Ben PietersI recently came across an article by Lesley Stones dated 15 December 2014 titled “The flaw in King’s board formula”.  It covered the opinion of public relations practitioner Shonisani Makhari expressed in his MBA dissertation against the background of King III.

I also read Ansie Ramalho’s response to Shonisani’s article dated 1 February 2015 titled “Expertise the key for independent directors”, as well as Chris Barron’s article of 19 October 2014 titled “King code got it wrong – Mouton”.

Makhari’s study against the background of King III focused on two variables — the ratio of non-executives on the board and the influence on the return on equity.  According to him “This was not a case of finding out whether companies were performing progressively better, but whether they were performing progressively better as a result of the proportion of non-executives.

King III - non-executive directorsHe backs this up with a review of the results of 40 JSE-listed companies between 2010 and 2012, as well as to refer to related international studies in the US, India and Spain. Accordign to him it was found that directors who have a financial interest in the business in the form of shares perform better than those with no vested interest in its success.

This is also the view of Jannie Mouton, chairman of the Stellenbosch-based PSG Group, which owns Capitec.  The article however does not indicate what his views are as regards the experience, skills, diversity or age of such directors.

I am intrigued by Shonisani’s view that “having more non-executives on the board doesn’t mean you will do better.

King III: Analysis of Shonisani’s findings

I honestly cannot see how his analysis of a small sample of only 40 companies over a 3 year period could lead him to arrive at this conclusion.

Firstly, although the article does not indicate how many of these boards experienced a change in the composition of non-executive directors, it is likely to have been a few only, if at all. The reason for this is that non-executive directors representing significant shareholders seldom resign or are not re-elected, while independent directors usually serve for periods of 3 years or more.

If Shonisani’s study of the same JSE-listed companies covered several 3-year periods, highlighting the changes in the board composition vs the financial performance of these companies during each such period, it might have been more helpful.

Secondly, his findings only focuses on the role of the non-executive director.  He does not distinguish between non-executive directors and independent directors represented on these boards. The article also does not indicate the composition of non-executive vs independent directors on the boards of these 40 companies.

King III is quite clear on the important differences between independent and non-executive directors. I do not however imply that non-executives are any less “independent in character and judgement” than their independent colleague serving on the same board.

Thirdly, he correctly points out that “What’s really important are the skills, experience and know-how of the directors. Diversity also has an impact and I’d venture to say not just the race and gender, but the education and age, too.

Ansie also touches on the need for independent directors to have industry knowledge and relevant experience.  This she considers to be important if they want to “oversee, challenge and contribute” at board level, which is correct.

However, neither of them refers to what is, in my opinion, of fundamental importance, namely the internal dynamics at play at board level.

It is of little use to know what its role and function is, if the board is dysfunctional and unable to provide guidance to management.

For a board to be effective, its internal dynamics must be ticking over at optimal levels.  This in turn means that achieving board effectiveness is a journey, not an end result.  I recently dealt with a number of aspects which have, in my opinion, a bearing on how internal dynamics play out at board level.  Read our paper on “The role and function of the board

Fourthly, the fees paid to non-executive and independent directors should not be an issue.  Companies cannot afford not to attract the right calibre of person to serve as independent directors.  This is not easy given the onerous obligations and potential exposure under the Companies Act, 2008 faced by individuals prepared to serve on boards.

In my view King III got it absolutely right in principle 2.18 “The board should comprise a balance of power, with a majority of non-executive directors.  The majority of non-executive directors should be independent.

No flaw exists in this principle. The problem either lies in the way companies are applying it, or in the internal dynamics operating at board level.