"Shareholders suffer as independent directors pay fat cats • by: ADAM CREIGHTON From: The Australian August 28, 2013 INDEPENDENT directors have destroyed shareholders' wealth and contributed to skyrocketing pay for poorly performing chief executives while enriching themselves, a landmark study has found. Australian companies that instituted boards with a majority of "independent" directors in response to a 2003 change in the Australian Securities Exchange's listing rules have lost almost $70 billion in value compared with other listed companies. "The relative ignorance of 'independent' directors combined with their lack of incentive to monitor has been a fatal combination for Australian company performance" said Peter Swan, the report's author and professor of finance at the University of NSW. Professor Swan called the ASX's rule change "the most costly and disastrous regulatory change ever implemented in Australia by a private regulator". His study compared the performance of 969 Australian companies over nine years to 2011, including 561 that changed their board structure following the introduction of the ASX's "if not, why not" guidance for listed businesses to have boards with a majority of "independent" directors without links to management or substantial shareholders. The analysis, to be presented at the Chulalongkorn Accounting and Finance Symposium in Thailand in November, found that the longer a firm had a board with a majority of independent directors, "the poorer was its performance based on both market and accounting-based performance measures and the higher was CEO pay and average director fees". Simon Marais, chief investment officer at fund manager Allan Gray, was unsurprised by the findings and considered the existing rule "ridiculous". He said: "The best director is someone who has as much money at stake as possible in the company." "What is important," Professor Swan added, "is independence from management, not from the owners." Over the nine-year period, total chief executive pay roughly doubled to $2.2 million at the companies that enacted more "independent" boards, and non-executive director fees were almost $45,000 a year higher. "If you owe your position to the CEO would you be hard on him?" Mr Marais said. Professor Swan blamed the "ludicrous" rule for contributing to a "catalogue of corporate disasters", citing Fairfax, Qantas and Rio Tinto in particular. "Rio has 14-odd directors sitting in London all divorced from the reality of the Australian business," he said. "When the stock price plummets due to poor monitoring, a director with negligible shareholding feels less pain than does a substantial shareholder." Mr Marais decried the inertia and lack of investor discipline applied to local boards. "It's often like the old Soviet elections when investors have a choice of six candidates for six positions," he said. The share of independent directors at top 200 companies has jumped from less than 10 per cent in 2002 to about 60 per cent today. "They solved the 'principal agent problem' by destroying the principal," Professor Swan quipped, alluding to the theory that explains why managers (the agent) of a firm are able to profit at the expense of the owners (the principal). Ian Ramsay, professor of corporate governance at Melbourne University, said skills, expertise and experience were more relevant criteria than "independence" per se. But he said there was "no simple answer", suggesting the existing rules were in any case guidelines and did not need to be changed: "The quality of decisions of directors with substantial wealth tied up in the company may also not be in a company's best interests." Under the auspices of improving corporate governance, stock exchanges in the US and Europe began in the early 2000s insisting that listed firms had boards with a majority of independent directors, following the high-profile collapses of US giants Enron and WorldCom. "It's amazing regulators cite these examples as justification for independent directors when those companies in fact had majority independent directors," said Professor Swan, who said the ASX deserved credit for making the independent director rule optional. An ASX spokeswoman said it continually reviewed its rules and was open to improvements."
