02 Jun Restoring Confidence

By Alexis Kyprianou

Can we restore confidence in a business with an independent Board of Directors, or not?  The issue is not as simple as that.

Board Directors are elected by shareholders and have a legal responsibility to act in the best interests of the company without differentiating between shareholders and taking into account the interests of all stakeholders. In Cyprus, a few interest groups – in particular construction companies –  accumulated ownership positions in banks in order to influence the nomination of Directors and, by extension, to influence the lending of money to their own interest groups. Board Directors have appeared on public television stating that they represent a particular shareholder. Boards have been accused of the ineffective oversight of risks which have brought down their companies.

Regulation and corporate governance codes have introduced measures encouraging and even obliging certain companies to elect independent Directors onto their Boards. “Independent” is a label that indicates you are judged to be free from the influence of major stakeholders, the management and the company itself.  Cyprus’ banks, for example, now have an average of 57% independent Directors on their Boards. Is this enough to restore confidence?

Is “independence” a reliable measure of objectivity or even realistically achievable in small business centres like Cyprus? Relationships and influences are much more subtle in small business environments compared to the international definition of standards of independence. Everyone in Cyprus is “a good friend of the brother of….”. In Luxembourg, another small business community, the average Board of Directors has 88% non-nationals. You might argue that 57% of Luxembourg’s 550 000 residents are non-nationals and Luxembourg is where numerous foreign investment funds are domiciled. However, the Luxembourgers are quick to counter that “outsider” board representation protects them from international criticism of “insiderism” that would otherwise tarnish their reputation as a credible financial centre with high standards of corporate governance, essential for attracting foreign investment into a small country. Can we learn something from Luxembourg?

Independence addresses objectivity, but does independence have any correlation to performance? Of all the studies undertaken, none has been able to prove a correlation, with the exception during a corporate crisis. A KPMG study shows that 72% of all EuroStoxx600 companies in the five years to 1 March 2013 suffered at least one “crisis”. Crisis was defined as a sudden share price drop of more than 20% relative to the market index. 61% of those same companies were found to have faced at least two “crises” in the same five years. Given that the average tenure of a Director is just over 6 years in Europe, a Director should reasonably expect to face at least one crisis during his/her mandate. It is also worth pointing out that the incidence of crises has not diminished with increasing levels of independence over this period, even if the crises are dealt with more effectively. The conclusion? Build a Board able to face and manage crises i.e. experience in managing risk and availability of what Directors to deal with it.

Corporate governance codes already require the Board to evaluate itself regularly. This should be the stimulus for a discussion on the composition of the Board, not just when directorship mandates are up for renewal. That looks virtuous on paper. However, even if the Board is more independent, its members are not necessarily any more objective when it comes to self-evaluation. We’re all human. Should we demand that evaluations be orchestrated by a third party outside the Board as a means to getting a better composition?

Let us not lull ourselves into a false sense of security just by appointing more independent Directors to our Boards – either in terms of independence as a measure of objectivity, or independence as a guarantor of promoting an appropriate Board composition. The winning composition of a Board of Directors goes far beyond independence.