CK Low FCIS FCS, Associate Professor in Corporate Law, Chinese University of Hong Kong Business School, argues it is time for a shift of focus away from complex definitions of the independence of independent directors and towards the importance of ensuring appropriate expertise and diversity on the board. He also puts forward a new proposal to empower independent shareholders in the process of electing INEDs.
As regulations place an increasing emphasis on the ‘independence’ of independent non-executive directors (INEDs), one should ask whether this is but a state of mind in many jurisdictions throughout Asia where the family- and/ or state-owned company dominates. After all, no definition of independence, no matter how exhaustive, is completely foolproof.
There have been suggestions that many INEDs, although they comply fully with the listing requirements, are in reality only ‘résumé independent’. There may be some truth to this since it is extremely difficult to fathom how an individual would be invited to serve as an INED of a company unless there had been some prior relationship and trust, whether direct or indirect. In short, no candidate would even be nominated, let alone get appointed, as an INED unless he or she has the blessing of the controlling shareholder.
In such circumstances, would the proposed INED not already be subject to some degree of bias in favour of the management and/or the controlling shareholder upon his or her appointment to the board? With this in mind, can one unequivocally say that the INED is truly independent and would be able to represent the interests of all the shareholders of the company?
If the INEDs were truly independent, their positions should not be affected by any changes in the ownership structure of the company, regardless of whether such changes arise through a voluntary sale of shares by the controlling shareholder or through a contested hostile takeover. However, in reality it is not uncommon for the INEDs to step down from the board of directors when control of a company changes hands so as to facilitate their replacement by a new ‘team’. Herein lies the irony: if the INEDs were truly independent and can be called upon to effectively discharge their duties in the interest of all the shareholders of the company, then why would it be necessary for the new controlling shareholder to appoint persons of their choice to the office?
Numerous academic studies have affirmed that there is no correlation between the number of INEDs and the financial performance of the company. Having a higher degree of independence on the board does not guarantee better financial performance. Similarly, research indicates that INEDs may not necessarily enhance the effectiveness of monitoring executive management although there are some positives with respect to the ‘quality’ of financial reporting. That said, with respect to the latter, one may legitimately query whether this is due more to the introduction of new and more rigorous accounting standards following the global financial crisis rather than being attributable to the presence of INEDs.
While recognising that the concepts of independence and of the INED bode well for good corporate governance, one must take a realistic view of the issue in its widest perspective and in light of its limitations. In the circumstances, rather than continue or tinker about with a system that is at best difficult to apply, and at worst impossible to effectively monitor, it may be appropriate to think outside the box and consider options that are not presently practised in other jurisdictions. We should candidly admit that independence is not a panacea and that the time has perhaps come for the focus to shift towards expertise and diversity of the board.
On another note, is it possible to empower minority or independent shareholders in the process of electing INEDs without disenfranchising the majority? The Financial Conduct Authority in the UK has taken a step forward with its Policy Statement PS14/8 which provides for enhanced voting power for minority shareholders when electing or re-electing INEDs for a premium listed company where a controlling shareholder is present. However, this may not be sufficient for Asia and due consideration must be given to the pitfalls of regulatory transplanting since what works well in one jurisdiction might not necessarily achieve the same results in another. One must recognise the various legal and cultural differences that prevail. For example, cross-directorships across ‘friendly’ corporate groups are not uncommon in Asia where the family and/or the state dominate the shareholding landscape.
Perhaps it is high time for regulators in Asia to innovate by thinking about ‘negative voting’ – a process through which the election or re-election of INEDs requires not only the majority support of shareholders but also draws no more than a certain percentage of ‘dissenting or opposing’ independent shareholders. The latter can be based upon a sliding scale depending on the numbers of years which the INED has served on the board of the company. After all, if the shareholders of the company are happy with the performance of their INED, what moral right has the regulator got to interject by stating that one loses his or her independence after a set number of years in office? Shouldn’t this decision be best left to the contributor of the company’s capital who must surely be the better judge as his or her money is at stake?
Low Chee Keong, Associate Professor in Corporate Law, Chinese University of Hong Kong Business School