Directors must choose substance over form – but the form has to have substance


    The Business Times, 9 February 2024


    SINGAPORE – Do all listed company directors in Singapore properly discharge their fiduciary duties, particularly the preservation of minority interests?

    Corporate governance advocates, including the Securities Investors Association of Singapore (Sias), would reply that quite a number do not – there are simply too many governance shortfalls that the market has witnessed over the years to conclude that boards in general have indeed worked hard to serve their stakeholders.

    The problem, however, is that while criticism of boards is easy, formulating solutions to improve matters is not.

    As some have asked, is taking harsher disciplinary action against errant boards the answer? What evidence is there that greater sanctions will lead to a better-governed market, or will such actions serve as a deterrence to suitable individuals from stepping forward to serve on boards?

    Also, does having more regulations really help, or would it only result in companies giving boilerplate, box-ticking answers, as some observers have suggested?

    Governance lapses which have raised questions

    In recent years, the retail public has had to contend with several examples of boards appearing to fail in their duties.

    High-flying water treatment firm Hyflux is a good example of a company whose board, although on paper comprising the requisite proportion of independent directors as per the rules, most probably failed to conduct a proper risk assessment before the ill-fated diversification into power generation that eventually bankrupted the company.

    Before and after Hyflux’s collapse and even until the present time, the market has witnessed numerous examples of “lowball” privatisation offers that boards have recommended minorities accept despite compelling reasons to the contrary.

    Shareholders of these firms who have found themselves forced to accept such offers can quite legitimately question whether their boards actually did look after their interests, or instead bowed to the wishes of the controlling shareholders behind the privatisation offers.

    In recent weeks, shareholders of cord blood bank Cordlife discovered that their board knew of the irregularities in storage temperatures long before those irregularities were revealed by the Ministry of Health.

    Investors of semiconductor testing firm AEM Holdings have had to contend with the sudden disclosure of an inventory overstatement due to “human error” that will likely materially affect profits, and which has led to an industry-wide downgrade of the stock price.

    Many more lapses can be found, but to be fair, directors appearing to fall asleep at the wheel or possibly acting in subservience to controlling shareholders are common occurrences in other markets as well, not just here. The real issue, therefore, is not that boards have been found to be lacking but how to improve matters and ensure that most act properly as often as possible.

    What can be done?

    In What Makes Great Boards Great (Harvard Business Review, September 2002), Yale School of Management Professor Jeffery A. Sonnenfeld said that contrary to expectations, a close examination of boards of failed companies such as Enron and WorldCom revealed no broad pattern of incompetence or corruption.

    “In fact, the boards followed most of the accepted standards for board operations: Members showed up for meetings; they had lots of personal money invested in the company; audit committees, compensation committees, and codes of ethics were in place; the boards weren’t too small, too big, too old, or too young,” said Prof Sonnenfeld.

    The conclusion was not to have tighter regulations but instead to focus on strengthening the social system of what boards actually are – “to be strong, high-functioning work groups whose members trust and challenge one another and engage directly with senior managers on critical issues facing corporations”.

    Stated differently, creating a work environment of “virtuous cycle of respect, trust, and candour” actually boils down to establishing the right corporate culture at the highest level of an organisation.

    Right culture comes from within

    In this regard, comments by Mr Ravi Menon, then managing director of the Monetary Authority of Singapore, at Sias’s Corporate Governance Conference in November 2023 provide valuable insights.

    Mr Menon mentioned that the authorities are studying whether to introduce culture provisions into the Code of Corporate Governance.

    In discussing the Hong Kong Exchange’s 2021 amendment to its Code that requires all directors to act with integrity, to lead by example and to promote the desired culture, Mr Menon stated: “But the right culture has to be built from within companies, it cannot be imposed from outside.”

    Similarly, in Keys To Success: Nurturing Effective Boardroom Culture (Ivey Business Journal, October 2013), the authors identified several weaknesses with existing governance arrangements, namely that “current governance best practices are all externally imposed upon the organisation, its board, management and employees, rather than nurturing effective governance from within”.

    Go beyond box-ticking

    In other words, research into board effectiveness suggests that externally derived regulations or sanctions are only of limited use in making sure companies operate with the right corporate culture.

    Boards, therefore, have to be manned by suitable individuals who are able to practise substance over form and go beyond mere box-ticking when discharging their duties. By so doing, they then create the right corporate culture.

    This is all well and good, but Sias strongly believes that in order to find such individuals, there should be certain objective criteria to guide the selection process. In other words, the form should have substance in the first place.

    Currently, the qualifications needed to be a director, as set out in the Companies Act, are simply too broad – essentially, any natural person above 18 years who is not a bankrupt, does not have a criminal record and has not run foul of the courts can be appointed.

    This has resulted in many unsuitable individuals finding themselves serving on boards, an unsatisfactory situation that must be corrected.

    Sias strongly recommends that all first-time directors who have had no experience serving on listed boards must be accredited by the Singapore Institute of Directors (SID) and also be subjected to periodic assessments by it.

    Having this requirement would ensure that, at the very least, directors are fully aware of their legal and, more importantly, fiduciary obligations – something which is currently not the case. There has to be a willingness to update themselves on the developments affecting their role as directors.

    The foundation of the accreditation framework is the SID Director Competency model, which reflects eight competencies that directors need to exhibit in the boardroom. These are governance, director duties and practices, financial skill sets, risk management, strategy development, digital skill sets, human capital, and sustainability fundamentals.

    Making it compulsory for first-time directors to be SID-accredited will provide assurance that directors have met a minimum, objective standard to serve shareholder interests. At the very least, qualified individuals would possess the basic competencies to sit on boards.

    This is not to say that there is no need for stronger rules or sanctions if boards are found wanting. If clear lapses are identified, then it is only right that these are highlighted and action taken.

    By all means, also introduce new Code provisions pertaining to culture, directors’ training and assessment and other areas deemed necessary to produce better-governed firms.

    But the challenge to all listed companies is whether their leadership can practise substance over form by recognising and accepting that unless they internalise the right attributes to correctly carry out their duties, they will always face criticism and scrutiny from a sceptical marketplace.

    To aid this process, a good starting point for ensuring substance over form would be to ensure that the form has more substance in the first place. Ideally, all directors eventually should be members of SID, just as lawyers are members of the Law Society and professional accountants are members of the Institute of Singapore Chartered Accountants.

    The writer is president of the Securities Investors Association (Singapore).