Conflicts of interest — the broader context

The Institute of Directors in New Zealand has published a Practice Guide on recognising, declaring and managing conflicts of interest.  It provides an overview of how directors should recognise and manage conflicts of interest in the boardroom, using an “identify-declare-manage” framework.

This post sets out some other aspects of the broader context of conflicts of interest, not directly addressed in the Practice Guide, that directors should also have on their radar.

  • Avoid:  A fourth element could be added to the “identify-declare-manage” framework: “Avoid”.  If you are holding yourself out as a independent non-executive director, it just makes sense to avoid the potential for unnecessary conflicts of interest.  This does not require becoming a hermit, but it does require getting your priorities right.  Senior members of other professions, such as accountants, lawyers, and public servants put some effort into arranging their affairs to avoid the potential for significant perceived or actual conflicts of interest.  Professional directors should do the same.  The IoDNZ Code of Practice for Directors explicitly states: “Directors should avoid conflicts of interest so far as possible.”
  • Board member recruitment and selection:  The Practice Guide is aimed at incumbent directors.  The potential for conflicts of interest should also be at front of mind in the director selection process.  It is an issue both for candidates and for selection panels.  Candidates “need to assess whether you have the independence necessary to make clear, impartial decisions, unhampered by present involvements that would interfere with you acting in the best interests of the organisation”, and need to be careful not to let the excitement of getting a new role cloud their judgement.  Selection panels need to draw out the potential for conflict of interests so that any potential conflict of interest of the successful candidate can be properly managed from the outset, while candidates with intractable potential conflicts can be identified and declined, thereby avoiding the need for disruptive management of issues when they arose down the track.
  • Unconscious bias:  Another element of conflict of interest in the director selection process is favouring candidates for reasons other than in the best interests of the company.  This is charitably referred to as “unconscious bias” but it can arise more explicitly, such as with nepotism (favouring relatives or friends), or with appointing someone in order to gain their favour, for example, to gain reciprocal appointments to roles they have influence over.
  • Advisors and executives:  The Practice Guide focuses on conflicts of interest brought to the board table by directors.  It is also important to bring into the process the interests of other participants in board decision-making.  Advisors can have obvious interests, such as other clients for whom they work, that may need to be managed.  They also have less obvious incentives, such as the prospect of getting further work or of maximising their commission, that need to be addressed explicitly. Executives who attend board meetings may be participating in board deliberations that will affect the tenure, prospects, role, and remuneration of themselves or of their work colleagues, so care needs to be taken about when and how executives are engaged in board discussions so that maximum value is drawn from their essential involvement, while personal interests are acknowledged.
  • “Skin in the game”:  Requiring a director to have a significant shareholding in the company (“skin in the game“, as Warren Buffett described it) is one mechanism for aligning incentives for the director to act in the best interests of the company, and the evidence (e.g. here) supports its effectiveness.  However, the director needs to keep in mind that the alignment is not perfect, and it is not a license to make board decisions solely on the basis of your own personal benefit.
  • Insider trading:  The chapter on conflicts of interest in the NZ Institute of Directors’ bible, The Four Pillars of Governance Best Practice, includes an extensive discussion about insider trading and how to navigate its legal implications.
  • Company culture:  Conflicts of interest don’t just arise at the board table.  They can arise for individual employees across the whole company and lapses can significantly affect company performance.  The board is ultimately responsible for establishing the company’s control systems and setting the tone to manage this.  Conflicts can arise with specific legal consequences for the company and the individual concerned, such as fraud or bribes. They can also arise less explicitly when employee incentives diverge from the interests of the company.  This is referred to clinically in the agency theory literature as moral hazard.  Further, gifts and hospitality are an area that seems innocent enough, but can raise issues of conflict of interest, both for the recipient and for the host.
  • International implications:  Different jurisdictions and cultures can have different rules, norms and expectations around conflicts of interest and how they are interpreted and dealt with.  Directors of companies with international or cross-cultural operations need to reconcile these differences.
  •  Background and experience:  Finally, it is useful to be clear that background and experience in an area, in themselves, do not constitute a conflict of interest.  Indeed that experience may well be very valuable to the board. As the Auditor-General said in her 2015 inquiry into the Health Promotion Agency:  “A conflict of interest does not arise simply from a person’s general background, or from their personal or professional involvement in a sector or industry. Rather, it is necessary to point to a specific connection between the person’s other interest and a particular matter or decision coming before the public entity.”