What is an Outside Director
Let me explain what an outside director is: this is a member of a company's board of directors who isn't an employee or stakeholder in the company. You should know that outside directors get paid an annual retainer fee, which can come in the form of cash, benefits, or stock options. Corporate governance standards demand that public companies include a certain number or percentage of these outside directors on their boards. In theory, they are more likely to offer unbiased opinions. An outside director is also called a 'non-executive director.'
Breaking Down Outside Director
In theory, outside directors benefit the company because they have less conflict of interest and can view the big picture differently from insiders. However, the downside is that since they are less involved with the companies they represent, they might have less information to base their decisions on and fewer incentives to perform well. Additionally, outside directors can face out-of-pocket liability if a judgment or settlement isn't fully covered by the company or its insurance—this happened in class-action suits against Enron and WorldCom.
Board members with direct ties to the company are known as 'inside directors.' These can include senior officers or executives, as well as any person or entity that beneficially owns more than 10% of a company's voting shares.
Outside Directors and the Example of Enron
Outside directors carry a significant responsibility to maintain their positions with integrity and to protect and grow shareholder wealth. Take the case of Enron: many accused the company's outside directors of negligence in overseeing the firm. In 2003, plaintiffs and Congress pointed fingers at Enron's outside directors for allowing former CEO Andrew S. Fastow to engage in deals that created a major conflict of interest with shareholders. He devised a plan to make the company seem financially solid, even though many subsidiaries were losing money.
Outside Directors and Corporate Governance
As the Enron example demonstrates, it's crucial to establish and support clear corporate governance policies to reduce the risk of such fraud. Corporate governance is a comprehensive system of rules that control and direct a company. These protocols balance the interests of various stakeholders, including shareholders, management, customers, suppliers, financiers, government, and the community. They also assist a company in achieving its objectives by providing action plans and internal controls for measuring performance and ensuring corporate disclosure.
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