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Hall, Kath; Mire, Suzanne Le --- "A company ID - Corporate governance" [2006] MonashBusRw 37; (2006) 2(3) Monash Business Review 14

A company ID
Corporate governance

Kath Hall, Suzanne Le Mire

The independent director is hailed as a tool to monitor and improve corporate management and decision making. This role is premised on the belief that directors who are independent of a corporation can be faithful guardians of its interests. However, powerful group influences can sully this, write Kath Hall and Suzanne Le Mire.

Independent directors have no real direct or indirect connection with the company, other than the board position and a shareholding of less than five per cent. So no wonder there is much talk about the independence such directors bring to bear on management performance. How well this works in practice however remains unclear. While external directors have been present on corporate boards since the 19th century, focusing on them as monitors of board behaviour is still a relatively new area of interest.

The role of independent directors has been growing steadily in Australia since the 1980s. However, a spate of corporate failures, such as Enron (December 2001), World.Com (June 2002), HIH (March 2001), One.Tel (May 2001) and Ansett (September 2001) saw the Australian Stock Exchange convene the Corporate Governance Council in August 2002 to provide corporate governance guidance. Its report, Principles of Good Governance and Best Practice Recommendations released in March 2003 gave listed corporations choice – either comply with all recommendations or tell us why not.

The report states that a board should have a majority of independent directors but does not state what they should do. There should be a majority independent audit committee, a nomination committee and a remuneration committee. It states that a non-executive director will not be independent if they are a substantial shareholder or have been an executive, professional advisor or consultant to the corporation in the last three years. Business relationships will only preclude independence if they are “material”, a term that the corporation should define, or they “materially interfere with, or could reasonably be perceived to interfere with, the director’s ability to act in the best interests of the corporation”.

As a result, independent directors have been given additional responsibilities both on the board and through committees controlling the audit, compensation and nomination functions once exercised by management. In Australia about 38 per cent of the top 250 corporations claim to have a board with a majority of independent directors and all but 19 of the top 250 corporations have at least some independent directors. In the US the changes have been more stark, with the boards of the majority of publicly listed corporations dominated by independent directors.

The effect of these reforms has been to increase the numbers of independent directors and improve their independence. Although the efforts to increase numbers appear to have been reasonably effective, improvement to the definition of independence has been less successful.

While the UK, US and Australia have achieved some common ground in their definitions of independence, there are significant differences. All three state that past employees are subject to a cooling-off period before being classified as independent. In addition, there is a common focus on the compromising nature of material relationships, such as business connections, family relationships and interlocking directorships. The UK has emphasised the potential for independence to be lost as time passes and so directors in the position for more than nine years are no longer classed as independent.

What does the independent director do?

The monitor

The independent director monitors management, corporate performance and compliance with regulation and at those times where management interests conflict with shareholders’ interests, this works as a safeguard.

The decision-maker

The independent director has a role in making major policy decisions and brings important outside experience and specialist knowledge. Clearly executive directors will have a greater knowledge of the corporation itself but the independent director may contribute experience gained in other spheres or on other boards.

The voice for others

An independent director represents the interests of both owners and shareholders. This may require direct contact with shareholder groups. It has also been argued that the independent director has a special role to play as a representative of non-shareholder groups.

The ambassador

‘Big name’ independent directors on corporate boards can represent the corporation to the market and attract potential investors. At times, particularly if they act as chairperson, they have to explain the actions of corporations and, as in the case of James Hardie’s Meredith Hellicar, become the public face.

Possible problems with this role

As O’Connor writes: “Social psychology teaches that people are fallible. Specifically, good corporate actors can make bad decisions when placed in certain situations. They can do so without guilt, however, because self-serving biases allow them to rationalise their behaviour to maintain self-esteem. Societal and corporate norms foster this rationalisation process so that corporate actors can continue to think of themselves as honourable people”.

In other words, being able to speak out effectively in the decision-making process can be compromised by being part of a strong team. Independent directors are expected to not only work within the board’s collective interest but to cooperate with other board members in reaching consensus, an arrangement that can compromise independence.

Inner circles

One risk with corporate boards is the formation of inner circles or an ‘in-group’ with strong pressure to conform, an idea informed by the concept of ‘groupthink’. Researchers have shown that strongly cohesive in-groups can become captured by group blindness, group pressure and self-interest. Members unconsciously generate shared illusions that hinder critical reflection and reality testing. As Justice Owen noted of HIH: “There was blind faith in a leadership that was ill-equipped for the task. There was insufficient ability and independence of mind in and associated with the organisation to see what had to be done and what had to be stopped and avoided. Risks were not properly identified and managed. Unpleasant information was filtered and sanitised. And there was a lack of sceptical questioning and analysis when and where it mattered.”

Clearly, cohesiveness can have positive benefits for group decision-making such as can lead to confidence, risk-taking, optimism and competitiveness. However, the desire to maintain group cohesiveness can also override critical judgment. As many boards have high levels of cohesiveness, this raises questions as to how ‘cognitively independent’ external directors are really able to be.

Rationalisation and socialisation

Although initially independent directors may be well placed to identify poor governance practices, they can quickly be socialised to accept those practices as normal, most commonly through co-option and compromise. With co-option, rewards, often subtle and offered over a period of time, can be made to change attitudes to particular behaviour. They can include donations to a director’s favorite charity, provision of desirable business or social connections and investment opportunities. In the case of Enron, executives at Merrill Lynch were co-opted by the prospect of large fees and a closer relationship with the board.

• Raising awareness of the power of group dynamics to compromise independent directors is essential. Here are some practical steps to help avoid compromise:

• Protocols put in place to ensure independent directors are automatically passed important information.

• Agendas to be set at the end of each board meeting to allow board members to add any important issues.

• Encourage independent directors to share ideas and concerns away from the board process.

• Give independent directors access to independent outside advice.

• Increase the awareness of external issues and improve decision-making by giving shareholders and stakeholders indirect input via independent directors.

The time to ensure independent directors work best in their role on corporate boards is now. With new reforms in place and the number of independent directors increasing, we need to consider all possibilities that affect the potential of independent directors, especially the human and behavioural aspects of the corporate board room.

MBR subscribers: To view the full academic paper, email mbr@buseco.monash.edu.au

Public access: www.mbr.monash.edu/previous_issues.php (six month embargo applies)

Cite this article as

Hall, Kath; Le Mire, Suzanne. 'A company ID'. Monash Business Review. 2006.; Monash University ePress: Victoria, Australia. http://www.epress.monash.edu.au/. : 14–16. DOI:10.2104/mbr06037

About the authors

Kath Hall

Kath Hall is a legal academic with more than 10 years’ teaching and researching in universities in Australia and overseas. She has published numerous articles on corporate law and is currently undertaking doctoral study on the regulation of corporate dishonesty at ANU.

Suzanne Le Mire

Suzanne Le Mire is a PhD student and tutor at Monash University Faculty of Law. Her research interests include regulatory theory, corporate governance, professional regulation and ethics. Her PhD thesis examines the role of the independent director in large publicly listed corporations.


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