IS THERE AN ALTERNATIVE TO DIRECTOR INDEPENDENCE?

e intentions of fairness behind director independence are unassailable. But that doesnt mean its worth pursuing at all costs and ignoring other options
By David W. Anderson

EVER-TIGHTENING RULES FOR director independence are hard at work in a full-on eort to banish conicts of interest from the boardroom. And, in light of front-page board behaviour featuring apparent abuses of power and questionable decisions made with serious conicts at their heart, its clear why regulators, stock exchanges and institutional investors around the world have taken up the issue. Yet even as quotas and guidelines show success in creating more structurally independent boards in Canada and other countries, there is also a growing concern that vital business knowledge and the boards condence to question management are being squeezed out in the process. As the losses accrue, they threaten to reduce the very eectiveness of boards that greater independence was supposed to enhance. When costs threaten to outweigh value, its time to revisit the assumptions. To this end, some further discussion as to what independence can reasonably achieve, how the costs can be minimized along the way, and what alternative means are available, is required. THE ARGUMENT IN FAVOUR of director independence is compelling:

require directors charged with making decisions to be independent of the interests that are engaged or aected by such a decision. Corporate stakeholders ought to be able to rely on clean hands deciding matters of consequence. Measures to put greater distance between management and directors are well-based in the argument that conicted decision-making has a reliable habit of favouring vested interests holding power, and disadvantaging uninformed or weak parties. Certain areas of decision-making over which boards have responsibility make this conict clear: director nominations, director pay, audit oversight of nancial performance and disclosures, relatedparty transactions and executive pay. Quite justiably, then, independence logic has made its way into the standing committee structureaudit, compensation and human resources, governance and nominationand the ad hoc committees reviewing such things as related-party transactions and special circumstances. In fact, with so many committees requiring independent directors, boardsalready smaller in number by choicenow o en consist entirely of independent directors with the exception of the CEO. But its what happens next where the problems may emerge: kExperience changes us. Even if directors are independent when elected, its hard to remain functionally independent of management over time. Directors commit considerable time to the role, they have income and wealth tied up in the company, and they form bonds working closely with executives. kUltratransparency. With expectations of accountability at an all-time high, all it takes is a hint of dependence or relatedness to impugn even the most sterling reputationsas Purdy Crawford and Maple Leaf Foods discovered. Some shareholders may even question a directors purported independence as a tactic to gain inuence over board decisions and composition more to their liking. kBureaucracy triumphs. Choosing certain members only to ll quotas hurts boards eectiveness and credibility. We see it too o en: as directors, these recruits are polite, happy for their newfound status, grateful for the payand largely unable to make any meaningful contributions.
28 Listed / /Spring 2011

So what are some solutions? ose who argue that a strict independence criterion for service has weakened boards oer a promising but vague alternative: loosen the independence requirement and elect directors pragmatically, based on their ability to contribute. But thats hardly practical for shareholders who would be hardpressed to know who to vote for, given that boards produce the nominations and theres little substantive communication between the two groups. Judging actual performance for subsequent elections would be even harder. e British solution is to require only 50% of the board to be fully independent, leaving ample room for outside directors (non-executive, but neither fully independent) and current executives privileged with helpful knowledge and perspective to serve on the board. e Scandinavian solution, meanwhile, is to attack at the root of the problem, at least in one area: director nominations. e conict of interest among directors self-nominating is simply eliminated by removing the responsibility for director nominations from the boards hands and placing it with major shareholders. Boards are thus not self-nominating, self-judging or self-perpetuating.
SO THERE ARE OPTIONS. And thats critical. Because what the debate on director independence also shows is were pushing up against the logical limits of our current governance model. e simplicity of a single board holding the global decision-making authority over itself, management and the company has the virtue of unied power and the burden of trying to face down conicting interests. We may have good reason to clean up corporate governance. But in our current model, director independence seeks to square the circle by taking conict out of the one all-powerful body by putting in people with no connection to the business. is approach may well suit a subset of board decisions (e.g., adjudicating related-party transactions), but at the cost of reducing the potential value of the board overall to the business. One nal, more radical solution worth considering, long championed by governance thinker Dr. Shann Turnbull, is to separate fundamentally dierent classes of decisions (governance, business, related-party transactions) and assign them to dierent decision-making bodies, who are then composed of people best suited to the task. For example, the essential governance mattersoversight of audit, pay, director nominations and related-party transactionscould be assigned to a governance board made of people who logically hold these responsibilities: a representative set of owners, fully independent of both the board they appoint and management. Such thinking is not likely to nd its way into the mainstream any time soon. Until then, there is no escaping the challenge faced by owners and the boards they elect, to carefully nominate and select directors who meet strict independence criteria and who are ableby sheer intellect, motivation and commitment of timeto learn the business well enough to add value to executive thinking while remaining objective enough to keep the trust of stakeholders in determining the fate of their corporations.

David W. Anderson is president of and a Listed contributing editor.

e Anderson Governance Group in Toronto

www.listedmag.com

Photograph TK