News & Press: IoDSA in the Press

Director due diligence

Thursday, 23 January 2014  
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By Parmi Natesan
Senior Governance Specialist
Institute of Directors in Southern Africa

Companies are hugely dependent on the knowledge, skills, experience and qualities of their directors. According to the IoDSA Board Appraisal Benchmark Study Report[1], board composition probably has more impact on the future success of an organisation than any other aspect of governance.

Principle 2.19 of King III[2] states that directors should be appointed through a formal process. According to paragraph 80, Shareholders are ultimately responsible for the composition of the board, and it is in their interest to ensure that the board is properly constituted from the viewpoint of skills and representivity. Procedures for the appointments to the board should be formal and transparent and should be a matter for the board as a whole, assisted by the nominations committee, subject to shareholder approval.

Not surprisingly, companies are increasingly concerned to ensure that their boards contain the right mix of skills and expertise to help them implement their business strategies effectively.

According to a paper on Director Due Diligence[3], released by the IoDSA’s Corporate Governance Network, the key goal in selecting directors is to build a mix of skills and experience that achieves a well-rounded team in fulfilling the board’s duties and responsibilities. King III states in principle 2.18, paragraphs 71 and 72 that "Directors should be individuals of integrity and courage, and have the relevant knowledge, skills and experience to bring judgement to bear on the business of the company.” and "every board should consider whether its size, diversity and demographics make it effective. Diversity applies to academic qualifications, technical expertise, relevant industry knowledge, experience, nationality, age, race and gender. ”

The nominations committee (or if none the board), should determine the nominees who will be put forward to the shareholders for election. This should be based on the assessments of the proposed candidates (review of CV’s, background checks and interviews) as well as the needs of the board. This robust due diligence process will ascertain whether the nominees are suitable for consideration and should be nominated for appointment i.e. whether they have the right knowledge, skills and personal attributes to effectively fulfil their legal duties.

According to King III, Chapter 2, paragraph 81, "Boards should ascertain whether potential candidates are competent to be appointed as directors and can contribute to the business judgement calls to be made by the board. In looking at the skills and suitability of a proposed candidate director, there are three dimensions that require consideration, namely:

· The knowledge and experience required to fill the gap on the board

· The apparent integrity of the individual; and

· The skills and capacity of the individual to discharge his duties to the board.”

Apart from these general governance considerations, it is important to ensure that the potential candidates are not disqualified from serving in terms of the Companies Act of any other relevant legislation.

Prospective directors also need to take the time and trouble to perform a similarly intensive due diligence exercise on companies whose boards they have been asked to consider joining. It is imperative that prior to accepting an appointment, a potential director satisfies himself/herself that the company is a company in which he/she can have faith and in which he/she will be well suited to serving.

This due diligence allows the prospective director to assess the risks posed through involvement with the company, its governance procedures, financial management and its strategic aims and objectives. The exercise may also reveal to the individual whether he/she has the knowledge, skills and capacity to make a meaningful contribution.

In terms of King III, Chapter 2, paragraph 86, "The onus is on individual directors to determine whether they have the requisite skills and capacity to make a meaningful contribution and are free from apparent of actual conflicts.

Given the hugely increased exposure to personal liability that the Companies Act imposes on directors, it becomes even more important for potential directors to inform themselves about how the company is run and what risks it faces.