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In whose interest is it anyway?

A board composed of members with varying but complementary skills and experience relevant to the industry in which the company operates is the best way to make the board more useful to the ultimate owners of the company.

A board composed of members with varying but complementary skills and experience relevant to the industry in which the company operates is the best way to make the board more useful to the ultimate owners of the company.

In my previous article, I wrote about the role of the non-executive director and argued in favour of the law being revised in an effort to re-define the role and purpose of the NED. In fact, I declared that the shareholder would be better served if he knew that the chairman, the executive directors and top management were under the scrutiny of an independent and competent NED who had the obligation, resources and competence to test the robustness and appropriateness of key business decisions.

In an effort, perhaps, to reinforce this point, I would like in this article to focus on the possible tensions between shareholder(s) and executive director(s) and/or top management. I am referring to Maltese publically listed companies or family businesses in their second, third and fourth generation of family ownership. In other words, this article applies to companies where there is a division of control.

I recently read an article entitled The Myth of Shareholder Capitalism wherein it was argued that “shareholders do not own the corporation [the company]” and (perhaps equally as controversial) “…when directors go against shareholders wishes - even when a loss in value is documented - courts tend to side with directors”. I think the research interestingly revealed that in America (the land of shareholder capitalism), historically, shareholders have tried to unseat directors in large companies through lawsuits just 24 times over the past 20 years and they’ve succeeded only eight times! That is a success rate of just 33 per cent.

This, therefore, means that the executive director effectively is autonomous and his/her “loyalty” is not necessarily to the shareholder. If this is relevant to Malta, which I suspect it is, there might be an even greater need for us to strengthen and expand the role of the NED; at least in the interests of the shareholder. I point this out because, and contrary to probably what a lot of Maltese family businesses think, the director is bound to act (and I quote the Companies Act) “in the best interests of the company” and not the shareholder(s).

You might argue that the best interests of the company and the best interests of the shareholder(s) are the same. Not always; and you’d be surprised how often they differ, for example reinvesting company profits versus paying out dividends, disposal or retention of company assets, executive pay / compensation or increasing the gearing of the company so as to finance CAPEX investments.

This random list merely highlights instances when the shareholder(s) might disagree with the board or vice versa. Allow me to elaborate: there may be several shareholders each with their own varying agenda and interests. In which case, the board of directors would be looking out for the general “best interests of the company” (article 136 of the Companies Act) rather than serving specifically the interests of a particular shareholder(s). Alternatively, a director or several directors may be at odds with say the single largest shareholder of the company (more than 30 per cent but less than 50 per cent ownership) and take board resolutions which plausibly go against the direct interest of that shareholder yet the company is obliged to respect / honour such a decision(s) vis-à-vis third parties (vide article 137 of the Companies Act) given the fact that a director can only be removed by a majority vote.

What is my point? My point is that the law does not necessarily see the interests of the company and that of the shareholder as being one. In fact, I would argue that in companies where there is a division of control in the company, the interests of the shareholder(s), the director(s) and management are not all the same, all the time. I, therefore, see the role of the NED as a sort of conscience of the company from the owner’s perspective.

To use politics as an analogy to (hopefully) better explain my thinking: the shareholder is like the voter, the board of directors the government and management the civil service. Does the voter have real-time and complete control over his government? Does the government have absolute power over its civil service (the BBC comedy series Yes Minister springs to mind)? These are obviously rhetorical questions but they help me explain my thinking on the ownership and interests of a company.

In conclusion, I therefore think that the formal introduction of a newly defined and empowered NED to the Maltese boardroom is crucial and that this should perhaps be followed-up with legal reform on the composition of the board of directors itself. I believe that a board (which includes at least one NED) composed of members with varying but complementary skills and experience relevant to the industry in which the company operates, is the best way to make the board more useful to the ultimate owners of the company (the shareholders). Thus the NED reform is the first important step.

Probably, the reform on the composition of the board of directors is the next! In whose interest is it anyway? I say the shareholders: the residual bearers of the business risk!

www.fenci.eu

Mr Fenech is managing director</p><p>of Fenci Consulting Ltd.

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