ACTION STATIONS - JSE MAGAZINE

ACTION STATIONS

The scrutiny of the composition of the boards of companies and their level of independence and expertise is crucial to good business practices

ACTION STATIONS

The requirements for independence and objectivity lie at the roots of corporate governance, says Ansie Ramalho, chief executive of the Institute of Directors of Southern Africa (IoDSA).

‘Companies as separate legal persona offer a benefit in that providers of capital are able to participate in commerce without putting their personal estates at risk. However, this resulted in a situation where [at least as far as public companies were concerned] ownership and management were separated, which left owners of shares at risk of their capital being mis-appropriated by management.

‘The situation was exacerbated by the advent of stock exchanges at the turn of the 19th century, which led to shareholders becoming more geographically spread and diverse, therefore creating even more distance between management and shareholders.’

She says to compensate for this risk, the board is a governance measure intended to serve as a check and balance for the power and activities of management. ‘Activities’ is the operative word when it comes to describing management’s function vis-à-vis that of the board, which is supposed to assume a more reflective, strategic position. To do so, the board must deliberately remain at arm’s length from management for it to maintain objectivity and independence.

This need for independence is one of the basic yet best-known governance requirements, says Ramalho. ‘Unfortunately it is also one of the requirements that are applied without consideration of what its objectives are. The boards of listed companies tend to follow the objective independence criteria as set out in chapter two of the King III report, to determine and classify whether its members are independent.

‘This is a good starting point as perceptions are crucial and generally based on these objective criteria. However, the subjective state of mind is also an important consideration – as pointed out in King III. Passing the objective test is by no means a guarantee that a board member is in fact independent of mind, something that many boards disregard or do not have the courage to address.’

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In addition, she says, it must be remembered that independence enables the board to hold management to account.

‘Without the necessary experience and knowledge, independence is entirely toothless, as such a board member is not able to challenge and interrogate the assumptions or conclusions presented by management. This is just another example of how governance recommendations need to be accompanied by a judicious application of the mind, and cannot be merely a box-ticking exercise.’

Patrycja Kula, Business Development Manager: Issuer and Investor Relations at the JSE, says that although many of the King III principles are not mandatory, there are some compulsory principles when it comes to board appointments, board committees (such as audit and remuneration committees), board responsibility, the position of the company secretary in relation to the board, and finally, the capacity of directors that must be applied. These principles apply to companies seeking a listing, those already listed and should be considered for private companies. ‘Listed companies are required to explain how the King III principles have been applied, and most importantly, address the extent of the company’s non-compliance in its annual reports, as well as give reasons for each instance of non-compliance,’ she says.

Ramalho says that more recently there have been interesting developments with regard to independence in corporate governance. ‘To protect shareholders against excesses by management, measures have been introduced to align managers and shareholders’ interests. It has become fashion able to award management shares or options in lieu of remuneration.

‘The unintentional consequence of these awards, depending on the structuring thereof, is that they may lead to a focus on immediate financial return to shareholders at the expense of the sustainability of the company in the long term.

‘In light of this, the legitimate expectations of other stakeholders from our corporations (which often compete with the immediate interest of shareholders) demand board member independence, even from shareholders.

‘We are already experiencing the first ripples of this through the legal requirement that listed companies have social and ethics committees. It will be interesting to see how this development unfolds further and impacts on board composition.’

By Louise Brougham-Cook
Image: Gallo/GettyImages