LETTER | Term limits on independent directors will not reduce shenanigans

LETTER | Recently, the Securities Commission (SC) announced that it will impose a mandatory 12-year tenure limit for independent directors (ID) of public listed entities and this will be introduced in the listing requirements next year. 

It cited a change in the skills profile and composition of the board is required to meet the growing demand for businesses to evolve beyond the traditional emphasis on shareholders and profit maximisation towards greater consideration of broader stakeholders’ interest.

Primarily, the fiduciary duty of an ID is to the company’s shareholders while its role and responsibilities are to ensure good governance in the companies they are appointed to. 

To do that, the IDs are expected to have a full and good grasp of all the compliance issues set by Bursa Malaysia, in terms of related party transactions, practice and adherence to financial reporting standards by the companies. 

Yes, relevant skills and experience does help them to discharge their roles and responsibilities more effectively.

By emphasising skills profile and profit maximisation as one of the justifications for the introduction of tenure limit, the line appears to have blurred in defining and understanding the meaning and the word independence of an ID. Does this mean IDs also oversees the profitability and operations of the business when his or her role is non-executive and acts independently from the management?

Ownership patterns

Corporate governance in public listed companies in Malaysia is largely influenced by ownership patterns. It is either controlled by families or owned by the government through various government-linked funds. Thus, these two types of ownership resulted in the majority of the public listed companies being mostly closely held companies.

Generally being the largest shareholders, the founder of the business or his eldest or designated offspring is appointed as the CEO of the company who then would have the say and control over the appointment of the IDs for those listed companies controlled by families.

And in the majority of these companies, IDs are normally recruited from friendships and networks built up over many years by the founder or the CEO. In reality, it is practical to appoint IDs who are friendly to the company. 

The controlling shareholders would not want a troublemaker, otherwise, the board would not be able to function. Thus, a common problem in many of these companies where while ensuring independence, the appointment of these IDs represent an ethical issue.

Some appoint IDs that have industry experience from outside the industry in which the company in question competes while some preferred those with involvement in the same industry with aim of tapping into their perceived higher technical knowledge of issues in that industry, network of contacts and an awareness of what the strategic issues are within the industry. 

While these might be of some benefit, a lot of times, the prior industry involvement might also reduce the ID’s ability to be objective and uncontaminated by previously held views, in other words, they can make the ID less independent.

In large and highly visible companies, they have retired senior government ministers or former civil servants who have no previous material business relationship with the company as an indication that they are materially independent.

The potential for conflict for IDs occurs when the management is extremely competent, who have spent their whole career in one sector, experts in their business and very often, these people have grown from the bottom of the organisation to the top. 

Or in those companies controlled by families, emotional baggage and sense of entitlement from the families thinking they are entitled to sit on the board and or be appointed to senior management position could potentially influence the decision-making process, be it strategic or operational, posing a risk to transparency or it can sometimes result in irrational decision-making.

Fully aware that having board independence does not guarantee to improve the company’s performance, some companies just comply with the required number of IDs on the board, but measures would then be implemented 'subtly’ to neutralise the powers of such directors, for example, the IDs appointed are known to be passive, rarely challenge executive powers or irrelevant background.

Specifically, the presence of an ID is the joint outcome of both the director deciding to stay in the company and vice versa the company deciding to retain the ID. Both the ID's and the company's decisions are made endogenously.

Capital market

Term limits are not only confined to the capital market in Malaysia but in other jurisdictions too whose capital markets are much more established. The premise is that new directors will infuse innovative ideas and energy into the boardroom. 

For example, in the US, boards played an important role in the decision to dismiss a CEO in case of poor performance whereas, in the capital market here, this is almost unheard of.

Does a term limit for the tenure of the ID really help? The implication is that directors become entrenched and aligned with managers after an extended period and are, therefore, unable to monitor them adequately. 

In proposing for this, does the SC just rely on discussions and feedback from the capital market or aping developed countries such as in the UK, the Financial Reporting Council does not consider a director who has been on the board for longer than nine years to be an independent director.

Does the SC have the data measuring the actual independence (relative to the socially declared independence) of board directors, their specific expertise and their networking benefits with tenure as a distinguishing attribute?

Just as a long successful tenure is seen as increasing the CEO's bargaining power, a longer tenure should also buttress the position of the ID, helping him/her to balance the CEO's influence when it comes time to making decisions in the boardroom.

Limitation of role

IDs do not spend their full time in the position and given the limited time spent in the company and the constraint in accessing privileged information, in reality, they are hampered from performing diligent duties and judgment in discharging their duties.

If the IDs, especially those newly appointed and are not familiar with the management and are keen to monitor the CEO strictly, it might lead to the management withholding information from the board, compromising advising quality.

Thus, regardless of their tenure, all IDs are dependent on the CEO or inside directors for company-specific information. Having some long-serving IDs who have built specific knowledge could help new IDs to reduce dependence on management as a source of information thus fulfilling their role and responsibilities as ID.

What about those poorly performing companies? In a real-life situation, 'high quality' directors 'self-select' to join high-quality companies, leaving the poorly performing companies as the only board seat opportunities available to qualified persons of perceived lower quality. 

This creates a perception that directors accept the board positions at poorly performing companies because they cannot gain board seats elsewhere, implying that directors who join poorly performing companies are of significantly lower quality relative to directors who join better-performing companies. 

And sitting on the board of a poorly performing company can be highly undesirable for IDs. Potentially, they could suffer damage to their reputation and increased litigation risk.

What the investors actually want to see the SC doing proactively is to investigate and to do so quickly and not the type of time frame that the public are witnessing presently in prosecuting directors and owners for malfeasance or misdeeds where by the time the accused are charged, it could be a few years down the road. 

If resources are limited, perhaps the regulators can outsource the investigative work to outside professionals with the costs borne by the companies that they are investigating.

If possible, the regulators should create a fund for minority shareholders, who mainly do not have the financial resources on their own, to take action before the courts on the behaviours of IDs, a situation which would then motivate IDs to behave more like ‘reasonable’ independent directors. 

There should be a shift of emphasis by the SC away from looking at the processes carried out by capital market participants towards the outcomes they seek to achieve, for investors, the companies, the capital market and all other relevant stakeholders.

The views expressed here are those of the author/contributor and do not necessarily represent the views of Malaysiakini.