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Can Boards of Directors Really be Independent? 

Categories Business, Management

Essay, Pages 11 (2567 words)

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Essay, Pages 11 (2567 words)

Board of director independence is assumed to be an important and effective governance mechanism. Independence is critical to effective corporate governance, and providing objective independent judgment that represents the interests of all shareholders is at the core of the board’s oversight function. Accordingly, a substantial majority of the board’s directors should be independent, according to applicable rules and regulations and as determined by the board.

In many countries, the Code of Corporate Governance and regulators recommend that the composition of board members should be balanced and consist of independent directors.

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However, mere compliance with the recommendations is not enough if the independent directors fail to exercise their functions effectively.

Board Independence

An independent director should not have any relationships that may impair, or appear to impair, the director’s ability to exercise independent judgment. Independence, allows a director to be objective and evaluate the performance and well-being of the company without any conflict of interest or the undue influence of interested parties.

Berghe and Baelden (2005) examined the issue of independence as an important factor in ensuring board effectiveness through the monitoring and strategic roles of the directors. The ultimate factor for the board independence is by acquiring enough numbers of the independent directors on board. They stated that the director’s ability, willingness and board environment might lead to the independent attitude of each director.

Nowak and McCabe (2008) have studied the roles of the independent directors in Australian public listed companies by interviewing 30 directors.

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The participating directors agreed that a majority of non-executive directors (NEDs) on the board would provide a safeguard for a balance of power or management relationship.

Besides that, there was a distinction between the boards with independent non-executive directors and non-independent directors. Independent directors would provide a variety of independent thinking, and majority of them could reduce the dangers of ‘group think’.

A study by Ararat, Orbay and Yurtoglu (2010) on the board independence in controlled firms in Turkey found three main important findings. The first finding indicated there was no significant effect of board independence and equity issue. Besides, the independent directors in Turkey were less efficient in restraining related party transactions.

Also, they found that there was a negative relationship and a non-relationship of independent directors and firm’s performance. The results were due to the fact that independent directors of Turkey’s listed companies were not truly independent. The independent directors had personal, financial, and social ties with the dominant shareholders and this influenced their independent judgement, thus jeopardizing their functioning as independent directors.

Role of Independent DirectorsThe role of an independent director is important for all companies and not-for-profit organizations alike; however, it is particularly important for private companies where it is not always apparent who has the interests of minority shareholders top of mind.

For a private corporation, an independent director would be a director with no substantial capital invested, contractual obligations, or ties to the business or its principals. They can objectively contribute to the governance process of the company and have the experience and knowledge to evaluate the best interests of the company.

A corporation’s business is managed under the board’s oversight. The board’s oversight function encompasses a number of responsibilities, including:

Selection of CEO- in most private and public companies, the board of directors selects and oversees the performance of the company’s CEO and also oversees the CEO succession planning process.

Approving corporate strategy and monitoring the implementation of strategic plans – the board of directors approves the company’s strategic plans and regularly evaluates implementation of the plans that are designed to create long-term value.

Overseeing management of risk – The board oversees the process of identifying and managing the significant risks facing the company.

Financial reporting and other disclosures about corporate performance – the board of directors approves the company’s financial reports that are published, as well as any other disclosures about corporate performance.

Funding – the board of directors approves the organisational funding requirements. Some organisations are funded through debt capital, whilst others are funded through equity capital or a mixture.

Budget Approval – the board of directors reviews and approves annual budgets presented by management.
Director recruitment – the board of directors nominates directors and committee members, and oversees effective corporate governance.

Overseeing the compliance program – the board of directors oversees the company’s compliance program and any regulatory issues that may arise.

All directors have a responsibility to carry out their duties without conflict; however, a special responsibility is placed on independent directors to ensure that all decisions are arrived at in the best interests of the company and all shareholders are treated fairly. Having independent directors allows the company to have best-in-class leadership within the industry.

Factors that affect independence of a board

There are several factors that affect board of directors’ independence:

Selection or recruitment of board members

Several organisation have the Nominating and Corporate Governance (NCG) Committee that assist in the nomination and making recommendations to the Board as appropriate. One responsibility of the NCG Committee is to identify individuals qualified to become Board members and recommend potential new Board members.

The NCG Committee seeks to ensure the Board has a sufficient range of skills, expertise and experience to allow the Board to carry out its mandate and functions effectively. The NCG Committee receives and evaluates suggestions for candidates from individual directors, the CEO and from professional search organizations.

Persons proposed for appointment as members of the Board of Directors must meet the requirements in the company bylaws and the board regulations. In particular, the directors must meet the necessary suitability requirements to hold the directorship. Thus, they must be considered to be of commercial and professional good repute, possess adequate knowledge and expertise to perform their duties and be in a situation in which they can exercise good governance of the Company.

For example in the Financial Services sector, a nominated board of director must be vetted for suitability by the Central Bank’s registrar of banks, if they fail, then they may not sit on the board of directors. According to Steven A. Seiden (2017), studies have proven that companies with totally independent and diverse boards are better performers.

Prof. L.A.A Van Den Berghe and Tom Baelden (2003) in their study on corporate governance, found out that having a strict selection guideline of selecting and nominating board of directors, will increase the probability of selecting real independent directors to the board. In the second hypothesis of their study “In order to achieve vigilant monitoring and objective decision-making, the members of a board of directors do not (only) need to be formally independent, but need to have the right attitude.

They should be critical thinkers, with an independent mind, who are able to exercise an objective judgement on corporate affairs.” they concluded that the there is a positive relationship between board independence and ability to monitor the institution.

The selection process may however, not achieve full independence of the board of directors, because of the nomination process itself. More often than note, the nominators normally pick colleagues that they share certain interests with, or have sat on same boards previously. This will make the board have like-minded people which is an advantage that where like-minded people meet, they will be pulling in one direction and normally have a similar vision and understanding of issues.

An example is Steward Bank where most board members have a relationship with Econet Wireless or have had past working relationships with Econet Founder and executive chairman Strive Masiiwa. This has allowed growth of Steward Bank from the time that the bank was acquired from TN to this day. This is primarily because there is a shared vision and a common understanding about the strategic direction of the organisation.

Selection of like-minded people may also be detrimental to the organisation where there is really no diversity and critical thinking. Selection of a board with diverse skills set brings in a wealth of ideas from a cross-section of the industry.
Board compensation

The board Remuneration Committee (RC) normally deals with executive management and independent board remuneration. The setting up of an RC can align CEO pay and firm performance to a great extent. CEO pay in the case of early adopters of RCs is more closely related to firm performance. (Chii-Shyan Kuo and Shih-Ti Yu, 2014).

Higher board compensation is strongly related to ineffective monitoring and weaker corporate governance (Basu, Hwang, Mitsudome, & Weintrop, 2007; Brick, Palmon, & Wald, 2006; Core, Holthausen, & Larcker, 1999). Board compensation plays an important role in independence of the board. In some organisations some board members are highly rewarded and may not be comfortable to go against the board chairman or the CEO.

High profile cases where board members have been highly rewarded include PSMAS where the board members were then compromised in their oversight function. This resulted to issues of corporate threatening the viability of PSMAS as an institution.

On the other hand, the setting up of RCs has assisted many organisations to have independency in the board of directors. According to the an article by Paul Nyakazeya in the Fiancial Gazette(16 February 2017), Directors Fees could come under spotlight, he noted that companies like CBZ Holdings and FBC holdings paid huge amounts to director’s in 2016, but these corporates have sound corporate governance frameworks in place, and this has translated to company performance. The huge fees have not impacted on the director’s independence and they are able to carry out their oversight role effectively. CBZ and FBC are major banks in Zimbabwe by capital base and market share.

Political interference

State Owned Enterprises (SOE) in developing countries are, in many cases, characterized by the lack of respect of formal rules and frequent political interference from the government. Introducing independent directors may not produce tangible results, if, for instance, formal procedures are not in place to produce the necessary insulation of Boards from governmental interference.

Whereas the government, as the shareholder of SOEs, has a legitimate right to influence SOEs, the scope and extent of influence in practice has been excessive and calls for some limitations. Appropriate roles for the government includes setting objectives and performance targets, appointing directors, monitoring the performance of the enterprise and its Board. Aside from these intervention rights – which need to be clearly spelled out and publicly disclosed – the remaining authority should sit with a professional Board and management. (Maria Vagliasindi, 2008)

Board of directors mainly in Zimbabwean parastatals are appointed on political backgrounds. Political appointees are normally there to appease the appointing authority. This has led to may parastatals having so called independent board of directors which are not so independent.

Even if the boards are independent, there is too much political interference for the board to effectively carry out its oversight function. This has led to many of these boards failing to execute their oversight role in transparent manner, the cases of Zupco, Air Zimbabwe, National Railways and recently the censorship board come to mind.

Ownership and Control

Ownership and control of an organisation plays an important role in the independence of board of directors. On the one hand, dominant shareholders have both the incentive and the power to discipline management. On the other hand, concentrated ownership can create conditions for a new problem, because the interests of controlling and minority shareholders are not aligned.

There are companies in Zimbabwe like Econet Wireless where the founder is the executive chairman and also at TN holdings where Tawanda Nyambirai used to be the chairman of the board. Whilst it is encouraged for the shareholder to normally sit on the board, because some scholars believe that only the shareholders or owners have an interest in the affairs of the company, the rest of the board care too little about the company because they have nothing to lose.

At TN, although there were some independent directors, they did not have much say in the affairs of the company, this led to the demise of the company whilst Econet, with the same setup is doing quite well. The conclusion therefore is that ownership and control does not necessarily lead to failure in organisations, but may lead to serious corporate governance challenges that may affect company performance. Although the Econet owner is the executive chairman, because he observes corporate governance guidelines, the company is doing well.

Director Tenure

A topic of increasing focus for boards is the impact director tenure has on performance (James Beck and Jennifer Tunny, 2014). Many governance authorities recommend a limitation on the length of service of a director for two reasons:

There is a concern that independent directors may lose the independence and the external viewpoint that they were intended to bring to the board if they remain on a board for an extended period. This can be as a result of becoming ‘too trusting’ of particular executives (or to a lesser extent by alignment to a faction of a board).

Some commentators voice a concern that a long ? serving director’s contribution and usefulness may wane (for example, as a result of running out of new ideas) or become less relevant to the organisation’s future
The general acceptable trend in Zimbabwe is that board members must serve at most two three year terms. CABS and Steward bank recently changed their board chairman because they had served the required number of terms.

Board structure

The board structure affects the independence of the body, some companies have very few board members, although this sometimes promotes continuity and consistency in terms of the decisions, it may actually be a down side in that there are very few ideas that are brought to the table. The board may not be able to have the required independence and number of committees to fully execute the oversight role of the board of directors.

The board size and structure is normally guided by the size of the organisation or the industry. Banks in Zimbabwe have an average of 10 board members. Besides the main board where all board members attend, sub committees like Audit Committee, Loans Review and Risk Committee, Remuneration Committee, Nomination committee and several others may be established for effective monitoring of various institutions.

Conclusion

Studies have shown that although some companies may have independence board of directors, some may fail due to factors highlighted above. Studies have also shown that organisations with independent board of directors perform better than ones where the directors are not independent. This is because the directors are compromised in their oversight function.

References

  • Ararat, M., Orbay, H. & Yurtoglu, B. B (2010) The Effects of Board Independence in Controlled Firms: Evidence from Turkey, working paper.
    Berghe, V. D & Baelden, T. (2005).
  • The complex relation between director independence and board effectiveness, Corporate Governance.
    Chii-Shyan Kuo and Shih-Ti Yu (2014).
  • Remuneration Committee, Board Independence and Top Executive Compensation
    James Beck and Jennifer Tunny, (2014). Director Tenure Kurt A. Desender (2009).
  • The relationship between the ownership structure and the role of the board Prof. L.A.A Van Den Berghe and Tom Baelden (2003),
  • The complex relationship between director independence and board effectiveness.Maria Vagliasindi (2008).
  • The Effectiveness of Boards of Directors of State Owned Enterprises in Developing CountriesNowak, M. & McCabe, M. (2008).
  • The independent director on the board of company directors. Managerial Auditing Journal.Paul Nyakazeya (Fiancial Gazette, 16 February 2017),
  • Directors Fees could come under spotlightSteven A. Seiden (2017). Board recruitment

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Can Boards of Directors Really be Independent? . (2020, Jun 02). Retrieved from https://studymoose.com/individual-assignment-1-21354-new-essay

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