A new definition for independent directors – Part 1

A lead independent director will work with other independent directors to supervise the board and ensure it lives up to the company’s long-term goals and shareholder expectations

By Ricky Lai

Aiming to improve corporate board governance, the Hong Kong Stock Exchange (0388.HK) issued a consultation paper in June on improving the Corporate Governance Code with a special focus on better requirements for independent non-executive directors (INED) of listed companies. The paper proposes that a “lead INED” should be appointed if the chairman of the board is not an independent director. It also proposes that individuals cannot serve as independent directors for more than six listed companies at once, and that any director will lose his independent status after more than nine years on a company’s board.

The paper also proposes a transition period of three years, with the changes taking effect on Jan. 1, 2028. Enacting these revised rules can address investor concerns about some independent directors sitting on dozens of boards at once or serving for indefinite periods, bringing Hong Kong practices more in line with global standards.

As proposed in the paper, the “lead INED” will lead at least three independent directors, while also leading and working together with other independent directors, to supervise the board’s performance and ensure it is living up to the company’s long-term goals and shareholder expectations. The lead INED will act as a bridge between the company and shareholders to facilitate two-way communication and strengthen shareholder trust in the company.

By virtue of his or her independence, the lead INED will be able to provide professional advice on risk assessment and management and assist the board in developing sounder risk management strategies. On important matters relating to mergers and acquisitions as well as major investment decisions, the lead INED’s advice can be especially valuable or even indispensable. Their professional advice and views aside, they can also help the company avoid violating disclosure rules for listed companies.

Moreover, the lead INED can properly manage the division of labor among the three independent directors under his or her charge to avoid overlapping responsibilities, regulatory non-compliance or violation of listing rules.

The key role of lead INED

The lead INED’s critical role notwithstanding, the effectiveness of his or her mandate will differ based on specific circumstances of each company. For example, the makeup of each board is a key factor to consider. If independent directors hold more than half the seats, then having a lead INED might boost the interests of independent shareholders. But if executive directors outnumber independents, the board’s overall operational effectiveness will see little impact from having a lead INED.

It’s also important to note the lead INED is usually appointed by the company’s controlling shareholder or chairman, which might incentivize him or her to pay more attention to major shareholders’ interests at the expense of minority shareholders. For example, in the case where a major shareholder holds over 50% of the company’s stock, even with the participation of a lead INED, small shareholders’ interests might still be lost in the shuffle during discussions and approvals of board decisions.

Therefore, I suggest that if the position of lead INED is instituted to improve board independence, consideration should be given to the ratio of the number of executive directors to independent directors, and an appointing mechanism should be carefully crafted to maximize the interests of the whole board. One idea is that the lead INED should be selected by independent shareholders, while controlling shareholders and other directors abstain from participation in the process.

In addition, lead INEDs should preferably have higher credentials than other independent directors. They must be well-versed in listing rules, know the company’s operations inside and out and invest certain amounts of time in the company’s governance. Therefore, perhaps a nominating committee can be set up to select and appoint the person based on each candidate’s qualifications and history as well as their performance as independent directors on the board. Finally, the person elected as lead INED will lead other independent directors.

To be continued

Ricky Lai is secretary for a Hong Kong Stock Exchange-listed company and lectures part-time at various Hong Kong tertiary institutions

This commentary is the view of the writer and does not necessarily reflect the views of Bamboo Works

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