Why director independence matters, and how can boards ensure it

“Boards often invite us to have these facilitated discussions,” said McCormack, Accenture’s global leader of board effectiveness and sustainability. “It’s because they’re difficult. So they said, ‘Debbie, can you come in and help us discuss, are we having appropriate independence and are we meeting what’s expected of us?'”

For McCormack, director independence is critical because it allows board members to take opposing positions to management.

“There needs to be healthy tension and robust discussions between the board and management,” she said. “It’s really important that the advisory and oversight functions are independent so that (directors) can actually exercise oversight and remain objective. Most importantly, I think board members need to make decisions that are in the best interests of shareholders, so that means there is no interest conflict.”

Public companies must meet legal requirements to appoint directors who have no significant relationship with the business and are not involved in day-to-day operations. However, some experts question how useful the current definition of independence is and argue that board members are susceptible to management influence, making organizations vulnerable to activist investors.

At the same time, the longer tenure of nominally independent directors hampers efforts to promote board diversity.

“Public companies have always been well served by independent directors, who bring different perspectives, experiences and diverse industry backgrounds,” said Tierney Remick, vice chairman and co-leader of the organizational consulting firm’s global board and CEO succession practice. Korn Ferry. “When they sit at the table, they bring a perspective that’s not just about the company, but what they’ve seen in other similar or consistent situations. First and foremost, they also always focus on the stakeholders.”

In the United States, the federal Sarbanes-Oxley Act of 2002 McCormack said the bill stipulates that the audit, compensation, nomination and governance committees of public company boards can only have independent directors. “Exchanges have also adopted their own standards, and of course, they are also tied to legal mandates.” There are also regulations at the state level.

New York Stock Exchange and Nasdaq Stock Exchange need both Most members of the board of directors of listed companies are independent.The two exchanges also stipulate that in order to obtain independent qualifications, directors of listed companies can obtain Not to exceed US$120,000 Receive compensation from it over a 12-month period.

However, there are no mandatory term limits for directors, which could put their independence at risk. “Board members who have worked with management over time can develop really deep friendships, but this can challenge independence,” McCormack said. “They become friendly with management rather than being truly objective.”

McCormack noted that many European countries have term limits. “That actually puts them in a position where they need to be updated on the board to meet the requirement that the majority of the board members be independent,” she said. “This is an area where we see some challenges on the board because you expect these board members to ask these difficult questions.”

Remick believes boards have made progress when it comes to director independence: “Ten, 15 years ago, board composition was largely determined by connectedness,” she said. “Over the past 10 years, and especially the past five years, strong boards have been very strategic, very objective in how they bring in new board members. How does it balance with all the other skills on the board; how does it align with strategic needs? So I think there’s been a shift in how the board approaches this issue.”

Korn Ferry noticed another shift, Remick added. “We’re actually seeing more and more private boards that, frankly, don’t have an independence requirement, but by the same token they are actively seeking multiple independent directors for private boards, including private equity boards,” she says. “They want objective, stakeholder management; they can’t be bought by management for whatever reason. They bring great experiences, great perspectives. If they’re well-trained, they can Challenge without being too picky.”

But according to governance expert Richard LeBlanc, the definition of director independence is flawed. “It fails to identify pre-existing social, political and personal relationships that directors may have who may qualify as independent but may not have intellectual independence within the board,” said LeBlanc, professor of governance, law and ethics at York University. University in Toronto. For example, a director may have gone to college with the CEO.

James also pointed out that there are no mandated term limits, and he gave some examples of incentives that management could offer directors. “‘Do you want to go to dinner? Do you want to go to a meeting? Do you want to go to a club? Do you want to go to a resort? All of these things are under the radar screen.”

LeBron believes it’s easy to “occupy” the boardroom. “You spend 10 or 20 pounds and you now have a board of directors,” he said. “Even if you put an independent director on the board, there’s nothing to say you can’t use management resources to capture that person.”

James warned that activist investors are taking advantage of the situation. “When I help activist investors,” he said, “they tell me that every director has been caught. It’s just a matter of figuring out the relationships, the cascading links.”

LeBlanc explained that if activists decide to attack a company, they hire people to dig into each director’s background and demonstrate pre-existing ties to management. “It could be academic, it could be work-related, it could be a favor, an honorarium, a gift,” he said. “Activists did breach regulations.”

When McCormack talks to clients, they keep mentioning the length of time some people have served on the board.inside 2022 Spencer Stuart Board of Directors Index She noted that the average tenure of independent board members at S&P 500 companies is 7.8 years, according to the executive search and leadership consulting firm.

“Some of the board members have been on the board for over 20 years, and some of them … this is their first year,” McCormack said. “But they are still equally considered independent. If you think about it, some of them have probably been around longer than the CEO or multiple CEOs.”

McCormack stressed that this would impact diversity on the board. Last year, 68% of directors on S&P 500 boards were men, according to Spencer Stuart. “Is that where we want to be?”

It seems many business leaders share the same concerns.in the recent United Nations Global Compact—Accenture CEO StudyMcCormack said 31% of about 2,600 CEOs surveyed said they wanted to increase diversity on their boards. “If we didn’t make the effort to provide refreshments, this wouldn’t happen.”

Do the rules regarding director independence need reform? Aaron Neely, associate professor of law at the University of Wisconsin-Madison, would like to see some changes. He said that today, in response to investor pressure, the vast majority of directors of large U.S. public companies are so-called independents. “But what does that mean in practice?”

Most of these organizations now also have an independent chair or lead independent director, designed to help the board rein in the power of management.But after examining data from 900 companies recent papersNeely found that many “board gatekeepers” were not worthy of their reputation. “Although companies designate these types of roles, they often lack any material power.”

Neely said this shortcoming exposes the troubles of relying on abstract stand-alone concepts, which can mean different things to different people. For him, the answer is better disclosure: “Regulation ensures that companies provide enough information to investors so that they can determine for themselves whether they believe that person, that director, is independent.”

Neely believes the move will empower directors. “Once they allow investors more information about how companies appoint independent directors, they can push companies to provide them with more substantive tools,” he said. “They have more information at their disposal to put checks and balances on management, and more powers given to them in corporate documents allow them to create a board environment where independence is actually reflected in practice.”

Although LeBlanc doesn’t think the U.S. has much appetite for more regulatory reform, he suggested similar changes. “The definition should be more stringent so that you can really measure true independence,” he said.

James also believes the SEC should force public companies to reveal the origins of every proposed board member. “How and why did you choose this director?” he asked. “You should also be forced to explain your nomination process.”

James suggests that this explanation should address gender and diversity in addition to ability. “There has been some progress on diversity, but directors and boards still have considerable latitude,” he said. “It’s the old adage: it’s who you know. That doesn’t make a good board. A good board is based on what you know, not who you know. Who you know should be Disqualification.”

In the UK, listed company boards are required to undergo regular peer reviews of their independence by third parties. Likewise, Remick noted that many U.S. boards now conduct an evaluation every two to three years, which he calls a “board effectiveness health check.” The process is designed to ensure that all directors are contributing as expected and that the board culture is conducive to supporting management, she said. “The chair leads the effort, but there is often a third party that helps activate it.”

McCormack favors such assessments: “Our clients find board assessments critical to improving their overall performance and effectiveness, and independence is part of that, especially when third parties are involved.”

She also suggested having an annual discussion about the independence of board members. “Has anyone been serving on the board?” McCormack asked, giving an example. “Has the $120,000 threshold been met?”

For McCormack, it also involves meals and refreshments. “Boards should review their skills matrix annually and determine whether they have the right directors to support the company’s strategy,” she said. “It will help them look at their independence and help them see if they have the right skills, rather than them having to look for them.”