Independent Directors

Much is made of the value of having independent directors serving on a company’s board of directors. These directors are not employed by the company and are supposed to be able to freely challenge management plans and thereby protect shareholder interests. I’m not convinced that independent directors are better than owner directors.

If a director has his or her net worth tied up in company stock, this aligns the director’s interests with those of shareholders. A director who is an employee with minimal ownership actually has interests that are opposed to those of shareholders. An independent director is somewhere in the middle.

As a shareholder, I would place more trust in an owner director than an independent director. I would look for directors whose share ownership is large relative to the income they receive from the company. In this measure, I wouldn’t count stock options as ownership and I would count any form of income whether direct or indirect.

Independent directors may work hard defending shareholders, but then again they may just pay little attention and collect their director’s fees. Or worse, an independent director and the CEO may serve on each other’s board of directors and trade favours.

Independent directors are better than employee directors, but owner directors seem best to me.

Comments

  1. The Blunt Bean CounterJuly 12, 2011 at 7:01 AM

    Directors in theory are supposed to bring a specific skill set to a board, be it an expertise in the company’s industry, be it finance expertise, be it M&A expertise. So a best of breed board without getting into their share ownership is a mix of the above. It is doubtful you would find these skill sets in what you call either an employee director or owner director.

    I agree, many independent directors although bringing skills to the table are part of an old boys club which is problematic. Also, in most cases they are already financially secure and have little skin in the game and rely on stock options and director fees for any income from that company.

    You say “a director who is an employee with minimal ownership actually has interests that are opposed to those of shareholders”. In my opinion, assuming the employee had a skill set to bring to the board, I would say having interests opposed to the shareholders would probably be a good thing. What do most shareholders want? I would say most only care about a large profit as fast as possible, only so many are true long term holders. Thus, an employee who did not really care about short-term stock gains would probably be an asset.

    For owner shareholders, you say their interests are aligned. I could argue they are only aligned for short term gains and if the owner manager can capitalize short term they may not really care long term.

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  2. @Mark: If a controlling group of shareholders want a company to take actions detrimental to the business but superficially look good to deceive other investors, then I think the company is in trouble. In my limited experience, such a group of shareholders can get honest and competent independent directors removed.

    The most important qualities for a director are competence and integrity. I've seen such qualities more often in owner directors, but as I said, my experience is limited.

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  3. There's no one right answer for the composition of a board. I believe the original intention was a type of democratic representation of shareholders. But as Mark pointed out, and probably because democratic representation wasn't working, board members are selected for bringing other benefits.

    I don't think good governance is well understood by most investors, so it isn't demanded. That's possibly why it's so common to try and incentivize management instead.

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