Non-Executive Independent Board: Reason for and Against - Coursework Example

Student Name: Instructor’s Name: Title: Non-executive independent boards are a waste of time Course: Institution: Non-Executive Independent Board: Reason for and Against Introduction Globally, the role of non-executive independent board is a hotly-debated and one of the important subjects within the field of corporate governance (Iwu-Egwuonwu, 2010). The issues of board structure and processes, defined in terms of board size, the establishment of various committees, the separation of the posts of the chairman of the board and the CEO, and non-executive director independence and representation have been central to management reforms throughout the globe (Weir, Talavera & Muravyev, 2008:3). Although the role of non-executive independent board in organization/companied has attracted renewed attention, the results are quite mixed. This could be linked to the fact that there is no clear definition which encompasses the various dimensions of the board like their professional experience. Non-executive independent board is associated with significant contribution and success of a company (Kakabadse et al., 2001: 7).On the other end, it is argued that there is no any significant contribution made so far, hence the premise that “‘Non-executive independent boards are a waste of time. They have little involvement in a company and are not aware of what is really going on’ It is against this backdrop that this paper seeks to discuss the various reasons for and against the role of non-executive independent board in a company. It is organized as follows. Next section the 3 gives brief definition of key concept .Section 3 presents various reasons for the presence of non-executive independent board. Section 4 highlight on the shortcomings. In the last section 5, conclusion is drawn. Conceptualization of the Term, Non-Executive Independent Boards There is paucity of a universally recognized or accepted definition of what constitute Non-executive independent Boards. However, the present understanding are derived from definitional principles by sovereigns which dictate and elucidate the criteria for defining the subject matter but only in meeting their peculiar need or circumstance (Iwu-Egwuonwu, 2012:191). This can be attributed to the fact that although independent directors or boards may be ‘independent’ at least from a legal perspective, the issue of independence in substance may be but an issue of a different ballgame; the state of Independence is the creation of mind and cannot be codified through a statute. Some companies may invite people or outsiders whom they are familiar with and whom they expect to be contributing or toe the line without constructive challenge. However, if the non-executive board is one associate with constructive criticism, then the actual independence which at the end of the day is bound to bring success in the company’s decision making (KPMG, 2011:4). From the definitional criteria given by different region or nation, a working definition of a non-executive independent board is one which is not a representative of a shareowner who has the ability to control or significantly influence the company’s governance and is not an employee of the firm, or the group, or in any executive capacity for a period of at least three years (Engelbrecht, 2012:126). In other words, they are boards which are independent in character or judgment and devoid of any material relationship with the business beyond his/her directorship (Iwu-Egwuonwu, 2010:191). Benefits of Non-executive independent Board The role of non-executive independent board in a company cannot be underestimated. The various benefits associated with it are as discussed below: One of the advantages relates to increased organization performance. There is an empirical endorsement or confirmation form various studies that a board composed of independent non-executive directors positively influences an organizational performance. For instance, the Corporate Governance Code (2010) in UK and Adams and Ferreira (2009) for the US companies. The role of independent non-executive boards in steering the growth and performance of a company can be explained from the standpoint of the agency theory, which reveals that there high tendencies of conflicting roles especially when same person acts or performs his or her duties as an executive director for some business or firm but as a non-executive director for another company. Therefore independent non-executive boards may be a source of company conflicts when acting as executive directors but a source of reduced firm’s costs when acting as non-executive directors (Weir, Talavera & Muravyev, 2008:4). Independent non-executive boards also helps in controlling the companies challenges through evaluating, monitoring and controlling the opportunistic behaviours which if unchecked can be costly to the agency (Al-Materi et al, 2012:242).They act as whistle-blowers on the board hence highlighting warning signs in the process the monitoring the companies’ operations. Some of the negative aspects of the company worth considerations are for instance unusual or abnormal price markets, trading volumes of the business stock, reports of the valued investments or even procurement without due agreement and adequate briefing on accounting figures. In addition, the involvement of independent non-executive boards also encourages the firms’ performance through a thorough scrutiny of the business performance according to the set or agreed visions, standards and company’s objectives (Engelbrecht, 2012). However, this will depend significantly on the commitment of the non-executive independent board who among other things need to take full responsibility associated with monitoring the performance of executive management, particularly in relation to the success and progress made in the direction of desired end; the company’s performance strategy and objectives. In the highly competitive market, having non-executive independent board not only encourage good performance but also add value for shareholders. They are seen as not only safeguarding but also and providing significant source of competitive advantage especially in the contemporary business arena where they form part of that extra board level ingredient, over and above the qualities of the top executive team and the rest of the board (Chambers, 2005: 24). Without their vital contribution, boards may be faced with numerous challenges and end up becoming management board overwhelmed with responsibilities including the legal, regulatory as well as those emanating from shareholders (Engelbrecht, 2012:131). According to Choi, Park and Yoo (2007) board independence is particularly vital in post-crisis emerging market environments characterized by lack sufficient liquidity and infrastructure, and which are susceptible to economic instability and external shocks. A case in point is South Korea, an emerging market country, where board independence encouraged firm performance, particularly in the aftermath of the Asian crisis of 1997 which was a consequence of the poor governance system of that region. Another evidence is from the study entitled “Separation of Powers: Active, Independent Boards Enhance Credibility” conducted by Deli et al. (2005) who argue that in which the CEO is a separate position from chairman of the board are given greater credence by the markets. Results of the study also show a correlation between informative earnings and greater independence of the board. The independent non-executive boards also plays a very important role in management structure of a firm as it brings with it an objective and external judgment on various issues of the company like strategy, performance, resources and standards of conduct and evaluation of performance to the board. King II (2002: 56) argue that apart from the courage and wisdom, the element of independency should be the characteristic or hallmark if any at all the board is to act in the best interest of the organization. In the same breadth, the Institute of Directors’ guidelines (2009), argue that the main and most important role of independent nonexecutive board is to bring about constructive criticism. While it is true or a popular held belief that executive or director is highly skilled and able to visualize the firm’s issues in a more broad manner, independent non-executive board have preferred since they poses wide experience and positive qualities (IOD, 2009). This can be attributed to the fact that by virtue of being an “outsider”, the independent non-executive board may be well equipped with a clearer view of the external business setting or market consequently; they can provide a creative and informed opinion and act appropriately and critically in relation to the firm’s objectives. Lastly, the independent non-executive director can help to connect the business and board with networks of potentially useful people and organizations (ibid).An effective non-executive independent board is one which is also independent not only in fact but also the attitude of a reasonably informed entity. Accommodating a good number of independent non-executive members in a board is an effective governance tool in a variety of situations, such as providing support whenever the chairperson is in need to enhance the effective functioning of the board. They may also help in balancing the role if executive director since they can give constructive contribution and objective views to the board. They are quite unique in that they independent of the corporate governance and free from any business, dealings or any relationship which could materially or otherwise interfere with the normal operation of the company especially in terms of executing independent judgment (ICAC, 2008:25).The Cadbury Report (1992 as cited in Horn, 2005: 23) has given some insight and benefits of companies characterized by non-executive independent board. They bring about or widen strategic view of boards and the firm’s vision for the future while also sustaining the board’s observance of the company’s interest and enlighten the board on the external world and the dynamic nature of public expectations to board deliberations. Inclusion of non-executive independent board in a company facilitates a wide variety or diversity. One of the ingredient of effective corporate governance is boards composed of an appropriate mix of personnel or people with various skills and experiences .This is because the in the current business environment, not all executive directors are available in most times to coordinate and influence or make all decisions. Consequently, the need for non-executive independent boards of governors in consistent with the need to have people contributing differently in light of what it takes to have a successful and effective board (Iwu-Egwuonwu, 2010). Other advantages associated with diversity among board of governors as brought about by allowing the non-executive independent staff is by the fact that board or groups tend to make better decisions so long as the to the information available is more diverse and also if the board or group understands different specializations, that is “who knows what” in order to capitalize on the available knowledge. Again, board composed of non-executive members or directors can Leverage or control their diversity to reach out more effectively to a wider set of constituencies to help avert problems or solve them when they arise. According to Goodstein, Gautam, and Boeker (cited in Iwu-Egwuonwu, 2010) diversity on boards of directors has been found to help companies manage key constituencies including shareholders and employees. It is worth noting that the benefits associated with wealth of diversity are determined by how clear expectations of the non-executive indepdent boads are made Non-executive independent ensures that there are adequate safeguards of the interests of the company where there may be conflict with the personal interest of directors very well placed and capable in relation to conflict management in the company especially possible conflicts that may arise between the various interests of executives and those of shareholders of the company(Engelbrecht,2012:129).Other examples of conflicts may be linked to where an employee or a staff member involvement in the procurement department has financial interest in the organization preferred by the listed firm in the selection of the suppliers’ agency. Moreover, it may be that the agency under consideration is either a very close relative or a friend to the person mandated with the responsibility for purchases (ICAC, 2008:14). Conflict resolution requires not only an independent entity (formally and informally), but also with the right attitude, independent mind, who are able to exercise an objective judgment on corporate affairs. Apart from conflict resolution which forms part of a firm’s of a credibility in line with the company’s corporate governance policies and laid down procedures , non-executive independent board also encourage a wider, more general and special experience into board discussions, objectively monitor and review executive and management’s performance against laid down strategic approaches (PricewaterhouseCoopers, 2002: 14). Shortcomings of Non-Executive Independent Board Unfortunately, the are some negative effects linked with non-executive independent board which if care is not taken can compromise the various gains. Various studies have for stance pointed out to the fact that the presence of more executive board impact positively on the organization’s performance than can ever be contemplated under a board with majority of non-executive independent directors. In the same vein some research has also shown that in some situations or circumstances, the continuous composition of non-executive independent board prevent or makes positive firm performance next to impossible(Iwu-Egwuonwu,2010: 196) including the profitability of the firm as confirmed by Fich and Shivdasani (2006) who contend that firms significant number of independent boards for instance, directors serving three or more boards tend to have lower profitability as a result of being unable to fulfill the role of effective monitors due the existence of substantial social ties between outside directors and top management(Hwang & Kim,2009). Further evidence is given by Kumar and Sivaramakrishnan (quoted in Iwu-Egwuonwu,2010) who have used an agency model of the firm to arrive at the conclusion that other things held constant, a more dependent board exhibits a greater alignment with the CEO as opposed the non-executive independent board. Shareholder value increases significantly with board dependence but not otherwise (independence). In other words, when a board is more independent it performs worse. This is attributed to the fact that when directors get equity awards, conflicts or tension is created between the board’s monitoring and contracting (supervision) roles on the other hand, a more dependent board tends to get less benefit from superior information about the organization’s economic performance or prospects generated by monitoring than a less dependent director. According to the tow, it follows that as more dependent executive board or directors sit on the board; there is a great potential for a substitution effect which eventually lowers or dilutes its optimal monitoring effort. On the other hand, from the viewpoint of shareholder value maximization, such a board is also more inclined to award less efficient contracts to the manager’ further bringing about a negative wealth effect on the board if it has an equity stake (Iwu-Egwuonwu,2010: 193). Research also highlights that diversity associated with non-executive independent board may also result in lower cohesion, reduced trust and even high rate of turnover within the board especially if the members are not trained to accommodate and trust one another. There is also possibility for minority groups with divergent or different opinions to be discriminated or be on the receiving ends and sometimes receive lower performance evaluations (Tyson Report, 2003). Conclusion This paper sought to explore the role of Non-executive independent boards in a given firm or company. The paper has captured some of the prevailing research evidence for and against the conventional wisdom for the role of non-executive independent boards. From the many benefits mentioned , I uphold the view that the role of Non-executive independent boards cannot be ignored in any organization hence refute the statement that ‘Non-executive independent boards are a waste of time and that they have little involvement in a company and are not aware of what is really going on’. The fact that there are some inherent problems is not strong enough to brush away the significant contribution of these boards however, the various benefits should be embraced with some degree of caution and taking necessary steps in averting some of the negative effect as empirical evidence is quite mixed, given the advantages and disadvantages. Independent directors on the board of a company come from diverse backgrounds and more often than not, they are not from the same industry. Therefore, a formal on-boarding program for new directors is most helpful in getting new board members up to speed quickly and enabling them to contribute sooner. Bibliography Adams, R. and Ferreira, D. (2009) Women in the boardroom and their impact on governance and performance, Journal of Financial Economics, 94(2), 291-309. Al-Materi Y.A, Al-Swidi A.K, Bt- Fadzil F H and Al-Materi E M (2012). Board of Directors, Audit Committee Characteristics and Performance of Saudi Arabia Listed Companies, International Review of Management and Marketing, Vol 2(4):241-252 Choi JJ, Park SW, Yoo S (2007). Do Outside Directors Enhance Firm Performance? Evidence from an Emerging Market. J. Financial Quantitative Analysis vol4 (4):941-962. Deli D, Gillan S, Anderson K (2005). Separation of Powers: Active, Independent Boards Enhance Credibility (Electronic version). Knowledge @W.P. Carey. Retrieved on December 17, 2012, from http://knowledge.wpcarey.asu.edu/article.cfm? articleid=1009 Engelbrecht, M. (2012). The art of shape shifting: facilitating strategic foresight to independent non-executive directors - a strategic approach to corporate governance in SA. Doctor of Philosophy Studies Dissertation at Stellenbosch University. Fich, E. and Shivdasani, A. (2006) Are busy boards effective monitors? Journal of Finance, 61(2), 689-724. Horn, R.C. (2005). The legal regulation of corporate governance with reference to international trends. Mini-Dissertation. Bellville: University of Stellenbosch Business School Independent Commission against Corruption (2008). Good Governance and International Control-A Corruption Prevention Guide for Listed Companies: ICAC, Hong Kong IOD. 2009. Guidelines and eligibility. [Online] Available: httpp://www.iodsa.co.za/about.asp?CatID=116 Accessed: 17 Dec, 2012 Iwu-Egwuonwu, Ronald Chibuike (2010). Some empirical literature evidence on the effects of independent directors on firm performance, Journal of Economics and International Finance Vol. 2(9): 190-198 Kakabadse, A., Ward, K., Korac-Kakabadse, N. & Bowman, C. (2001). Role and contribution of nonexecutive directors. Journal of Corporate Governance, 1(1), 4–7.PriceWaterhouseCoopers (2002). Being a director: Duties and Responsibilities. Corporate Governance Series, Johannesburg. King II Report on Corporate Governance in South Africa (2002). Institute of Directors. KPMG International. (2011). Role of Independent Directors: Issues and Challenges, Audit Committee Institute. KPMG International. 2007. The audit committee journey: Evolving priorities, practices and perspectives – A global view. Audit Committee Institute Kumar P, Sivaramakrishnan K (2007). Who Monitors the Monitor? The Effect of Board Indepedence on Executive Compensation and Firm Value (Electronic version). Retrieved January 15, 2010 from http://ssrn.com/abstract-988543. The Tyson Report on the Recruitment and Development of Non-Executive Directors(2003).A report commissioned by the Department of Trade & Industry following the publication of the Higgs Review of the Role and Effectiveness of Non-Executive Directors in January, London Business School Weir C, Talavera O and Muravyev A (2008). Performance effects of appointing other firms' executive directors to corporate boards: an analysis of UK firms Read More