DEFINITION of '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 antitrust legislation, interlocking directorates are not illegal as long as the corporations involved do not compete with each other.

BREAKING DOWN 'Interlocking Directorates'

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.

One near-violation of this 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.

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.

Interlocking Directorates and 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.

The board of directors helps shape corporate governance. Shareholders generally elect shareholders, or other board members will appoint them. The board makes a range of critical decisions, such as executive compensation and dividend policy. 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 bring a new dimension to the decision-making process. Independents can also dilute the concentration of power and help align shareholder interest with those of the insiders.

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 land companies points with ESG and social impact investors who value transparency and accountability.

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