Conflicts of interest

Jun 01, 2018
Many corporate governance mechanisms are symbolic rather than substantive, which only serves to worsen the malaise.

Corporate governance reforms have placed much focus on director independence. While director independence and conflicts of interest are related, the finer subtle points of handling conflicts of interest have received less attention.

Conflicts of interest are pervasive in corporate governance – conflicts between corporate objectives versus other objectives. Directors’ duty is to look after the interests of their company, not their own personal interests. Directors’ personal interests may conflict with the company’s interests, which can compromise good corporate governance.

Conflicts of interest can occur between directors and their company, shareholders and their company, shareholders and directors, parent companies and their subsidiaries, parties in a joint venture, government ministers and state companies, and stakeholders (customers, employees) who are also board members. They are a feature of family businesses, where there may be conflict between family interests and business objectives.

Mechanisms are in place to manage conflicts of interest, such as declaring conflicts of interest at the start of board meetings, directors leaving board meetings when an agenda item with which they have a conflict is being discussed and not circulating papers/minutes to directors concerning the conflicted issue. So-called “Chinese walls” are another mechanism, acting as a barrier to the exchange of information between conflicted parties.

Such mechanisms may work when the conflict is occasional but, in my opinion, can rarely operate successfully where the conflict is systematic and pervasive. Like many corporate governance mechanisms, they may operate in a symbolic rather than substantive manner. Take, for example, the following anecdote I heard: an item arises at a board meeting and the chairman says: “Seán, should you step out of the meeting?” At this point, the whole board burst out laughing!

Disclosure is the most popular mechanism for handling conflicts of interest. Disclosure offers something to everyone. It is a symbolic rather than substantive response to the problem. Disclosure of a conflict of interest offers the recipient the opportunity of discounting advice from a conflicted party, thereby helping the recipient make better decisions. But there is evidence that recipients may not sufficiently discount the biased advice. 

Disclosure may have the added pernicious effect of legitimising bias from the conflicted party. Thus, rather than mitigating the risks from the conflict of interest, it may exacerbate those risks. This perspective prompted the following comment in the New Yorker: “Transparency is well and good, but accuracy and objectivity are even better. Wall Street doesn’t have to keep confessing its sins. It just has to stop committing them.”

Disclosure has minimal impact on the status quo for the conflicted parties. For example, disclosing a connection on a board of directors is better than the more substantive action of resigning from the board to address the conflict.

An additional insidious consequence of conflicts of interest in boardrooms is their effect on decision-making. The Financial Reporting Council’s Guidance on Board Effectiveness identifies the risk of conflicts of interest distorting judgement and introducing unconscious bias into decision-making. Research has shown that the mechanisms to manage conflicts of interest are no match for unconscious bias.
Handling conflicts of interest requires different types of thinking, along the lines of Daniel Kahneman’s Thinking Fast and Slow. Academics have compared the automatic mental processes concerning self-interest as being fast, effortless, involuntary, not amenable to introspection; managing conflicts of interest, on the other hand, involves slow, effortful, voluntary introspection.

Shareholders appoint the directors at the annual general meeting. The law provides relatively little redress to shareholders where things go wrong due to the actions of directors. If shareholders appoint unsuitable persons as their directors, then they must bear the consequences. Shareholders need to take care not to appoint persons to the board that have systematic conflicts of interest with the company. I question the wisdom of appointing worker directors (especially elected worker directors) to state boards because of their conflict of interest to look after the best interests of the state entity versus to look after the best interests of their electorate with a view to being re-elected.

Substantial elimination of conflicts of interest is the first line of defence. It would help to also change the mindset of business from a self-interested individualistic culture, in favour of a pro-social good-of-society perspective.

Prof. Niamh Brennan is Michael MacCormac Professor of Management at UCD College of Business.