Contrary to board compositions in the past, independent directors have been increasingly hailed as the solution for better returns in the case of shareholders. However, research is inconclusive in this regard, and harks back to studies conducted in the 1980’s, which observed that independent directors would act as a system of checks and balances for CEO’s and result in greater transparency. In addition, it is assumed that an independent board implies greater access to external resources, business and social networks.
In recent times, almost all boards have a majority of independent directors but this has actually been linked to negative outcomes including lower profits, less than stellar performance and organisational disruption. To give some context, data from a survey done by Institutional Shareholder Services has shown that around 36% of S&P 500 companies did not have an employee on the board, besides the CEO in 2000. At present, this number is at 75%. The rapidly evolving trend raises issues such as whether the board is truly more efficient with more independent board directors.
Require The Right Information
There are certain costs associated with having a board comprise of independent directors. Studies have demonstrated that the level of performance and quality of advice given by independent directors is very much dependent of the type of data they are provided. As an employee, one has unique perspectives with regard to the day-to-day operation of a company, which is considerably less when one is an outsider that does not spend as much time at the organisation.
Typically, insights and observations pertaining to the strategic direction of the organisation are shared with the board by the CEO, which itself may result in a biased source and reduce the authenticity of the information given. In addition, an independent director may not attend all board meetings, as they are often full-time executives that are hired for their knowledge base and extensive experience in the industry. Such inconsistent interactions mean that there is less continuity in information exchange between the independent directors and senior management at the organisation.
Higher Likelihood of Error in Judgement
If there is a majority of independent directors on the corporate board, it might result in additional challenges when fulfilling the task of replacing the CEO as required. Due to the nature of their role, independent directors are quite removed from senior executives at the respective organisation, and have mostly limited interactions with them. If they are part of the decision-making committee for electing a new CEO, they might be considerably ill-informed and unable to take a call on which person is best suited to take on the reigns. In addition, the board may even go ahead with an external candidate without giving the internal candidate a chance to prove himself or herself due to less familiarity.
Less Exposure to Organisational Strategy
Pru Bennett head of investment stewardship, Asia-Pacific at BlackRock recently made the observation that the days when a director could receive papers a week before the monthly board meeting, attend the meeting and have a post-board dinner are over.
“Institutional investors expect directors to walk the floor of the business, engage with employees from all levels, engage with key stakeholders and monitor changes in key data related to culture and conduct. If directors cannot “feel” the culture of their organisation, they are not doing their job.”
Independent directors do not have the chance to develop a strong foundation in company-specific objectives and challenges, in comparison to senior executives at the organisation. Even when a new CEO is hired, they are unable to integrate as quickly to the workings of the board due to a lack of interaction on planning and strategy. If it’s a fully independent board, members are likely to be spending four to six days in the year directly involved in company operations. There is a high chance that they receive information that is not comprehensive, and then use that to guide managers. If the CEO is an internal hire, they are bound to struggle with a tougher learning curve that might cost the company at a later point.