And there may be other compositional factors at work, suggests Martin Lawrence, one of the founders of corporate governance adviser Ownership Matters. He, too, points out that small mining companies have performed very well during the past decade and most of them initially didn’t have a majority of independent directors.
Lawrence says that once they become established miners and start producing, they attract the notice of institutional shareholders and so start following the ASX’s independent director guidelines. But this is usually after the miners have made their spectacular price gains, so the installing of independent directors coincides with a slowdown in share price appreciation.
Swan dismisses the criticism about the study’s composition, saying “treated” firms are matched with “untreated” firms of the same size and in the same industry, such that this problem cannot arise.
Lawrence agrees that it is a good thing to have directors own shares in a company to help align their interests with shareholders, but he says a board shouldn’t be dominated by substantial shareholders. Substantial shareholders, with stakes well above 5%, can extract private benefits of control. For instance, a steel mill operator who was a major shareholder in an iron ore mine could use its control to extract a better purchase price for the commodity.
Lawrence also says directors should be independent of management.
“That’s their job – to oversee management. You don’t want directors who are all executives because typically in a board that’s full of executives it’s very hard for minority non-executive directors to override the executives,” he says.
A chairman’s chief role is to hire, oversee and perhaps ultimately fire the CEO, and Lawrence questions how someone such as Jamie Dimon, the chairman, president and CEO of US bank JPMorgan Chase, could perform such a role.
But Swan argues executives have the company-specific knowledge that independent directors lack, and far from having board members who are independent of the company, its own executives should be on the board.
Swan says his research suggests that boards need only a small number of directors who are independent of management. The ideal board structure, he says, is of about five people – the chief executive and a couple of other senior executives, whose interests are aligned with shareholders’ through their own shareholdings, and a couple of substantial shareholders.
The ASX guidelines to ensure that independent directors are independent of management still allow all sorts of relationships that would interfere with the directors’ judgment.
“You often find that the so-called independent directors went to the same private school, they might be the godfather of the children of the CEO, they might have been intimate friends for 20 years, and many of them are,” says Swan.
Indeed, far from making directors independent of management, the ASX guidelines make them “completely beholden” to management. This is because without a substantial shareholding, directors focus only on their own welfare as directors.
“If the director has no substantial financial interest in the affairs of the company, the only thing they’re going to care about is their own wellbeing,” Swan says. “And who’s going assure their wellbeing? Well, it’s going to be the management of the company that is going to either renew them or not, essentially.”
While shareholders can in theory vote off under-performing directors, it rarely happens in practice and it’s very difficult for shareholders to know if directors are acting in their own interests or in the interests of the shareholders and are competent to do the job.
The Australian Institute of Company Directors (AIDC) believes boards should have a majority of independent directors and disagrees with Swan’s view that the board should have significant management representation.
“It’s more likely that you would have a situation where the directors of the board are operating in the interest of management as opposed to those other stakeholders in that situation,” says Steve Burrell, the AICD’s general manager of communications and public affairs.
Burrell acknowledges that executives might have more company-specific knowledge, but adds: “It doesn’t automatically follow that an executive who has more information is going to necessarily act in the interests of the broader shareholder group as opposed to their own interest.”
He says that ensuring non-executive directors get enough company-specific information can be “tricky” but independent boards have strategies for dealing with this, particularly through expert independent directors.
“Every board in its own way tries to deal with that issue by making sure that the reporting to the board is as good as it can be and that the board members do become engaged in their companies,” Burrell says.
The AICD agrees that directors should have a shareholding in their company but, like Lawrence, says a cap should apply to remove the potential for conflicts of interest. And Burrell says the financial incentive isn’t the only factor that motivates a director, as they also face a legal liability and have their reputations to protect.
“I don’t think it follows that you are not doing your job as a director simply because you don’t have a large amount of skin in the game,” he says.
