What is good guidance for the composition of an effective Board of Directors?

This is a common question for many SME owners and it is a very relevant issue not just for commercial companies but also for non-profit organisation.

To answer this question, we must first understand the important role that the Board plays vs the Company management and how would a board be effective?

The Board is effectively the most powerful officers representing the Company and under Company Act s157, the directors are empowered to “managed by, or under the direction or supervision of, the directors and may exercise all the powers of a company except any power that this Act or the constitution of the company requires the company to exercise in general meeting”. In short, the Board decides the Company affairs except those matters which specifically require shareholders (or members) approval under the Constitution or Company Act.

The Board performs the governance role of the Company and oversight over the Company management. The management of the day-to-day matters of the Company is performed by the Management (“Key Management Personnel (KMP)”) which typically refer to members of the top management team of the company eg the C-suite, CEO, COO, CFO, CHRO, CCO, CRO, CTO, president, managing directors etc.

Therefore, for the Board to be effective in performing its governance function, 2 key factors are important – Independence and expertise.It is important that the Board has both perceived and actual independence from the management and shareholders (or members). One of the key governance functions is to ensure any transactions with related parties (management, shareholders, related companies) is done at arms’ length and at the Company’s interests. The point to note that the Board’s fiduciary duty is to the Company, not to the shareholders or management or any specific group of related party. In a typical conflict of interest situation, where a NED (a non-independent NED) is a substantial shareholder (with shareholding > 5% or for company limited by guarantee, voting rights > 5%), he cannot be acting in his interest as a shareholder (or voting member) but instead his fiduciary duty is to the Company. This may relate to share acquisition or disposal of the Company by the shareholder and non-independent NED where his shareholder’s motive to maximise his gain may not necessarily align with the Company’s interest. For non-independent NED acting as holding company representative (corporate shareholder), it is pertinent that you take down your shareholder’s hat in every Board meeting of your investee.

With independence and expertise in the affairs of the Company, the Board is more likely to be effective vs a non-independent board even if that non-independent Board has the expertise on the affairs of the Company. The existence of a non-independent Board does not necessarily imply that biased decision making would happen in a conflict of interest situation but rather inherently it has that non-independence bias actual or otherwise. A non-independent Board voting on matters on which some board members are conflicted is sometimes inevitable. Abstinence from voting by the conflicted members or mere disclosure is not good governance and certainly the latter does not constitute compliance.

What constitute a good guidance to the Board’s Independence ?

The SID CG guidance for public listed board in Singapore listed the following:

1. Independent directors (ID) must forms the majority of the Board (or at least a sufficient number) to ensure that objectivity is brought to bear on Board decisions. This helps to avoid groupthink and encourage more rigorous decision-making. An “independent” director is one who is independent in conduct, character and judgement, and has no relationship with the company, its related corporations, its substantialshareholders or its officers that could interfere, or be reasonably perceived to interfere, with the exercise of the director’s independent business judgement in the best interests of the company.
2. The Chairman of the Board must be independent. Where the chairman is not independent, the proportion of IDson the Board must increase to ensure an appropriate level of independence. In addition, a Lead Independent Director (Lead ID) must be elected or appointed from the group of IDs to play an additional facilitative role within the Board to chair its meetings, represent the group and to provide leadership in situations where the Board Chairman is conflicted (an independent Chairman).
3. The Board must constitute Non-Executive Directors (NEDs)(or at least a majority) to perform an effective oversight on the management (ie over the executive directors).

NED is a director who does not have a material or business relationship with the company or related persons, except in respect of director fees. Conversely, an ED is a working director and a paid full-time staff who participates in the day-to-day running of the company and who has a decision-making role (as delegated by the Board), in its daily operations. Eg C-suite. An ED is, by definition, deemed to be non-independent. This is obvious that you cannot expect a working executive to perform oversight on his own performance.

4. The Board size and diversity must be appropriate to the size and complexity of the Company. Diversity is not about numbers, it is about the quality, independence and agility. Less is more and a large board does not necessarily is an effective board.
5. The importance of NEDs and ID to meet regularly without management. This is to ensure the Board remain independent and free from management influence.

In summary, in the hierarchy of independence, NED is more independent vs ED. Within NED, ID is the most independent, followed by non-independent NED. In most cases, keeping independence of the Board is the most challenging elements, as in this multi-connected and globalised market, one seems to be connected to another in many ways. Therefore, rigorous selection of the Board members from the start on independence current and future helps to mitigate the risk of the non-independence of the Board going forward. It is good governance mindset to strive to maintain a “clean” Board, and other mitigation (eg lead ID) on non-independent Board (or Board chairman) as a last resort.