More Independence Is Needed on Boards of Hong Kong SAR Companies

Olympic records are a matter of pride. Some records in corporate governance, however, have questionable value. The current tenure recordholder among independent nonexecutive directors (INEDs) on boards of Hong Kong SAR–listed companies has been on the same board for 47 years, and has served as a director since 1974 and as an INED from 2000. After serving on the board for more than half of his long life (the individual is 92 years old), we wonder whether he can be considered truly independent.

This is an extreme example of an individual who has served as an INED well past the period when he or she can reasonably be expected to retain a level of independence. Long tenures tend to make INEDs overly comfortable in their roles, cosy with the management, and unwilling to “rock the boat.” According to Stock Exchange of Hong Kong (HKEX) data, 214 INEDs have tenures of 20 years or more among 8552 such positions in companies listed on the exchange.

The issue of long-serving INEDs on boards of Hong Kong SAR companies is just one of several issues that cast doubt on the level of independence such individuals bring to boards and the state of corporate governance in the territory. In its report “Independent Directors in Asia Pacific,” CFA Institute highlights the relative paucity of INEDs on boards of Hong Kong SAR–listed companies compared with other markets in the region, the numerous cases of individuals serving on multiple boards, the low number of female directors, and the influence of controlling shareholders in appointing INEDs.

Although all markets analysed in the report, including Australia, Hong Kong SAR, India, Japan, Malaysia, and Singapore, have issues, Hong Kong SAR does poorly by comparison on several measures.

Individuals appointed to boards as INEDs are expected, as the term implies, to exercise a high level of independence in thinking and not to be biased or controlled by company executives or major shareholders. Their duty is to challenge and counterbalance the company’s management, thereby mitigating the agency problem of corporations. This is a critical issue when assessing related-party transactions.

Independent boards make better decisions, more reliably hold management to account, and better safeguard shareholder interests. The lack of INEDs on company boards can lead to insider control, a disregard for shareholder needs, biased decision making, and, in extreme cases, corporate misconduct.

Appointing majority-independent boards is a common practice in developed markets, such as the United States, the United Kingdom, and Australia. It is one of the best practices of corporate governance that CFA Institute promotes as part of its mission to deliver better outcomes to investors by fostering more efficient and transparent capital markets.

The HKEX listing rules state that each listed company should appoint at least three INEDs and that INEDs should constitute no less than one-third of the board. In practice, among Hong Kong SAR–listed companies with a market cap of $500 million or more analysed by CFA Institute based on data from FactSet, INEDs fill 38% of board seats. This compares unfavourably with almost all other markets analysed in the study, where the share ranges from 47% in India to 58% in Singapore.

The number of INEDs on the board, however, does not tell the whole story about its ability to make unbiased decisions, challenge management, and prioritize shareholder interest. The long tenures of INEDs lead to reduced independence. The view of CFA Institute is that INEDs should serve in such roles for no longer than 10 years. HKEX appears to share that view, but it stops short of forcing companies to limit the tenures of their INEDs, asking only that those who serve longer than nine years be approved by independent shareholders and that they be subject to additional disclosures. In India, for example, the tenure of INEDs is limited to 10 years.

Another issue is that of “over-boarding,” which is the practice of individuals serving on several boards at the same time. Although many INEDs are talented and hardworking, time is limited. It is doubtful whether today’s recordholder, who serves on 17 boards (including in 16 INED roles), can devote sufficient time and attention to each company, in addition to fulfilling other required duties.

Over-boarding is more common in Hong Kong SAR than in many other industrial markets. An analysis by Bloomberg shows that in 2019 the number of HKEX-listed companies (113) with a director serving on more than six boards was almost triple that of New York Stock Exchange (NYSE)–listed companies (39) and eight times larger than Singapore Exchange (SGX)–listed companies (14). Some progress is evident, however, as the number of individuals with more than six directorships has declined by a third since 2017, after HKEX imposed additional justification requirements when appointing a person for their seventh such role.

In its most recent proposed update to the Corporate Governance Code, HKEX made a push for gender diversity, stating, in effect, that boards with no female directors would no longer be acceptable. This is a welcome move, as it recognizes that more diversity—not only of gender but also of age, cultural background, education, and professional experience—makes for a better board. On gender diversity, Hong Kong SAR again compares unfavourably with most other markets in the analysis, with only 13% of female directors on average in the FactSet sample of companies, less than in Australia (30%), Malaysia (24%), India (17%), and Singapore (15%). Only Japan, where traditional attitudes to doing business still dominate and women have a difficult time advancing on the corporate ladder, has a lower number of women directors (6%).

Board independence, however, should be evaluated not only according to the number of INEDs and their diversity but also on the basis of the quality and skills of individuals appointed to these roles. Many Hong Kong SAR–listed companies are controlled by founders, their families, or mainland-based state-owned enterprises. Such entities wield power to nominate and appoint directors, including INEDs, whom they like: pliant ones who are not likely to cause trouble and who will support the management unconditionally. How often this happens is difficult to ascertain, but common knowledge among governance professionals is that in Hong Kong SAR, this issue is more prevalent than in markets where companies are broadly held and institutional shareholders play a major role.

The analysis by CFA Institute shows that governance of companies in Hong Kong SAR, in particular around the functioning and independence of boards, has much room for improvement. Ideally, in addition to limiting the tenure of INEDs, we also would see a requirement that the roles of the chair of the board and the CEO are separated and that the chair be an independent director. In Hong Kong SAR, the CEO was the chair in 29% of companies included in the FactSet sample, more than in all other markets except Japan, where it is a standard business practice.

The notion of a company’s board being chaired by an INED may be hard to swallow for the region’s numerous founder-, family-, or promoter-dominated companies. Malaysia shows a way forward, requiring that if the chair is not independent, a majority of the board should be. Appointing a lead independent director to serve as a voice of minority shareholders is recommended in such situations.

Good corporate governance, and in particular the quality of company boards, comes to the fore in times of crisis, such as an economic downturn or a pandemic, when close attention needs to be paid to the business environment and difficult decisions must be made. Experienced, independent, diverse boards play a crucial role in steering companies and ensuring the best outcomes for shareholders.

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