THE PERENNIAL QUEST FOR BOARD INDEPENDENCE: ARTIFICIAL INTELLIGENCE TO THE RESCUE?

Author:Kamalnath, Akshaya
 
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INTRODUCTION

The question of the ideal composition of company boards is unlikely to have the perfect answer. While the need for independent directors was emphasized in the early nineties (1) and continues to be emphasized even today, (2) additional new ideas have crept in. The separation of the CEO and chairperson roles is well accepted across jurisdictions. (3) The idea of board diversity, and especially gender diversity, has become popular in recent times. (4) The rationale, at least in part, for most of these proposals is to ensure that the board is active, acts independently of management, and is able to consider various perspectives that might affect the company while making decisions. (5) Could artificial intelligence (AI) help solve some of these problems? This Article argues that AI can help enhance board independence by reducing agency costs. At first, AI can be used to help directors discharge their duties, and as AI for boards become more reliable, corporate law will have to evolve to ensure that duties of officers are meant to ensure the safe and efficient use of AI. In proposing practical safeguards to the use of AI on boards, this Article draws from processes followed in the context of cancer treatment where AI is currently being used.

AI, in simple terms, refers to a computer system "able to perform tasks normally requiring human intelligence, such as visual perception, speech recognition, decision-making, and translation between languages." (6) Within this broad umbrella of AI is machine learning, which simply "involves teaching computer programs to learn by finding patterns in data." (7) The computer system improves as more data is input into it. (8) AI has permeated into almost every profession and activity. AI exists in law firms, (9) the healthcare industry, (10) financial advisor offices, (11) self-driving cars, (12) and virtual assistants like Siri and Alexa. (13)

So far, the board of directors has remained relatively out of the eye of the storm. However, AI is coming for all professions including that of board directors. As Richard and Daniel Susskind write, "The day will come, for most professional problems, when users will be able to describe their difficulties in natural language to a computer system...," and receive a satisfactory response to the standard of an expert professional. (14) Although the Susskinds don't discuss board directors as a profession in their book, boards, too, need to prepare for and engage with AI at two levels. The first level is to be aware and able to assess and decide on Al-related issues (15) especially where decisions concern investment into business using AI. The second level of preparedness and engagement required from boards is to leverage the benefits of AI (including relevant ethical issues (16)) so as to be able to perform optimally. This Article is concerned with the latter issue.

In 2014, a Hong Kong venture capital firm made headlines when it announced that it appointed an AI to its board of directors. (17) While this announcement made for flashy headlines, the reality was that a machine learning algorithm, VITAL (Validating Investment Tool for Advancing Life Sciences), was allowed to vote at board meetings based on processing a range of data. (18) Professor Noel Sharkey of the University of Sheffield was of the opinion that "the idea of the algorithm voting [was] a gimmick," and that it was "not different from the algorithm making a suggestion and the board voting on it." (19) Four years since then, we still have not yet reached a point in time where AI has replaced human directors or where the board is populated by a mix of AI and human directors. However, it is not such a distant possibility anymore.

AI offers real benefits that have been harnessed in other areas. For corporate law, if AI can overcome human frailties, the key benefit is to mitigate agency costs in corporate management. Board independence (along with disclosures) seems to be the chief tool thus far in the arsenal of corporate law to counter agency costs. Since these tools have not always succeeded, (20) AI might be a significant solution provided that the right set of incentives are put in place to ensure its effective and ethical use.

The Article proceeds in five parts. Part I lays out the role of the corporate board and the underlying principles behind the duties of directors. Part II discusses the problems board face and the potential for AI to overcome these problems. Part III discusses the use of AI in oncology and identifies learnings relevant to the use of AI in corporate governance. Part IV sets out a model to integrate AI into corporate governance. Part V concludes the Article.

  1. THE CORPORATE BOARD-EXPECTATIONS AND FAILURES

    An analysis of the role of the corporate board, our expectations from the board of directors, and major failures will help identify the potential role and benefits of AI on the board.

    The board of directors is central to the functioning of the company, and the functions they are meant to perform can largely be understood under the three heads of strategy, monitoring, and providing access to networks. The OECD Principles of Corporate Governance, published in 2004, states briefly that the role of the board is to provide "strategic guidance [to] the company," to be an "effective monitor[] of management," and to be "accountab[le] to the company and the shareholders." (21)

    "The theoretical basis for the monitoring role of the board [comes from] agency theory...." (22) According to agency theory, the separation between those who owned the company (shareholders) and those who controlled the company (managers) gave rise to agency problems since the principals (shareholders) were not in a position to directly oversee their agents (managers) in order to ensure that they were acting in the principals' best interests. (23) More specifically, there would be agency costs involved in ensuring that the agents acted in the principals' best interest. (24)

    One of the main purposes of corporate law is to address the agency problems present in a corporation. (25) The agency problem in the corporate setting arises because the agent (manager) has more information about the governance issues than the principal (shareholders). (26) Because of this information asymmetry, the principal cannot costlessly ensure that the agent's performance was exactly what was agreed upon. (27) Thus, the agent has an incentive to not perform at the expected quality or to divert to him or herself what was promised to the principal. (28) By imposing a monitoring role on the board of directors, it becomes one of the mechanisms through which agency costs are mitigated. (29)

    Corporate law has also codified the board's role into a set of duties, a breach of which will result in liability for the directors. (30) These duties arise from the view that directors hold a fiduciary relationship to the corporation and shareholders. (31) The word fiduciary is typically associated with relationships of trust where one party has an "implicit dependency upon and peculiar vulnerability to another within defined parameters." (32) The role of fiduciary norms then is, on one hand, to provide beneficiaries (the dependent party) with ways to protect their trust, and on the other hand, to provide fiduciaries (the second party) with "disincentives to abuse that trust." (33)

    To quote from an often-cited case, the duty imposed on directors implies a standard of behavior which is "the punctilio of an honor the most sensitive,... the level of conduct for fiduciaries [has] been kept at a level higher than that trodden by the crowd." (34) Professor Bernard S. Black states that the "classic statement" as articulated by common law is that "directors owe to shareholders, or perhaps to the corporation, two basic fiduciary duties: the duty of loyalty and the duty of care." (35) The content of each of these duties can be viewed as serving to address the principal agent problem between shareholders and management.

    The duty of loyalty, in essence, aims to ensure that the people in control "act in the interests of the [corporation]" rather than "in their own interests." (36) This would "require[] a director to put the interests of the corporation and its shareholders ahead of the director's own personal interests," which might not be aligned with those of the shareholders. (37) Mostly, this duty would require directors to not engage in transactions where they have a conflict of interest; if this is not possible, to have the transaction approved by disinterested or independent members of the board. (38) Another important fiduciary duty is that of disclosure. (39) In certain circumstances, this duty requires full disclosure of all the facts and circumstances relevant to the board's decision to the corporation's shareholders, especially when they are seeking shareholder authorization for a proposed course of action. (40)

    The second fiduciary duty is the duty of care, and it requires that the directors have "the duty to pay attention and to try to make good decisions." (41) In other words, directors have to "inform themselves of all material information reasonably available to them before making a business decision." (42)

    Related to the duty of care is the business judgment rule, which provides that directors are not liable for losses arising from mere errors of judgment if they acted in good faith. (43) The purpose of this protection from liability is that business decisions are often made in a specific context, and it is not proper for courts to, in hindsight, "substitute their judgment for that of the directors." (44)

    The duties of directors have now been codified in most jurisdictions, and courts refer to the relevant statutory provisions while deciding cases. (45) Apart from the core duties, most jurisdictions also have additional layers of regulations and "best practices" that company boards need to follow...

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