What is an Interlocking Directorate?

Malcolm Tatum

An interlocking directorate is a situation in which the boards of directors of at least two different business entities share one or more directors in common. While a common phenomenon, there are sometimes governmental prohibitions that limit the type of this sort of corporate interlocking that may take place. Often, those prohibitive regulations are aimed at minimizing the potential for those connections to result in the creation of a market environment where competition is adversely affected to the point that it undermines the ability for fair trading to take place.

The federal government does not prevent the creation of an interlocking directorate by two different business entities.
The federal government does not prevent the creation of an interlocking directorate by two different business entities.

While federal laws do not prevent the creation of an interlocking directorate, there are situations in which a board member of one business cannot simultaneously serve on the board of another company. This is especially true in situations where there is some potential for that relationship to create an unfair advantage in the marketplace for either of the two companies, or allow the board director to influence board decisions in a manner that provides him or her an unfair advantage in terms of personal financial rewards. In order to prevent this type of conflict of interest, many governments implement antitrust laws that address these types of issues, along with other business practices that may result in undermining free trade.

One example of this type of governance of the range and scope of an interlocking directorate is found in the United States. The Clayton Act of 1914 serves as an amendment to the earlier Sherman Act. Within the text of this legislation, limits are put in place to prevent price discrimination that may arise from this cross-pollination between different companies via their respective boards of directors. The legislation also prohibits such actions as the creation of mergers or contracts between those entities, when the action is likely to result in lessening competition in the marketplace or create a monopoly that threatens to control an entire market sector.

There are two schools of thought regarding the imposition of laws and regulations that place limits on the formation of an interlocking directorate. Proponents see measures of this type as being essential to keep businesses of all sizes from creating unpublicized connections that lead to unfair market advantage. At the same time, the laws help prevent a small group of individuals from manipulating the decisions of several boards and benefiting from those efforts at the expense of the companies involved. Critics of the interlocking directorate typically feel that businesses should take a more active role in creating bylaws that prevent board members from sitting on the boards of companies where a conflict of interest may exist, and leaving the enforcing of those bylaws to industry and not government.

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