To motivate independent directors, put them in the spotlight
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Many countries require listed companies to have independent directors sitting on their boards. These directors have no ties to the company, are not on the executive team, and do not participate in daily operations, ensuring ethical and effective management while balancing stakeholder interests. Unfortunately, it is not uncommon for these overseers to be besieged by multiple issues that prevent them from performing their roles.
Among many possible reasons, controlling shareholders often immensely influence the nomination of independent directors, who receive meagre compensations, giving them less motivation to exert monitoring efforts. A lack of expertise could also be the cause, as many independent directors are industry outsiders with little business experience. Regardless, their oversight function is vital in ensuring corporate governance.
George Yang, Professor of the School of Accountancy at the Chinese University of Hong Kong (CUHK) Business School, tries to address this issue. He investigates the effect of China's 'sunshine enforcement', where the regulators use public enforcement mechanisms to encourage independent directors to step up their game. The concept is based on increasing transparency and public visibility in enforcing laws to improve accountability and compliance.
In a study titled Public enforcement through independent directors, Professor Yang and his co-authors, Li Xiaoxi and Rao Pingui of Jinan University, as well as Yue Heng of Singapore Management University, examined the role of independent directors in responding to a comment letter, a publicly shared inquiry from regulators regarding companies' filings, disclosures, or compliance with regulations. Specifically, the researchers look into certain transactions between companies and parties with pre-existing relationships. Such transactions, known as related-party transactions, are particularly concerning in emerging markets like China as they can lead to expropriation, an unfair practice where controlling shareholders take advantage of their position to benefit themselves at the expense of minority shareholders.
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'Using data from China, we find that firms receiving comment letters concerning related-party transactions from stock exchanges significantly reduce their related-party transactions in subsequent years,' says Professor Yang. 'Managers, including independent directors, particularly care about their 'face'. They would be ashamed if they received sanctions from the market regulators, which would result if the issues in the comment letters were not properly resolved.'
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