Question

3. Discuss the merits of the following statement: Inside directors should constitute the majority of a corporate board, because insiders have superior understanding of the firm’s business operations. What evidence can you cite in support or in opposition to this assertion?

Answer 1

It is true that insiders have superior understanding of a firm's business operations. However, insiders being on the board of directors presents the problem of corporate governance - insiders may have a vested interest, either personal or otherwise.

If the board of directors is composed of a majority of insiders, there is no independence in governance. The managers and those charged with governance are the same set of people. This leads to multiple conflicts of interest and lack of independence.

For example, the Enron and Siemens corporate scandals resulted from a lack of independence on the board of directors. These scandals could perhaps been avoided if those charged with governance (directors) were not majorly insiders. In fact, following the Enron scandal, rules relating to directors were overhauled to include more independent directors on corporate boards