Board Independence: Reality or Myth?

Board Independence: Reality or Myth?

GGAPP Forum for Independent Directors

October 19, 2015

I congratulate Dr. Francis Estrada on his most comprehensive and educational lecture on global corporate governance practice. If  I were in the U.S. or any other OECD country, I would say "amen" and my remarks  end here.

However, we are in the Phl.  Here the  challenge is keeping  in step with these global practices, but making very sure that we "Inculturate"  to Philippine  and ASEAN situation. It is a most apt term I first heard from CJ Panganiban.

We need to sweat some of the emerging details that are now before us, for instance in the draft corporate governance blueprint making the rounds.  Let me attempt to do that now --

The theme of this symposium is a provocative one. Board Independence, Reality or Myth.  In the course of addressing the question, I beg your pardon in advance. I will try my best to be provocative.

What does the symposium title mean? When we say independent, independent from whom? And independent to do what?

The Corporation Code and the SEC Corporate Governance Memorandum, 2002   provide the answer:

"It is the Board's responsibility to foster the long-term success of the corporation and secure its sustained competitiveness in a manner consistent with its fiduciary responsibility, which it should exercise in the best interest of the corporation and its shareholders ".

I would myself interpret independence to mean, free to perform such a responsibility unhampered by forces, be it management,  the majority shareholder, or  for that matter-- any other interests--- pushing interests that  are not aligned with the corporation and its shareholders in achieving its long-term success. 

The particular subset of "independent director" is  defined in the SEC Memo to be one who is without a relationship with the corporation,   is expected to exercise a higher level of diligence in ensuring actions are in the interest of all shareholders.

The need for such independent directors especially arose from cases of misgovernance  in the west -- of the "principal agent problem" type. In many companies with defused ownership and with no controlling shareholder it has happened that  management became unaccountable to anyone, and becomes its own principal.  Addressing this incentive misalignment has been the driving force behind initiatives in OECD countries to increase the number of ID's, in fact to a minimum of majority. And to ensure that that the Chair is an ID, and other such limitations.  This is wholly appropriate in that context.

However, the situation in the Phl and the rest of Asia is quite different.

Here there are really almost no such thing as companies with defused ownership.  Here,  the principal value creators  are anchor investors, typically a family that has nurtured and grown the corporation and continues to nimbly navigate it in fast globally  changing environment.  In fact many passive  investors, not just local but global strategic investors,  put money in these companies on the premise of continuity of that anchor investor family  being in control.

In short under this model, the interests of all shareholders are generally aligned with the controlling shareholder. Think of the continuity across generations being provided by the Ayalas, Sys, Aboitiz, Gokungweis, et al.   The  advantages of this model has been well described in special section  in The Economist a few months ago. It contrasted it with the short termism observed in many firms in the west.

This difference in situations give rise to question of  appropriateness of the OECD model to Asia, where “family anchor investors” are  the value creators.  Take for example the rule that majority of the Board should be independent or that ID's should be especially empowered.  In Asia, It is not clear how requiring majority independents enhance long term shareholder value.   Especially when coupled with the preference that terms of independent directors should be short.

As well described by Chief Justice Panganiban,  the role of ID's in the Phl and similar Asian context, is an oversight role,  to make sure Board actions are for the benefit all shareholders, that  related party transactions are at arms length and disclosed, and that there is full compliance with laws of the country, especially ones on corporate behavior  and governance. That majority of the board should be independent  is not needed for this,  as rightly not provided under our laws now. And it should stay that way.

Let me now turn to the question of what will assure independence,  and effectiveness.    The draft CG blueprint as well as past SEC issuances contain measures which I think miss  the point.

The most ones most discussed pertain to term limits and number of seats.

A.  Term limits.

1. No evidence that longevity compromises independence nor  on the advantages of term limits.

2. Longer serving directors are more effective. And companies with longer serving directors perform better.

(See for example,  "the Non-Correlation Between Board Independence and Long Term Firm Performance" by Sanjai Bhagat and Bernard Black, professor of Finance, University of Colorado, and professor of law in Standford University, respectively.

On Limits in number of seats held by an ID. The evidence  likewise point to the opposite.According to a study by Ferris, Jagannathan and Pritchard, professors in the University of Missouri-Columbia, Binghamton University and University of Michigan Law School respectively-- "We find firm performance has a positive effect on the number of appointments held by a director. We find no evidence that multiple directors shirk their responsibilities to serve on board committees. We conclude that the evidence does not support calls for limits on directorships held by an individual."

My exhibit A based on first hand experience as I am honored to be in common boards with them are:  CJ Panganiban, Amb. Joey Cuisia, Mr. Washington Sycip, Mr. Oscar Reyes.

I challenge anyone to contend that these gentlemen, despite having multiple seats/full time jobs, do not perform effectively as directors in the boards they are in. Or that the quality of governance in the corporations they serve will improve if they resign, as compelled to by  regulation.

What then assures  independence in the actions of ID's ? From my own experience -- it is the commitment of the controlling shareholders to the highest quality of corporate governance.  These shareholders seek out men and women with solid reputations who share this commitment, who can contribute diverse and independent views for the long term success of the corporation.

How about the ID's themselves-- how do we ensure they act with independence?  At the end of the day, the one thing that assures independence is an ID's  regard for a reputation of a lifetime of integrity, probity, diligence.  Which the person will not risk when put to the test.

In fact, one can argue that the more board seats, and longer more solid  reputation built, the more independent such ID's likely to be.  ( Ever heard the adage if you want something done-- give it to a busy man? )

Why do good corporations, their majority shareholders and management, seek out such independent minded men?   It is not just by what they can contribute due to their experience, knowledge and wisdom, but indeed by their well earned reputation that they do not compromise integrity.   The companies, in turn, are letting the world know that their corporate governance practice can withstand scrutiny by such men and women.  We should not shackle such good aspirations with ill-advised fiats like limits on term or number of seats of IDs.

The particular case of limits on even non-ID is even more serious.  This effectively disenfranchises owners, the value and job creators, from overseeing their own companies.  I requested PSE to tally the number of individuals who will be affected-- those with 5 or more board seats. There are 53.

B. The risk of over-regulation.

In the U.S. I understand the number of listed companies have dropped from 8 k to 4 k in under A decade, a combination I think of overregulation and readier assess to capital without listing with the growth of private equity funds and in a world slushing with liquidity.  Here in the Phl we have the lowest number of listed companies in ASEAN, and the one with the lowest growth in listings. Perhaps, not coincidentally, we are also at the cellar of "ease of doing business" of the World Bank in ASEAN.

Scoring and ranking of corporate governance as is now pushed in ASEAN is fine, provided the scorecard is well developed and acculturated -- I have issues with it. And is not pursued obsessively. Otherwise it too becomes a  case of shortermism.

But what we need to watch out for is over regulations-- which create a compliance mind set, or worse -- uncertainty, red tape, compliance costs, delays,  and eventually deterioration in governance.

My worry is the drift seems to be to regulate more at a time when our regulators, well intentioned and diligent  though they are, are already overburdened.   In the 2015 edition of the World Bank's Ease of Doing Business, we are ranked 161 of 189, the lowest in ASEAN 6, behind Indonesia and Vietnam. On starting a business, we have the most number of procedures at 16 steps and will take 34 days. Singapore takes 2.5 days, Malaysia 5.5 days.

I therefore welcome the intent to shift  to "comply or explain" model similar to the rest of ASEAN, in addition to scoring , as a basic approach. Rather than strict fiat. The language, though, of the draft CG blue print is confusing.  In "comply or explain", "explain" should mean "disclose to the public" not "explain to the SEC who would then have the power to reject the explanation as unsatisfactory". That to me is not "comply or explain", but "comply or comply".

Why am I concerned over this?  There are a number of new areas in the draft CG blueprint that go way beyond what is now in law.

For example, there is an entire section on "Duties to Other Stakeholders". If these duties were limited to those in law or by mutual contract, I would not have a problem. I am concerned however over possibly ambiguity once we stray from "fiduciary responsibility to the company and its shareholders " to "duties to other stakeholders".  Just to site possibly far fetched examples to make a point--

Will Directors be  duty bound to heed the  clamor,  say of labor unions, or even, SharePhil or ICD  against labor contractualization even if this is allowed under our laws?  Or by Greenpeace against a coal plant even if it has the approval signature of DENR, local govt and all of the 150 other signatures to start a power plant?  Who defines who is a stakeholder?

Someone was telling me also of initiatives to compel gender balance. Here I will be at my most provocative.  To me this is both intrusive and unnecessary.  On two grounds.

First, I think it is just a matter of time before women take over.  We are seeing this everywhere, in UP, there are more women in the college of law. And in the college of medicine, it is the men who are given a quota.  In the BPI, already a third of our Board are women, and the majority of management corps are female.

Second, let me ask a question -- is it not the height of regulatory heavy handedness to make women in corporate boards mandatory, when they are no longer  even mandatory in some marriages?

With that I end my remarks,  I think I have been provocative enough.