Are independent directors more than just Christmas tree decorations?
Read Nicki Crauford's article (The Independent, 5 November 2009).The financial crisis has tested many organisations across the globe and some have been found wanting. Many had a hand in the mistakes: banks, regulators, credit agencies, governments and, some say, unquestioning consumers who were the willing buyers of cheap mortgages and loans that became financial weapons of mass destruction.
The finger has also been pointed at non-executive directors, especially those on overseas bank boards. Their calibre has been questioned as it appeared they had not exercised the scrutiny and independent oversight required. There is no place for groupthink in corporate governance but that seems to be precisely what happened.
The same questions have been asked by investors in failed New Zealand finance companies. Jane Diplock, chair of the Securities Commission commented: “There have been instances of too few directors, even sole directors, and at times there were no independent directors on boards. In some cases, independent directors failed to ensure they were adequately informed or took insufficient interest in the business. Some directors were swayed by persuasive management and did not exercise independent judgment.”
Independence means having no material relationship with the company as a partner, officer or substantial security holder. Non-executive or independent directors govern the organisation on behalf of all shareholders and are there to challenge management strategies and probe performance results. The Higgs Review in Britain called them “custodians of the governance process”.
But do they add anything or are they as useful as "baubles on a Christmas tree", as the late Tiny Rowland said? A good hierarchy is one in which the higher layers add something significant. The Institute of Directors believes that a preoccupation with creating or adding value must underpin all notions of governance. A board must add value.
Two prerequisites of an independent director are that they possess some capability needed by the firm and must understand the business in question well enough to make informed decisions. Impartiality and objectivity, combined with knowledge, promote good judgment.
Directors must ensure that the information received is unvarnished and appropriate, and that incentives for executive managers reward success but curb reckless behaviour.
We fish from a small director pool in New Zealand and there are inevitably times when compromise is required. Take, for example the appointment of Lloyd Morrison to the board of Auckland International Airport (AIA), even though his company Infratil owns rival Wellington Airport. With assurances that any conflicts would be carefully managed, Morrison’s value lay in his industry knowledge and business expertise. (Due to ill health, Morrison has been temporarily replaced on the AIA board by Infratil chief executive Marko Bogoievski.) The Infratil case shows that, while independence is important, it is not everything.
When duty is to be done, the independent director’s lot is not always a happy one. Recruitment, evaluation and dismissal of the chief executive officer are key responsibilities. They can be criticised from all sides - shareholders and legislators - for perceived failure to effectively monitor the company, and from management for not adding value. Their actual contribution, many managers say, is to inadvertently distract or interfere in a way that delays decisions, lifts costs and sets inappropriate priorities. Critics argue that because they are removed from the day-to-day business they are unlikely to add value except in special circumstances, and that the more independent they are, the less chance they have of adding value.
However, independent directors cannot be expected to understand all the minutiae of their company’s performance successes and failures. They can and should be able to stay focused on long-term trends and their impact, and must lead from the boardroom, ensuring there are checks and balances in place and that the power in the company is not too centred on one person.
Independence does not require balkanisation and should not come at the expense of a dynamic that leads to a well-functioning board and an effective partnership with management. A healthy environment is one where members can disagree without being disagreeable, where robust debate precedes collective agreement.
Good governance is the key to a successful corporate. The seeds of recovery from the current crisis lie in market regulators and firms moving to control uncertainty by tightening systems. The role of the custodians could never be greater.