Do Independent Directors Curb Financial Fraud? The Evidence and Proposals for Further Reform

Abstract

In this article, we argue that the U.S. corporate governance rules put too much faith in the independent board members and insufficient emphasis on the shareholders themselves to control and monitor the top management. Given the agency problem between the board of directors and the shareholders, outside directors can be captured by management, thereby leading to inadequate checks on management. The evidence presented in this paper shows that outside board members do not exercise sufficient controls on the management even when the management has gone awry. To solve this agency problem, we propose increasing the power of the principals: make shareholder resolutions binding on management, require a one share, one vote rule to increase the voting rights of shareholders, as well as give the shareholders the ability to directly nominate and/or actively vote against board members.

Keywords: Corporations, Securities Law, Directors, Corporate Governance, Sarbanes Oxley, Corporate Scandals, Corporate Law, Shareholders

JEL Classification: G30, G38, K22