At the session of the Presidential Commission for Modernization and Technological Development of the Russian Economy held in Magnitogorsk President Dmitry Medvedev announced a 10-step programme aimed at improvement of the investment climate. One of these steps is change of corporate governance standards in state-owned companies and, as a result, exclusion of government officials from boards of directors to be completed by summer 2011.
Officials will be replaced by independent directors. “As for boards of directors, the government must initiate taking decisions at shareholder meetings to replace relevant ministers and vice-premiers by independent directors in major companies until mid-2011,” said Dmitry Medvedev.
Who is an independent director? There is no clear definition of an independent director in international practice. We can say that an independent director is a director who is not affiliated with major stakeholders, and his position does not imply a conflict of interest. Generally an independent director is a director who is not directly or indirectly, financially or otherwise, dependent on the shareholder owning more than 25% of the voting shares, not affiliated with the company management and the board, and not associated with external auditors.
Why do companies need independent directors? The most complete and at the same time the shortest answer to this question is given in the Independent Directors Register of RUIE designed to bring together people engaged in professional activities as independent directors and determine respective qualifications and standards, “To ensure effective functioning of the board of directors it is necessary to include independent directors on the board.” In case of replacing a government official it is quite clear. “When the company's strategy is clear, independent director receives a relevant mandate as a step towards the state exit from business. In this case the director should take part in pre-sale activities. This is not just about replacing government officials by independent directors. When there is no goal it is unclear what the mission of an independent directors is,” said Alexander Shokhin, RUIE President, in an interview to Itogi (#15) magazine commenting on the fifth point of the programme announced by Dmitry Medvedev. Alexander Shokhin himself serves as an independent director on the board of several companies, including OAO LUKOIL, TNK-BP Limited, OAO TMK, and OAO RZD.
“Today nobody doubts that the board of directors, which is designed to reflect the interests of shareholders, shall include not only shareholders but also independent directors, whose task is to help increase the company value. These people must have significant management experience and solid reputation in the industry. Presence of independent directors on the board demonstrates a certain level of transparency of business in compliance with corporate governance,” notes Nikolay Netbalsky, Director of FGUP Moslesproekt and an independent director of the Russian Financial Corporation and Abakan airport. His view is supported by a major rating agency Standard & Poor's (S&P) that provides analytical research of the financial market and evaluates companies on the basis of the GAMMA rating (governance, accountability, management, metrics and analysis). This rating implies assessment of non-financial risks associated with purchase of company shares on the emerging markets and is designed for investors who invest in shares of these companies. One of the components of this ranking is the number of independent directors.
Thus, the more independent directors, the more attractive the company is for investors. However, this benefit is not always free for companies. Of course, often an independent director does not receive any compensation, but “in public state-owned companies, where there is no 100% presence of the state, independent directors do receive compensation. After all, to invite a high-level director from the international, global market, you need to attract him by the compensation among other things. So the expenses for board of directors are likely to increase,” says Alexander Shokhin.
The institution of independent directors is fairly new for Russia. It has come from countries with developed market economy and is part of the so-called corporate governance, a method of improving business performance through efficient use of resources, risk management, control over top managers and their motivation. By the way, Russian companies invite more foreigners to the board of directors who bring their international experience and expertise for strengthening the company. Jonathan Tubb, an independent director of Bank Zenit, told us what Russian companies expect from a foreign independent director, “I do not believe that Russian companies are different from any other foreign organizations in terms of looking for best practices and solutions, improvement of corporate governance, market positioning, etc. when they invite an independent director from abroad. A foreign independent director can bring a more global view on issues important for the company such as development strategy and corporate control; in addition the company may benefit from personal and professional contacts of the director.”
However, this institution in Russia is not yet established. Alexander Ikonnikov, Chairman of the Supervisory Board of the Independent Directors Association, noted in an interview to Expert magazine, “Today the quality and efficiency of the board of directors is the weakest link. It plays a key role in maintaining the interests of shareholders, ensuring their equal treatment, transparency and information disclosure. The board should have an opportunity to voice independent judgments and take professional decisions in the interests of the business. Boards of directors in the majority of Russian companies only have one or two independent directors, while according to international practices more than half of the board members should be independent directors. Independent chairmen of the board are an exception, whereas in the UK, for example, it is a usual situation.”
According to Sergei Pyatenko, Director General of FBC Economics and Law School, the main problem is that “in Russia the business community has not recognized the advantages of independent directors as such.” Alexander Shokhin says, “Presence of the board of directors in the structure of the company management only demonstrates compliance with corporate behaviour, but does not guarantee an effective system of corporate governance. One of the main indicators of the level of corporate relations in the company is the efficient interaction of all participants of the board of directors.”
In Russia there is a need to strengthen the institution of independent directors, including state-owned companies. RUIE plays an actively role here – since 2009 it has been a co-organizer of an annual Director of the Year Award which includes an Independent Director of the Year nomination designed to mark the personal contribution of directors in the development of corporate governance in companies and the work of the boards of directors in Russia.
How to attract independent directors? There are several ways, and one of the most popular is through executive search agencies, which, in my opinion, is a highly effective tool for selection of high level executives. Combination of professional profile, skills and experience in a specific industry is unique for every company. Moreover the independent director should not only have management experience, but also possess an ability to confront, if necessary, the largest company shareholder. He must be a diplomat in order to convince other board members that his point of view is right and the solution he proposes – the most effective. Therefore, the selection must be very sensitive and precise because is not easy to find someone who is loyal to the major shareholder, an expert in a certain industry and combines all above mentioned personal qualities.
To conclude, measures proposed by the government to further strengthen the institution of independent directors are real steps to improve the investment climate in the country, however the issues of development of this institution in Russia, the effectiveness of independent directors and the availability of skilled managers who can rightfully occupy the position of an independent director remain unresolved.
Russian Industrialist Magazine, Vyacheslav Konovalov, Business Development Director, 4Astra/IMD International Executive Search