Board Independence

Edited by Demetris Nicolaou, CFA

Member of the Board

CFA Society of Cyprus

Investors should determine whether a company’s board has, at a minimum, a majority of independent board members.

Board members owe a duty to make decisions based on what ultimately is best for the long-term interests of Shareowners. In order to do this effectively, board members need a combination of three things: independence, experience and resources.

This article covers the issues of Board Independence. 

Boards should be composed of at least a majority of Independent Board Members with the autonomy to act independently from management. Board members should bring with them a commitment to take an unbiased approach in making decisions that will benefit the company and long-term shareholders, rather than simply voting with management.

What is Independence? Independence, as it relates to board members, refers to the degree to which they are not biased or otherwise controlled by company management or other groups who exert control over management.

 

Implications for investors.  A board that is not predominantly independent, or a committee that is not completely independent, may be more likely to make decisions that unfairly or improperly benefit the interests of management and those who have influence over management. These decisions may also be detrimental to the long-term interests of shareowners.

Things to consider. Investors should determine whether:

• Independent Board Members constitute, at a minimum, a majority of the board. A board with this makeup and one which is diverse in composition is more likely to limit undue influence of management and others over the affairs of the board.

• Independent Board Members regularly meet without the presence of management and report on their activities at least annually to shareowners. Such meetings permit these board members to discuss issues facing the company without influence from executive board members.

• the board chair also holds the title of chief executive. Combining the two positions may give too much influence to executive board members and impair the ability and willingness of Independent Board Members to exercise their independent judgment. A number of national corporate governance codes require the separation of these two positions.

• Independent Board Members have a lead member if the board chair is not independent.

• the board chair is a former chief executive of the company. If so, investors run the risk that this arrangement could impair the board’s ability to act independently of undue management influence and in the best interests of shareowners. Such a situation also increases the risk that the chair may hamper efforts to undo the mistakes made by him/her as chief executive.

• individuals who are aligned with a company supplier or customer, or are aligned with a manager or adviser to the company’s share-option or pension plan, are members of the board. In some cases, a company with a large number of suppliers, customers and advisers may need to nominate individuals to the board who are aligned with these entities to ensure that it has the expertise it needs to make reasoned decisions. Investors should determine whether such board members excuse themselves on issues that may create a conflict.

Where to find information about the independence of the board and its committees:

• In most jurisdictions, companies disclose the names, credentials and company affiliations of existing board members either in their annual reports to shareowners, or in their annual proxy statements to shareowners.

• Companies often devote a special section in their annual reports to a discussion of the issues confronted by the board and board committees during the past year.

• The websites of many listed companies provide information about board members’ independence.

The CFA Society of Cyprus is a member society of CFA Institute, an international, nonprofit member organization of more than 82,000 investment practitioners and educators in 124 countries. The CFA Institute awards the Chartered Financial Analyst (CFA) professional qualification, the designation of professional excellence within the global investment community. For more information on the CFA designation, visit www.cfainstitute.org or the CFA Society of Cyprus web page on www.cfacyprus.com , e-mail: [email protected] .