Hong Kong’s decision not to set directorship limit is a mistake

The Hong Kong Exchanges and Clearing recently decided not to place any limit on the number of directorships anyone can hold. This could very well encourage talented executives to hold high numbers of directorships, to the detriment to very companies they are meant to provide valuable board oversight to.

There is a limited pool of good quality independent directors available in Asia and indeed, the world. As such, it is natural that working or retired executives with strong business experience and networks are invited to become board members at a variety of companies other than their own. Many of the highly sought directors after hold over six to eight board memberships each. (These are just the board seats on listed companies that we know about and do not even include official or unofficial directorships at privately held companies).

Often times, the more reputed a CEO or senior executive, the larger number of external boards he/she tends to sit on, according to a study by Dinesh K Padmanabhan1 & Chinmoy Ghosh (2009). Cash compensation for such executives also increases with both their reputations and the number of external board seats they hold. Having executives who hold external board seats within their peer groups or industry can be useful to companies. The authors state that companies reach higher levels of profitability when their CEOs sit on other well performing companies’ boards.

Multiple directorships are hence recognized as a good thing, but to a point. The same study showed that when a CEO hold a “large number of outside directorships” however, his/her cash compensation decreases, due to shareholders’ worry that their CEO may be spending too much time away from their own firm.

In another 2007 study, “Multiple Directorships and Acquirer Returns”, authors Seoungpil Ahna, Pornsit Jirapornb, and Young Sang Kimc argue that multiple directorships affect the quality of managerial oversight. In studying 1,163 announcements of mergers and acquisitions over a period of six years, the authors found that the acquiring firms experience more negative abnormal returns, when their directors hold more outside board seats. They interpret this result as suggesting that directors serving on multiple boards allow value-destroying acquisitions when they become too busy beyond a certain point.

The demands on board directors are increasing. Regulations are on the rise and the business world is ever more complex. To be effective, directors need to be able to contribute independent perspectives, essential skills and experiences, and an understanding of the evolving global marketplace. They should not be deterred by the increased demands placed upon corporate directors, even when those demands involve greater potential liabilities, difficult travel schedules, or complex leadership challenges. Such responsibilities call for dedicated time and effort. Membership in a large number of boards limits anyone’s ability to provide proper corporate governance in all of one’s board appointments.

From observing and advising boards in Asia over the past 15 years, it is evident that a board director who is not tied to a full-time executive job can still effectively contribute if he/she sits on a maximum of five or six boards, and no more. Fully employed executives are best advised to take up only two or three board positions at most.

The Hong Kong Exchanges and Clearing should not bow to the argument that those hoping to make a full-time job out of independent directorships should be able to accept several – with no limit. Mainland regulators currently limit the number of board seats an individual can hold to five, and Hong Kong should consider the same.