What difference do independent directors actually make? - Peter Crow

I see the Italians have updated their corporate governance code. The new code, most of which comes into effect on 1 January 2015, requires, amongst other things, publicly listed companies to have at least two independent directors. This sounds like a good move; one which is consistent with codes elsewhere, including New Zealand and Australia for example. The basis for requiring at least two independent directors (also called outside directors in some jurisdictions) on the boards of publicly-listed companies sounds robust: independence is said to be conducive to improved decision-making and to transparency, and two directors have more chance of exerting influence than one lone voice.

But what of the holy grail question? Do independent directors enhance business performance?

Many practitioners think that the approach to discussions, debate and decision-making by independent directors is more deliberate and objective (than executive/insider directors), primarily because independent directors are thought to be less emotionally involved in the day-to-day business and that they have less to gain or lose. Over the last three years, I have read upwards of 50 research papers on independent, non-executive and outsider directors. While the research is not unequivocal, the general tenor seems to bear practitioner perceptions out.

However, the impact of independent directors on business performance far less clear cut. A variety of conclusions are apparent in the research. Cause has not been established. It's a bit like saying that female directors cause companies to perform better. Increasingly, people are realising that board performance is more likely to be contingent on what directors do in certain situations than on who they are or any specific board structure or composition. Like gender, the independence attribute is likely to be a proxy for something else. We need to discover what that might be, so it can be used to qualify the suitability of director candidates and inform board performance assessments. Only then will the writers of codes be able to move beyond the reasonably blunt instrument currently in use: proxies.

6 Comments

Les Horn - 1 week ago

Firstly it would be interesting to define how independent they really are. Non executive helps to define the position. Shareholding is OK so long as the level of ownership is relative small (for example in public companies a fraction of less than 1/10th % would seem reasonable) (in private companies less than 1%) would seem reasonable. Finally not having any familial relationship to any of the executive would be a guide.
Having established independence then the criteria is simply one of bringing a skill set that adds value to the board.

Peter Crow - 1 week ago

My thesis is that structural independence, like gender, is not the defining issue. Codes that require independent directors (however they are defined) are simply tackling the symptoms. I am sure that any linkage between board practice and company performance is due to something else—something that is not visible and therefore cannot be directly observed.

Alan Kennedy - 1 week ago

Always a treat to read your musings, Peter. I wonder if independent directors make a difference because ownership/management has accepted that an independent voice can be useful.

As an aside, is it the board's role to drive better business performance or to provide meaningful oversight which should result in better performance but is quite different from the focus of the first.

Cheers and keep musing!
Alan

Thank you for your support Alan!

If we accept that the purpose of the board of directors is to proxy for the owners, to represent their interests, then better of the choices is former (drive performance). However, if the board is conceptualised as a watchdog (ie, the increasingly discredited agency theory of board-manager interactions), then the role is reduced to oversight.

To assume that effective oversight results in better performance is a huge call though!

judith maccormick - 1 week ago

Should we rather consider it a role of directors to provide both effective oversight AND to represent the owners interests?

Hi Judith

Indeed we should (in my view anyway). Sadly, owners are often forgotten by directors, and sometimes directors fail on your "effective oversight" point as well.