An outside director is a crucial member of a company’s board of directors, standing apart as neither an employee nor a stakeholder. Unlike their internal counterparts, outside directors contribute by offering more unbiased perspectives and are compensated through an annual retainer fee, which can be in cash, benefits, or stock options. Generally, public companies adhere to corporate governance standards requiring a specific number or proportion of outside directors on their boards. The separation from internal affairs in theory positions them to deliver impartial opinions more effectively.
Outside directors are also identified under the term non-executive directors.
Understanding the Influence of Outside Directors
Theoretically, outside directors enhance the company’s vision, particularly due to their reduced conflict of interest and a differentiated outlook compared to insiders. However, they face unique challenges: limited daily involvement might result in narrower insights for crucial decision-making, and perhaps, fewer incentives for optimal performance. Moreover, outside directors can sometimes be held personally accountable for judgments or settlements not fully covered by the company’s insurance. Infamously, this was evident with the class-action lawsuits filed against Enron and WorldCom.
Inside directors assume roles within the internal framework of the company. They are often senior officials, major stakeholders, or individuals holding significant ownership of the company’s voting shares.
Lessons from the Enron Scandal: Responsibilities of Outside Directors
Outside directors bear a profound duty to uphold principled positions, safeguarding and fostering shareholder wealth. A cautionary example is visible in the Enron scandal where outside directors faced accusations of negligence. It was alleged that they failed to restrain their CEO, Andrew S. Fastow, from entering into deals with blatant conflicts of interest. Various transactions artificially propped up Enron’s financial stability, hiding financial distress among its subsidiaries.
The Essence of Corporate Governance in Preventing Frauds
The Enron case underscores the invaluable nature of robust corporate governance policies. Effective corporate governance encompasses comprehensive rules that steer and oversee company operations. These policies not only balance stakeholder interests – including those of shareholders, management, clients, and the community – but also chart out the path to meeting organizational objectives. This involves defining precise action plans, establishing internal controls, and ensuring transparency through performance measurements and corporate disclosure.
Related Terms: inside director, corporate governance policies, internal controls, stock options, retainer fee, Enron scandal
References
- Stanford Law Review. “Outside Director Liability”.
- U.S. Securities and Exchange Commission. “Officers, Directors, and 10% Shareholders”.
- U.S. Government Printing Office. “The Role of the Board of Directors in Enron’s Collapse”.
