Efforts towards strengthening corporate governance have seen regulators around the world enact Codes to improve ethical standards in business. A common theme in the Codes is the independence of the Boards of Directors that oversee corporate managers. The crux of the Agency theory upon which corporate governance is based, is the existence of an independent Board that will ensure that the managers (agents) do not act in their own self-interest to the detriment of the owners (principals).
Many of the Codes require Boards to appoint Independent Directors with no material relationships with the company. An Independent Director can be defined as someone who has never worked in the company or any of its subsidiaries or consultants, is not related to any of the key employees, and does not/did not work for a major supplier or customer. He or she also holds a very insignificant percentage (ranging between 0.1% and 2%) of the Company’s shares.
The rationale for appointing Independent Directors is that Board members with close business relationships with the company may not assess its performance dispassionately or may have vested interests in some matters for Board consideration. Similarly, Directors with significant equity stake in the business will more often than not, take decisions as “owners”, and oftentimes may not take account of the interests of other stakeholders. The presence of Independent Directors would afford the Board the opportunity of objective and broader considerations in taking decisions in the overall interest of the Company.
Laudable as the concept is, some have criticized the emphasis on Independent Directors, claiming that while they are independent in their scrutiny, they have much less information than “insiders”. Others have argued that the limited “stake” of the Independent Director, would not engender enough commitment to “act in the best interest” of the enterprise. Perhaps the most significant concern that the Board should always keep in view is ensuring that the Independent Director does not lose his independence.
A major threat to independence is familiarity. The Central Bank of Nigeria (CBN) guidelines on th appointment of Independent Directors limits the tenure of IDs to two terms of four years each. Long term relationships engender familiarity, which in turn may becloud independence. Some would argue that eight years is enough time to get familiar. Another factor that could impugn independence is the process of appointing the Independent Director. There are instances where the ID is a nominee of a substantial shareholder, or indeed that of Management.
Economic considerations or self-interest that places the Independent Director in conflict of interest situations is another threat to independence. The CBN guidelines limit remuneration to sitting allowance, director’s fees and reimbursable expenses incurred in pursuit of the Bank’s business. Whilst the company should seek to provide adequate compensation for the time and effort deployed by the Independent Director, care should be taken that such compensation is not of a quantum that would affect independent reasoning.
Ultimately, sustaining the independence of the Independent Director is a function of the ethical culture of the Board on which he sits and the personal integrity of the Director. Where he can no longer act in that capacity, he should have the strength of character to take his leave.