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Independent Directors

Provided by IFC Corporate Governance


Importance of Independent Directors

Establishing a strong and independent board is a wise decision that most families in business take once their company’s operations reach a critical size and complexity. A study conducted in the United States of more than 80 family-owned companies run by the third or later generation, showed that the existence of an active and outside (non-family-controlled) board was the most critical element in the survival and success of these companies.[1]

In reality however, when it comes to board membership, most family businesses reserve this right to members of the family and in a few cases to some well trusted non-family managers. This practice is generally used as a way of keeping the family control over the direction of its business. Unfortunately, the absence of outside independent directors might make it difficult for a family business board to gain the knowledge and expertise that it is missing. Truly independent directors will also challenge the family thinking and add more discipline to the board meetings. In addition, the presence of independent directors during board meetings will discourage family members from wasting valuable time on family issues and concentrate on the business strategy and oversight instead. Finally, independent directors can also play the “buffer” role among different family members in case these have contradictory views on business issues.

Some of the advantages of having independent directors include:[2]

- Bringing an outside perspective on strategy and control.

- Adding new skills and knowledge that might not be available within the firm.

- Bringing an independent and objective view from the family.

- Making hiring and promotion decisions independent of the family ties.

- Acting as a balancing element between the different members of the family and, in some cases, serving as objective judges of disagreements among family-member managers.

- Benefiting from their business and other contacts and connections.

 Definition of Director Independence

The definition of director independence differs from one market to another; however, its main components remain the same. The general principle is that an independent director should be free of links to management, controllers (family), and others that could influence his/her judgment. The following is the IFC definition of independent directors:

 

 Indicative Independent Director Definition[3]

"Independent Director" means a director who is a person who:

1-      has not been employed by the Company or its Related Parties in the past five years;

2-      is not, and is not affiliated with a company that is an advisor or consultant to the Company or its Related Parties;

3-      is not affiliated with a significant customer or supplier of the Company or its Related Parties;

4-      has no personal service contracts with the Company, its Related Parties, or its senior management;

5-      is not affiliated with a non-profit organization that receives significant funding from the Company or its Related Parties;

6-      is not employed as an executive of another company where any of the Company's executives serve on that company's board of directors;

7-      is not a member of the immediate family of an individual who is, or has been during the past five years, employed by the Company or its Related Parties as an executive officer;

8-      is not, nor in the past five years has been, affiliated with or employed by a present or former auditor of the Company or of a Related Party; or

9-      is not a controlling person of the Company (or member of a group of individuals and/or entities that collectively exercise effective control over the Company) or such person’s brother, sister, parent, grandparent, child, cousin, aunt, uncle, nephew or niece or a spouse, widow, in-law, heir, legatee and successor of any of the foregoing (or any trust or similar arrangement of which any such persons or a combination thereof are the sole beneficiaries) or the executor, administrator or personal representative of any Person described in this sub-paragraph who is deceased or legally incompetent,

and for the purposes of this definition, a person shall be deemed to be "affiliated" with a party if such person: (i) has a direct or indirect ownership interest in; or (ii) is employed by such party; “Related Party” shall mean, with respect to the Company, any person or entity that controls, is controlled by or is under common control with the Company.

 

 



[1] John Ward, Creating Effective Boards for Private Enterprises (Family Enterprise Publishers, 1991).

[2] Fred Neubauer and Alden G.Lank, The Family Business: its Governance for Sustainability (Routledge New York, 1998).

[3] International Finance Corporation, http://www.ifc.org/ifcext/corporategovernance.nsf/Content/CGTools-FamilyFounderUnlisted.

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