Independent company directors: A lonely road?

Conventional wisdom suggests that companies perform better with a majority of independent directors.  Indeed, around the world Stock Exchanges – including the New York Stock Exchange, the ASX  and the UK Corporate Governance Code – and other regulators have made an industry of defining and policing director independence.  In the process, it’s become apparent in some quarters that executive director roles have become “tainted”.

The latest contribution to this “industry” is the NZX engagement involving its Corporate Governance Institute (CGI) with Director Independence - Initial Consultation Paper.

Independent directors’ positive impact on company performance is based on an assumption that “directors with an independent perspective are more likely to constructively challenge each other and executives – increasing effectiveness” (NZX Consultation Paper – p9).  The NZX made changes to the Code commentary in an earlier 2022 review of the NZX Corporate Governance Code, reflecting stakeholder feedback that “there is often a stigma associated with a determination that a director is not independent…”

Recent thinking, however, suggests some caution is needed about corporate governance “conventional wisdom”. Seven Gaping Holes in Our Knowledge of Corporate Governance questions the extent of evidence of factors that support director independence.  The authors conclude that “most studies find very modest or no relation between independence and corporate outcomes”.   Not much has changed since the publication of 1999 research Do Independent Directors Add Value? which found “US and UK studies have produced mixed results on whether independent directors add value”.  That same research found from Australian studies that “on the whole, the studies produced no solid evidence that the proportion of independent directors influences corporate performance (whether measured as share price returns or accounting performance).”

None of this means that independent directors don’t add value. It does, however, suggest two key things:

• Care is needed in putting in place prescriptive rules on director independence in regulation and governance codes. It is possible that director independence does add value in conjunction with other governance practices that drive board effectiveness.
• Those arrangements that are put in place need to be monitored and evaluated to assess their effectiveness.

The Institute of Directors submission to the NZX on its director independence initial consultation paper reflects these challenges and suggests ways to address them.