This Article develops a new theory to explain the widespread use of independent directors in the governance of startup firms. Privately held startups often assign a tie-breaking board seat to a third-party independent director. This practice cannot be explained by the existing corporate governance literature, which relies on diffuse ownership and passive investment—features unique to the publicly traded firm. To develop an alternative theory, I model a financing contract between an entrepreneur and a venture capital investor. I show that allocating a tie- breaking vote to an unbiased thirdparty can prevent opportunistic behavior that would occur if the firm were controlled by its entrepreneur or VC investor. Rather than monitoring management, independent directors in a startup firm “arbitrate” disputes between entrepreneurs and investors. Consistent with my theory, empirical data from Silicon Valley startups illustrate several mechanisms entrepreneurs and VCs use to select an unbiased independent director. My analysis has implications for corporate law, as it suggests that heightened fiduciary protections could undermine the role of the independent director in startup firms.
CITATION STYLE
Broughman, B. (2011). the Role of Independent Directors in Startup Firms. Utah Law Review, 2010(2), 461–510. Retrieved from http://www.epubs.utah.edu/index.php/ulr/article/viewArticle/425
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