Independence isn’t the power the ‘directorati’ would have us believe

Source: Financial Review

By: Gabriel Radzyminski

The upper echelons of corporate Australia are drawing their battle lines against the notion that shareholders might nominate directors.

Esteemed National Australia Bank chairman Phil Chronican has weighed in, citing conflicts of interest should super funds nominate directors to the boards of the companies in which they have an ownership stake.

At its core, this is a discussion about the fundamental conflict of interest in the corporate world – that of principal and agent. In case they’ve forgotten, independent directors are agents and they too have conflicts.

Conflicts of interest are a reality of life. To suggest otherwise is naive, or worse.

Now that we’re discussing conflicts of interest, shareholders also need to consider the potential conflicts of interest that arise from boards making their own nominations.

One of the sources of power and prestige within Australia’s boardrooms is the ability to select those who will gain access to those high tables.

There are king- and queen-makers across corporate Australia. They’re well known and very influential. Securing their patronage can be key to being invited. Of course, the whole process is undertaken in the name of “independence.”

But how independent can someone really be when the club they have joined imposes strictures on them.

The irony is the skills you need to secure invitations to join boards are perhaps the antithesis of the skills required to effectively monitor and test management.

The “directorati” would have us believe that “independence” is a prime objective. Boards comprising majorities of independent professional directors form an impenetrable barrier to conflicts of interest and conflicted decisions. The corporation must be protected from conflicted owners. The corporate elite has built a narrative around itself that it alone can do the job. It’s as if independence is the directors’ superpower.

It was not that long ago that, under the oversight of majority-independent boards, a large proportion of our major banks and financial services companies were keel-hauled by the Hayne royal commission.

So, is it any wonder large investors are questioning the status quo?

Empirical research by a number of academics (for example, Professor Peter Swan at UNSW and Professor Alex Frino at University of Wollongong) suggests that independent directors aren’t the panacea they like to portray, and perhaps they aren’t possessed of any superpowers.

In fact, some evidence suggests boards with more independents tend to destroy more value. Professor Swan argues “experienced shareholders are better than independent directors”.

Some other countries, for example the Nordics, have gone so far as to have external nomination committees, whose members are appointed by the major shareholders.

It is important to remember that what is regarded as good governance in Australia is largely dictated by the ASX Corporate Governance Council, of whose members only a minority represent investors. Furthermore, good governance of the day is usually a reaction to the last great disaster or scandal. For example, the independence imperative has only existed since 2003.

We accept that investor nominees can pose challenges. There are conflicts of interest that must be managed (and disclosed), but this does not mean they are disqualifying conflicts of interest.

We also need to consider whether our expectations of professional independent directors are unrealistic. For the most part, directors will rely on information presented (and selected) by management. The Australian Prudential Regulation Authority inquiry into the Commonwealth Bank after the Hayne royal commission highlighted this very challenge for directors.

Shareholders, particularly those of a certain size, can ask for board representation. Clearly, that director would bring certain conflicts of interest into the boardroom, though not necessarily disqualifying ones. Asking is that shareholder’s prerogative, and they would usually have good reasons for asking for that kind of representation, as it’s not a decision to take lightly.

The other way shareholders might seek to influence the composition of a board is by nominating one or more independent directors for election at a general meeting. To do this, one would have to own more than 5 per cent of a company (individually or among a few investors acting in concert).

The problem in Australia is that boards consider nominations as their exclusive territory – and for the most part, they are. Aside from a particular set of technical skills or experience, the primary attribute the board is looking for is a candidate they have selected.

If shareholder nominations of independent directors were to become common practice, boards would likely see this as the loss of a critical aspect of their personal power. That itself is a subtle, yet pernicious, conflict of interest.

So, when Chronican raises the issues that might arise from investor nominations, we should also think about conflicts of interest at the boardroom more generally.

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