The dependent independent director

KUALA LUMPUR: Independent directors are expected to provide objective, impartial and independent judgement to the board.

Their role is particularly important because they are supposed to challenge management, scrutinise major decisions, protect shareholders' interests and ensure that the board does not simply become a rubber stamp for executive management or dominant shareholders.

Yet independence on paper does not always translate into independence in practice.

An individual may satisfy the formal definition of an "independent director" while gradually becoming psychologically, financially or socially dependent on the company, its management or controlling shareholders.

This phenomenon can seriously weaken corporate governance.

How does independence become compromised?

Long tenure and familiarity

One of the most common causes is prolonged service on the same board. Over time, an independent director develops close relationships with the chairman, chief executive officer and fellow directors. Familiarity can make difficult questions uncomfortable.

The director may gradually become reluctant to challenge people whom he or she has known for many years.

Professional scepticism can be replaced by trust, and constructive challenge can give way to "we know how things work here."

Dependence on board fees

Although directors' fees are normally modest compared with executive remuneration, they can nevertheless create a psychological dependency, particularly when an individual holds several directorships or relies substantially on board appointments as an important source of income.

The fear of losing the appointment can unconsciously influence behaviour. A director may ask: "Will I still be invited to serve on this board if I oppose management?"

Once that question enters the decision-making process, independence is already under pressure.

Appointment controlled by dominant shareholders

Where a controlling shareholder effectively determines who joins the board, the independent director may feel an obligation to the person who appointed him or her.

This can create a subtle but important conflict. The director's legal and fiduciary responsibilities are to the company, but psychologically the director may feel that loyalty is owed to the controlling shareholder.

Social and personal relationships

Independence can also be compromised through friendships, business relationships, family connections and social networks.

Directors who regularly socialise with senior management may find it difficult to challenge their decisions objectively.

The problem is not necessarily misconduct. Human beings naturally tend to trust and support people with whom they have developed relationships.

Information asymmetry

Management controls much of the information presented to the board. An independent director who depends entirely on management for information can become dependent on management's interpretation of events.

If management presents only selected information, minimises problems or frames alternatives in a particular way, the board may unknowingly become dependent on management's narrative.

Board culture

A powerful chairman or dominant CEO can create a culture in which dissent is discouraged. Directors who repeatedly challenge management may be labelled "difficult", "negative" or "not being a team player".

Over time, some directors learn that agreement is easier than disagreement. The board may then develop groupthink, where maintaining harmony becomes more important than asking uncomfortable questions.

Why does dependency develop?

The fundamental reason is that independence is not merely a structural condition; it is also a behavioural quality.

A director can meet every regulatory test for independence and still lack the courage to exercise independent judgement.

There are also powerful psychological forces at work. Directors may suffer from confirmation bias, preferring information that supports management's existing position.

Familiarity bias can cause them to place excessive trust in people they know well. Reciprocity can create an unconscious sense of obligation toward those who appointed or supported them.

Another factor is the desire to maintain board cohesion. Directors may believe that disagreement damages relationships or undermines the board.

Consequently, they compromise their own views in the interest of consensus.

The consequences

When independent directors become dependent, the board's ability to provide effective oversight deteriorates.

Poor management decisions may go unchallenged. Related-party transactions may receive insufficient scrutiny.

Financial reporting issues may not receive adequate questioning. Risk exposures can be underestimated, and warning signs may be rationalised rather than investigated.

The greatest danger is that the board can appear independent while no longer functioning independently.

This is particularly dangerous for minority shareholders because they rely heavily on independent directors to act as a counterbalance to management and controlling shareholders.

How can independence be strengthened?

Companies should look beyond the formal independence declaration. Boards should periodically assess whether directors demonstrate independent minds, independent judgement and constructive scepticism.

Regular board evaluations should examine whether directors speak up, challenge assumptions, request additional information and disagree when necessary.

Tenure should be monitored, particularly where long service may create excessive familiarity.

Board appointments should also consider whether a director has genuine freedom from relationships that could influence judgement.

Most importantly, independent directors must recognise that their responsibility is not to be popular. Their responsibility is to ask the difficult question when necessary.

A truly independent director should be able to say "no" without fear, "I disagree" without hesitation, and "I need more information" without embarrassment.

Ultimately, independence is not a title conferred upon a director at the time of appointment.

It is a quality that must be demonstrated repeatedly through conduct, judgement and courage throughout the director's tenure.