CSE is seeking to strengthen board independence

By Michael S. Olympios

 

The CSE will announce tomorrow at a press conference some small but crucial changes in the corporate governance code aiming to strengthen board independence.

On the outset, the CSE is not seeking to restore just a true balancing act but also market confidence.

Currently, there are three categories of directors; executives, non-executives and independent non-executives. The new provision, which will become effective as of April 30 this year, will now assume that the first two categories of directors are the same and hence a balance between them and the independent directors must be sought. That can only be achieved by ensuring that proportionately more independent directors sit on board.

This is likely to cause some headaches to companies that pay lip service to corporate governance such as family firms, where the founders hand-pick “independent” directors, often from their social circles but have stronger preference for friends and relatives. Currently many non-executive directors are failing to challenge their board on departures from best practice corporate governance or in other strategic matters simply because they are the minority among a third of executives and a third of non-executives. To make matters worse many “independent” directors have other ties with the firm but hardly anyone is looking.

The implosion of the Suphire affair with the mismanagement of the Electricity Authority’s pension fund, in the order of millions of pounds, revealed the true extent of the problem. According to the corporate governance report in its 2004 annual report, Mr. Nicolas Papadopoulos, the president’s son, was classified as independent non-executive director. Mr. Papadopoulos was also serving as the company’s external lawyer. For what it’s worth, Mr. Papadopoulos also admitted that he was a close friend to the company’s CEO and his wife.

But Suphire is not an isolated case. Nearly every family firm follows similar practices and the CSE is struggling to change that. Only the largest companies claim full compliance, both in the letter and in the spirit of the principles, though small departures might appear from time to time.

There are enormous benefits to be realized from a balanced board membership. “The potential competitive advantage of the unitary structure lies in its combination of the depth of knowledge of the business of the executive directors and the breadth of experience of the non-executive [independent] directors…The executive directors bring to the board their inside knowledge of the workings of the business and the nature of its markets, while the outside directors bring their experience, knowledge, and independence of judgment” argues Sir Adrian Cadbury.

Derek Higgs’ prescription was that “there should be a clear division of responsibility at the head of the company which will ensure a balance of power and authority such that no one individual has unfettered powers of decision.”

Professor Andrew Chambers on the other hand rightly argues that “the essential difference between “the board” and ‘management’ are the non-executive directors. Strip out non-executives from boards and boards become just another management forum,” he says.

More independence alone cannot guarantee that companies are run well. For proof, look at Enron. On paper, the company’s corporate governance was admirable. What really counts in the end is how directors behave and what questions they ask.

 

Michael S. Olympios is Chief Consultant at Allied Consultants. e-mail: [email protected]