As described in my previous article on governance (see Estate Living, Issue 25), conflicts of interest abound at board level. They constitute a significant issue in that they affect ethics by distorting decision making and generating consequences that can undermine the credibility of boards, organisations or even entire business entities.
Many corporations require board members to sign a conflict of interest policy at the time of appointment or to declare any conflicts of interest at the beginning of board meetings. Conflict of interest policies normally specify how directors should avoid conflicts of interest. This narrow focus only scratches the surface, given the scope, responsibilities and dynamics of decision making in the boardroom. In the previous article we defined conflict of interest in very broad terms:
- no employment relationship;
- not a major supplier;
- not a major customer;
- declaring shareholding or other affiliations.
We then also investigated the King Report’s explanation on the Companies Act by adding that ‘major’ is defined as anything above 50%, and ‘significant’ as 20% or above. It is recommended that former executives have a long cooling-off period before any involvement, and that long-standing relationships, professional acquaintances or affiliations must also be considered before deciding whether a conflict exists.
To accept a directorship, one must self-evaluate, and some questions that can be used as a guide are:
- Am I independent and without conflict?
- Do I have the expertise or skills required?
- Will I have the time expected?
- Do I understand my role?
- What induction do I require?
- What led to my possible involvement?
- What director’s indemnity insurance is in place?
The real danger lies in the extent to which elected directors are unaware of the subtle conflicts of interest that they might be dealing with. A boardroom remains a dynamic arena. In this arena the struggles of emotions, ego and power surface, and it is not always clear, in the muddy water stirred up by adding group dynamics, just exactly what constitutes a conflict of interest. Director duties, operational involvement and functioning practices tend to diverge from one estate to another, which adds even more complexity.
In a community association, boards are composed of interested directors, such as fellow owners, developers, representatives of employees, and other stakeholders. The loyalties of these representatives are often divided, and considering that a multiple-role director must balance different interests, the potential for conflict becomes clear and often boils to the surface during the most uncomfortable times.
In this article we will attempt to further examine conflicts of interest, by exploring the conflicting situations in more depth, right down to the fundamental purpose of business, with a view to helping a board of directors make better decisions by taking an ethical stand in shaping their community.
Level 1 Conflict: Individual Directors vs Company: A firstlevel conflict is an actual or potential conflict between a board member and the company. The concept is straightforward: a director should not take advantage of his or her position. Major conflicts of interest could include, but are not restricted to, salaries and perks, misappropriation of company assets, selfdealing, appropriating corporate opportunities, insider deals and so forth. All board members are expected to act ethically at all times, notify promptly of any material facts or potential conflicts of interest, and take appropriate corrective action.
Directors are supposed to ‘possess the highest personal and professional ethics, integrity and values, and be committed to representing the long-term interest of the shareholders’. However, in many cases shareholders have sued directors for taking advantage of the company. In a community association cases are often heard of; they are, however, not often pursued and hence a dark cloud is starting to form over even the most ethical boards as they are faced with the fears caused by rumours that are in most cases never truly investigated or verified.
A company is normally considered as a separate legal entity that is independent from its directors, executives and shareholders. Powerful directors – such as founders, developers or dominant shareholders – can be accused of misappropriating company assets if they are found to be stealing from their own company.
Another conflict of this type is when board members fail to dedicate the necessary effort, commitment and time to their board work. Lack of effort, focus and dedication are types of conflict of interest that have not yet received the attention they deserve. Board members have all the social power of being on the board and being active when they please, but they avoid the general responsibilities.
When directors lack commitment and dedication to their duties, the conflict of interest is somewhat subtler and much less obvious in the eventual execution of power.
Level 2 Conflict: Directors vs Shareholders: These conflicts arise when a board member’s duty of loyalty to shareholders or the company is compromised. This would happen when certain board members exercise influence over the others through compensation, favours, a relationship, or psychological manipulation. Even though some directors describe themselves as ‘independent of management, company, or major shareholders’, they may find themselves faced with a conflict of interest if they are forced into agreeing with a dominant board member. They tend to represent their own interest rather than the interests of the company as a whole.
Being loyal to shareholders in the private sector is, in any case, easier said than done – more so in a residential community where the shareholders have long-term involvement and interests. These shareholders will interact with board members frequently and exercise most of the pressure, but when they put personal interest before that of the ultimate community, interests could be misaligned. For example, certain shareholders, often the representatives of a group, may be striving for short-term personal agendas or results while the preservation of the company’s long-term stability is actually more prudent.
Personal, familial and professional relationships can also potentially affect a director’s judgment. The social connections between directors and CEOs or chairpersons cannot always be thoroughly checked. For example, retired CEOs may remain chairpersons on the board, and many of the directors on that board may owe the chairperson their fame and recognition for being proposed and supported in an election. Or the CEO may invite close friends to join the board as directors. In both cases, the directors in question may be influenced by a sense of loyalty or duty to the chairperson or CEO, even if the CEO or chairperson is not acting in the best interests of the company or its shareholders or other stakeholders. Independent directors would be reluctant to contradict the views of a CEO or chairperson to whom they felt they owed their loyalty, so rather than do so they may either comply or step down from their role.
Boardrooms are dynamic places where heated discussions occur. Those occupying positions of power, such as the CEO and the chairperson, may manipulate directors into agreeing with their preferred decisions using psychological tactics such as tone of voice and eye contact to dominate the discussion, rebuff criticism, or intimidate others for their personal gain. Such unbalanced dynamics, including superiority and inferiority complexes, reduce the effectiveness of board discussions and prevent independent directors from exercising their duty as directors.
Level 3 Conflict: Shareholder vs Shareholder: Conflict emerges when the interests of groups are not appropriately balanced or harmonised. Shareholders appoint board members, usually outstanding individuals, based on their knowledge and skills and their ability to make good decisions. Once a board has been formed, its members have to face conflicts of interest between groups of the community, between different stakeholders or developers. Board members must address any conflicts responsibly and balance the interests of all individuals involved in a contemplative, proactive manner.
This business judgment rule protects directors from potential liabilities, as their decisions are not tainted by personal interest. Though directors are not allowed to act in their own interests, they can promote the interests of a stakeholder group against that of the association or community.
Directors on boards must keep in mind that the interests of weak or distant stakeholders must not be overlooked.
The board is the decision-making body, and its successes and failures are determined by the ability of the board to understand and manage the interests of key individuals, contractors and groups. There is no ‘one size fits all’ solution to corporate governance, and there are no straightforward answers to manage all the conflicts of interest given the unpredictable nature of the various business contexts, boardroom dynamics and human behaviours.
In principle, decisions at the board level should be ethical and reasonably balanced.