Interlocking Directorate Definition Explained Examples Benefits

Interlocking Directorate Definition

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In this kind of management system, a director serves or is common to many corporations, referred to as multiple directors. But such businesses should avoid competition among themselves, or such a practice becomes illegal. Such a process can occur between two or more companies, not-for-profit organizations, or any private company and government entity.

Key Takeaways

Interlocking directorate refers to the process in which a member of the board or management of one company serves in multiple companies as director or management.There should not be any competition or conflict of interest between the concerned companies, or the procedure should become illegal.The board members are shared across the organization and are termed, multiple members.Such interlocking can occur between government and private entities, two standard profit-making companies, or a general business and a non-profit organization.

Interlocking Directorate Explained

The interlocking directorate concept occurs between companies when the board members or management of one company act as the management or director in one or more other companies, thus controlling all of them simultaneously. To legalize interlocking arrangements, the firms must ensure that the companies are not competitors.

The use of interlocking directorates in business has gained significance due to the opportunity for diversification of interest by the board. Interlocking can be done through a direct or indirect method. In the direct method, the board member of one company serves as a board member of another company. In the indirect method, board members of two companies come together to serve in a third company.

Many years ago, Louis D. Brandeis, former associate justice and lawyer in the United States Supreme Court, said that the above idea would have some adverse side effects. For example, there might be a lack of healthy competition, inefficiency in day-to-day affairs, unfairness, and favoritism. In addition, the adverse effects would compromise decisions and actions.

The interlocking directorate concept should allow the board members to be independent and make quality decisions. Some laws in the United States forbid interlocking as a corporate practice if the organizations belong to the same industry. However, it is best to follow strict ethical principles so that the interlocking concept gives maximum positive results to the business without any harm or compromise.

Examples of Interlocking Directorate

Let us go through some examples related to the interlocking process of directors.

Example #1

Let us assume that there are two firms, Sunlight International and Silver Corporation. Both firms operate from California, United States. Sunlight International is into the medicine manufacturing business, and Silver Corporation is into providing storage and warehouse facility for medicine manufacturers.

Each firm has six members on the board. However, it has been decided that John, who is currently serving on the board of Sunlight International, will also be elected as one of the directors of Silver Corporation. Thus, from now on, John will be a common director and control the operation of both firms.

In this example, John is the interlocking director since he will serve on the board of both firms. It is to be noted that the businesses are not of competing nature; instead, they compensate each other with their service. Medicine manufacturing is always a great business to meet the medical needs of the people, and a storage and warehouse facility is the most crucial requirement that any medicine manufacturer will need.

Example #2

A few years back, Melinda Gates, already holding important positions in various organizations, was elected as the Washington Post Co. director. The Washington Post Co. was later renamed Graham Holdings. At that time, she was the wife of Bill Gates, chairman of Microsoft Corp. Her entry as the director of the Washington Post increased the number of directors to 10, which included prominent personalities like Warren Buffet from the business field, Barry Diller and Alice Rivlin from Hollywood, etc. She is also the co-founder of the Bill & Melinda Gates Foundation.

Example #3

A few years back, Google and Apple also implemented the idea of an interlocking directorate in business. As a result, they had two directors in common on their board, the chief executive of Google, Eric E. Schmidt, and the former chief executive of Genentech, Arthur Levinson.

However, problems began when it came to light that the arrangement could result in an antitrust law violation, the violation of the Clayton Antitrust Act of 1914. In addition, the Federal Trade Commission suspected that this process would reduce competition and efficiency.

Benefits

Now let us go through the interlocking directorate importance and benefits.

Promote corporate governance – A company with strong corporate governance can achieve maximum return while giving equal importance to the interest of all stakeholders. For example, implementing the idea of an interlock of directors help eliminate conflict of interest due to its legal aspect, preventing the board from collecting information to help competitors, which promotes corporate governance and business ethics.Increase in corporate power – Since the method involves companies working together under the supervision of the same board or management, it increases the power of the executives over workers, customers, and the government. Sharing information – It helps to communicate critical information among the group companies, making the process transparent and efficient.The diverse interest of directors – The board members usually have vast knowledge and skill to implement in different companies they serve. This experience is highly beneficial for the growth of the business.Increase horizontal cooperation – The process brings competitors together, promoting better use of ideas and good communication.Increase vertical cooperation – The interlocking process also brings together suppliers and customers because the board of these two types of companies may have joint members. As a result, they help in better coordination and information flow.Eliminate uncertainty – Competition reduction also reduce uncertainty which ultimately helps in profit maximization.

Thus, the above points highlight the interlocking directorate importance in the corporate world and how companies can use it for the best interest of the stakeholders.

Clayton Antitrust Act Of 1914

All firms having directors or members of management in common has to abide by Section 8 of the interlocking directorates Clayton Act. According to the law, the Clayton Antitrust Act, passed in 1914, does not allow a board member to simultaneously serve on the board of two or more firms if the business is competitive. The rule identifies that if a joint director serves on the board of two competing firms, it is possible to access inside information through unfair means, thus promoting unhealthy trade practices and degrading the sense of duty and loyalty towards the company.

Thus, the Federal Trade Commission continuously monitors corporations with huge capital and high revenue engaged in interlock. Of course, certain exemptions to Section 8 of the interlocking directorates Clayton Act exist. But a close vigil is essential to maintain a healthy corporate structure.