The role of an external director

In my last article published in October 2023, I raised the issue of external directors by saying they could either be independent or not. It’s not a question of how much they’re paid, as some people think: it’s far more complex and multidimensional than that.

Let’s start by clarifying these two concepts.

External versus independent directors

I would define external directors as those who serve on the board yet play no role in the company’s ownership (they don’t own shares) nor in its management (they don’t participate in the firm’s day-to-day leadership).

Describing an independent director is a bit trickier so let’s turn to the official definition given by the Spanish stock exchange:

Members of the Board of Directors who must perform their duties without being conditioned by any relationship with the company’s management team or controlling shareholders. They are chosen based on their personal and professional credentials.

The fundamental mission of independent directors is to defend the interests of all shareholders, particularly minority shareholders who do not have access to a seat on the Board; this is particularly relevant in situations of potential conflict (related-party transactions, takeover bids, mergers, etc.).

This is a good definition, in my view. It makes it clear that independent directors, like the other directors, serve on the board with the aim of contributing value. Otherwise, there would be little justification for their presence.

Governance in family-owned firms

In family businesses, the notion of “not being conditioned by relationships with the company’s management team or controlling shareholders” is sometimes difficult to achieve.

While challenging, some companies do this to the letter. One case that comes to mind is a bank where more than 80% ownership is in the hands of one person and whose board of directors would, in my opinion, meet all the criteria of good corporate governance.

Yet in other cases, family-controlled firms confuse trust with loyalty and fealty by ascribing a link between the first and the third. While good external advisors would logically be loyal and trustworthy, they should also be able to freely express their opinions without fearing any consequences.

External directors chosen based on psychological and psychosocial criteria – rather than their own merit – may lead to undesirable outcomes.

The qualities of stellar board members

Board members must be capable of reasoning and not pretending to be right at all costs. These competencies apply to both external and proprietary directors alike.

All directors should be honest and committed, and espouse personal values that align with the owner family, without going to adverse extremes. Their schedules should allow them enough availability to serve the firm as board members.

Responsible by nature, they should be able to form rational decisions and defend them with resolve and respect, and possess the prestige, reputation and authority to ensure their expertise is heard and heeded.