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It is recommended by the King Committee in its latest report that share options should not be granted to independent non-executive directors. What can be done where a company wants to offer performance-related rewards to a non-executive director?

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King III redefines ‘independence'

 

The King III report (September, 2009) recommends that share options should not be offered to non-executive directors who qualify as being ‘independent' within the definition of that term in the code.  For some time, whether share options should be offered or not has been questioned. The King II report recommended merely that share options should be considered but should not be granted on a scale likely to impair the independence and objectivity of the director concerned.

 

In the meantime, the granting of options is reported to be a common practice in the US and Canada; whilst it is not generally condoned in the UK and the EEU.

 

The committee has now come down on the side of the UK/EEU approach on the grounds that these are our major trading partners.

 

One's first reaction may be that this is a storm in a tea-cup, given that the Board can give options to anyone - so that, if it wishes to give options to a particular director, it can and will do so. The significance of this new corporate governance rule however is then that that director no longer qualifies as an ‘independent' director. This may mean in turn that another director will have to be appointed to perform the duties reserved for independent directors (typically the duties which have to be performed on the audit and remuneration committees).

 

In the result one may find that the character of the independent directors on listed company Boards becomes archetypal - the positions occupied by professional lawyers and accountants; and their fees effectively equal to their professional charge-out rates. In this case, we will have bred a new high-level team of auditors - responsible for auditing the corporate governance system whilst serving on sub-committees, and reporting thereon to shareholders.

 

The need for options in perspective

 

Whilst this ‘watchdog role' is obviously useful (even critical), there is another role that independent directors are expected traditionally to play as well - which we can provisionally call ‘the entrepreneurial role'.

 

For example, in the case of a mining company that appoints a semi-retired mining magnate on to its Board, there may indeed be an expectation on the part of that Board and by shareholders that he will bring with him his expertise and connections, which are brought to bear on investment opportunities. Share options are it would seem a natural form of incentive to offer such directors.

 

And, it may be argued following the US position that this is the primary role of the independent director - to make a contribution to the Board in an entrepreneurial way - giving the company then its strategic direction. The watch-dog role may even be considered secondary in this context - especially where there are other controls in place to regulate risk and determine senior executive pay policy.

Also, share options are generally granted in the US to independent directors not as once-off rewards for a single deal, but as financial assistance in the building up by each incumbent director of a meaningful stake in the company, which is to be held for the duration of the term of office. An ongoing shareholding of this kind will in the long-term tend to more closely align the interests of those directors and the shareholders, which is surely highly beneficial.

 

Yet, these aspects are not even commented on by the King Committee - perhaps because they are obvious.

 

Cost implications in perspective

 

The new rule may therefore have some serious cost implications for some listed companies - being the cost of yet more directors.

 

Consider here that additional professional independent directors may cost between R120 000 and R240 000 each in terms of their annual fees, based on the time that has to be devoted typically to audit and remuneration committee work.

 

This may be an enormous additional cost to a low cap company entering the market.

 

For, in many cases it is found that three independent directors have to be appointed to carry out the committee work - since each committee needs a chairman and then also an understudy - for how can one entrust the areas of risk management or remuneration policy to one person, who may resign or become incapacitated. That is in itself a risk to be managed!

 

Conclusions

 

We will therefore predict, and hope, that two classes of independent directors emerge in SA following King III - the ‘watch-dog class' in compliance with the call by the King Committee for more objectivity and professionalism in the management of risk and remuneration, and the ‘entrepreneurial class' to assist the Board to achieve greater strategic direction and thrust.

 

There is surely room for both, and hopefully the additional cost will prove to be worthwhile!

 

If you want to read more on this topic, go to Chapters 1.2 and 1.3 in the library.

 

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