RHTLaw Taylor Wessing Managing Partner Tan Chong Huat and Head of Capital Markets Ch’ng Li-Ling co-authored an opinion piece in The Business Times article titled, “A strategic move to enhance independence of directors”. The article was first published in The Business Times on 1 February 2018.
A strategic move to enhance independence of directors
By proposing two options – the hard-limit and the two-tier option – the Corporate Governance Council hopes to generate more discussion in boardrooms.
The ongoing consultation on proposed revisions to the Code of Corporate Governance and the SGX Listing Rules by the Corporate Governance Council (CGC) and SGX is timely, given that corporate governance practices globally have continued to evolve since the last review of the Code five years ago.
Generally, the Code is intended to be a principles-based system of corporate governance, under which SGX-listed companies should comply with the spirit of the principles or explain the different arrangements made. An important principle of the Code which is intended to strengthen board quality is the requirement for an SGX-listed company to conduct a particularly rigorous review on the independence of any independent director who has served on its Board beyond nine years from the date of his first appointment.
The Nine-Year Rule was intended to address the concern that an independent director’s independence may be compromised given his familiarity with management, but a natural threshold question arises as to whether there is any magic to the nine-year tenure period.
WHY NINE YEARS?
Tenure-related guidelines in relation to independent directors are not uncommon in other jurisdictions with the recommended maximum tenure for independent directors ranging from nine (UK, Hong Kong) to 12 years (France) before certain requirements kick in. The Nine-Year Rule is therefore consistent with global corporate governance norms. However, to the layman, it would appear strange that an independent director can be deemed to automatically lose his independence after the expiry of an arbitrary time period.
That said, there is empirical evidence which suggests that a nine-year tenure period is not unusual. In a survey of more than 2,000 American companies over a 13-year period (1998 to 2010), two academics from Singapore Management University and Georgetown University observed that peak values in the measure of a company’s market value in relation to its assets were found when the average tenure of independent directors was in the range of eight to 11 years after controlling for other variables such as board size. It may also be useful for a similar study to be conducted on SGX-listed firms to see if the nine-year period is supported by empirical evidence.
A HARD LIMIT OR SUBJECT TO SHAREHOLDERS’ APPROVAL?
Turning to the consultation proper, companies have, in practice, been rather taciturn with their explanations for deviations from the Nine-Year Rule. The CGC noted that companies often handled this review process with “boilerplate disclosures with scant justifications underlying the independence assessments”. This was not helped by the ambiguity surrounding the requirements of a “particularly rigorous review”.
To address the issues of ambiguity and inadequate disclosure, the CGC proposed that the Nine-Year Rule either be stipulated as a hard limit or subject to two tiers of shareholders’ approval.
By proposing two options for consultation, without leaning in favour of either, the CGC has made a strategic move to generate discussion in boardrooms and beyond as to how to deal with the elephant in the room.
While the CGC briefly examined each option in its consultation paper, it is useful to take a closer look at the ramifications of each option.
The Hard-Limit Option essentially imposes a blanket ban on an affected director from continuing as an independent director on the relevant Board that he is serving on. Other than its utility as a clear bright-line rule, this approach may not be in the best interests of the company as it would deprive the company of the services of an experienced director. Consequently this may impose undue administrative and cost burdens on the company in finding replacement independent directors who, as per the Singapore Institute of Directors’ Board Guide 2017, should also be familiar with fundamentals of the company’s industry business.
In essence, while the pool of qualified independent director candidates may be large, the pool of qualified and relevant candidates may be rather small and the Hard-Limit Option may not be equitable for companies across all industries in various jurisdictions.
Anecdotally, in the property development and construction industry, given the long-term nature of projects, the experience of independent directors on the boards of such companies is necessarily built up over a longer period of time and such experienced directors may be harder to replace.
Also, foreign issuers on the SGX Mainboard face the additional constraint of being required to have at least two independent directors who are resident in Singapore, which necessarily shrinks the pool of qualified and relevant candidates for them even further.
While we recognise that an affected director may continue to serve on the Board as a non-independent director, this may result in additional uncalled-for costs to the company in view of the proposed amendment to the SGX Listing Rules which mandates that independent directors should constitute at least one-third of the Board.
TWO-TIER APPROVAL OPTION
Cognisant of the need to give minority shareholders a stronger voice, regulatory authorities in other jurisdictions have moved towards a more layered approach in appointing independent directors. For example, the UK’s two-tier voting process for premium-listed companies requires approval at the shareholder level and the independent shareholder level at first instance, but allows companies to propose a further resolution to be approved at the shareholder level 90 days after the original resolution.
The Two-Tier Approval Option similarly adopts a layered approach by requiring the approval of the majority of all shareholders and the majority of non-controlling shareholders. However, it would appear to emasculate controlling shareholders in preference of minority shareholders, who may unduly use this vote to express their dissatisfaction with the company’s short-term performance. It may be perhaps better to adopt the UK approach but subject the fees payable to the affected independent director to a resolution to be passed by the two-tier shareholder approval process.
Nevertheless, the Two-Tier Approval Option may be nimbler than the Hard-Limit Option, as it allows the Board to retain experienced independent directors while at the same time giving a voice to the minority shareholders.
As a side note, we are in favour of the CGC’s recommendation for companies to disclose non-controlling shareholders’ votes on the appointments and re-appointments of independent directors (though we note that these votes do not affect independent directors who have served less than nine years). In fact, the regulators could extend this further and mandate that a company be required to propose alternative candidates in place of independent directors who have not received minority shareholders’ approval for three consecutive years.
Whichever option is finally implemented in the SGX Listing Rules, we are heartened by CGC’s proposal to grant companies a grace period of three years to accommodate the transition. This would allow the affected Boards to have adequate time to source and have available a stable of potential candidates if their composition needs to be reconstituted.