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Too Much of a Good Thing Is Not Necessarily Better

Starting with the 1992 Cadbury Report in the UK, the emphasis of most codes of best practice has been on ensuring a sufficient number of independent directors on corporate boards. Successive codes of best practice have then attempted to increase the number of independent directors even further. It is then no surprise that Spain's Iberdrola has won successive prizes for its corporate governance. Indeed, nine of Iberdrola's 14 members of its board of directors are independent directors with another three being external directors and the remaining two being executives.

Iberdrola's board of directors, Source:

So does having more independent directors on a board always mean better corporate governance? Well, not necessarily. First, the academic literature on the value consequences of board independence  with board independence typically measured by the percentage of independent directors on the board  has found little or no evidence of an effect of board independence on firm performance and value. Still, this literature is riddled with major methodological issues, which make it difficult to obtain conclusive evidence as to the existence and form of a link between board independence and firm performance. Many will also remember the case of the British bank Northern Rock, which experienced the first bank run for more than 150 years in 2007. Northern Rock had exemplary corporate governance as it was in full compliance with the Combined Code, the then UK code of best practice in corporate governance. The problem with Northern Rock was that its independent directors did not have a clue about its risky business model, which consisted of financing mortgages, i.e. long-term loans for house purchases, via the money market, a market for raising funds with maturities ranging from overnight to just below a year. When the money market collapsed during summer 2007, Northern Rock was in deep trouble. Its independent directors simply had not had the expert knowledge to ask Northern Rock's the right questions about the appropriateness and riskiness of its business model.

Second, corporate governance theory (yes, there is such a thing!) suggests that the balance between executive and independent directors matters and that this balance is determined by the firm's needs for monitoring and advice from its board. Mature firms with large free cash flows, such as Iberdrola, likely require more monitoring than advice from their board of directors. For such firms, more rather than fewer independent directors would be the best way forward in terms of ensuring good corporate governance. In contrast, smaller, younger and high-growth firms require advice rather than monitoring from their board. For such firms, a board dominated by independent directors may make the executives feel uncomfortable about seeking advice from the board. Hence, and contrary to most codes of best practice, more independent directors does not necessarily equate to better corporate governance for all firms. One size does not fit all when it comes to corporate governance.

Returning to Iberdrola, one expects this firm's monitoring needs to exceed its needs for advice as it is a mature firm and in a relatively safe industry. Hence, more rather than fewer independent directors seems the way forward. Still, Iberdrola also has CEO-chairman duality as Mr José Ignacio Sánchez Galán assumes the roles of both CEO and chairman. And, he has been on Iberdrola's board since 2001, a tenure well beyond the maximum tenure recommended by various international codes of best practice, including the French, German and UK codes. To be fair, Iberdrola has a vice-chair, Ms Inés Macho Stadler, to counterbalance the power of the CEO-chair. Still, she has also been on the board for a long time with her initial appointment dating back to 2006. Apart from Mr Sánchez Galán, Mr Francisco Martínez Córcoles is the only other executive on the board. However, he has only been on the board since March 2017. As a result of all the above, one could criticize Iberdrola's board of over-reliance on the all powerful CEO-chair.

Legal disclaimer: This blog reflects my personal opinion and not necessarily that of my employer. Any links to external websites are provided for information only and I am neither responsible nor do I endorse any of the information provided by these websites. 


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