When company directors lose their independence

Shareholder activists in SA have disapproved of lengthy tenures for directors on boards of listed public companies. They have exerted pressure on long-serving directors to resign.Boards with many long-serving directors are regarded as entrenched, hence the rising calls from activists that they should be refreshed.

Director tenure attracts attention worldwide. The concern is that directors lose their independence by becoming too close to management if they serve for too long on company boards.

This pertains, in particular, to external directors, also known as independent nonexecutive directors.

Nonexecutive directors are not involved in the day-to-day management of the company’s business and are not full-time salaried employees. They are independent if there is no interest or relationship that is likely to unduly influence or cause bias in their decisions.

Independent directors protect shareholders’ interests, manage conflicts of interests and ensure compliance with legislation. They play an important role in detecting fraud and mitigating corporate corruption.

To promote objectivity and reduce the possibility of conflicts of interest in SA, the King IV Report for Corporate Governance recommends that the majority of board members should be nonexecutive directors, and most of them should be independent.

The Companies Act gives original powers to directors to manage the business of the company, unless this is restricted in the company’s constitution. The directors delegate particular responsibilities to the executive directors. The nonexecutive directors in turn monitor the executive directors and exercise oversight over them.

The concern is that if directors stay in their positions for too long they lose this oversight capability because they become too familiar with the company and its ways.

The situation in SA points to the need for change. Some independent nonexecutive directors have served on boards of JSE-listed companies for as long as 46 years. One study found that 27% of nonexecutive directors on boards of JSE-listed companies have served for nine years or longer. Another study found that directors in the consumer services sector had the highest average tenure, followed by the industrials sector and then the consumer goods sector.

The Companies Act does not put a cap on how long a director may serve on a board. A director elected by the shareholders may serve on a board indefinitely or for a term set out in the company’s constitution, if any.

Under King IV, nonexecutive directors serving for longer than nine years are classified as independent if the board concludes each year that they are independent. When a nonexecutive director has served on the board for longer than nine years, a summary of the board’s views on their independence must be disclosed to the shareholders.

In my research on the tenure of directors in international jurisdictions, I found that the approach to board tenure may be divided into three categories. SA could learn from them. It should review and modernise its approach to director tenure to bring it in line with international developments. This will ease shareholder activists’ growing concerns about directors’ lengthy tenures.

It is controversial whether directors lose their independence if they serve for too long on company boards. This is because research on this matter reveals conflicting results.

Some studies show that long-serving directors become friendlier with management and can no longer monitor the actions of management objectively.

Other studies, however, show that long-serving directors are in a stronger position to monitor management. This is because they are less vulnerable to peer pressure and less likely to be controlled by management.

It is argued that limiting director tenure increases board diversity and attracts new perspectives and skills to the board. On the flip side it is argued that long-serving directors have vital experience, industry knowledge, and a better understanding of the company’s strategies. This may be lacking with newly appointed directors.

In my opinion the optimal director tenure varies by industry and company. The length of stay of a director isn’t necessarily a bad thing provided that the director is able to remain independent.

But the view that long-serving directors are so enmeshed with the company that they lack independence is gaining traction among corporate governance experts and shareholder activists.

Director tenures in other countries

At one end of the spectrum are jurisdictions that don’t impose any limits on how long a nonexecutive director may serve on the board. This approach is adopted in the US.

At the other end are jurisdictions that place a hard limit. For example, the European Commission recommends that companies in the EU should limit the tenure of nonexecutive directors to 12 years. This is done in France.

In between is a third category which says that there should be a limit on director tenure but it can be extended if the shareholders agree.

For example, in Singapore and Hong Kong independent nonexecutive directors can stay on the board after nine years if shareholders approve. In Malaysia, shareholder approval is needed after 12 years. In India it is needed after only five years. India introduced this requirement because of the high levels of corruption in its economy and to ensure that independent directors remain independent.

Weaknesses in SA’s approach to director tenure

In my view SA’s approach to director tenure reveals three weaknesses.

First, it fails to give shareholders any formal say on keeping independent nonexecutive directors on the board after nine years.

Second, the board may disclose to the shareholders only a summary of its views on the independence of a long-serving nonexecutive director. This might not provide them with enough information.

Third, the board doesn’t need to engage external independent facilitators in assessing a nonexecutive director’s independence after nine years, but can do this evaluation itself.

Action

SA should not introduce a hard limit on director tenure because the types of businesses conducted by companies are so diverse. We should not ignore variations across different industries. A hard limit will also deprive companies of the expertise of experienced directors.

Instead, shareholders should be involved in the decision of whether to keep independent nonexecutive directors on the board after nine years.

Involving shareholders in this decision will encourage active shareholder engagement. It will give shareholders an opportunity to assess the independence of directors. It will also enhance the reputation of companies and improve investor confidence. And it will avoid a situation where shareholders publicly challenge boards on the lengthy terms of their directors and press directors to resign.

Disclosure and transparency are strongly emphasised in the King IV Report. Thus the board should make a full and proper disclosure to shareholders of the reasons for concluding that long-serving directors are independent.

And, to enhance objectivity, external independent experts should be involved in assessing the independence of nonexecutive directors every year after they have served for nine years. This applies especially to listed public companies and state-owned companies.

Lastly, companies should work with shareholders and external experts to review their approach to director tenure.

*Cassim is associate professor in company law at Unisa. This article first appeared on The Conversation​ Africa