Questions to help you identify potential conflicts between directors and stakeholders

In Part one we looked at conflicts between individual directors and the company. In Part two, we will look at Tier-II conflicts, or those between directors and stakeholders.

Tier-II conflicts arise when a board member’s duty of loyalty to stakeholders or the company is compromised. This can happen when certain board members exercise influence over the others through compensation, favors, a relationship, or psychological manipulation.

To whom do board members owe their loyalty? This depends very much on law and tradition, and the prevailing legal system, social norms or the company’s specific situation.

The complex institutional loyalty of board directors – in the US, directors often have a duty of loyalty toward the company’s shareholders. Others argue that since the directors and executives are paid by the company, they are employees of the company so they should thus focus on the interests of the company rather than on those of the shareholders.

Influence of domineering board members on others – both independent and interested directors can potentially be influenced by powerful CEOs, chairpersons or other directors through compensation, favors, relationships, or psychological manipulation. Board members may also forsake their institutional duties out of personal loyalty to the CEO or chairperson. One way directors can determine whether they have been overly influenced is by asking themselves, “Have I been influenced or manipulated in order to agree with others?”

Board directors organized as a self-interested stakeholder group – regulators and researchers have argued that boards should comprise a greater number of independent directors to ensure that business decisions are not disproportionately influenced by powerful stakeholders.

To examine your possible Tier-II conflicts of interests, consider these questions:

• In your legal system, to whom do board members owe their duty of loyalty?
• Can you define whether, in your specific context, loyalty to shareholders or loyalty to the company is primary? Are there minority shareholders to be concerned about?
• If a director claims to owe their duty of loyalty to shareholders, could you specify who the shareholders are, i.e. fund managers or activists, large shareholders on the board, minority shareholders not on the board, or the ultimate shareholders?
• Can a director be fully independent when the CEO or chairperson decides on the compensation and succession of the directors?
• If a director is independent, could you specify who they are independent from (i.e. management, shareholders, other stakeholders, etc.)?
• Have you experienced a situation in which domineering directors felt they were having a heated discussion while others felt as though they were being suppressed?
• Are you aware that directors can form coalitions and leverage their full control of the board to benefit one another in an “I’ll scratch your back, you scratch mine” type of relationship?

To deal with Tier-II conflicts, directors need to disclose their relationship with stakeholders. This gives them an opportunity to declare in advance whom they represent. It is also crucial to specify who nominates new directors, who decides on directors’ compensation, how the pay structure and level are determined, and how pay is linked to performance and function.