An understanding of the company’s business is critical to the effectiveness of a board.
Corporate governance guidelines prescribe that independent directors must not be substantial shareholders of a company in order to maintain their independence.
Lack of independence is deemed undesirable and hinged on the premise that a common theme in corporate collapse is the lack of independence of directors.
For independent directors who hold a minute number of shares or no shares in the company there exists a division between the corporate control they exercise and ownership of the company.
Essentially, these directors are controlling and spending other investors’ money, not their own. Individuals generally make more prudent decisions regarding matters that directly affect them. Thus, there is the risk that such directors may act out of their own rather than company interests.
This means that the long term interests of the shareholder and the director will not be aligned. Therefore, the separation of ownership and control essentially undermines shareholder protection yet shareholder protection is one of the main tenets of sound corporate governance.
Besides executive board members, non-executive and independent board members bring to along unique skills, competencies and experience gained in different sectors. Therefore, they may not sufficiently comprehend the business of the company or the industry even after the requisite board induction and training.
Such directors may become over-reliant and trusting of management information and may not fully interrogate it. Consequently, they may not be quick to pick warning signs when the company faces imminent collapse. An understanding of the company’s business is critical to the effectiveness of a board.
By owning a reasonable number of shares of the company, directors will be motivated to gain deep understanding of the company’s business, leading to more informed, vigilant and balanced decisions.
Directors should be encouraged to invest in the company. It is a sign of confidence in the firm. Furthermore, the best way to ensure management proposals and board initiatives are deliberated from a shareholder’s perspective is to ensure directors are shareholders.
Any risks taken by the company are integrated into the value of shares held by shareholders including directors. If directors stand to lose a lot if their decisions cause the value of shares to plummet, then they may make more astute and prudent decisions.
Companies should seek to include, in their board charters, those owning a reasonable number of shares as a condition to becoming directors.
Directors’ shareholding could be a percentage of nominal share capital of the company, be part of the free float of the company and should be purchased in the open market so as not to affect the capitalisation of the company. In addition, there should be a timeline for a director to acquire shares such as six months after taking office.
Furthermore, directors should be encouraged to hold the shares until termination of their contract with the company. A director disposing of shares is a negative indicator of the company’s future.
To stay in line with corporate governance principles of protecting shareholder interests, director shareholding requirements must not lead to majority shareholder tyranny where the board uses their combined shareholding to further their own agenda.
