Balancing acts: for directors, the virtue of independence should be leavened with the strengths of industry knowledge and experience.

• Author: Raymond, Doug
• Position: LEGAL BRIEF

THE CURRENT DIALOGUE on directors' roles has largely focused on the value of independence, particularly for public company directors, who are seen as the protectors of the stockholders' interests against the otherwise unchecked self-interest of management. Of course, the more independent the director, the less likely that she will have significant depth of knowledge and experience in the business. The completely independent director, with a "pure heart and empty head," may be a great gatekeeper, but perhaps not so effective at assessing the corporation's strategic plans and visions.

A recent study by Moody's Investors Service reminds us again that a balance of perspectives has tremendous value when considering directors and their roles.

While the relationship between corporate governance and credit quality has received relatively little attention, Moody's has conducted several studies in this area in recent years. Moody's focuses on corporate credit risks as part of its ratings of debt issuances. It recently published a report that addresses some of the credit risks particularly associated with the governance aspects of private equity ownership. While some of Moody's conclusions were unremarkable, such as the finding that private equity-backed companies have a high tolerance for debt (which can increase the risk to existing bondholders), other observations were less obvious and should provide boards with food for thought as this election season gets under way.

The starting point for Moody's analysis is the fixed investment horizon of most private equity funds, which typically is between three and five years. While public companies also have a relatively short-term focus, the focus on quarterly earnings does not have a fixed endpoint, which, as Samuel Johnson pointed out in another context, "concentrates the mind wonderfully." Unlike directors in a public company, the directors of a typical private equity portfolio company anticipate a major liquidity event for the stockholders within a fixed time frame and generally are focused on how best to accomplish that goal. Moody's observed that this short-term view may sacrifice a company's longer-term prospects to the detriment of its creditors. Whether the public market's almost overwhelming emphasis on quarterly earnings is better or worse for bondholders--and stockholders--is, however, far from obvious.

But the Moody's study makes a broader point: "Boards of private equity-owned companies, which...