Sunday, 28 December 2008
Expect More Independent Directors to Abandon Ship
Public companies are not required to tell how they have equipped the independent directors. Yet, it is reasonable to believe that most firms prefer to do little because the more knowledgeable the independents are, the more demanding they will be and the more difficult the job of the executives will become.
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Expect More Independent Directors to Abandon Ship
Shirley Yam
27 December 2008
It has happened again. Another listed company has seen the resignations of all but one of its independent directors in tandem with the disappearance of its chairman.
The latest example is a mainland frozen food producer named First Natural Foods Holdings. Two days after Deutsche Bank sued the company for US$16 million for the early termination of an interest rate swap agreement, First Natural Foods said its executive chairman was missing and five of its seven directors and its company secretary had resigned. Operations have been left in limbo.
This is not the first time independent directors have disappointed shareholders. Having failed to locate problems in a company, block high-risk investments or make timely disclosures of them, they jump ship immediately when the time bomb goes off. As the economy continues to deteriorate, we are going to see more of this.
Our system has put high hopes on the 3,038 independent directors to protect the interests of minority shareholders. But other than a requirement in the listing rules that each firm should have at least three independent directors, we know little about how the system works.
Who are these independent directors? How did they get hooked up with the company? How much do they know about the company in order to do a proper job?
I asked some independent directors, investment bankers and executive directors these questions. Their answers offer little comfort.
Imagine you are the chief executive of a medium-sized company that is planning a listing in Hong Kong. How do you fill the three independent board seats?
Your advisers - lawyers, auditors and sponsors - are more than happy to provide you with names. In fact, as part of their service as sponsors, major investment banks in town have databanks of potential candidates. Head-hunters offer a similar service but for a fee.
Populating these lists are retired corporate executives, lawyers and accountants. Of course, there are the professional independent directors, whose directorship is their only source of income.
It is not much different from shopping for a party service online. You list the criteria for the independent directors and pages of PowerPoint listings with the candidates’ backgrounds and pictures will soon be in your mail.
You can do it in an even more casual way. This is because the listing rules only recommend that one of the independent directors need have a financial background and stipulate no professional requirements for the rest. You can appoint your friends, as long as there is no official business link between you.
In the case of First Natural Foods, its three independent directors included one accountant, an academic at Fujian Agriculture University, where the chairman’s son graduated, and the Hong Kong-based owner of a printing house. That is the most popular combination - one academic, one accountant, and others.
Then you negotiate the annual fee with them, ranging from HK$120,000 to HK$1.5 million. That does not sound like much, but considering that most companies hold four to six board meetings a year, that is not bad pay. (Full-time financial controllers of small and medium-sized listed firms are getting HK$250,000 to HK$480,000 nowadays.)
If you want household names, former regulators or retired partners of Big Four audit firms, you have to pay more. If you specify no work-hour commitments, you pay less.
Now the independent directors have signed up. They know nothing about your business. You can choose to fully educate them so they can offer better advice in the interest of the company, or to do nothing. The regulators state no requirements.
What do I mean by “fully educate”? A well-rounded orientation would include on-site factory visits, meetings with department heads and briefings by lawyers on the company’s articles of association and the listing rules.
This would be followed by regulator updates, site visits and distribution of discussion papers a week before meetings.
The resources required are undoubtedly considerable. The commitment by the majority shareholders is far more important, according to two chief financial controllers of listed firms that run such an orientation.
Public companies are not required to tell how they have equipped the independent directors. Yet, it is reasonable to believe that most firms prefer to do little because the more knowledgeable the independents are, the more demanding they will be and the more difficult the job of the executives will become.
The exceptions appear to be the state-owned mainland enterprises listed here. Thanks to the efforts of the State-owned Assets Supervision and Administration Commission in preventing embezzlement by management, they have a more formal policy in choosing and briefing the independents.
Sure, there are directors who have a name to protect and may work on their own initiative. But it is hard to believe that they account for the majority of the 3,038 independent directors. For those who do not have a valuable “name” and are just selling their independence and time for a decent fee, there is little incentive to do more than act as a rubber stamp.
Of course, the latter face the eventual risk of their firms running into compliance and financial problems. But this is only a theoretical issue. By then, they would have already jumped ship.
It is true that the listing rules do require the board, and therefore the directors, to make accurate and timely disclosures, but the rules have no statutory teeth. The Securities and Futures Ordinance does hold directors legally liable for some crimes, but keeping silent is not one of them.
So the highest price those rubber-stamp directors need to pay is to face a public reprimand by the Hong Kong exchange. That is cheap.
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