Declaration of Independence
By Bill Rock
In 2017 the Conference Board, a think tank, held roundtable discussions with different corporate stakeholders to produce a series of reports entitled “Just What Is the Corporate Director’s Job?” As part of this exercise, directors were asked to create a generic “help-wanted ad” for a director. The ad the directors jointly created started with: “Looking for an open-minded individual who is both a generalist and a specialist who understands the needs and wants of a company’s stakeholders, while also acknowledging the importance and power of large shareholders.” The directors at the roundtable went on to further stress the importance of a deep understanding of the company’s business and knowledge of the shareholders’ objectives.
Finding qualified directors who have a significant familiarity with the business and an intimate understanding of shareholders’ views and objectives is difficult. It is even more challenging for public companies that are required to have a majority of independent directors, which NYSE defines as someone without a material relationship with the company. For public companies — which have a large number of shareholders, most of whom are frequently unengaged — the requirement of a majority-independent board can provide a needed protection. In many cases, independent directors may not be as beholden to management and can more easily hold the CEO accountable. (Although, as Warren Buffett noted in his last letter to Berkshire Hathaway shareholders, as a class of professional directors has developed who derive a substantial part of their income from board fees, are they truly “independent”?)
Many private companies on the other hand, have a smaller number of shareholders who frequently are highly engaged in the business and who often have a deep understanding of the company, its employees, its customers and its suppliers. They do not need the same level of protection from self-dealing. In fact, many private company boards, including many of those who have won our Private Board of the Year awards, find that some of the best board members are those who would not be considered independent by the current definition. This flexibility in requirements is a significant advantage private companies have when seeking directors, allowing them to consider customers, employees, suppliers, bankers and lawyers. These individuals’ knowledge and experience with the company is more than episodic, and their relationship with the company in many cases is actually a net positive.
Private equity-backed businesses have seen this as a benefit for years. Rather than having directors with limited understanding of the business who parachute in a few times a year, PE firms’ portfolio companies frequently appoint board members with significant company- and industry-specific insight. Likewise, many family businesses have found success with board members who have very close long-term relationships with the shareholders, such as lawyers and bankers as well as longtime employees. With a closely held business, the conflicts of interest of non-independent directors can be more visible to shareholders, enabling them to partake in the benefits with open eyes. This allows these companies to create a balance of independent and non-independent directors that best suits their business and needs.
The Conference Board’s “help-wanted ad” was spot on. And without mandates on the definition and number of independent directors, private companies have advantages in fulfilling the ad’s requirements.