Corporate Governance, Iceland and Independent Directors

This Blog tries, when the opportunity is presented, to shed light on corporate governance practices from other countries that vary from those in the United States. In part this illustrates the lack of uniformity in the area. In addition, however, it demonstrates that there may be ways the US can learn from the experience in other countries in reforming its own governance process.

In the Fall, students from my comparative corporate governance class produced some posts that raise interesting issues. Over the next week or so, we will publish some of them. The following post today is by Alicia Buckingham, a student at the University of Denver Sturm College of Law, who looked at the concept of independence and applied it to Iceland, a country of little more than 300,000 people.  Here is her post. 

In early October, the Icelandic government took control of three of the country’s largest banks. Having grown far larger than the nation’s economy, with assets exceeding 1000% of the country’s gross domestic product, the banks kept only 2% in foreign currency reserves. As the value of the Icelandic krona plummeted, the government imposed restrictions on foreign currency exchange, a disaster for a country dependent upon exports.  The disaster raises serious issues about the country's system of corporate governance.

With a population of roughly 300,000 people and a limited capital base, Iceland has, in recent years, encouraged foreign investment and cross boarder business relationships. To increase its competitiveness, it adopted a voluntary corporate governance code resembling those in nearby European countries. The code relies on the “comply or explain” format, and provides for an independent board. Similar to the definition in the United States, the code defines independent generally as not having a financial or relational interest in the corporation.

The approach represents an example of the implementation of internationally accepted principles that will probably not work in Iceland.  The setting in which the standard was designed to operate, anonymous board members and disparate and fractional ownership, does not exist in this country.   In such a small society, Icelanders know their corporate directors, and a corporation would struggle to find board members who have limited connections to the relevant company. 

Nor have Icelandic corporations actively sought foreign directors to broaden the pool. If shareholders elect foreigners, they do so based on the individual’s connection to the company as opposed to a desire for independent board members. Foreign directors currently sitting on Icelandic boards mostly resulted from foreign acquisitions. For example, Bakkavor Group, the largest provider of fresh prepared foods and produce in the United Kingdom, currently has eight board members consisting of five Icelandic and three British directors.  All three Britons obtained directorships after the entity in which they each had an ownership interest was acquired by the company.

Similarly, an absence of economic ties is not necessarily the most appropriate measure of independence in a close knit and communitarian society.  A recent article (Crime, Shame, and Recidivism: The Case of Iceland; Eric P. Baumer, Richard Wright, Kristrun Kristinsdottir, Helgi Gunnlaugsson; 42 Brit. J. Criminology 40 (2002)) discussing the importance of social reputation and the Icelandic community’s use of shaming makes evident that, instead of focusing on a European notion of independent, the country should utilize its unique culture to define a director who will independently discharge his or her duties to the company.  This informal social control polices a director’s decision making and discourages jeopardizing one’s personal reputation.  Directors who highly regard their societal standing have not only a business but also a personal interest in fully discharging their directorial duties. Therefore, these individuals may engage in less self-dealing than other relatively anonymous board members from other countries.

Finally, independence should not be measured entirely by standards designed to benefit shareholders.  The Guidelines on Corporate Governance require corporations to consider a broader constituency than merely focusing on profit maximization.  Icelandair, the country’s largest airline, exemplifies a corporation faced with this broad demand. In the 2007 annual report, the Chairman noted the company’s responsibility to provide Icelanders with transportation to and communication with the rest of the world. 

The presence of a voluntary corporate code, therefore, does not alone elicit market confidence, even for companies that agree to adopt its provisions.  Perhaps the misfit definition of independence explains at least in part the current financial turmoil within the country, that Icelandic banks would have benefited more from a board that emphasized reputation over economic independence.