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An independent board of directors is normally made of members who have no material interests in a company. Most companies with such boards are publicly listed. The purpose of an independent board is to make sure members are not influenced by interests in the company. They are there specifically to help a company run honestly and efficiently.
The board of directors in some firms is composed of shareholders, or people with interests in the company. An independent board of directors is comprised of people who totally have no material interests in the company other than their directorship. In the last two decades, the concept of independent boards of directors has increasingly become popular as investors demand good corporate governance.
Federal and various state laws require that a member of an independent board is free from any influences that might compromise his relationship with the company. The International Finance Corporation requires that the supervisory board ensures that each member meets stipulated qualifications (listed below) that will guarantee a truly independent board.
Requirements for Independence
In order to qualify to sit on a board as an independent member, one should not have been involved with the company in the last five years. None of the members on such boards should have had any business dealings with customers of the firm or firms with which the company has any business dealings in the past five years.
Limit on Remuneration
Independent board members receive compensation for their role in the company. But the rules of an independent board require that they should not use their directorship on a company board as a major source of annual income. An independent board member should have another source of of income in order to sustain his livelihood. In short, directorship on an independent board should not be a full-time job. That is why no pension is paid. To keep them independent, such board members are not even allowed to have shares in a company.
Most private companies now have independent boards. However, not-for-profit organizations are also now seeking to have similar boards. St. Francis Hospital and Medical Center in Hartford, Connecticut, for instance, now requires that two-thirds of its trustees be independent from any hospital business outside of their involvement on the board.
The movement to independent boards started in the 1980s when firms were exchange-listed in the US, UK and Canada. At that point, governments and financial institutions began to recognize the importance of independent boards. By 1999, more than 60 board members were independent in the three countries. Stock and exchanges and securities commissions throughout the world have supported the concept of independence, resulting in about 81 percent of the boards for firms listed the on S&P 500 in the US as independent. The statute of the Sarbanes-Oxley Act of 2002 in the US tries to promote such boards in order to attain good governance. The Sarbanes-Oxley Act was named after Senator Paul Sarbanes and Representative Michael Oxley, who championed the legislation that was aimed at enforcing proper financial reporting after a series of acts of corporate malfeasance, which saw companies such as Enron collapse, and investors' money be lost.