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CAI JIN

Tighter guidelines needed on IDs' payouts

Independent directors of firms should stay truly impartial to protect investor interest

The season for annual general meetings (AGMs) is just round the corner and for small-time investors, attending these once-a-year gatherings is still one of the best ways to size up a company's management.

AGMs usually commence with the board of directors trooping up to the stage and getting seated behind a table - and then keeping quiet for the next hour or so.

Most directors rarely speak at AGMs, leaving the chairman to field questions from shareholders. However, some of them do stay behind after the meeting to mingle with shareholders and discuss the work which they perform for the company.

Many board members in recent years have been appointed from outside of the company's management. These independent directors (IDs) are vested with the heavy responsibility of keeping an eye on the management and ensuring, among other things, that questionable practices do not slip through.

Why is such a safeguard necessary? This is because quoted equity is a peculiar way of owning a stake in a business. Even though an investor puts his capital at risk when he buys the shares of a listed company, he has no say over the running of its business and no direct control over its assets.

Thus, his only recourse is to rely on the IDs to exercise objective judgment. This explains why casting even the slightest doubt over an ID's independence can have serious ramifications.

Singapore Post shares, for example, took a beating when corporate governance issues were kicked up over an ID's interest in three recent acquisitions made by the company.

Since "indies" play such an important role, part of the code of corporate governance - which enshrines shareholders' rights - is devoted to laying down guidelines to ensure these directors remain just that: truly independent.

Now, guidelines such as requiring that an ID has no relationship with a company, its subsidiaries, management or substantial shareholders, which may affect his ability to make objective business judgments, are easy to follow through.

The code, however, recognises that there are some IDs who are paid by the company for other services, and that such payments may compromise their independence of judgment.

In such cases, it states that "payments aggregated over any financial year in excess of $200,000 should generally be deemed significant" enough to deem an ID non-independent.

Now, providing a ballpark figure of $200,000 as a guideline on an ID's objectivity of judgment is all well and good.

But there have been instances that made me wonder if such a guideline oversimplifies the issue and whether a tighter definition for IDs, who also provide professional services to a company whose board they sit on, is needed, given the instances of lapses seen over the years.

One company director, for example, noted that a fellow ID has become less and less "independent" in his assessments because he is also getting paid for the advisory services he renders to the company. Even though the advisory fee is well below the $200,000 threshold, it is considerably higher than his ID's fee, possibly motivating him to toe the line on contentious issues.

It is hard to tell if similar problems occur in other listed firms, but there is one case worth recounting that became so contentious that it triggered a full-scale inquiry into a firm's corporate governance practices.

In 2011, the Singapore Exchange (SGX) was sufficiently rattled by payments made by China Sky Chemical Fibre for accounting-related services from a firm linked to a former ID, Mr Lai Seng Kwoon, that a special audit it demanded of the S-chip firm also included this issue.

The sums paid by China Sky to Mr Lai's firm were all below the $200,000 threshold prescribed by the corporate governance code - $112,000 in 2008, $183,000 in 2009, and $72,000 in 2010.

But the advisory fees were presumably much higher than the fees paid to him as an ID. China Sky paid directors' fees of 780,000 yuan (S$165,000) in 2008 and 800,000 yuan each in 2009 and 2010, which were payments that had to be shared among six directors.

Mr Lai tried to make light of the issue by saying that it would stretch the imagination to think that he would risk his licence, professional reputation and integrity for $100,000.

But one concern was that while the sums might not have been big in the scheme of things, he was China Sky's audit committee chairman when the services were provided by his accounting firm, and there was a potential conflict of interest as he would be in a position to review his own firm's work.

The seriousness the SGX attached to the issue attests to the importance of the role IDs play in a listed firm. Otherwise, why would any investor seriously want to plough his money into a listed firm if safeguards such as IDs are compromised?

Then there is the question of the fees paid to IDs who also sit on the boards of the subsidiaries of a listed firm.

Very often, these subsidiaries are based overseas and there is no breakdown of the fees paid by these subsidiaries to the IDs in the annual report. The fees paid by the subsidiaries also do not require any form of approval by shareholders, unlike the ID fees which are paid at the listed company's level.

So there are concerns whether an ID's independence will be compromised if the payout he gets from the subsidiary is much higher than the ID fee he collects from the listed firm.

One remedy is to have a tighter definition in the corporate governance code to ensure that all payments an ID receives from the other services that he renders to a listed firm do not exceed his ID's fees. This should be on top of the guideline figure of $200,000 now stipulated in the code.

Some will argue that this will only exacerbate a shortage of qualified people willing to sit on the board of smaller listed firms. But this will not be the case if it results in listed companies becoming willing to pay more to get good people as directors.

Surely, in the upcoming AGM season, this is one issue that deserves to be aired - if only to ensure that IDs are seen to be truly independent.

It will give investors a big boost in confidence, knowing that there is a group of good men and women looking out for investors' interests.

A version of this article appeared in the print edition of The Straits Times on March 14, 2016, with the headline 'Tighter guidelines needed on IDs' payouts'. Print Edition | Subscribe