INDEPENDENCE – ITS IMPORTANCE IN GOOD CORPORATE GOVERNANCE

INDEPENDENCE – ITS IMPORTANCE IN GOOD CORPORATE GOVERNANCE

Introduction

There are many core concepts at the heart of good corporate governance and words like integrity, probity, transparency and accountability have become a familiar part of the business world and its attempts to change for the better. However, there is one concept that seems to be the most important of all to good governance – independence.

What is Independence?

To be independent is to have no links with someone or something. 

This lack of linkage should mean that if A is independent of B, then A can look at B in an objective way, meaning that A’s mind can analyse the actions of B without any other factors affecting A’s assessment. 

Because A is objective, he is more likely to give an appropriate opinion on B – quite simply, A has no reason NOT to give an appropriate opinion. 

As well as BEING objective, those who give opinions for others to rely on need to be SEEN to be objective, otherwise even an appropriate opinion will not be believed or trusted. 

Imagine that a person arrested by the police accuses them of physical abuse at the police station. If the police investigate this matter themselves, they are neither objective (as they may wish to protect the reputation of their police force) nor are they likely to be believed to be objective by the person making the accusation or the outside world. 

So, independence is important as it allows those giving opinions and monitoring others to do so in an objective way, leading to better quality assessments and an increase in assurance for those reading them.

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Importance of Independence in CG

External Audit

In the external audit process, a company recruits a firm of accountants to come in to the company and give an opinion on the truth and fairness of the financial statements, this opinion being primarily for the shareholders. 

It is essential that the external auditors are independent from the company they are auditing, or they may be tempted to give the wrong opinion on purpose. For example, if the firm are earning very high fees form the company, they may ignore errors in the financial statements in order to keep the client happy and preserver the fees for the following year. 

Even if the auditors have integrity and would not do such a thing, the high fee level is likely to create suspicion that they MIGHT give the wrong opinion – and this is enough to damage the usefulness of the audit process. 

As such, external auditor independence is of paramount importance and must be protected at all costs.

Non-Executive Directors (NEDs)

A company’s NEDs are on the board for a number of reasons, but in overview their role is to monitor the Executive Directors, as well as overseeing certain key aspects of the company’s systems and operations. 

If they are to perform this monitoring role properly and give opinions that are correct and can be trusted, it is essential that they are independent of the executives and systems that they are monitoring. As such, NEDs should ideally be brought in from outside the company, should not serve on the board for an excessive number of years, should have n close links with any of the other directors etc.

The Chairman

The company chairman is the main “representative” of the shareholders on the board. Under UK corporate governance, it is essential that the chairman and CEO are two different people, and that there are no strong links between them. 

UK business history has seen several occasions where one dominant person on a board has resulted in fraud or company collapse. By having two separate people, with no links between them (i.e. independent of each other), the chairman should be able to monitor and control the actions of the CEO.

Internal Audit

Internal audit provides a challenge for the concept of independence, as many companies employ their own full-time internal audit staff to do the role. Clearly if you work for a company, your ability to view it in an objective fashion is reduced. One way around this would be to outsource the internal audit function to a firm of external accountants. 

When auditors, whether external or internal, are put under such pressure not to do their jobs properly, and their concerns are ignored, they should realise that their lack of independence is harming the quality of their work and consider resignation.

Conclusion

As you can see, there are many applications of the concept of independence within corporate governance.