Last year two academics from the University of NSW stirred some controversy (and provoked a lot of thought) with a research paper that didn’t just question the conventional wisdom about the virtue of having a majority of independent directors on boards, but attacked it.
A more focused version of that paper comes to the same conclusions.
Last year’s paper was co-authored by the university’s Peter Swan and Marc-Oliver Fischer. It looked at a sample of nearly 1000 Australian listed companies and their relative performance since the ASX introduced its best practice guidelines for board composition in 2003, with their 'comply or explain' or 'if not, why not' approach.
In assessing the relative performance of 57 per cent of the companies with a majority of independent directors against the 43 per cent which didn’t comply with the guideline, their conclusion was that those companies that conformed to the accepted wisdom that a majority of independents is desirable had destroyed at least $69 billion of shareholder value.
Professor Swan and another UNSW colleague, David Forsberg, have reportedly updated that research with a paper presented to a conference at the weekend that focused on ASX 200 companies. It came to a similar conclusion, arguing that the companies with a majority of independent directors had destroyed between $30.7bn and $51.6bn of shareholder value.
The reasons proffered for the under-performance of companies that have conformed to perceived best-practice relate to not having 'skin in the game'. They therefore have no meaningful alignment with the interests of shareholders, are slower to act and are less effective than their non-complying counterparts; they are tardier in replacing ineffective chief executives and pay CEOs and themselves more than boards where directors do have skin in the game. They have little (if any) direct experience with the company or even its industry.
The point the papers have made is that the rules promulgated by the ASX Corporate Governance Council more than a decade ago, and which reflect what is almost a globally accepted view of best practice, were put in place without any objective research. This is now being remedied.
The ASX rules deem directors not to be independent if a director has been an executive with the company or an adviser during the past three years or if they have a substantial (five per cent-plus) shareholding in the company. Longevity as a director is also seen to undermine independence.
The push for a majority of independent directors was driven by a view that it would improve corporate governance, bringing independent eyes to the actions of management, avoiding conflicts of interest and representing and protecting the interests of shareholders-at-large. To the extent that there was any thought given to the impact on performance, it was assumed it would be a positive.
One of the issues the papers have raised is the quality and size of the pool of available independent directors, many of whom are professional directors, and whether they do bring independence of thought and sufficient understanding of the companies and their industries to the boardroom rather than just their independent status. Some companies, of course, do go to great lengths to construct boards with a range of skills and experiences that are appropriate to their needs.
A wider discussion might put the conclusions of the papers into the context of the more general focus on corporate governance over the past couple of decades. Such considerations may include the increased exposure to liabilities and reputational damage that non-executive directors face and the risk-aversion and 'box-ticking' mentality that might create for people who, because they don’t have large shareholdings in the companies, have an asymmetrical risk-reward equation that would inevitably make them more conservative.
There might well be a compromise between good governance and performance that could be achieved, not by doing away with the notion that independent directors can provide a watchdog for the wider shareholder base, but by reducing the 'incentives' for them to focus on governance and self-protection ahead of performance.