DIRECTORS AND THEIR SHARES

By Jeremy Thorn

As an experienced Non-Executive Director, Jeremy Thorn has a special interest in helping boards and their directors. In this article, he asks whether it is always a good idea to encourage directors to hold equity in their companies.

Directors are regularly encouraged to invest in their businesses, ‘to align their interests with those of the shareholders’. Sometimes, this is worth challenging - especially when appointing new directors. (Once done, it is hard to go back!)

SHARE(d) INTERESTS

Many investors claim that ‘shared pain - shared gain’ by shareholding directors is essential to ensure that their attention is fully focused on growing the business and enhancing shareholder value.

Meanwhile, many directors may see the rewards of equity participation as a key component of their overall remuneration package. Further, tying in other key employees with at least share options can also be very powerful, to encourage key managers to commit to the long-term, to protect the value in the business.

So what might be said against directors holding shares in their employer?

DIFFERENT FOLKS, DIFFERENT STROKES

Naturally, companies and their boards vary greatly. Small ‘start-ups’ often behave quite differently from others; companies funded by highly leveraged buy-outs may experience quite special shareholder pressures; private companies may act significantly differently from those that are publicly quoted; all can behave differently if under-performing or subject to predators.

Equally, different types of director may also behave very differently. There may be a world of difference in the motivation, interests and behaviours of directors with a dominant share, a minimal share or a family share for example; or with a predominant operational role or a more supportive one; let alone executive directors compared with non-executive directors.

So a ‘one-size-suits-all’ approach to seeking financial ‘commitment’ by directors is unlikely to be universally applicable.

FALSE ASSUMPTIONS

Some common assumptions in tying a board in with equity are worth challenging.

“Only shareholding directors will look after investors’ interests as their own”.

All Directors have a fiduciary duty to look after the interests of their company and shareholders, whether shareholders or not.

“Directors will only be fully motivated if they hold equity”.

Research consistently shows that many will be driven at least as much by their personal values, professional development, career security, peer regard and job fulfilment, than they will be financial risk and reward.

“Shares are the best way for rewarding exceptional directors’.

Performance-based/profit-related bonus schemes can often be far more flexible and focused (even if not the most tax-efficient).

DOWNSIDES TO NOTE?

There can be many significant disadvantages in having a board whose members are expected to be shareholders. This inevitably depends on the circumstances, but may the following seem familiar?

‘Risk-averse, over-stretched’

When key shareholding directors invest more than they can personally afford to lose, they can become so risk-averse they can readily kill a good business by vetoing essential new investment.

‘Over-confident, unaware’

Most executive directors necessarily believe in themselves and of course what they know about their part of the business. But this is rarely enough. Such powerful individual shareholders can have unwarranted influence on a board without the neutral counterbalance of a wider picture.

‘Get-rich-quick’

Promises of untold riches through share investment can distort many people’s judgement. For example, conflicts of interest can readily arise between a director’s desire for individual gain and the need to avoid any statement or action that may unwarrantedly distort the share price. Many corporate failures start with small indiscretions that, in the act of hiding, grow exponentially to the point where they can no longer be hidden. Even private company boards can fall into this trap when corporate governance and integrity are stretched.

‘Hang on to my job’

Some shareholding directors may feel they can’t afford to move on when perhaps they should, in the best interests of everyone. If there are no ready buyers of their shares, this can be a quite unnecessary impediment.

‘Whose side are you on?’

Divided boards are rarely effective boards. Shareholders necessarily need to know that their interests will be respected, but sometimes neutral directors may be worth their weight in gold to help broker this best.

‘Shareholding Non-Execs’

For smaller companies in particular, equity participation is often a means of attracting highly respected individuals to act as a NED, to help access funds, markets and experience.

However, one of the principle roles of any NED is also to maintain a check and balance on executive directors’ actions. Unless all parties are clear of the NED’s role, confusion can reign and the NED’s focus may then be on the more ‘interesting’ areas of their remit. (Perhaps such individuals should better be board-attending consultants, whether investors or not?)

Both Cadbury and Greenbury identified this issue in their Corporate Governance reviews. The Combined Code expressly discourages granting share options to NEDs and says that where, in exceptional cases, they are proposed, shareholder approval should be sought first.

SUGGESTIONS?

Every situation is different, but be quite clear before appointing any director:

what you expect of them;
what drives them;
what they can contribute.

The issue of shareholdings may then be quite secondary.

If it isn’t, it may be important for both parties not just to ask why, but what lies behind this!

Jeremy Thorn is the prize-winning author of books as varied as ‘How To Negotiate Better Deals’, ‘The First-Time Sales Manager’, and ‘Developing Your Career in Management’. The past founding-Chairman of QED Consulting, he is an experienced Non-Exec Director, board adviser and executive coach, and a frequent coach, workshop leader and public speaker on many practical business topics.