Faculty of law blogs / UNIVERSITY OF OXFORD

Towards a Credible System of Independent Directors in Latin American Listed Companies


Oliver Orton
Aurelio Gurrea Martínez
Associate Professor of Law, Singapore Management University


Time to read

4 Minutes

As shown by the law and finance literature, most Latin American companies have concentrated ownership structures with controlling shareholders (La Porta et al, 19981999). As a result, the primary corporate governance challenges typically existing in Latin American companies have not been the traditional agency problems between managers and shareholders (prevalent, for example, in the UK and US markets), but the risk of opportunism by insiders (i.e., managers and controlling shareholders) vis-à-vis minority investors. Regardless of whether this expropriation by insiders (often referred to as ‘tunneling’) ultimately occurs, the very risk of such opportunism may discourage outside investors (especially overseas investors) from providing funding to Latin American companies. This in turn could have the knock-on effect of impeding the development of capital markets and the promotion of economic growth in the region. 

There are a variety of mechanisms to prevent or, at least, minimize, the risk of tunneling by corporate insiders. Among them, the use of independent directors has been one of the most common tools implemented across jurisdictions around the world. In a recent paper, however, we argue that, while we find independent directors to be a potentially valuable mechanism to protect minority investors, it is insufficient and, further, policy-makers have not properly addressed the main challenge faced by independent directors in companies with controlling shareholders: how to credibly make the case to minority investors that that the independent directors are both able and willing to prevent tunneling by insiders. 

In general, most countries in Latin America (as in other parts of the world) have considered that a director can be considered “independent” if he or she does not have any economic, employment or family relationship with the company. Nevertheless, this definition seems to ignore a key matter: the fact that, in companies with concentrated ownership structures, the controlling shareholder has the ability to appoint and remove all directors due to its influence in the shareholders’ meeting – the very forum in which independent directors are appointed and removed, usually after a recommendation of a special committee formed by ‘independent directors’. Therefore, regardless of whether these independent directors appointed by the controlling shareholder ultimately perform their duties in a proper manner and behave with the best of intent (and we do not suggest otherwise), outside investors nonetheless have reason to be cautious. Namely, they will likely wonder whether the independent directors (indirectly) appointed and removed by the controlling shareholders can and will effectively prevent opportunism by the controlling shareholder vis-à-vis minority investors. Therefore, as confidence is the basis for both corporate governance and the operation and development of capital markets, the traditional system of appointment and removal of independent directors in Latin America may end up harming firms’ ability to access finance and the development of capital markets in the region.  

As a result of the aforementioned problem, our paper proposes a change to the system of appointment and removal of independent directors in Latin American listed companies. This proposal is mainly based on the existing literature (especially the proposal made by Professors Lucian Bebchuk and Assaf Hamdani) but it also combines some regulatory solutions existing in other countries as well as some new elements that we find appropriate to create confidence in public investors without harming the operation of the board or creating holdout problems by minority investors.

Namely, we propose the implementation of a system by which the appointment and removal of independent directors should be based on two levels of approval: (i) a majority of the shareholders’ meeting; and (ii) a majority of minority shareholders (MOM). Thus, minority investors will have the ability to block the candidate proposed by the controlling shareholders. This not only gives more voice and power to minority investors but it can also encourage the controlling shareholder to think twice about the person whom it is going to propose as an independent director in the first place, and create the necessary conditions for dialogue. Nevertheless, as this system may have several drawbacks (including holdouts by minority investors and internal disputes that may end up blocking the appointment and removal of independent directors and therefore the operation of the board), we argue that this system should only apply in the first round of elections – that is, in the first attempt to seek approval from both the shareholders’ meeting and the MOM. Therefore, if the candidate approved by the shareholders’ meeting is not ratified by the MOM, an alternative system should apply in the second round. In this second attempt, the candidate should be able to be approved by a “minimum qualified majority” (MQM) of all shareholders. This MQM would take place when the controlling shareholder (if any) gets support from a minorityof minority shareholders – for example, 5-10% of those minority investors entitled to vote represented at the shareholders´ meeting. Thus, our proposal would require a minimum percentage of support of minority investors but prevent the risk of creating a holdout problem by some minority shareholders. 

Finally, taking into account that, under our proposal, the controlling shareholder would still have significant influence on the appointment and removal of independent directors, we propose that, in addition to the previous system of appointment and removal of independent directors, minority investors should always be allowed to appoint at least one independent director. Although some may argue that the existence of this “outsider” may disrupt the “friendly” and efficient operation of the board, we believe that a minimum level of dissent can create several benefits – in fact, this is one of the economic justifications for the promotion of diversity. Moreover, it would do so without preventing the controlling shareholder from pursuing its long-term business strategy. 

In our opinion, this proposed system of appointment and removal of independent directors may not only provide a greater level of confidence to potential investors (mainly foreign institutional investors) considering investment in Latin American listed companies, but it may also improve the decision-making process (and consequently the quality of decisions) in the boardroom as a result of having at least one “real outsider” on the board. We believe that this “outsider” may bring new ideas (and new dissent) to the boardroom. Moreover, the presence of this independent director appointed by minority investors will probably encourage the “real insiders” to prepare for the board meeting in a more organized and professional way, something that we see as particularly relevant and beneficial in countries with many family businesses, as is the case in Latin America. Therefore, this proposal may even generate other benefits apart from the facilitation of finance, the development of capital markets, the attraction of investment, and the promotion of economic growth in Latin America.

Aurelio Gurrea Martínez is a Fellow in Corporate Governance and Capital Markets at Harvard Law School, Lecturer in Law and Finance at the Centro de Estudios Garrigues and Executive Director of the Ibero-American Institute for Law and Finance.

Oliver J. Orton is the Program Manager of Corporate Governance for Latin America at the International Finance Corporation, World Bank Group.


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