By Jeffrey Pittman
The role that sound corporate governance structures play in protecting the financial interests of Newfoundland and Labrador’s residents has largely flown under the radar in public policy circles.
For example, extensive theory and evidence imply that monitoring by boards of directors of companies, including state-run enterprises like Nalcor, suffers when persons with social or political links to the government are appointed to the board. In one of their main responsibilities, boards of directors are supposed to actively monitor management to ensure that its decisions reflect the best interests of the company’s shareholders. In the case of Nalcor, for instance, its shareholders are essentially the province’s residents. However, recent research suggests that directors with social or political connections to the government are reluctant to impose strict monitoring or challenge the company’s current strategic direction because they want to avoid damaging the relationship with the governing party that led to their appointment in the first place.
It is important to appoint directors without social or political ties to the government because tough external monitoring requires both competence (for example, the ability to identify issues that threaten to undermine the company’s long-term goals) and independence (such as the willingness to raise these sensitive issues in the boardroom).
To use Nalcor as an example, rather than serving as a watchdog for the province’s residents, the captured board — in the sense that its independence is highly questionable — may become a lapdog for the government.
Regrettably, board appointments that reflect the government’s social and partisan political networks are likely to suffer on both fronts.
First, rather than the government casting a wider net in recruiting for director positions, they tend to focus on a shallower pool of connected persons. In turn, appointees may lack the necessary expertise to serve on the board.
Second, directors coming from social and political networks will have strong incentives to remain loyal to the government that appointed them rather than focusing intently on protecting the interests of the company’s shareholders (for example, the residents of the province).
To use Nalcor as an example, rather than serving as a watchdog for the province’s residents, the captured board — in the sense that its independence is highly questionable — may become a lapdog for the government.
Another downside to allowing appointments to stem from durable social and political networks is that it lowers the likelihood that women will be invited to join the board, as recent research suggests. Even setting aside the clear social justice implications, extensive evidence implies that corporate governance improves when boards are more gender diverse. In fact, companies benefit when women join the director ranks. This situation routinely results in boards performing better in both monitoring and strategy formulation: its two core responsibilities. The presence of women on boards tends to translate into better information-sharing and collaboration among directors, as well as less groupthink. Gender-diverse boards are more likely to confront difficult and delicate issues. Similarly, boards with women are more likely to adopt a co-operative decision-making framework that improves decision quality when there are competing interests at stake. Regrettably, boards are likely to remain dominated by men when existing social and political networks shape the recruitment of new directors.
From a public policy standpoint, a natural reform would be to rely on an independent body to handle all board-level appointments to state-owned companies like Nalcor. Indeed, the provincial government has taken steps to move in this direction by launching Newfoundland and Labrador’s Independent Appointments Commission in May 2016. However, recent research suggests that they should resist the temptation to allow exceptions that would enable the government, at its discretion, to bypass the commission’s vetting process; these very situations are apt to lead to the appointment of board members without the required competence and independence. In other words, the commission should be responsible for all board-level appointments without any interference from the government, that is, the government should not have the flexibility to circumvent the recommendations of its own Independent Appointments Commission.
Finally, the Independent Appointments Commission Act could be amended to include a provision requiring government boards to meet quotas for gender diversity.
About the Author
Jeffrey Pittman (Business Administration, Memorial University of Newfoundland) primarily analyzes the role that firm- and country-level governance structures play in shaping economic outcomes in private and public companies. He was appointed Memorial’s chair in corporate governance and transparency in 2011.
