Can boards ever be truly independent or is it a myth?

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By Tom Barkley – Tom.Barkley@EthicalBoardroom.com

Governance issues and managing governance challenges are now central tenets of everyday corporate life.  The Sarbanes- Oxley Act of 2002 imposed numerous corporate governance requirements on U.S. corporations and likewise legislative or regulatory measures have been put in place globally. New and more stringent practices have been brought into company governance models so that day-to- day focus can be applied to business success and goals. However, the problem of filling the board with members meeting independence and professional requirements remains a challenge and competition for qualified individuals remains acutely fierce. Even with an increasing amount of concern the question still remains – can anyone, including board members, ever be truly independent?  

The post crises recovery is fuelling a new phase of mergers and acquisitions (M&A) activity across the global marketplace and meeting independence constraints is a tougher challenge now.  The challenge is primarily caused by the high probability of top-level executives having had some type of business interaction previously which is most likely fundamental to their skill set.  For example, retired executives are a logical choice for director candidates, both for their business acumen and their ability to dedicate time to the job.  However, recruiting retirees to serve on audit committees can be problematic and create numerous conflicts if a former employer is the corporation’s current or recent past auditing firm. An intimate understanding of all business functions, operations and constituencies is needed in boardroom members and this can only be developed through past experience in the business world – therefore perhaps no one board member can ever be truly independent. 

Despite the questionable end points of this endeavour, understandably, a trend in seeking truly independent directors is growing. Certain measures have been put in place to at least strive towards achieving independence- perhaps this is the most that can be hoped for in the board room. To sacrifice the required amount of business skill, acumen and experience in the name of independence would neither be in the best interests of shareholders nor the business and could prove more costly than beneficial in the long run.  In the U.S., the New York Stock Exchange (NYSE) and NASDAQ now require listed companies to have boards comprised of a majority of independent directors. Nominating and compensation committees of NYSE companies must have only independent members, while the NASDAQ allows these bodies to be either fully independent or contain a majority of outsiders. The Securities and Exchange Commission (SEC) and the exchanges require an all-independent audit committee, with the added condition that members be “financially literate.”  While establishing the independence of directors is challenging, there are some common guidelines. In the US, the NYSE and NASDAQ listing standards define independence.  In general terms, the standards require that a director must have had no business relationship with the corporation for a minimum of three years, and they describe the types of family and business relationships that are prohibited. In the UK, the Combined Code on Corporate Governance, periodically revised by the Financial Securities Authority, places a five-year limit on a business relationship in order for a director to be considered independent. Companies are required to prove independence. In most countries, corporations must disclose the criteria used to determine independence. 

Despite the obstacles, it is possible — through planning and effort — to recruit highly qualified and independent (to the best possible extent) directors. The best results will occur when boards and nominating committees are realistic and thorough in the selection process.  Boards and nominating committees must accept that it may take more time to identify and qualify candidates, and should be prepared for refusals. The number of executives who have made the choice to avoid directorships or limit them to one or two is increasing due to the high-litigation and accountability climate in this area. The very fact that independence is so elusive and intangible, especially to prove in court, has made board directors targets of lawsuits from shareholders and this can be extremely costly and damaging to both the company and the individual.  This has made candidates find board membership less appealing and the supply is consequently shrinking.  With the competition for qualified director candidates remaining fierce, the nominating committee and its advisors will need to be more creative in identifying potential directors. They should look beyond their company’s industry about possible candidates all the while keeping independence and objectivity as a key feature of their choice.  By taking a more studied approach to selecting directors, nominating committees will find more suitable candidates. This will result in a better functioning board, a key factor to a company’s long-term success.