Hard term limits for independent directors: about time?


    The Business Times, 12 December 2022

    AS a corporate governance concept, director independence is as fundamental as it gets. To serve in the best interests of the company, the board has to be independent and free from conflicts of interest. Yet, many markets around the world have met with limited degrees of success while attempting to institutionalise this into their governance regimes.

    In Singapore, the Code of Corporate Governance states that an independent director (ID) is “one who is independent in conduct, character and judgement, and has no relationship with the company, its related corporations, its shareholders or its officers that could interfere, or be reasonably perceived to interfere, with the exercise of the director’s independent business judgement in the best interests of the company”.

    A controversial aspect of independence has been how the length of time the ID has been with the company affects his independence.

    Term limits

    The connection between director tenure and independence was introduced in the 2012 revision to the Code, which required the independence of a director who has served on the board beyond nine years to be subjected to “a particularly rigorous review”.

    Implicitly, this meant that nine years, typically the equivalent of three three-year terms, was viewed as an adequate timeframe for members to meaningfully contribute to the board as IDs. But ceding to the argument that one’s independence should not be solely attributable to tenure, it was left to the discretion of the nominating committee (and, by extension, the board) to make this determination when IDs hit the nine-year mark.

    Gaming the system
    The unintended consequence of this concession was that it gave boards with long-serving IDs wriggle room. Rather than go through the hassle of replacing these directors, the easier alternative was instead to undertake a “review” to confirm their independence. Whatever went into such reviews was really anybody’s guess, as there was technically no guidance (nor requirement) to disclose anything beyond describing them as being “particularly rigorous”.

    What then ensued was the proliferation of boilerplate statements in annual reports justifying the continued independence of long-tenured IDs.

    If at first you don’t succeed

    In 2018, the rule was further enhanced to a hybrid approach that stipulated a nine-year tenure restriction on director independence but left it to the shareholders to ultimately make the call via a two-tier voting mechanism when this limit was breached. A three- year transition period was factored into the implementation process.

    In the three-year transition period, not only was there still a significant proportion of IDs serving past nine years through endorsement via the two-tier vote, it became abundantly clear that a large majority of affected boards had little intention of refreshing themselves.

    The Singapore Board of Directors Survey 2022 provides a glimpse of this: 67 per cent of respondents with long-tenured IDs are looking to put them through the two-tier voting process. This suggest that what was intended as a last resort has instead become the default choice for this group.
    A final landing?

    The Singapore Exchange Regulation has proposed to do away with the two-tier voting system in a consultation paper in October 2022. The suggestion is to impose a hard stop to ID independence at the end of nine years. If this goes through, Singapore will join a group of markets that have implemented or are considering implementing similar restrictions on ID tenure. IDs in Malaysia, for example, will no longer be considered independent after their 12th year, come June 2023.

    Many markets in the US and Europe do not have such restrictions on director term limits. Rather, the prevailing view is that independence needs to be considered holistically, accounting for a multitude of factors, of which tenure is but one of them. After all, a board can comprise directors who are independent in form but not in substance.

    Are the rules and regulations in Singapore sufficient to ensure that boards comprise directors able to act in the company’s best interest and are willing to challenge management when required? The nine-year hard limit may go some way to nudge boards to renew and refresh themselves and, to an extent, address issues surrounding board diversity, but it can never truly guarantee the independence of directors.

    Beyond drawing a line in the sand

    The broader issue lies with the standards to which boards hold themselves. Nominating committees should be held to account. If the current state of disclosures and propensity for two-tier voting is anything to go by, it calls for an uplifting in the level of rigour and discipline in key activities like board effectiveness assessments and succession planning.

    When all else fails, regulation becomes instrumental in driving desired behaviours. But it cannot exist nor operate in isolation. Apart from shareholders needing to be more assertive and vocal, the onus is also on the director community to further professionalise and take director independence more seriously.

    The writer is a member of the Board of Directors Survey and Advocacy and Research committees of the Singapore Institute of Directors.