How do companies ensure their independent directors are really independent?

The independence of Hong Kong listed companies’ independent directors is sometimes questioned, since restrictions don’t forbid certain personal relationships

By A. Au

Every listed company has a board whose directors steer the company’s general direction, decide its important matters and direct the work of employees at all levels. The Hong Kong Stock Exchange stipulates that each listed company should appoint at least three independent non-executive directors (INED), accounting for at least one-third of the board. At least one of those should have appropriate professional qualifications, including accounting or other financial management expertise, to assist in auditing the company’s accounts.

An independent director is defined as a person who does not hold office within the company, who is independent of shareholders and executive directors, and who does not have significant business or professional connections with the company or its management. Such directors are qualified to exercise independent judgment in the company’s affairs.

To demonstrate their independence, some independent directors should also not hold any shares or share options of the companies on whose board they serve, helping them to avoid conflicts of interest in their decision-making.

But unlike rules for listed companies in Europe, the U.S. and Australia, independent directors of Hong Kong-listed firms seldom specify the amount of time a director has to commit and the number of meetings the person must attend each year. Therefore, it is difficult to compare their remuneration levels with those of independent directors at listed companies in other countries.

Independent directors at Hong Kong-listed companies generally receive just HK$200,000 ($25,600) to HK$300,000 in compensation each year, and figures can even go as low as HK$100,000, which is a tiny fraction of what executive directors make. With pay at such low levels, it’s no wonder many independent directors may be largely window dressing, and many such people may simply be “moonlighting” in several companies.

Long tenure jeopardizes independence

The independence of independent directors in Hong Kong is also sometimes questioned. While relatives of major shareholders and directors may not serve as independent directors, classmates, friends and people with other relationships with the company are still allowed to be considered as independent parties. That’s why it’s difficult to prevent listed companies from naming independent directors who share the “same voice” as management, which affects the board’s independence.

It’s a matter of fact that when independent directors serve on a company’s board for long periods, they will become quite familiar with other directors, and may even develop tacit understandings with each other, potentially undermining their independence.

Periodic changes to the board’s membership can avoid the prolonged presence of any individual independent directors, which can help to maintain the overall board’s accountability.

Recognizing this, the Hong Kong Stock Exchange has implemented a new corporate governance code requiring listed companies to disclose whether an independent director should continue to be re-elected by way of a separate resolution after being in office for more than nine years. Moreover, when all independent directors have served for more than nine years, a company is required to appoint new independent directors to maintain the board’s independent voices.

Other nearby stock markets, such as Singapore and Taiwan, also plan to introduce similar rules to eliminate the unhealthy phenomenon of “perpetual” independent directors. Hong Kong can strive to do even better by considering corporate governance codes in Europe and America. Raising the proportion of independent directors to half of the board or more, or adding a “chief independent director” to mediate conflicts between major and minority shareholders, can help to enhance corporate governance at listed Hong Kong companies.

In summary, listed companies have a paramount responsibility to safeguard the interests of their shareholders, and their directors’ exercise of powers should be subject to checks and balances. Only through taking such steps can a group of independent directors who are genuinely detached from the company’s interests become an effective watchdog that acts as a positive force in the company’s long-term development.

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

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