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Why independence in the Board, how do NEDs need to be, and how to assure their effectiveness

 

a) Independent and friendly outside directors. Firm Value.

 

Corporate Governance scandals in early 2000`s led to increased director independence as a result of regulation. As Sung Wook Joh and Jin-Young Jung show –“Effects of Independent and Friendly Outside Directors”-, many studies bring forward the fact that directors connected with Ceo and management are “more likely to pay excessively the management, that succesively performs worse than otherwise”. Those studies centered on the Directors`monitoring role. In large firms, in those where directors easily acquire information, whithout asimmetries, this is the case.

But the advisory role, and the directors` connectedness (that helps expand businesses), both are also related with firm value, and perhaps this is more relevant when monitoring is already effective externally, through equity markets and the M&A threat, or because of a highly volatile environment. Friendly outsiders can in this case be positive for firm value, as they do in stand-alone and distressed firms.

When there is a strong regulatory pressure, politically connected ousiders are positive for firm value, through their help in resources` acquisition, (licenses, and so on). This is also the case for firms acting locally.

 

This helps understand why some firms still keep recruiting friendly directors, deeply believing that they act efficiently, even if they send a negative signal to markets

 

It would also help understand why “When regulation forces a board to become more independent than endogenously determined, the CEO may counteract by strengthening connectedness with other key players governing the firm” so as to weaken the regulatory effect, (“The Independent Board Requirement and CEO Connectedness”, by E. Han Kim and Yao Lu, where the authors consider a bad effect of Ceo connectedness on governance, monitoring, performance, and hence, firm value).

 

b) What is an Independent Director?

 

The Spanish Governance Code, (Código Conthe), establishes that an independent director is one that is elected for his/her personal and professional profile, and is isolated from pressure coming from management, significant shareholders and the corporation itself. He cannot have been Director in other group`s firm, he cannot be employee or otherwise receive significant fees or payments from the company; he cannot be himself or have been named to represent a significant shareholder; he cannot be a manager`s relative; he must have been proposed by the Nomination Committee. Basically, he needs to be an unconflicted director. As Richard Leblanc affirms, (“Rethinking what it means to be an “independent” Director”),  the problem is the way conflict is determined: it is usually judged by the Board, whether “there are material relationships,…., that can reasonably be expected,…, to interfere with their independent judgement”. For an employee, a conflict of interest is understood to exist, when a superior and objective body, (a manager, the Board), thinks it exists, and the judgement is not limited to what the employee thinks by himself. But when the Board assesses the subject itself, it very often forgets to notice social connection among directors, long tenure, other perks and capture instruments offered by management, and so on. Perhaps the existence of conflicts of interest should be assesed in a much objective, even external to the Board, manner.

 

c) What are the main qualities of an Independent Director?

 

According to a survey and report by Korn Ferry International, (“Greatness Cultivated in the Boardroom”), there are different sets of required attributes for a NED:

–         Core characteristics: they need to be strong but not domineering, strategic but able to drive into the detail, engaged and team oriented, while able to preserve thinking independence, and committed. Of course, experienced.

–         Characteristics on the rise: they need to deeply understand risk, (so as to determine the company`s risk appetite, not just approving managers` decisions on that), have a global outlook, be responsive to change, and familiar with new technologies and social media; of course, they need to have a long term view and perspective,  (both on corporate responsibility matters, and strategy).

 

There is also a perceived list of behaviors that Neds need to avoid:

 

–         Hostility, egocentrism, uncommitment, policeman style, captiveness of compliance.

–         Non-stop talkers, nodders, hesitators.

–         Particularly relevant, NEDs need to understand the challenges the company is facing.

 

d) What should a Board/and the NEDs themselves do to optimise a NED`s performance

 

–         Boards should use personal and collective evaluation of NEDs and boards, and of course provide them with all reasonable support.

–         NEDs need to: learn as much and as fast as possible, ask and listen before issuing uneducated comments, commit to add value, and reach out other directors and relevant people.

 

 

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