Interlocking Directorates

What Are Interlocking Directorates?

Interlocking directorates is a business practice wherein a member of one company's board of directors also serves on another company's board or within another company's management. Under the antitrust legislation, interlocking directorates are not illegal as long as the corporations involved do not compete with each other.

Interlocking directorates were outlawed in specific instances wherein they gave a few board members outsized control over an industry. In some cases, this opened the door for them to synchronize pricing changes, labor negotiations, and more. Interlocking directorates does not prevent a board director from serving on a client’s board.

Although there are still many opportunities for collusion through interlocking directorates, recent trends in corporate governance have shifted more power to the CEO. Because of this, many CEOs have been able to appoint and dismiss board members as they please, without giving them outsized influence.

Understanding Interlocking Directorates

Interlocking directorates are legal and typically occur when an individual serves as an officer or director for two corporations. However, if those two corporations are competing with each other, interlocking directorates may violate antitrust laws. For example, if a firm purchases another company and a director or executive serves as a director or a member of their board of directors of both companies, it may cause an interlocking directorate issue.

Shareholders generally elect members of the board of directors, or other board members will appoint them. The board makes a range of critical decisions, such as executive compensation and dividend policy. Dividends are cash payments given to shareholders as a reward for owning a company's stock.

Boards contain both inside and independent (outside) members. Insiders are major shareholders, founders, and executives, while outside directors are more objective forces. They generally have significant experience managing or directing other large companies and bringing a new dimension to the decision-making process. Independents can also dilute the concentration of power and help align shareholder interests with those of the insiders. Typically, companies may try to prevent an interlocking issue before it occurs, such as during a merger or acquisition.

Interlocking Directorates and Corporate Governance

The board of directors is important in shaping corporate governance. Corporate governance is the system of rules, practices, and processes that direct and control a firm. Corporate governance essentially involves balancing the interests of a company's many stakeholders (e.g., shareholders, management, customers, suppliers, financiers, government, and the community). Corporate governance also provides the framework for attaining a company's objectives, covering action plans and internal controls, along with performance measurement and even corporate disclosure.

Poor corporate governance can cast doubt on a company's reliability, integrity, or commitment to its shareholders, which can negatively impact the firm's financial health. On the other hand, strong corporate governance can help with environmental, social, and governance (ESG) issues by appealing to social impact investors who value transparency and accountability.

Interlocking directorates can be helpful since it can prevent a director or board member from having a conflict of interest between two companies or competitors. As a result, laws surrounding interlocking directorates help prevent a board member from acquiring knowledge of one company that could be used to benefit a competitor.

One near-violation of the interlocking rule occurred in 2009 when Google announced that its board member Arthur D. Levinson was stepping down since he also served on the board of Apple. Earlier in the year, Apple announced that Google’s CEO, Eric E. Schmidt, was stepping down from the Apple board. Since the two companies are competitors, they would have violated antitrust laws if they had not taken steps to separate their boards.