Independent Director System

The Corporate governance is a hot topic of tecent years' discussions surrounding the Corporation Law, Because of the rapid progress made by American Economy in tehl990s, great attention began to be attached on its corporate governance. In particular, the independent directors system born in the U. S. A became the focus of global research on corporate governance. In2001, China Secarities Regulatory Commission formulated the Guidelines for Introducing Independent Directors to the Board of Directors in Listed Companies (herein after "guidelines" ).From then on, Independent Director System(hereinafter "IDS" ) began to be officially introduced into Chian. However, more than 3 years have passed withont th IDS's effectire performance expected by China Securities Regulatory Commission (hereinafter "CSRC" ).Thus,criticism of the system increasingly comes thonghact the country. In America, IDS also suffers condemnation both in speech and in writing, owing to "the Enron Scandal " Where is the origin of IDS? How about its future in the world, particularly, in China? The answers to these questions are what the following five chapters of this article will present.Chapter â…  Definition and Origin of Independent DirectorsDue to the aggravation of "insider control" phenomenon, the name of "independent directors" appeared in replacement of its previous name- "non-employee directors" -in the 1930sand 1940s' America. In the 1990s, the name got its formal affirmation through the reform of Boards of Directors in America. However, up to now, a unified authoritative description concerning the definition of independent directors hase't been offered yed. Instead, there are 3 different types of definition made in accordance with 3 different measures, which are the generalization, the enumeration and the mixation, ie, The mixing of the above two measures, Thouht in practice, people are inclined to pay more attention to the definition made according to the second measurethan the first one. They can still distill the connotative meaning from independent directors'generalization-made definition:They are members of the Board of directors and they are indeperdent, unaffiliated outside directors.Apart from the characters shared with other directors, independent directors still possess their own special characters in law:They are independent, outside from the corporation:They one just and objectire: They are rich in their professional knowledge. In common classifications of directors, they can be classified as managing directors-non-managing directors; inside directors-outside directors;affiliated directors-unaffiliated.dinectors. And judging from the connotation and the characters mentioned above, independent directors must be in the same team with non-managing directors, outside directors and unaffiliated directors. But they are not totally the same, because independent directors have the smallest scope of denotation in comparisons to the other directors in the team. What's more, the other 3 types of directors in the team cannot be taken as the same or converged into one kind of directors. Because to do such things is to take/run the risk of getting the independent edge of directors worn off. The second topic in this chapter centered on the origin of IDS. From the angle of law, the designing and owrangement of IDS is the measurement adopted to perfect corporate governance structure-to protech the whole interests of the compang, (?)cial attention to see to it that the legitimate rights and interests of medium sized and small investors are not harmed. The seperation of the company's ownership from its controlling power put the demand on the research of corporate governance, which was first conducted in the 1930s. The term "corporate governance" began to be widely used in the 1970s. After that, in 1990s, the corporate governance grew into a global fashion, IDS's birth was to let America's demand on the improrement of the old governance mode make peace with its refusal to change the traditional one. At present, two types of corporate governance are current in the world:one used to be applied in Britain and America, etc, whose supervisory work relys on the market. The other mode is adopted by German, Japan, etc. having a supervisorysystem conducted by shareholders. In addition, each of the two modes has its own characters and defects. Take the first mode for example, its defects hide in the convergence of corporate's executive system and supervisory system, which leads to the low efficiency of corporate supervision. To cure such defects, the IDS is set up by common law countries to improve the supervisory system within the frame work of the original unitary system Furthurmore, both the rising of institutional investors and the assimilation of the two modes impelled by the globalization of the world econymy proride momentum to propel IDS's extension and development.Chapter â…¡ Theordtical Basis of IDSThree root theories of IDS are presented in this chapter:the agency theory, power shifting theory and the interest-related theoly. In line with the theory of modern corporate contracts, the paper deems the corporation as the collective bady of contracts concerning interest-related members relationships. However, never a corporate contract can be complete enough to cover everything. As a result, agency system is introduced in the corporation to solve the problem brought by contracts incompletabilitytwho can make decisions on events that are not in the clauses of a draft contract? But even so, there still another problem exists:How can agents be made conscientionsly perform their duties, considering that the interst of agerts and that of principals are not always in harmony with each other? Usually speaking, the most important point to make independent directors or agents function as expected is that effectire in centives and monitoring system must be provided for them, However, it is much harde for principals to carry " the best way " out, Facing information enclosure, moral risks of agents, and the cost of agency, principals must establish a sound internal control system than can be used to regulate and encourage agents, so as to downsize the cost of agency and uplift the agents interest to the largest extent. As for the essential role played by independent directors in rectifying theagency relationship, they can prevent the "inside control" fromhappening, protect the whole interests of the compang and restrain shareholders from making medium-sized and small shareholders to suffer huge losses. The second theory presented in this chapter is power shifting theory, The term "power shifting" haer refers to the shift of power from shareholders through directors to managers, under the guidance of the theory of seperation of the two powers and agency theory.These two "migrations" of corporate power conform to the principle of efficiency. However, on the other side of the coin, as the power of corporate directors and managers increasingly swells, corporation controlling power gradually slips away from shareholders.which make the "inside control" become unavoidable. To prevent such risks and probabilities from coming true and to secure the corporation's good performance, the best thing to do is to set up a strong and effective monitoring system. For common law cuntries, because they have no system of Board of supervisors, the most effective ways to improve their corporate governance are to relocate the powers of the original Board of directors, to introduce external or outside directors into corporation and give them supervisory power. The third pillar theory concerning independent directors is the interest-related theory. Contrary to the traditional theory of corporate governance, the interest-related theory holds shareholders are not the only corplrate owners;the governance of corporation should be for the benefits of all interest-related members;The existence of corporation should be good for the whole society, etc, Influenced by such points of view, restrictions on the qualifications of directors and shaoes can scareely be seen/found in present countries Corporate Acts any more. Besides, in civil law countries, the initial goal set for directors is to serve corporate growth and development and the realization of this goal will help serre shareholders and other interest-related member better. In common law countries, it is thought that to maximize shareholders long-range interestes, directors can be authorized to protect legitimate rights and interests of corporate members witheconomice relationships with the corporation, even at the cost of sacrificing shareholders short-range intersests. In compliance with this thought, outside or indeperdent directors are inaugurated to harmonise the interest relationships in the corporation.Chapter â…¢ Legal Practice of IDS in the WorldIn America, the first act concerning IDS-Investment Company Act-was created in 1940. From the 1990s, some state-made cororate laws began to provid prescriptions on the set-up of indeperdent directors and their operating mechanisms. After the "Enron Sacndal" happening in the early 21th century, Sarbane-Oxley Act of 2002 was passed. From then on the corporate Auditing committee totally composed of independent directors became the corporation's internal supervisory organ prescribed by law. The Act is the first act in Americom history to give compulsoly prescriptions on the set-up of independent directors, owing to which, the IDS began to be endowed with stronge legal binding force. After it gained a foothold in America, the IDS began to speread out rapidly thooughout the world. In Japan for example, the introduction of IDS is provided but not compulsory by legislation. In Chian, the main problem of its listed companes as compared with those in western countries is the control by "big shareholdes" , that is ,the so-called "one share dominating" problem. Another type of problem is "inside control" .which has equally serions consequences and is an "affiliated" problem of the first one. In addition to those, the lack of efficiency of supervisory systems in china's listed companies is the third problem waiting for being solved.To dissolve problems abiding in the securities market and to keep its corporate governance in step with the world's demands.China decides to introduce IDS into the Board of Directors of listed companies, but such a system is lacking in the original social and legal environment of China. On one hand, a cleor-act stipulation concerning IDS still can not be found in China's corporatelaws.Neither does a certain mechanism propelling IDS's derelopment exist in China's judicial practice.Chapter â…£ Value of Independent Directors SystemTheoretically speaking, positive attitude towand IDS's valwe holds that independent directors can take an objective and "external" stand in restricting big shareholders and overseeing managers;Indeperdent directors equipped with professional knowledge plat ther roles in the making of the Board's decisions and impel the good performance of corporation.They can channel the corporation to the outside world by their personal relationships and good social status.They can, to a certain degree, resist management personnel from rigging the financial reports and misleading investors.They can also enhance the transporrency of the Board of directors and they are endowed with great powers in corporation making of decisions.Negative views believe that neither is the so-called independente possible nov reliable.It's runerable to the alluring power,honour and social status,etc Furthurmore, it cannot be mentioned in the same breath with justice-contradictions-the contradiction between the enumeration of independent directors and their monitoring initiality. The controdiction between depth of involvement and as their degree of their independence-are heavy. The work is " cuped "restrained by the element of time, information, energy and capacity. The disproportion of corporate incentine mechanism and independents' responsibilities may increase the sense of risk on the part of independent directors so that those unable to measure up to the stomdowds are hesitant to take up the post. This may detain the development of the corporation. Judging from those, the negatires conclude that independent directors don't display, their due roles in the improrement of the corporation, on the contrary, their existence makes theCorporation loaded down by their remunerations and the costs concerning their word, What's worse, corporate controllers just can take advantage of them, to shrink responsibilities with the pretence of "Justice" , practically speaking, judging from the results of their empirical studies, some scholars approval of the introducition of IDS, while others do not agree with it or think that has nothing to do with performance of the corporation.Regonding the different views mentioned abore the paper argues that defects existing in the IDS,can be cured by perfecting the IDS itself.The purpose of IDS,in essence,is to inprore the unitary system within the framework of the origin mechanism and solve problems such as the dominating power held by shareholders or maragers,information enclosure,the disproportimate power stnctwre,ect.In the appraisal of the introduction of IDS in China,it is one-sided to affirm everything or to negate everthing.The carry-out of the IDS should be conducttd step by step with no rashress.The paper also holds that the esseutial aim of independent directors is to strike a balance between the maximization of shoneholders' legitimate rights and interests and the protation of other interest-relatad groups Besides, independeng directors have two legal functions:monitoring and decision-making. Though detailed analysis of 2 internal monitoring modes in the corporation, the paper concludes that both the IDS and the board of supervisors have its strong points and inadequacies and a complementary approach will be excellent as long as they are taken as altornative paths to approaching the goal to uplift the corporation's monitoring efficienwp and improre corporation internal structures.Chapter The Operation Mechanism Of Independeng Director systemThis chapter observe the operation mechanism of IDS, and puts forwand some advice based on the analysis of drawvbacks of IDS, Firstly, the author analyses the independence of IDS,which should include two aspects:independence in essence andindependence in form. In practice, the main factors posing inflwence on the independence of IDS involve the empllyment of independent directors, tenure, pagmetit, business between companies, working time, authority and duty, etc, Albeit many laws or rules pescribe the standard of Indepordece in detail.it is impossible to find absolute independence. In addition, the objective criterion legal system designs for the independence of IDS may not make effect because of the "assimilation" of independent directors during the process of appointment. Tht law spares no effort to make these"indepondent requirements" independent in full wing in ordor to satisfy the practice. As for the standand of IDS in China, the author holds that a more strich and detailed standard Should include,a limit of elimination of intimately personal relationship and make a larger proportion for independent directors in the Board of directors of listed company with the purpose of keeping the independent directors more independent as a whole. Secondly , this paper make comprehensive investigation into the mechanisms of IDS is operation: appointment, distribution of power , undertake of responsibility, incentives, etc. The author raises his own advice for improving our IDS after the analysis and research on other western countries' system. As for operation mechanism, it is necessary to set a stricter and more detailed standard for the qualification for independent directors appointment, in other words, to prescribe relating regulations and modify our current IDS to clarify the disqualifying situations, disqualifying process and responsibility-undertaking. Considering process of appointment, avoidence of direct election by holding shareholders guaranteens the right of nomination enjoyed by midium-sized and small shareholders. On power distribution mechanism of: inderendent, directors, the extent of duties and powers of them in china is smaller than that prescribed by New York securtty Exchange, Moreover, the supervisory power of inderendent drectors and the Board of supervisors should be redistributed in accordance with their advantages and characters respecivdy, so as to solve the noblem of power overlapping between them.Sharing with the same end , independent directors and the supervisory board perform their functions properly and eoherently, each taking its own resporsibility. With this in mind, more specific proposals are presented by the paper: â‘  the major matters involing internal business, exchanges of big-sum money, investment acts, merger, reorganization of assets, development strategy of the listed company, etc should be superised by independent directors; other matters except those prescribed in artides of dssocicction of the company should be put under the superusion of the Board of supervisors; â‘¡ Fnacial dscowcting statistis reforted by the listed company should be "doubly" supervised by independent directors and the Board of supervisors; â‘¢ The two supervisory system should be mutually conducted. Besides, reinforcing the power of the Board of directors, compulsorily establishing sub-committees inferior to the board of directors and improving the environment of power-exereising make great to realke the indeperdence of independent directors, as well as to auoid their acting as "ornamental vases" . Concerning the responsibility meehanism, the aucthor observes that great attention to the regulation of independent directors' resporsibility should be attached from the start. On one hand, independent directors ' responsibilittes and their legal conseduences should definitely get prescribed. On the other hand, when an indopendent director undertakes the liabitity of indemnification resulting trom breachment of duties, we should strike a balance among the orcumstance of the fault, sum of material compensation and affordability of the indeperdent director. On the incentive system for indeperdent directors, china' s incentive system at present is lacking in operability in practice. Viewing this, the aucthor aduses setting up the "Independent Directors tssociation " to build up regulations concerning accesses and exits of independent directors, and provide qualified independent directors for listed companies uniformly. In addition, it is necessary to establish an uneduivocd criterion for the remuneration of independent directors. Moreover, the Independent Directors tssociation is also endowed with thepower to manage personal relationships among indeperdect Finally, discussions surrounding "How to carry out IDS in Chinese environment?" are exploited in the paper.