immediate family member who is,
or has been in any of the past three financial years, employed by the
company or any of its related companies as a senior executive officer
whose remuneration is determined by the remuneration committee; a
director accepting any compensation from the company or any of its
related companies other than compensation for Board service for the
current or immediate past financial year; or a director being a substantial
shareholder of or a partner in (with 5% or more stake), or an executive
officer of, any for-profit business organisation to which the company
made, or from which the company received, significant payments in the
current or immediate past financial year. 107
52 Useful though these provisions are, it is suggested that they
should go further." 8 To ensure that independent directors are truly
104 Ibid, s. 204.

'o' Supra note 41.
106 Supra note 41. Clause 912(4) of the Singapore Exchange Listing Manual, which is to
take effect for Annual General Meetings held from 1 January 2003, states that
companies listed on the Singapore Exchange should describe what aspects of the
Singapore Code of Corporate Governance they comply with. If they do not comply
with any aspect of the Code, they should disclose such non-compliance and the
reasons in their annual report.
107 Clause 2.1.
10' It has been suggested that without a more radical transformation of the position of
non-executive directors, they are likely to be of only limited effectiveness in
independent, certain third parties, whether an industry body,"' or a panel

appointed by the stock exchange or securities regulator110 should be
given locus standi to nominate directors. Such a third party should also
be tasked with the role of building up a comprehensive database of
potential candidates for directorships in order to fulfil its function.111
Shareholders will ultimately be responsible for the election of the
persons nominated.112 If they feel that some or all the persons nominated
are unsuitable, it is their prerogative to reject them.113 The appropriate
performing a control function: Parkinson, supra note 53, 194-5. See also PL Davies,
"Institutional Investors in the United Kingdom", supra note 48, 69, 92-4. One of the
problems with the present proposals outlined earlier is that they cannot exclude
relationships of a social or informal nature.
109 Such as the Singapore Institute of Directors.
110 See also RJ Gilson and R Kraakman, "Reinventing the Outside Director: An Agenda
for Institutional Investors" (1991) 43 Stanford Law Review 863; Parkinson, supra
note 53, 195-6; Davies, supra note 104, 93-4. Gilson and Kraakman suggest that
there should be a new class of professional outside directors to monitor management.
These professional directors would be elected by institutional investors who might
even collectively finance a non-profit organization charged with recruiting directors
and performing the routine processing and filing tasks that coordinated action among
institutional investors would inevitably generate. One or more of the industry groups
and consulting organizations that now promote the collective interests of institutional
investors might initiate such a clearinghouse. Indeed, the authors say that several
groups have already introduced databases that might be useful in operating a
directors' clearinghouse. While this in an attractive proposition, and indeed the idea
of a clearinghouse corresponds somewhat with this author's views, many countries
outside the United States do not have many large institutional investors such as those
found in the United States. Even in the United States, institutional investors have on
the whole not seen it fit to adopt this more activist approach advocated by Gilson and
Kraakman.
111 It is often said that the pool of potential directors is small. However, it may be that
this is the case because companies are currently prepared only to consider limited
categories of persons, e.g. bosses of other firms. They should perhaps trawl more
widely, see "Under the Board talk", Economist, 15 June 2002, 15.
112 The democratic premise of corporate governance is therefore unaffected.
113 It is very unlikely that a normal shareholder will vote against the nominees. Election
to the Board of Directors is very often a formality once a candidate has been
proposed for election or re-election. Occasionally, there may be a battle for control of
the company, or an institutional investor may wish to express its displeasure over the
conduct of one or more directors. These are rare though. Accordingly, if on the
proposal made here, a nomination by the third party is voted against, it is likely to be
because management has used its control of the proxy voting mechanism to veto the
candidate, or a substantial shareholder who may be in management has done so.
Provided that these matters have to be disclosed, the glare of public knowledge will
act as a suitable restraint on management. It will also force management, or
substantial shareholders who wish to vote against the persons nominated, to justify
their actions. At the same time, the law should be amended to ensure that those
seeking proxy votes have a duty to cast the votes given to them in accordance with
disclosures should then be made and in the event that some or all the
nominees are rejected, so be it. As long as there is disclosure of such
fact, the market can take this into account and react accordingly.
53 One criticism of this proposal may be that such a structure may
lead to a loss of collegiality. In addition, senior management of
companies must necessarily have discretion to manage the company's
affairs. A Board that is constantly looking over the shoulders of senior
management may constrain them from taking appropriate risks in a
timely fashion. It is suggested that these concerns are overblown. It is
unlikely that many independent directors will approach their role in an
overbearing, adversarial fashion, particularly when the company is doing
well. As Gilson and Kraakman put it,114 there is no reason to lament the
possible loss of collegiality. If a company were performing well, open
discussion would strengthen director relationships. It would give
management the satisfaction of receiving support and approval for its
achievements from a truly independent Board. Alternatively, if a
company were performing poorly, decorous collegiality would have no
place in the Boardroom. In such a case, management should be
compelled to account for its performance and address alternative
strategies because it would have lost its only legitimate basis, namely
success, for expecting deference from the Board. Furthermore, such a
criticism also stems from the (understandable) reluctance of senior
management to have to work within a new paradigm. Senior
management will have become accustomed to working with largely
toothless independent directors, who are often tacit allies. The prospect
of having to rigorously justify Board proposals must therefore be
somewhat unpalatable. In the longer term though, this will surely be in
the interests of the company.
54 Recognising the importance of the nominating process for
directors, the US Securities and Exchange Commission ("SEC") has
proposed new disclosure requirements that would expand disclosure in
company proxy statements regarding the nominating committee and the
the wishes of the shareholders. In Tong Keng Meng v Inno-Pacific Holdings Ltd
[2001] 4 SLR 485, Judicial Commissioner Woo Bih Li held that a person who had
received a proxy form duly signed was not under an obligation to cast the votes in the
manner specified by the proxy. The recipient of the proxy could choose not to cast
votes. In Tong Keng Meng, the recipient of the proxy was in favour of the resolutions
that had been tabled but the proxy stated that the votes were to be cast against the
resolutions. The recipient of the proxy did not have to cast those votes against the
resolutions.
114Supra note 110, 889.
nominating process.114A This enhanced disclosure is intended to provide

security holders with additional, specific information upon which to
evaluate the boards of directors and nominating committees of the
companies in which they invest. Further, the SEC intends that increased
transparency of the nominating process will make that process more
understandable to security holders. One key proposal is that if the
nominating committee of a company has a policy with regard to the
consideration of any director candidates recommended by security
holders, there should be a description of the material elements of that
policy, which shall include, but not be limited to, a statement as to
whether the committee will consider director candidates recommended
by security holders. Similarly, if there is no such policy, this should be
stated. Where the nominating committee will consider candidates
recommended by security holders, the procedures to be followed by
security holders who wish to nominate a candidate should be described
together with any minimum qualifications, or specific skills or qualities
which the nominating committee believes that a director of the company
should possess.
55 In addition, the SEC has also proposed that the company should
describe the nominating committee's process for identifying and
evaluating nominees for director, including nominees recommended by
security holders, and any differences in the manner in which the
nominating committee evaluates nominees for director based on whether
or not the nominee is recommended by a security holder. There should
also be a statement of the specific source, such as the name of an
executive officer, director, or other individual, of each nominee (other
than nominees who are executive officers or directors standing for re-
election) approved by the nominating committee for inclusion on the
company's proxy card. Should the nominating committee (a) receive a
recommended nominee from a security holder or group of security
holders who individually, or in the aggregate, beneficially owned greater
than 3% of the company's voting common stock for at least one year as
of the date of the recommendation, and (b) the nominating committee
decides not to nominate that candidate, there should be disclosure of the
names of the security holder(s) who nominated the candidate, and the
reasons why the nominating committee did not include the candidate as a
nominee. Where directors are to be appointed, the company should
include in the proxy materials a statement as to whether or not the
114A See "Disclosure Regarding Nominating Committee Functions and Communications

between Security Holders and Boards of Directors", available at
http://www.sec.gov/rules/proposed/34-48301.htm.
company's board of directors provides a process for security holders to

send communications to the board of directors and, if the company does
not have a process for security holders to send communications to the
board of directors, a statement of the specific basis for the view of the
board of directors that it is appropriate for the company not to have a
such a process.
56 If all this is seen as too radical, it is suggested that as a minimum
(and perhaps this is just as radical), the auditors of all public listed
companies should be appointed by an industry body,115 a panel appointed
by the stock exchange that the company is listed on, the stock exchange
itself, or the securities regulator.116 It is suggested that one of the
principal reasons why some auditing firms were implicated in one or the
other of the scandals affecting a number of public listed companies in the
United States was due to the close relationship between management and
the ostensibly independent auditors. Accounting firms are too beholden
to management for their appointment even though they are in theory
(again) appointed by the shareholders. Their independence is also
potentially compromised by the lucrative consulting and other services
that they provide to their audit clients.117 Prohibiting auditing firms from
providing consulting or other services to their auditing clients will go
some way to restoring auditor independence118 but is unlikely of itself to
solve the problem entirely. In fact, it is likely to increase their
115 Other than an industry body representing members of the accounting profession.
116 An editorial in The Economist, "The lessons from Enron", 9 February 2002, 9,
proposed the following: "The most radical change would be to take responsibility
for audits away from private accounting firms altogether and give it, lock, stock
and barrel, to the government. Perhaps such a change may become necessary... .As
an intermediate step, however, a simpler suggestion is to take the job of choosing
the auditors away from a company's bosses. Instead, a government agency-
meaning, in America, the Securities and Exchange Commission (SEC)-would
appoint the auditors, even if on the basis of a list recommended by the company,
which would continue to pay the audit fee."
117 Remarkably, for example, some auditing firms see nothing wrong with conducting
internal audits where they are also the external auditors. KPMG in Singapore has
recently announced that it will no longer conduct internal audits where it is also the
external auditor signing off on financial statements, the reason given being the need
to restore public confidence, see The Straits Times, "It may pay well but KPMG
will still say no", 12 July 2002.
11 Section 201 (a) of the Sarbanes-Oxley Act of 2000, supra note 103, amends section
10A of the Securities Exchange Act of 1934 and prohibits a registered public
accounting firm that performs for any issuer any audit from providing to that issuer,
contemporaneously with the audit, various non-audit services.
dependence on audit work119 and it is therefore crucial that their

independence from management be fortified.12 °
57 Under such a proposal, shareholders would no longer be

required to go through the meaningless charade each year of appointing
or re-appointing external auditors, which is a matter that management
has control over through their control of the proxy process. The task of
retaining and terminating the company's independent auditors will rest
solely with the external third party. This third party may, in the first
instance, allow existing engagements to continue. Adjustments will be
made over time with firms that under-perform being appointed to fewer
audits. In all other respects, the independent auditors will work with the
Board and in particular, the audit committee of the Board. The fact that
another body is determining their appointment and retention other than
the directors will mean that the independent auditors will be less
susceptible to pressure from management. At the same time, as this
author is somewhat sceptical of the degree of independence of outside
directors as a whole as presently constituted, it is suggested that the
recommendation in the NYSE report of 6 June 2002 does not go far
enough. In that report, one of the specific sub-recommendations found
under Recommendation 7 states that one of the duties and
responsibilities of the audit committee must be to retain and terminate
the company's independent auditors. While this recommendation is to be
welcomed, unless independent directors are in the first instance
nominated by a third party as suggested earlier and duly elected, or their
independence is in some other way secured, it would be preferable to
locate the hiring and firing of the independent auditors outside both
management and the Board structure. 121 By ensuring the likelihood of
119 Although accounting firms may be loath to admit it, it is likely that the external audit
services they provided were in the nature of 'loss leaders' that provided the means to
obtain other, more lucrative work.
120 See also P Montagna, "Accounting rationality and financial legitimation", supra note
55, Chapter 9.
121 Currently, there are exceptional circumstances where auditors can be appointed by a
third party, namely the Secretary of State pursuant to s. 387 of the Companies Act
1985, and the Registrar of Companies under s. 205(10) of the Singapore Companies
Act. In addition, under ss 9 and 10 of the Singapore Companies Act, a company
auditor must be approved by the Minister. This appears to mirror a provision in the
English Limited Liability Act of 1855 (since repealed), which provided that at least
one of the auditors of a company had to be approved by the Board of Trade, see
Horrwitz, supra note 9, 380. It is submitted that if there is nothing in principle against
[continuednext page]
Singapore Academy of Law Journal (2003)
truly independent auditors, Boards of Directors will in turn be better able

to discharge their duties to their companies. Outside directors may not
have the same technical and informational knowledge that management
has, but they should at a minimum be presented with financial statements
with a high probability of accuracy. Had this been done, the corporate
crisis of 2002 in the United States may well not have occurred.
G Conclusion
58 Notwithstanding the views of Millstein and MacAvoy, there is

reason to be sceptical of the extent of the utility of independent directors
and indeed, most of the studies do not show any correlation between
independent directors and company performance. Nor, it is suggested, is
there any real evidence that independent directors fulfil their monitoring
function well. This is not to say that there do not exist independent
directors who play their role well; independent directors who are
independent and who take the trouble to understand the company and the
business sector that it operates within. However, what studies and
practice appear to show is that the effect of having independent directors
is at best patchy. Nevertheless, independent directors are likely to
continue to be regarded as being crucial to good corporate governance.
For one, many institutional investors appear to regard the absence or
presence of independent directors as crucial to their investment
decisions. 122 Secondly, the requirement of independent or non-executive
directors is often seen as an indicator of a regulator or stock exchange's
commitment to international regulatory standards. Accordingly,
whatever their actual utility, it would be considered a retrograde step not
to at least presumptively require independent directors for publicly listed
companies. Any jurisdiction that does not stipulate the need for
independent directors may find itself unable to attract capital to its
the idea of government approved auditors, it is no radical extension to require all

auditors of public listed companies to be appointed by a third party. Auditors play an
important watchdog role and it certainly seems right that companies should not have
the freedom to appoint their own watchdogs.
122 See paragraphs 3 and 4 of the report of Singapore's Corporate Governance
Committee, available at <http://www.mof.gov.sg/cor/doc/cgcfinalrpt.doc>.
Institutional investors have the potential to play a bigger role in ensuring good
corporate governance as they tend to hold larger blocks of shares in companies.
However, on the whole institutional investors have not taken an active role in
corporate governance. There are several reasons for this. The stake they hold in a
particular company may be a relatively small one when measured against their
portfolio of securities. In addition, it takes time and effort to apprise oneself of the
affairs of the company and to take a more activist approach when the institutional
investor can exit relatively seamlessly.
securities markets.123 In the competitive global marketplace for capital,

this is something that no jurisdiction can afford. 24 Accordingly, since
there are pragmatic reasons for independent directors, steps should be
taken to increase the likelihood of their independence.
59 It has been suggested here that to do this effectively, independent
directors should be nominated by a third party, either an industry body or
a panel established by the stock exchange or securities regulator. If this
is unacceptable, at the very least auditor independence should be secured
by locating the power to retain and remove independent auditors in a
third party. This will reduce the pressure that management can bring to
bear on the independent auditors. Should management, or indeed the
Board as a whole, feel that there are good reasons for a change of
auditors, it ought to be open to them to persuade the third party that the
auditors be removed and that another firm be appointed in their place.
TAN CHENG HAN*
123 This is separate from the issue of the form that rules relating to independent directors
should take. It is easy enough to stipulate the need for independent directors. As this
author has attempted to argue though, ensuring that the system will allow
independent directors to play their monitoring role effectively is a different thing
entirely.
124 See BD Baysinger and HN Butler, "Race for the Bottom v. Climb to the Top" (1985)
10 Journalof CorporateLaw 431, 451-4; Easterbrook and Fischel, supra note 19.
Associate Professor, Faculty of Law, National University of Singapore. This is a
substantially revised version of a paper delivered at the East China University of
Politics and Law in Shanghai on 15 and 16 April 2002. I am grateful to President He
Qinhua for his kind invitation to me to speak at his university and for the very warm
hospitality that he and the faculty at the East China University of Politics and Law
showed me during my visit.

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Bluebook 21st ed.

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CORPORATE GOVERNANCE AND INDEPENDENT

through a corporate vehicle.2 Some also allow limited liability

control.7 However, such a clear dichotomy does not exist in all

B An excursion into history

4 From a historical standpoint,9 it will be seen that even without

6 However, over time the mode of engaging in business changed.

13 From where the term 'joint stock company' originates.

combining capital with entrepreneurship was appreciated. So too was the

17 Gower's Principlesof Modern Company Law, supra note 1, 27-8.

10 In the case of small companies in many Commonwealth

12 The two important safeguards available to shareholders in small

in the case of a publicly listed company, to give effect to any legitimate

13 Accordingly, two of the most widely used forms of protection

D Directors' fiduciary duties

14 Before considering the role of independent directors of publicly

15 Under common law, directors are said to be under a fiduciary

29 MC Jensen and WH Meckling, "Theory of the Firm: Managerial Behavior, Agency

Congress on 29 December 1993, which became effective on 1 July 1994.

18 It has been mentioned above that one way of managing the

Tabalujan, Indonesia Company Law - A Translation and Commentary (Singapore,

of it, there is much to commend this idea. Independent directors are

Asia have dominant shareholders 38 who essentially control the company 39

directors on the Board correlates with improved performance,

21 Similarly, Romano, who also surveys the literature, states that

43 R Romano, supra note 35, 375.

Centre for Corporate Law and Securities Regulation, 1999).

extent, have to be guided by the advice of management. They will be

26 It is perhaps hardly surprising that there should be reluctance on

Instead of an arms-length relationship, there was a collegial relationship between the

conformity among its members. As Cox and Munsinger point out, 4

54 Supra note 50, 91-9.

choice but to rely on the judgement of management. 6 After all, statistics

administrative machinery of the company. Accordingly, independent

31 In A WA, the plaintiff company purchased foreign currency

32 Rogers CJ held that the non-executive directors were not

62 Supra note 34.

executive directors ever became aware, or should have become aware, of

' Ibid, at 674.

notwithstanding even earlier authority that suggested otherwise.67 Thus in

35 What is significant about these cases is that the conclusion

similar, see Continental Securities Co v Belmont, 99 N.E. 138 (N.Y. 1912);

36 A literal interpretation of the relevant Table A article, and indeed

"This court decided not long since, in Automatic Self-Cleansing

37 Not only did Company Law favour centralised decision-making,

38 With the centralization of corporate decision-making, it was

75 Gower's Principlesof Modern Company Law, supra note 1, 14-17.

independent directors. Even where Boards with a majority of

40 The importance of this cannot be overstated. There is a tendency

83 Supra note 35, 384.

meetings to observe and record the Board proceedings) that are

F Strengthening the role of independent directors

46 In light of the corporate difficulties in the United States, the

93 See, e.g. "Designed by Committee", Economist, 15 June 2002, 70 (Special Report on