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The efficacy of oversight functions of independent directors

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Cesar L. Villanueva

M. A. P. Insights

The efficacy of oversight functions of independent directors

Since the Securities Regulation Code’s (SRC) promulgation, there have arisen many issues regarding the rationale or efficacy of the system of independent directors (IDs), with passionate advocates on both sides of the debate.

Confrontational Role of IDs Not Consistent with Filipino Culture

We shall first discuss and dispose-off the “cultural criticism” against the system of IDs, which holds that the system promotes a culture of confrontation within PHC Boards, which supposedly is contrary to the Asian culture of non-confrontation or which operates under a system of “smooth interpersonal relationship.”

In a study conducted by Professor Victor S. Limlingan for the Asian Institute of Management (AIM), he concluded that the appointment of IDs to company Boards is “irrelevant, ineffective and immaterial” to our corporate setting and recommended that the regulators shift to the “more harmonious” corporate governance system espoused by the Japanese. His main point in the study is that “The American good governance model is not applicable to the Philippines. The Western system is more confrontational while the eastern is more harmonious. The idea of having oversight bodies is basically adversarial. What we need are advisory bodies.”

Indeed, by definition of the ID under the SRC as “a person other than an officer or employee of the corporation, its parent or subsidiaries, or any other individual having a relationship with the corporation, which would interfere with the exercise of independent judgment in carrying out the responsibilities of a director,” the presumption is that all other directors are unlikely to be in a position to exercise independent judgment; that only IDs are “above suspicion.” Therefore, the ID’s primary duty would be to place the other directors on the path of independent thinking and decision making; or in essence, to be effective “fiscalizers” in the Board which acts under a supposedly constant threat of conflict-of-interest situations. The point of this criticism is that any system adopted that is inconsistent with the cultural underpinning to which it is placed is doomed to fail.

We believe that the “cultural criticism” has very little merit. Firstly, our culture is imbued with a sense of confrontation when based on principles of good governance, whether in the private or public sectors, as borne out by the sacrifice of our heroes during the Spanish, American and Japanese dominance of the Philippines, our EDSA revolutions against Presidents who were dictators or perceived as corrupt, the confrontational manner by which congressional hearings are held to ferret out corruption or inefficiency in government, our press which continuous to be one of the freest in Asia, as well as our people’s predisposition towards litigation in resolving issues.




Secondly, our corporate system is patterned exactly after the US corporate system, down to its common-law doctrines, and therefore the system of corporate governance as evolved in the US, including the system of IDs, fits well into the Philippine corporate system. In fact, the corporate governance reforms began in the developed countries as a reaction to Board passivism against overbearing Management headed by a strong CEO.

Although it is true that the system of IDs was first instituted in “widely-held companies” to allow an independent check on the professional management of a corporation in behalf of the scattered shareholders, the system has proven itself a workable check even in “controlled companies,” against corporate opportunism by the majority stockholders who have control of the Board.

Thirdly, since the publication of Mr. Limlingan’s work in 2002, the Japanese system of “harmonious corporate governance system” has proven to be unworkable for a sustained corporate governance reform movement and has proved to be fatal to Japan’s recovery program. In fact, Japanese companies are currently aggressively seeking to increase IDs among listed companies to ensure better corporate governance.

Diluting the Sense of Responsibility to the Corporation and Its Various Stakeholders

The foremost objection to assigning the role “to exercise independent judgment” to IDs of PHCs is that it seems to imply that regular directors do not have the personal means to exercise such function, or, worse, that they are not mandated to exercise independent judgment for the benefit of the company and all its stockholders, to whom they all equally hold fiduciary duties of diligence and loyalty. The criticism avers that the system of IDs specifically mandated to exercise independent judgment tends to dilute the system of Board responsibility towards the corporation, its stockholders and other stakeholders, since such responsibility is seen to shift primarily on the shoulders of the minority IDs.

The well-established principle in Corporate Law is that all directors owe fiduciary duties to the corporation and all its stockholders, and not just to the constituencies who elected them into office. This is true even with directors who were elected through cumulative voting — such minority directors are expected to exercise independent judgment for the best interest of the corporation and all its stockholders, and not just the minority stockholders who voted them into office.

Presumptuous That Only IDs Can Exercise Independent Judgment

The third criticism is that the system of ID presumes rather strangely, that only technically-defined IDs can exercise independent judgment on corporate matters, and that the logical extension of such reasoning is that all other directors are not predisposed to exercise independent judgment. If that were the case, it is rather strange that IDs are constituted always as a minority (20%) in the Boards of PHCs, and therefore would always be outvoted by the majority who are supposedly not capable of independent judgment, or who would act for the benefit, or to cover up the shortcomings, of management. In any event, the entire Board of Directors of every covered company is expected to act independently, especially of the Management, which is the one accountable to the Board.

Critics supporting this position raise the questions, “When IDs sit in the Boards of Directors of PHCs, for whose benefit are they supposed to exercise their business judgment?” and, “If all regular IDs are supposed to act for the benefit of the corporation and all the stakeholders, then what ‘greater’ or ‘other interests’ are the IDs supposed to champion?”

Since all directors are duty-bound to act in the best interests of the corporation and its stockholders, then the only area left for IDs in their special role is to protect the interest of the State or the government (which created their office) or to the “greater public” other than those members of the public who already qualify as stakeholders. This creates an anomalous situation, for the State bears no proprietary interests in the business enterprise of PHCs except to the extent that it should be carried on for the public good, which the State should fulfill through its regulatory powers. This rather hazy supra-fiduciary duty of IDs would make them truly “independent” of any ultimate principal, since the “greater public” interests do not really create any principal to whom they could be accountable, except to the extent defined by the IDs themselves. Under such setting, they are accountable only to themselves and what they may think is the “greater good” in the corporate world. We would then have a situation where there is a fiduciary position (whether as a trustee or as an agent) without a beneficiary; and, consequently, no real accountability to anybody.

The only measurable special function of the ID is to exercise independent judgment “for the benefit of the corporation and the various stakeholders.” If this be so, then IDs merely duplicate the function of non-executive directors.

Dubious Quasi-Public Role of the ID

The fourth criticism is that the underlying presumption in the corporate setting is that the IDs are supposed to be non-partisan; they do not owe any sector within the corporate setting a particular form of loyalty; and that their chief function is to be loyal only to a “corporate truth” or to the ideals of “good corporate governance.”

Such a purported role of the ID is in contrast to that of a regular director who must necessarily be partisan to well-identified constituencies, on whom the law imposes fiduciary obligations: the corporation, the stockholders, and now other stakeholders under the stakeholder theory. The position of ID is therefore equated to a “quasi-public” office, equivalent to those occupied by independent auditors and perhaps even credit rating companies, whose work of certification is supposed to constitute independent work which can be relied upon by the government and the public as a disinterested source of gauging the financial standing or credit worthiness of companies or securities, as the case may be.

Such quasi-public characterization of the office of ID is contrary to the very essence of the nature and function of the Board of Directors: it is the agency constituted by the Corporation Code to directly manage the corporate business enterprise and to exercise all of the corporation’s powers. By the very nature of their function, the Board and its directors are held to be partisan for the benefit of the corporation and their constituencies for whose benefits directors have been imposed with fiduciary duties and obligations. Under the doctrine of maximization of investors’ value, directors are supposed to be “die-hard fiduciaries” for the corporation and its investors to the exclusion of other interest, and to the extent they do not violate the law and contravene public policy.

IDs Eventually Get Coopted into the Controlling Stockholders’ Circle of Influence

The most enduring area of opposition to the system of IDs is the position that purports that the system of IDs would legally and practically exclude from their ranks leading experts and professionals in the field, business or industry engaged in by the publicly-held company they serve. Consequently, the only individuals who would qualify to be nominated and elected into the Board of PHCs are “strangers” to, and who would essentially be “lightweights” in the industry to which they are supposed to exercise business judgment. It is then argued that potentially, IDs would be hard-put at being effective contributors in the Board dynamics, based on two critical areas of importance: competence and remuneration-dependence.

The SRC implementing rules on disqualifications for IDs would qualify very few competent individuals for IDs since they would most likely have business or professional dealings in the industry where the PHC operates. The really remaining competent candidates for independent directorship would be few, and would thereby become expensive commodities. The other individuals who would qualify may be just starting on their careers and have not become too spread-out in the industry network as to be “disqualified,” or are individuals who come from outside the industry. In either case, such IDs may lack the moral and professional influence for their views to carry much weight in Board discussions.

In fact, being placed in the board situation where some of the captains and leading practitioners in the industry sit as non-independent directors may just literally place IDs into very passive roles, afraid to open their mouths and expose their ignorance of the intricacies of the industry and the operations of the company; and then the only real measure of how they have been “independent” is the near-silent posture they have taken during the fiscal year.

Ultimately, earning their upkeep from per diems and remuneration (if any) from the Boards they serve, and that their continued professional growth as IDs would be dependent on being able to keep their directorship position in the PHC, the ID would never feel the financial freedom that is so essential for their statutorily-mandated role; and in the tradition of the agency capture syndrome, they begin to consciously or unconsciously align their professional judgment along with the group that butters their bread.

The article reflects the personal opinion of the author and does not reflect the official stand of the Management Association of the Philippines or the MAP.

 

Cesar L. Villanueva is the Vice Chair of the Corporate Governance Committee of the MAP, the Founding Partner of the Villanueva Gabionza & Dy Law Offices, and the former Chair of the Governance Commission for GOCCs (GCG).

cvillanueva@vgslaw.com

map@map.org.ph

http://map.org.ph









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