INTRODUCTION
In ensuring good corporate governance and the sustainability of a company, the independence of directors is vital for avoiding undue influence from certain stakeholders. The requirement of independence is also intertwined with the requirement of impartiality required of directors in managing the affairs of the Company.
The above underscores the unique and sensitive roles of Independent Directors in running the affairs of companies, with particular regard to the sustainability of such companies. By their very nature, they bring an objective perspective to Boards whilst providing expert and uncompromised opinions exclusively in the Company’s best interest, thereby ensuring good corporate governance practices.
Over the years, the need for an Independent Non-Executive Director (INED) has moved from desirous to mandatory, as most corporate governance codes now insist on including independent directors in the composition of Boards. Specifically, the Nigerian Code of Corporate Governance, 2018, recommends that majority of the Non-Executive Directors (NEDs) of a company should be independent. The Nigerian Communications Commission Code and the National Insurance Commission Guidelines also emphasise the need for independent directors on the Board. Most notably, the Companies and Allied Matters Act (CAMA), 2020, makes it mandatory for public companies to have at least three independent non-executive directors on their Board.
The question then is, who are independent non-executive directors (INEDs)? Why is it essential to have INEDs on the Board? and Are INEDs truly independent and impartial? In addressing these questions, this article will examine the legal framework setting out the role that INEDs play as well as the factors that could affect the independence of INEDs, whilst equally examining the roles of INEDs and the need for their independence and impartiality.
LEGAL FRAMEWORK FOR THE STATUS OF INDEPENDENT NON-EXECUTIVE DIRECTORS IN NIGERIA
An INED is a member of the Board of Directors with no direct material or financial relationship with the Company or related entities, except sitting allowances, reimbursables, and director’s fees.
In Nigeria, the Nigerian Code of Corporate Governance (NCCG), 2018, addresses the status of INEDs in a company. The NCCG explains that INEDS bring high objectivity to the Board, ensuring stakeholder trust and confidence. It goes further to provide under Principle 7.1 that:
“An Independent Non-Executive Director (INED) should represent a strong independent voice on the Board, be independent in character and judgment and accordingly be free from such relationships or circumstances with the Company, its management, or substantial shareholders as may, or appear to, impair his ability to make independent judgment.”
In ensuring the independence and impartiality of the INED, the NCCG has provided threshold criteria for establishing the independent status of an INED. It provides that the value of the shareholding of an INED in a company should not be material as such will impair his independence, or he should not hold more than 0.01% of the Company’s paid-up capital.
Furthermore, to establish the independent nature of a director, the NCCG provides that such a director should not:
- be a representative of a shareholder that can control or significantly influence Management;
- be an employee of the Company within five years preceding his appointment;
- be a close family member of any of the Company’s directors, consultants, senior employees, advisers, auditors, key stakeholders (suppliers, creditors, customers), or substantial shareholders.
The NCCG has also provided that for an individual to qualify as an INED, such an individual should not have and should not have had, within five years preceding his appointment, any material business relationship with the Company either directly or as a director, partner, shareholder or should not be or should not have been a senior employee of a body that has or has had, such a relationship with the Company.
It is also important to note that for a person to qualify as an INED, such an individual should not have served at directorate level or above at the Company’s regulator within three years preceding his appointment; neither should he have rendered any professional consultancy, or other advisory services to the Company.
Finally, the NCCG provides that an individual to be appointed an INED should not receive and should not have received additional remuneration from the Company apart from director’s fee and allowances, should not participate in the Company’s share option or performance-related pay scheme, and should not be a member of the Company’s pension scheme.
The criteria mentioned above are not exhaustive but are some examples of the circumstances which may impair or appear to impair an INED’s independent judgment.
It is recommended that a company avoid reclassifying an existing NED into an INED on the same Board, and directors who previously served on the Board for more than nine years should not be made INED on the same Board. This is to ensure the independence and impartiality of the INED by preventing overfamiliarity due to the relationships that may have been built during the NED’S tenure.
The rationale prohibiting the reclassification of an existing NED into an INED is not far-fetched. The NCCG already provides criteria that make an individual eligible for the position on an INED. A sitting Non-Executive Director falls outside the abovementioned requirements and cannot be reclassified as an Independent Director.
Beyond the provisions of the NCCG 2018, it is imperative to note that the Companies and Allied Matters Act (CAMA) 2020 also provides for the mandatory inclusion of INEDs on the boards of public companies. The CAMA 2020 requires all Public Companies to have at least three independent directors.
Section 275(3) of CAMA 2020 defines an independent director as a director of a Company who, or whose relatives, either separately or together with him or each other, during the two years preceding the time of appointment as director:
- was not an employee of the Company.
- did not:
- make to or receive from the company payments of more than N20,000,000, or appointment of first directors.
- own more than a 30% share or other ownership interest, directly or indirectly, in an entity that made to or received from the company payments of more than the amount stated in 2 above or act as a partner, director or officer of a partnership or Company that made to or received from the company payments of more than such amount;
- did not own directly or indirectly more than 30% of the shares of any type or class of the Company, and
- was not engaged directly or indirectly as an auditor for the Company.
Furthermore, the Central Bank of Nigeria (CBN) Circular on Guidelines for Corporate Governance provides that an Independent Director should not have any direct material relationship with the bank or any of its officers, major shareholders, subsidiaries, and affiliates; or any relationship which may impair his ability to make independent judgments or compromise his objectivity in line with Corporate Governance best practices. The tenure for INEDs has also been provided as a period not exceeding two terms of four years each.
The United Kingdom Code of Corporate Governance 2018 also has the above criteria for determining if a Non-Executive Director (NED) qualifies as an INED. However, it is worth noting that it prohibits classifying a NED who holds cross-directorships with other directors as an INED.
The United States (“US”) has not adopted a universal corporate governance code for US companies but has various provisions in its state and federal laws, regulations, and listing rules. The New York Stock Exchange (NYSE) defines an INED as one the Board determines affirmatively has no material relationship with the Company either directly or as a partner, shareholder, or officer of an organisation that has a relationship with the Company.
THE ROLE OF INEDs AND THE NEED FOR INDEPENDENCE AND IMPARTIALITY
The presence of INEDs on the Board of a company is crucial in ensuring the observance of good corporate governance and the ultimate sustainability of the Company. They provide unbiased advice, perspective, and judgment to the Board of directors. They are also responsible for evaluating the strength of the Board, especially monitoring conflicts of interest, and complying with corporate governance guidelines.
It is important to note that while INEDs are a vital part of the Company’s Board of Directors because they bring a unique perspective, this is primarily possible due to their independent status. The role an INED plays on the Board is broad; they must give independent judgment to the Board on matters such as finances, strategy, performance, risk management, and critical appointments.
INEDs play an active role in succession planning, protecting the interests of all stakeholders and balancing stakeholders’ interests while making deliberations. They provide an objective perspective and opinion regarding the organisation’s status and key corporate decisions. INEDs also play a major role in monitoring the integrity of financial information, risk management, ensuring relevant controls are in place, and reporting unethical behavior, fraud, or violations of any of the Company’s policies.
In summary, INEDs play a crucial role in corporate governance and act as a check and balance to the power of the Chief Executive Officer (CEO), Management, and other stakeholders. INEDs’ role in ensuring good corporate governance and promoting the Company’s sustainability underscores the need to ensure that their independent and impartial status is preserved and not compromised.
FACTORS THAT COULD AFFECT THE INDEPENDENT STATUS OF AN INED
The need for the appointment of INEDs was borne out of the necessity of ensuring that independent-minded business managers exercise sound judgment, independent of any affiliation or personal interests in the Company, to protect the interest of the Company and all stakeholders.
Although the NCCG and the CAMA 2020 have set the criteria to ensure the independent and impartial status of the INED, independence goes beyond ticking the checklist recommended by the Code, as it is indeed possible for an individual to meet the set criteria and still fail the true test of independence.
Certain circumstances could affect the independent status of a director. These include the following:
Selection of INEDs
The question of the selection process of an INED is often overlooked but is essential in determining their status of independence as the independence of a director can be affected by the appointment process. The NCCG 2018 provides that the role of the Nomination and Governance Committee is to identify individuals suitably qualified to become Board members and make recommendations to the Board for nomination and appointment as Directors. This selection and recommendation is based on the established criteria by the Nomination and Governance Committee for appointment to the Board and Board committees.
However, we see that most INEDs are appointed based on recommendations from board members and other associates, without more. It has been noticed that the selection of INEDs in some companies involves the Chairman of the Board initiating the appointment of the proposed Independent Directors. In other instances, another member of the Board makes the nomination which the Board subsequently considers. Barring any exceptional reason, such nominations pass the usual selection hurdles, and the nominee becomes the Board designated ‘Independent Director’.
The above-described processes may unintentionally result in a beneficiary-benefactor relationship. In the stated scenarios, the process needs to be reviewed as having a benefactor relationship with the Chairman, or any other nominating director, will have, or at least appear to, impair the director’s ability to make independent judgments.
Multiple Directorship
Multiple directorships is a practice where board members serve on the boards of various companies. While multiple directorships are advantageous as it allows INEDs to have a more extensive network and wealth of experience, it could also threaten the independent status of an INED. Being an independent director on multiple boards can expose an INED to situations of conflict of interest especially in cases of Hostile takeovers and mergers.
Although CAMA 2020 and the NCCG 2018 encourage multiple directorships, it has set a limit to the number of Boards a director is allowed to sit on concurrently and has made it a duty of a director to disclose to each Board the fact of presence on other Boards. To curtail any conflict of interest, it is recommended that before appointment as a director of the Board of a company, the prospective director should disclose to the Board the fact of its presence on other Boards.
Cross-directorship
Cross-directorship is likely to occur in situations where multiple directorships is permitted. Cross-directorship occurs when two or more directors of a company sit on the same Board of other companies, meaning the executive director in Company A is an INED in Company B, and the INED in Company A is an executive director in Company B.
Cross-directorship is considered to make the boards of the affected companies too intimately involved with each other, potentially reducing the quality of the scrutiny that the INEDs involved in the cross-directorship can bring. In practice, such arrangements also involve some elements of cross-shareholdings, which further threaten the directors’ independence.
Cross directorships undermine the roles of INEDs on remunerations committees because it could lead to a situation where an INED, in deciding the salary of a colleague who is an executive director on the Board of a company, would be minded that the colleague who is an executive director may be an INED on the Board of another company where the INED serves as an executive director, which is an apparent conflict of interest. Neither director involved in the scenario described above is impartial, so there may be the likelihood of acting in a manner other than for the benefit of the Company’s shareholders.
Cross-directorship can undermine independence through negligence, failure to follow, mixing duties, and conflicts of interests among organisations. Furthermore, cross-directorship poses a threat where INEDs and one or more Directors serve on the boards of related companies. Interestingly, the Nigerian Code of Corporate Governance is silent on the propriety of an INED being a Cross Director.
To preserve the independent status of Directors it is recommended that the Code makes provisions on cross-directorship as well as recommend the minimum standard of practice. Preferably stating that INEDs should not be in a cross-directorship relationship with executive directors. This is because INEDs are usually in a position to make decisions that directly affect executive directors, and where such cross-directorship is not curtailed, this may affect the independence and objectivity of the respective Boards in the administration of the Company.
CONCLUSION
One way to promote good corporate governance is by appointing INEDs to check Management’s decisions. It is, however, essential to note that independence goes beyond appointing Directors who have no strong affiliation with the Company. Therefore, annual evaluations must be done on INEDs to determine the extent of their independence, which has not been compromised. Furthermore, independent auditors and consultants should be engaged in selecting, recommending, and reviewing INEDs.
Ultimately, the value of INEDs to the Board largely depends on their strength of character and personal integrity. In conclusion, INEDs are indispensable to corporate governance. However, ensuring that their independence and impartiality is not compromised is most important.
