The Independent Director (Part 2): Can We Have Truly Independent Decision-Making?
In part one of this article, I examined some of the principles underlying the concept of independent directors. I listed four types of situations that can bring into question the role of individual board members and the decisions of a board of directors: business relationships; employment relationships; family and personal interests; and the expectation of loyalty to another organization. In part two, I examine each of these situations and suggest ways to enhance the independence of board members.
People who have never run an organization may think it obvious that the board members should not be suppliers. However, occasionally, an air conditioner manufacturer finds themselves on the board of a nonprofit that needs an air conditioner. They can provide a good quality air conditioner at wholesale rather than retail cost. Should the nonprofit be denied this deal? Probably not, as long as the "deal" is confirmed by independent quotes and the equipment matches the need. Good record-keeping and communication are critical.
But in one professional membership organization I know of, the president was also the largest supplier, as proprietor of the association management company subcontracted to manage the organization. That arrangement, quite frankly, stank. Had the board not avoided confronting the obvious conflict, the president would have had to declare a conflict for most of the agenda of every board meeting. It is hard to chair from outside the room. Clearly, directors would have felt uncomfortable raising issues such as hiring their own staff to run the organization, returning to volunteer efforts, or switching suppliers. Wisely, the arrangement was eventually discontinued.
Such conflict situations occur frequently in the private sector. People at public companies think it normal for directors to do business with the company and bring business to the company. They may be required to own stock and make a profit from good company returns. This is a major difference between the sectors, between volunteers serving for the good of the community and paid directors serving to benefit a company's bottom line.
The rising number of sponsorships to nonprofits introduces a grey area, particularly in professional and trade associations. Members often see a first chance to sponsor events or activities at their own association as a member benefit and I have heard no objection to directors participating in the same way as other members. In my view, it is probably acceptable for board member to give money, services, or products to their own charity or association in their business name. However, naming a new charity building after a director's company might get a different reaction. I would love to hear from anyone who has seen this happen.
The most challenging type of independence question in the Business category is perceived future benefit. Was it a coincidence that Renee was appointed to the board of Ian's printing company three months after recommending Ian as a supplier? Perhaps there is no connection at all. Directors have to be prepared to deal with perceptions and sometimes step down if the perception is harming the image of the organization.
Although it is common in the business sector, there is general agreement that directors with subordinate relationships to the senior staff person lack independence. Managers who sit on corporate boards have great difficulty being perceived as impartial about their CEO's compensation! Imagine telling your boss that his or her performance does not deserve a raise, or that the raise is 2% when you are hoping for an 8% raise yourself.
This situation is far less common in the nonprofit sector, but it does happen. I know of an organization that badly needed to expand hours of service because of the nature of their clients, but staff members on the board blocked the change because they didn't want to work evenings and weekends. Sometimes, staff keep programs alive when they should be dropped in favour of serving emerging needs that require a different skill set or education. I have yet to hear a single good argument for having staff members on the Board and I hear many negatives. Advice from staff and communication with staff can be achieved in much less problematic ways.
Fair and impartial decisions are also jeopardized when chief staff officers sit on each other's boards and compensation committees. Such arrangements create the potential that they become beholden to each other and are might argue for high increases for each other.
Family and Personal Interests
With one exception, a nonprofit is not a family business, risking only the family's money. Once an organization is formed for public benefit, it should not be an employment haven for relatives or an excuse for family visits at organization expense. Investors are in fact pushing for an end to nepotism at publicly-traded companies such as British Sky Broadcasting Group PLC. They are suggesting that a young and inexperienced college dropout might not be the best candidate for a top job in the company, even if he is the son of the chair (Rupert Murdoch). This is refreshing!
Founders find it particularly hard to give up family members on the board and staff, because they started with the support of family and friends who agreed with their idea. They do not always realize how potential board members perceive such relationships. They may not see how decision-making is constrained because of the body language used when a director objects to an idea raised by a member of the founder's family. No one can be perceived as independent in hiring, managing and compensating an immediate family member, yet the system of married couples dong this, one as chair and one as Executive Director, continues. I keep wondering why anyone supports or joins such organizations. I have not heard of any ED terminated by their spouse for poor performance or lack of new and needed skills.
The one exception is family foundations, with a mission of using family monies to serve the public good. They are using their own monies and can operate more like a family business. Independent directors may be needed for skills on the board but that is an organizational choice. It is an example of why any standards or legislated solution must be exremely sensitive to the diversity of the sector.
I see this area as the most problematic to cover in sector-wide standards or law. Conflicts arising from financial interests are much easier to identify and control, but divided loyalties arise from less obvious circumstances.
- Friendships play a strong role in board recruitment and retention. It is inevitable that some board members will be friends with the chief staff officer and other staff members, and sometimes will vote the way those staff members wish.
- In multi-tier organizations some people will wear hats at various levels and be torn at times when the best decision at one level is not best for another.
- Occasionally, people sitting one more than one board will find that the interests of two or more of their organizations conflict.
I would argue strongly against any requirements that such divided loyalties be prohibited. I have no idea how multi-tier organizations could even function without the dedicated multi-hat people. At the same time, I would argue even more vehemently that the issue of divided loyalty should be a key concern of Governance/Board Development Committees.
In many multi-tier organizations, directors are appointed by the next lower level of the tier to serve on the higher body. But if a director of a regional organization says she must vote the way her local organization wishes, this is a honking big red flag showing a lack of good orientation and director training. The duty of loyalty has not been taught. It is the organization's responsibility to educate not only its directors but to some extent any organization which elects or appoints people to its board. The duty of loyalty means that while someone is at a board table making a decision on behalf of one organization, they must put that organization first. They are not there to represent the interests of any other organization, even the one that appointed them.
Having other bodies responsible for choosing your directors causes myriad other problems, including overly large boards in some cases and a lack of ability to match skill needs with appointments. Many organizations have changed their bylaws to address these concerns as well as the divided loyalty. The results is usually a higher percentage of directly elected board members, sometimes 100%, and often a smaller board.
Even without bylaw changes, the Board Development Committee can watch for and avoid divided loyalties. If Vince has voted in favour of every recommendation proposed by the executive director, including that those most of the board were against, he may not be a good candidate to put forward for re-election. If the executive director recommends her next-door neighbour and workout buddy for the board, think carefully.
I suggest avoiding any mandatory requirements about divided loyalties even if other areas ever get put into law.
The decisions of the board of our community organizations need to be fair and in the best interest of the organization and its community. To maintain trust and attract the support of donors, volunteers and others, the decisions must also appear to be fair and without personal benefit.
The best ways to do this are:
- to attract, retain and train directors with a passion for the cause, not because their friends are there or they have hope of personal benefit. Good recruitment practices can and should avoid situations where a director might not be fair and independent
- to provide good training to help directors understand what independence means, so they can act appropriately when a problem arises -- including resigning when they wish to apply for a staff position or when they sit on boards with conflicting interests
- to have good board structures and processes, such as occasional executive sessions, in order to get the best results from its board of independent directors.
With such commitments, the voluntary sector can continue to be a model to the corporate world and be in a position to justify the necessary differences.