boards / corporate governance / director / independent

Can a Director serve two Masters? Directors conflicts and independence

Independent directors are the basis of good governance and can provide objective and unbiased leadership and guidance. Independence means the director has “no known affiliation with the firm other than being on its board, taking into account the business, financial or personal affiliations, disclosed in financial statements, that compromise non-executive director independence” (Mulgrew & Forker 2006). Independence is one of the most analysed characteristics of the board but research on the impact or the importance of independent directors to firm performance is inconclusive (Beasley et al. 2000; Bhagat & Black 2001; Dulewicz & Herbert 2004; Peng 2004; Vagliasindi 2008; Kinsbergen et al. 2011). Nonetheless, the importance of independence is emphasised in governance codes with the UK Governance Code requiring half the board to be independent non-executives (FRC 2014, sec.B1.2).

Irrespective of independence, a director’s duty is to the company, and not to an individual shareholder or body of shareholders as established under common and statute law (1). This became very clear to the general public in 2012, following the appearances before the Oireachtas Finance Committee of the public interest directors of the rescued banks who were appointed by the government to represent the “public interest” (Walsh 2012). Their evidence highlighted that as directors they were still bound by company law and thus had to act in the company’s best interests, which could involve unpopular moves such as increasing interest rates on loans and mortgages, and squeezing as much out of distressed mortgage holders as possible.

S228(3) Companies Act 2014 does allow for consideration for “nominee directors”, directors who are appointed to represent a shareholder or a creditor, however, it is not a defence to claim that this removes the ability of the directors to exercise independent judgement (2). Thus unless the director is released from his duty as a director by the company constitution or by resolution in general meeting, they must avoid conflicts of interest between their duty to the company and any other duties or interests (3).

Directors also owe a duty of skill, care and diligence as established under common law and recently under statute (4). In practical terms, this means that directors are not liable for errors of judgement but will be liable for gross negligence, but establishing a breach of duty due to managerial incompetence is not clear cut.
These limitations of the law on conflicts of interest and skills, highlights the importance of independent directors as required under governance codes. Thus directors have a duty to prioritise the best interests of the company, avoid using their position for personal gain, avoid conflicts and be diligent, all while acting and and being seen to act with independence. A director who is not independent due to appointment by a controlling shareholder, or a stakeholder may thus find themselves in a difficult situation where the interests of the company and the party who appointed them to the board collide. They should remember the words of Lord Cullen “directors have but one master, the company” (5).

Beasley, M.S. et al., 2000. Fraudulent Financial Reporting: Consideration of Industry Traits and Corporate Governance Mechanisms. Accounting Horizons, 14(4), pp.441–454.

Bhagat, S. & Black, B., 2001. Non-Correlation between Board Independence and Long-Term Firm Performance, The. Journal of Corporation Law, 27.

Dulewicz, V. & Herbert, P., 2004. Does the Composition and Practice of Boards of Directors Bear Any Relationship to the Performance of their Companies? Corporate Governance, 12(3), pp.263–280.

FRC, 2014. The UK Corporate Governance Code Financial Reporting Council, London.

Kinsbergen, S., Tolsma, J. & Ruiter, S., 2011. Bringing the Beneficiary Closer: Explanations for Volunteering Time in Dutch Private Development Initiatives. Nonprofit and Voluntary Sector Quarterly, 42(1), pp.59–83.

Mulgrew, M. & Forker, J., 2006. Independent non-executive directors and earnings management in the UK. Irish Accounting Review, 13(2), pp.35–64.

Peng, M.W., 2004. Outside directors and firm performance during institutional transitions. Strategic Management Journal, 25(5), pp.453–471.

Vagliasindi, M., 2008. The Effectiveness of Boards of Directors of State Owned Enterprises in Developing Countries. Policy Research Working Paper. The World Bank, 4579(March), p.30.

Walsh, J (2012, December 24) Role of public interest directors needs tackling. The Irish Examiner. Retrieved March 22, 2017 from http://www.irishexaminer.com/business/role-of-public-interest-directors-needs-tackling-217799.html

(1) Companies Act 2014, sec.228 and Dawson International plc v. Coats Paton plc[1989] BCLC233
(2) Re 360Atlantic (Ireland) Ltd [2004] 4 IR 260
(3) Regal (Hastings)Ltd V Gulliver [1967] 2 AC 134 is the leading case where despite no male fides on the part of the directors they were still obliged to account to the company for the profit made due to their position.
(4) Re Brazilian Rubber Plantations and Estates Ltd [1911] 1 Ch 425, Re City Equitable Fire Insurance Co. Ltd [1925] Ch 407, Dorchester Finance Co Ltd v Stebbing [1989] BCLC 498 and Companies Act 2014 sec. 228
(5) Dawson International plc v. Coats Paton plc[1989] BCLC233

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