Defining Independent Directors and Their Fiduciary Duties
Discuss about the Corporate Governance and Review of Independent Directors.
The success of any business organization relies on proper corporate governance. The current companies are solely placed in the hands of the board of directors charged with overseeing proper management of the business and its other related activities. However, in the recent years, debates have arisen pointing out on the inefficiency of independent directors and financial crisis reinforcing the doubts about the contribution of board independence towards corporate governance. This paper is aimed at reviewing directors with respect to corporate governance issues. The paper begins by defining independent directors, their fiduciary duties and responsibilities, then it highlights the issue of independent directors and corporate governance issues, discussing successful alignment of directors and company objectives as well as misalignment, before making recommendations on how directors and shareholders could improve on company governance. Finally a conclusion is drawn based on the issues discussed.
According to Dravis and American Bar Association, 2007, an independent director refers to a director that has no employment, family or any other significant economic or personal connections to the company in which he or she is serving as a director in. These directors are appointed by the virtue of voting by the shareholders of the company.
Directors have a duty of due care, that is, they should make considered decisions, and loyalty, referring to the requirement that directors not base their decision making on self interest are the major duties of directors stated by the state law, (Dravis and American Bar Association, 2007). Additionally, directors have other duties that include; disclosure of decisions to shareholders and the duty to act in good faith, as highlighted by Dravis and American Bar Association. There are also rules established inside and outside the corporation that govern the behaviors of directors such as committee charters and company policies. Thus, the directors have a standard of conduct that they should consider before and when taking actions that affect the corporation.
It is arguable how independence of directors affects corporate governance of the company. As Swan and Liesen in their article, ‘Too many independent directors is heart of problem’, explain, the independence of directors means that they cannot have any special knowledge or connection with the corporation. This lack of knowledge mitigate against these independent directors’ ability to effectively monitor management or make a worthwhile strategic decision. Motivating these directors through huge pay to perform diligently, their lack of knowledge base and day-to-day involvement in the business activities and model of the corporation is a draw back to their performance.
Potential Issues with Independent Directors and Corporate Governance
Taking the case of mutual funds organizations, as explained by Carter & Lorsch, (2009), there has been growing concern that mutual fund independent directors are not independent enough as overseers of shareholder interests. Directors’ competence and will are very important to mutual funds shareholders. In addition, it is also important for the directors’ interests to be aligned with the interests of the shareholders. Directors interests in some instances have been aligned with management rather than with shareholders. Thus, inflation of earnings by management in pursuit of higher stock prices has in some cases led to the financially aligned directors buying this idea since they also stand to gain, (Carter & Lorsch, 2009).
The independent directors are accountable to the shareholders and should ensure accurate and timely disclosure of any decisions they make that affects the corporation, as well as all material facts relating to company activities to the shareholders. They should provide the true picture of the organization and should not lie to satisfy their own selfish interests. The principles used to review directors in this case include; accountability, fairness, transparency and responsibility, (Tran et al, 2014). Equal chances should be accorded to all the shareholders in obtaining effective redress of shareholders rights violations. Finally, the directors’ responsibility to act in the interest of the shareholders is also a principle for directors’ review.
The basic corporate governance framework brings together such aspects as company’s mission, strategy, culture, objectives and leadership. Thus proper alignment of all these aspects within the company is necessary to ensure sustainable performance. Alignment of independent directors within the organization requires the shareholders to ensure that these directors are first familiarized with the business mission, vision, goals and strategies, both short term and long term, (Sanders & Wood, 2015). Voting of competent directors who are familiar with the specific type and form of business that the corporation engages in is also a key requirement to ensure alignment of directors within the company.
After admission into the board of directors, they are informed of the company policies, rules and other related laws regarding to directors’ behavior within the organization. A supervisory board is also important in ensuring that the independent directors act in the interest of the shareholders and the company at large and also comply to the legal and state requirements. Further effective communication system within the organization also ensures alignment within the organization.
The independent directors have interests that are aligned to the organizational objectives. However, in some cases, there occurs misalignment of these directors’ interests with the organizational objectives, (Hien et al, 2014). Some of the causes of such misalignments are: the directors putting their personal remuneration as the primary goal instead of shareholders wealth maximization; lack of genuine desire to meet corporate governance responsibilities; taking advantage of the fact that they do not own shares in these organizations; constant pressure from the shareholders to maximize shareholder value; lack of the required skills and competency; failure of the supervisory board to effectively ensure that the directors act in accordance with the organizational objectives ; weaker regulatory processes that sometimes do not see through that those directors who engage in financial crises are brought under law and punished accordingly; and biased voting processes that sometimes see into office the inefficient directors, (Kellermann & De, n.d.).
Successful Alignment of Directors and Company Objectives
According to Carter and Lorsch, 2009, shareholder alignment into the corporate governance is an important factor as directors would perform better if they think and act like shareholders. Therefore, they should own stock and the more the better. Therefore, non-executive directors should be paid in stock or options and be required to own a given amount of equity. The more stock directors hold, means the more their compensation is at risk and thus the more aligned they would be with shareholders’ interests.
Taking an example of mutual funds organizations, Carter and Lorsch, 2009, highlight that several arguments are offered towards ensuring that the independent directors interests are aligned with the shareholders interests. These include: the directors should invest a significant proportion f their financial assets in the mutual funds they serve along with adequate disclosure; this would help in the alignment of directors interest on the basis of self interest. Secondly, mutual fund directors would be more aligned with shareholders if they were not chosen by the fund investment advisors. Also, ensuring effective communication between the independent directors and the shareholders would also help reduce misalignment, (Carter & Lorsch, 2009).
Moreover, avoiding the conflict of interest between the directors and the shareholders to ensure good corporate governance could also be attained through ensuring competency and will in electing directors and thorough scrutiny of each individual director’s profile, credit history and other relevant information before joining the company board.
Finally, constant audit of company assets and books of accounts along with directors’ corporate governance effectiveness is necessary to ensure that any slightest action that does not conform to the company policies or any biased decision would be detected early enough to avoid future diverse effects, (Clarke & Branson, 2008).
Conclusion
The issue of conflict of interest between the independent directors and the shareholders and the fact that independent directors do not hold shares in the companies which they control, often lead to corporate governance issues evidenced by financial crises or misappropriation of company funds, (Hien et al, 2014). Therefore, measures should be taken to ensure that independent directors are competent enough and have the will to effectively ensure sustainable performance and growth of the company. Further research is necessary to unveil more relevant actions that could be put in place to ensure good corporate governance in companies by independent directors.
References
Carter C.B. & Lorsch J. W. (2009). Back to the Drawing Board Designing Corporate Boards for a Complex World. Harvard Business Press.
Clarke, T. & Branson, D. (2008). The SAGE handbook of corporate governance. London: SAGE.
Dravis, B.F., & American Bar Association. (2007). The role of independent directors after Sarbanes- Oxley. Chicago, III: ABA Section of Business Law.
Hien D.T.N, Hoy D.T.N & Hung N.V. (2014). Modern International Corporate Governance Principles and Models After Global Economic Crisis, Part 2. Singapore, Partridge Publishing.
Kellermann A.J. De H.J. & De V. F. (n.d). Financial Supervision in the 21st Century. [recurso electronic].
Sanders N.R., & Wood J.D. (2015). Foundations of sustainable business: Theory, function and strategy. John Wiley & Sons.
Swan, P & Liesen, D. 2018, ‘Too many independent directors is heart of problem’, The Australian Financial Review, Thursday, 3 May, p. 55.
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