Democratise the Boardroom. Bring in Directors from the Outside

Dec 11 , 2021
By Asegid Getachew

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A divorce between ownership and management characterises corporations. A dispersed group of shareholders with different investment levels and competing interests would find it very difficult to run the day-to-day affairs of the corporation. As a result, they hire a professional group of managers as an agent to take care of business. The presumption here is that since managers are paid to do what they do, they can be considered stewards of the owner’s interest.

However, managers may not fully commit to maximising the owners' value. They may sometimes prioritise their interest against that of the corporation and its shareholders. This self-serving behaviour of managers creates an agency problem. High profile corporate scandals and crises caused by management malpractice can be taken as evidence of the damaging consequence of agency problems. The fraud and embezzlement perpetrated by managers have deprived investors of their capital, forced employees to lose their lifetime pension savings, and contributed to the bankruptcy of several firms.

To minimise the damaging consequence of the problem associated with agency, corporations use boards as a corporate governance mechanism. These have the ultimate responsibility of setting the corporation's strategic direction, supervising, controlling and hiring and firing managers. As a result, they can align managers' interests to that of shareholders. Including independent external directors in the boardroom is one of the several board governance mechanisms that can help resolve the agency problem.

Independent external directors are board members with no financial interest in the corporation, are not part of the executive management group, and are not involved in the corporation's day-to-day affairs. They are needed for independent judgment.

Including independent directors inside the boardroom has several benefits. Primarily, they do not have material interest that affects their independent judgment and thus provide critical scrutiny of the performance of management without fear of recrimination. They are also usually hired for the experience and expertise they bring to the boardroom and may have networks and political ties that might help corporations build a competitive edge.

Independent external directors are excluded in boardrooms of most businesses in Ethiopia. This is partly because of the commercial code that has been in effect for the last six decades, which requires only shareholders to be board members. However, things seem to have changed in the newly amended code. It welcomes the possibility of including non-shareholders to be board members. This paves the way for the independent external directors to join the board rooms of organisations.

Businesses gain a lot by opening their boardrooms to external independent directors. Zoltan Matolcsy, Donald Stokes and Anna Wright in their paper titled, “Do independent directors add value?” provide a compelling reason as to why this is true.

“A board dominated by inside directors would suggest relatively weak governance, as insider-dominated boards would be required to self-monitor. In particular, the monitoring of the CEO by these boards would be relatively weak, because the CEO can influence inside directors’ career paths," they argue. "Boards dominated by outsiders would provide stronger governance, as outside directors depend less on the CEO for their future incomes and have the additional role of monitoring and replacing poorly performing senior management, particularly the CEO.”

Empirical evidence indicates that a high portion of independent external directors inside a boardroom is associated with favourable outcomes. To this effect, corporations in Ethiopia can take the opportunity created by the new code to reconfigure their boardroom composition and welcome more independent external directors.

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PUBLISHED ON Dec 11,2021 [ VOL 22 , NO 1128]

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