Corporate governance is defined as the system of practices, rules, and processes which direct and control a company. Corporate governance fundamentally involves balancing the stakeholders’ interests such as customers, government, financiers, management, shareholders, suppliers, and the general community. Good corporate governance systems are needed to regulate risks in a company and reduce the chances for corruption. The success of any company is attributed to its corporate governance.
Having understood the meaning of corporate governance, it is important to understand the importance of independence in corporate governance. One of the reasons why directors are independent is because their legal obligation is not just to protect the shareholders and the company from potential subjective perspectives and views of the executive team but also to ensure that the interests of the minority shareholders and respected, heard, and protected (Kim, 2016). In matters corporate governance, I am for the view that having ‘skin in the game’ could compromise a director’s independence and even create new agency conflicts. Agency problem arises where the director (agent) does not act in the best interests of the shareholders (principal) (Fernando, 2012). Companies strive to motivate the directors to act in the interests of the shareholders because there is an agency problem when shareholders choose to act through others and their interests are dependent on others.
‘Skin in the game’ situation is created to ensure that like- minded people with shares in the company have higher incentive to manage and govern the company. As managers or directors are required to buy stakes in their companies because of the belief that they are likely to manage the companies effectively as they strive to protect their share in the company. Some people believe that a director with a considerable portion of his/her compensation at risk is likely to be more effective than one with nothing at risk (Narayanan & Gogate, 2012). However, an independent director should not have material or financial connection with a company except sitting fees for them to make impartial and unbiased decisions. With the restrictions given by the legal structure for companies, allowing independent directors to invest in a respective company is tantamount to compromising their independence and this may create new conflicts. Conflicts would arise because stock options are mainly awarded at no cost with expectations that both directors and shareholders would benefit when stock prices increase (Narayanan & Gogate, 2012). However, shareholders suffer a loss when the stock price declines but the directors do not experience any out-of-pocket loss. This shows that there is no commercial loss for directors with ‘skin in the game’ option; meaning that the director and shareholders win together when all goes well but do not lose together when all goes wrong. Therefore, this curved payment schedule and lack of equilibrium with the shareholders bring greater risk- taking on the part of directors, which may not serve the interests of the shareholders and therefore which may contribute to ne agency conflicts (Narayanan & Gogate, 2012). Based on this view, stock option brings only short- term benefits because the independent directors make decisions only on the basis of short- term returns that accrue with increase in performance.
Narayanan, N. & Gogate, M. (2012). ‘Skin in the game’: A case for incentivising independent directors. Journal of Governance, 1(6), 695-715
Kim, Y. (2016). The agency problem of Lehman Brothers’ board of directors. Illinois Business Law Journal, 1-5
Fernando, A. (2012). Corporate governance: Principles, policies, and practices. New York: Sage