A company whether it is a big or a small company, it will derive advantage from the exposure and experience that a good non-executive Director can transform. Non-executive Directors can offer a priceless involvement in the corporate decision-making practice, in influencing corporate strategy and in the distribution of resources to corroborate those plans. Their independence, impartiality and business wisdom should harmonise the specific knowledge and know-how of executive management.
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Non-Executive Director- A Definition
A non-executive Director is a member of the board of directors will not be in the rolls of a company and typically offers his service to the company on a part-time basis only. The prime responsibility of any director is to safeguard the company’s assets and to run the company in a manner that will end in most profitable and triumphant for the advantage of its shareholders. The NED (Non-executive director) may not assume any management function in the running of the business or to attend the day to day affairs of the company, other than helping in the deliberations of the board. However, the legal powers and duties are identical to those of decision-making process of the board of directors. The NED has a responsibility to keep him abreast of the business and about the financial standing of the company. It is, hence, crucial that he will have analogous right to access company information as the executive directors will have. Subsequent to the Higgs review, executive directors and senior managers must make sure that they offer non-executive directors with clear, complete and pertinent information to facilitate them to carry out the appropriate checks and balances; non-executive directors “should maintain that information is adequate, exact, apparent and timely.”(p 64 Combined Codes).
Any individual assuming as a non-executive director should have an extensive business background with diversity of talents extending ahead of business and financial wisdom.
It is always best not to employ the following individuals as non-executive Director:
- Company’s former executive
- A professional consultant retained by the company currently on a regular basis
- A major customer or supplier
That individual must be able to exert his effort in harmony with executive colleagues, able to preserve his reliability and assume a stand, where is required. A non-executive director must also aware when to hunt for supplementary information if he considers that they are not in full custody of sufficient information on which to base a solid decision.
Guidance and Induction
The latest Higgs Report and the Companies (Auditing and Accounting) Bill 2003 and Directors stipulates that NED is to have an up-to-date knowledge and well-known with all features of corporate governance. The Combined Code advocates proper assessment of the performance of individual director’s boards, and board committees. Hence, NED should be equipped with the required talents and information to carryout their duties as directors more effectively and proficiently.
Higgs suggests that funds should be made available for Directors to avail of suitable courses in professional development in order to build up and rejuvenate their acquaintance and skills.
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Duties of Non- Executive Directors
Some precise tasks may be achieved better by non-executive Directors which would be complex for the executive directors to perform impartially.
- Counselling the Chairman on succession in regard to top managerial positions, especially in respect of the Chairmanship itself and the position of Chief Executive.
- Apprising on top management and board about hierarchy
- Suggesting on the sufficiency of financial and other data available to the board.
- Counselling on the designing and pattern of remuneration of executive directors to be decided and finalised by Remuneration Committee in the case of listed and giant companies.
- Representing as a member of a committee of the board to assess a specific subject or region of operation. In particular, to represent as a member of an Audit Committee of the board.
- To make sure that strategic alternatives have been analysed appropriately, having regard to competitive and economic factors.
- To make a more separate analysis to bear on management accounts, budgets, and financial information supplied to stakeholders.
- Offering an independent outlook when a company is either contemplating on an acquisition or is in the process of a bid.
- Assisting with the issue of taking over in a family company by legal heirs and performing as an arbitrator in differences among family members.
- One another probable role of the non-executive director is to function as a counsellor to the Chairman.
As a part and parcel of the board of directors, a non-executive director will also have a function in analysing information or resolving upon matters put before the board for consent. Such issues may include deciding course of action, sanction of annual budgets and plans, deciding on packages of remuneration for executives, endorsement of public announcements.
Proper attention should be given to avoid employing non-executive directors in executive position which should be executed by the full-time directors and officials. This can harm the independent perspective that a non-executive can bring to an organisation..
The non-executive director should not of the view that his duty starts and finishes at board meeting. NED should always keep the interest of the company in mind, For instance, by forwarding any pertinent information to the Chairman, maintaining contact with the company and in general keeping abreast of related progress in the market.
The Combined Code suggests that “the Chairman should conduct the board or committee meetings with the non-executive Directors without the attendance of executives (§ A.1.3). Higgs recommended that the annual report should contain a report on whether such meetings have held.
Dedication of Time
The time dedication warranted from a non-executive Director have a tendency to vary significantly over the different phases of a company’s life cycle. The quantum of time that a non-executive director should be anticipated to expend on company issues and the compensation should be coherent with his role on the part-time basis and he should not sacrifice his independent outlook. Where non-executive Directors are requested to assume additional responsibilities, it is appropriate that their compensation takes into account these additional responsibilities.
As homework for board meetings and personal attendance of NED is time consuming, an ample time commitment is essential if efficient contribution is to be made as a non-executive director. The boards of giant companies often assign part of their proceedings to sub-committees, such as an Audit Committee, Finance Committee, or Remuneration Committee. This would result in further requirements from a non-executive director allocated to such a committee. A non-executive Director might also be required to assume other special duties, like chairing or participating in a special or ad hoc committee. This would, of course, entail an augmented time commitment and of course it may only for a restricted period.
The Combined Code demands for more open and precise procedures in the engagement of directors and for the employment of a wider list of candidates. It is vital, therefore, that the broadest probable search for possible candidates is initiated. A non profit-making organisation’s the Boardroom Centre differentiates in making such exploration for companies of all sizes and keeps a register of apt qualified candidates. For both the company and director, confidentiality is essential and any probable candidates should go all through this procedure.
Developments Corporate governance in the UK
Developments of Corporate governance in the UK are detailed as follows:
In the wake of corporate scandals such as Maxwell and Polly Peck, initial corporate governance developments in the UK started in the late 1980s and early 1990s.Sir Adrian Cadbury led the. ‘Financial Aspects of Corporate Governance Committee’ mainly to investigate the financial reporting malpractices. The committee published its Cadbury Report in 1992 which detailed a number of its recommendations for differentiating the organisation’s chief executive’s role with that of chairman, to have an equilibrated structure of the board, processes of appointment for non-executive directors, openness of financial reporting and the requirement for effective internal controls. The Cadbury Report contained principles of Best Practice and Cadbury’s testimonials were integrated into the London Stock Exchange Listing Rules.
After Cadbury’s recommendation, a ‘Working Group on Internal Control’ was formed to offer direction to companies on how to observe with Code 4.5 of the Cadbury Code, ‘accounting on the efficacy of the company’s method of internal control’. This paved the way in 1994 for publication of the Rutteman Report on ‘Internal Control and Financial Reporting’.
In 1995, following dilemma’s about directors’ share options and pay, the Greenbury Report stipulated vast disclosure on remuneration in annual reports and required the formation of a remuneration committee consisted of non-executive directors. Once again, the bulk of the recommendations were incorporated in the Listing Rules.
In 1996, in January, the Hampel Committee was formed to analyse the magnitude to which the Greenbury and Cadbury Reports had been enforced and whether the goals had been achieved. Thus, the Hampel Report paved the way for the release of the Combined Code of Corporate Governance (1998) covering up fields pertaining to operations and structure of the board, remuneration of directors, directors’ audit and accountability, relationship with institutional shareholders, and the duties of institutional shareholders.
The 1998 Combined Code made applicable to all listed companies from 31 December 1998 until reporting years starting on or after 1 November 2003 and then it was replaced by the revised Code in 2003.
Listing Rule 12.43A now demanding companies to offer in their annual reports an exhaustive report of how they made applicable the Code principles and report that they have observed with the Code provisions or not,. If it is yet to be complied, the reason for non-compliance of the same and up to what period.
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In between 1998 and 2003, Combined Codes demand companies to forward a report in their annual report on how they have enforced the Code Provisions and Code Principle pertaining to internal control. Elaborate directions for companies on how this should be accomplished were explained. In 1998 ,the Institute of Chartered Accountants in England & Wales (ICAEW) established Turnbull Committee by which then rechristened as the Turnbull Guidance, “Internal Control: Guidance for Directors on the Combined Code” which was released in September 1999. The direction has been approved by Securities & Exchange Commission (SEC) and such approved model is the guidance for management to demonstrate that they have reasonable internal control frameworks and financial reporting guidelines in place in order to observe with section 404 of the Sarbanes-Oxley Act.
In 2001, the association between companies and institutional investors was established with the Government instituted Myners Review, ‘Institutional Investment in the UK’. The main aim of the review was ‘to reckon whether there were elements straining the institutions capability for investment decision-making process. It contained recommendations for the improvement of information between companies and investors and supported institutional investors to think of their duties as owners and how they should opt for their rights on sake of beneficiaries.
The Directors’ Remuneration Report Regulations were brought in 2002 to further fortify the strength of shareholders in respect of pay of directors. The regulations augment the quantum of information of which shareholders are provided on directors’ remuneration, some disclosures, as well as performance data and graphs. Shareholders are given authority to vote in a consultant role to give their consent on the directors’ remuneration report.
HM Treasury and the Department of Trade and Industry (DTI) in July 2002 initiated a reappraisal of the Combined Code following a follow-up of company law. It started some steps on the Higgs Report “The Role and Effectiveness of Non-Executive Directors” which was released in January 2003. Higgs recommendations included a detailed explanation about ‘independence’ and the quantum of independent non-executive directors on the board and board’s committee, an elaboration on the function of the experienced independent director to offer a substitute channel to shareholders and guide assessment on the chairman’s operation its committees; modified stress on the procedure of nominations to the board through a transparent and stringent t procedure and evaluation of the performance of the individual directors on the board.
At the same time, the Financial Reporting Council released the Smith Report, namely “Guidance on Audit Committees”. In January 2003, both Smith and the Higgs Reports were released accompanied by the Tyson Report on the selection and growth of non-executive directors accredited by the DTI. The testimonials from Smith and the Higgs Reports resulted in transformations in the Combined Code of Corporate Governance released in July 2003. It is applicable to all companies listed on the primary market of the London Stock Exchange for covering years starting on or after 1 November 2003.
The Financial Reporting Council established the Turnbull Review Group In 2004 to deliberate the effect of ‘Internal control: Guidance for Directors on the Combined Code’ and to evaluate whether the direction required to be updated. Hence, “Internal Control: Revised Guidance for Directors on the Combined Code” was released by the Financial Reporting Council in October 2005.
The UK Government initiated a Company Law Review in 1998 and released a White Paper in 2002. A variety of recommendations in the White Paper pertaining to reporting by a company and an important development is the need for companies to offer a compulsory Operating and Financial Review to offer data on the company’s present and future strategy and performance. This came into effect from financial years starting from on or after 1 April 2005.
The corporate governance in the UK is significantly influenced by The European Union directive on corporate governance. The European Commission’s “Corporate Governance and Company Law Action Plan” which was released in May 2003 recommends a mixture of regulatory and legislative initiatives which will have impact on all its member States including U.K which relates to:
- requirements for disclosure;
- the manner in which voting rights are to exercised ;
- voting in case of cross- border transactions;
- institutional investor’s disclosures;
- Board member’s responsibilities.
Directors are wielding more pressure in the boardroom and have able to obtain greater independence from management.
As per recent survey perused by Mercer Delta Consulting, in collaboration with The Centre for Effective Organisations at the University of Southern California’s Marshall School of Business.
The study observed that of the directors surveyed:
- 92% observed that their board was independent of management “to a big” or “very big” degree;
- 94 %t informed that board members do offer opinions that contradict with the CEO’s outlook;
- 72% observed that CEOs have a smaller amount control over their boards “to certain extent” or to a “large or very large degree;”
- 91%informed they had control over the meeting program.
The findings are footed on feedback received from 221 directors of Fortune 1000 companies in the U.S. with median income of $10 billion.
Different kinds of Board of Directors
In normal practice, boards historically were ceremonious and not as efficient as they are trying to become. Normally, such boards constituted of friends of a majestic CEO.
Mercer Delta research classifies the boards into five groups, each with certain features:
A Passive Board operates at the prudence of the CEO. There will be limited activity and participation by Board. Likewise, there will be little accountability as the board ratifies management wishes.
A Certifying Board endorses to share-holders that the CEO is executing what the board wants and the management is having capability to initiate corrective action whenever required. It also stresses for independent or outside directors and there will be no participation by CEO in the deliberations made in the Board meeting. It launches a well-managed success method. It is gives a bird’s view on contemporary performance. It assigns external board of directors to assess the performance of CEO. It is able and willing to transform management to be responsible to investors.
A Board with independent directors offers insight, counsel and support to the management team and CEO on vital accomplishment and decisions. It also acknowledges its responsibility to supervise the CEO and to evaluate the company performance. The board meetings are differentiated by constructive two-way discussions of major issues. Board members acquire enough industry experience and pecuniary expertise to augment value to their discussions. More time and prominence is spent delineating behaviours needed from board members and limits of the board and CEO responsibility.
During a crisis situation, the intervening Board becomes deeply involved in decision-making and discussions confronting the organisation. In such situations, intense and frequent board meetings are frequently summoned on short notice.
The Operating Board arrives at major decisions that the management implements the same. This category of board is not infrequent in start-up companies or early-stage where board members fill up openings in sharing management experience.
The operating board and intervening board are more opportunity in nature and fill a gap in a company’s life cycle. Thus, it is significant to engage boards with the apt people, the right information and the apt constructive customs and climate and to spend more concentration on the right issues.
The hazard of legal case against Non-Executive Directors personally on the board which they serve is very remote. However, except for extraordinary occasions, Non-Executive Directors are individually accountable for their deeds and decisions while acting as individuals or as members of a Board of a company. Hence, most companies offer Non-Executive Directors with an insurance protection for conclusions arrived at the regular course of board business and in harmony with the exact procedures. The insurance is planned to mirror the safeguard that would be extended under a commercial insurance policy. A Non-Executive Directors or Director who has performed sincerely and in good faith will not have to pay out of his or her own personal income any personal civil charge which is paid by insurance company in the implementation or supposed conduct of his or her board purpose, save where the person has acted irresponsibly.”
NED’s engaged by Small and Medium Enterprises (SME) are more probably to act as consultant without adequate insurance cover which implies that SME regards them as of a mentor and not responsible for outcomes. There is a risk involved for NED’s who act as a director for SME’s as most of the companies do not provide insurance cover for them.
It is alleged that some non-executive directors are on the board of more than a dozen companies. Further, they are engaged by companies in which they have no experience or ever employed in such industries. It is also advocated that a part-time director cannot contribute much and hence all directorship position in a company should be made on permanent basis. Some also argue that there should be full disclosure of all data about executive’s remuneration.
National Association of Pension Funds demand that there should be restriction on number of positions that a non-executive director position that an individual can assume. Association demands that non-executive director should work one day per week per directorship and it also urges an increase in the pay structure for non-executive directors who are asked to work for a full day per week rather than working on part-time basis (Credit Management, 2002).
According to survey, the average annual compensation by way of fees paid to NED in U.K is £25,000. However, U.S NED’s receive the same quantum of fees as that of their European colleagues but the almost receive the double the amount by way of stock or share-linked fees.
Case Study 1
BBC (British Broad Casting Corporation) currently is having five non-executive directors who were appointed during 2007. The well experienced non-executive director is Mr. Marcus Agius, Chairman of Barclays, Mr. Mike Lynch, Chief Executive officer and co-founder of Autonomy Corporation, Mr. David Robbie, director of finance of Rexam, the packaging company, Mr. Robert Webb QC, general counsel at British Airways and Samir Shah, chief executive of an independent broadcasting production company and Juniper, an erstwhile head of political programmes and head of current affairs of the BBC.
It is not clear the idea of having outsiders or independents to evaluate the BBC’s executive operation was imposed by the British government or came from within the Corporation.
These independent directors have to operate more or less as non-executives in public companies sans financial risks by making certain that the board is executing its work properly. In other words, these independent directors should be critical friends tendering external judgments on decision made on the basis of their outside experience. Being the member of the Board of the Corporation, they are completely isolated from the Trust, which designs overall strategic direction of the BBC and supervises the actions of the Board.
For giving their valuable advise to BBC, they are paid a basic fee of £ 35,000 fee and also eligible for extra £ 5,000 for attending the committee meetings.
In the case of Samir Shah, a NED of BBC, there is potential conflict of interest since his company produces programs for the BBC. Mr. Shah usually abstains from sitting in the board when it deliberates on any province that might impact his business expertise in broadcasting.
For instance, Shan, along with another NED Agius, gave their advice to Director-General Mark Thompson over the Crowngate issue which paved the departure of the BBC 1 controller Mr. Peter Fincham. Usually, NED’s were consulted on the different episodes offakery that have shattered public hopes in the BBC’s integrity. (Evening Standard, 2007:30).
Case Study 2: Equitable Life
Equitable Life is filing cases against Ernst & Young for £ 2.05 billion and claiming up to £1.7 billion against erstwhile board of directors of Equitable Life in the background of financial adversity which made it to verge of collapse in July 2000.
The erstwhile non-executive directors of Equitable Life were of the opinion that £1.7 billion lawsuit initiated against them by the Equitable Life was mere a guise of getting into the “deeper pockets’ of its auditors Ernst & Young.
Equitable Life downfall descended after the holders of guaranteed annuity rate policies (GARs) succeeded a test case against the Equitable Life in the House of Lords.
It was held by House of Lords that the company functioned unlawfully when , in retort to mammoth decline in interest rates and current market annuity rates , it minimised the terminal incentives owed to GAR policyholders on retirement so as to stretch the available ‘pot’ among non-GAR clients as well.
Equitable Life asserts that E&Y was not only in breach of duty but also negligent in failing to report that 1997 to 1999 accounts of the society did not cover proper provisions for GARs and having failed to report forewarning in the 1999 and 2000 accounts of the risk of losing the GAR.
Former non –executive directors of Equitable Life were being accused of breach of fiduciary duty and negligence in not taking the legal advice before embarking on the differential terminal bonus policy which resulted to the GAR court case and in failing to mitigate the financial risk of losing GAR litigation and to intimate the policy holders about the risk.
The above case study illustrates how a NED can be later taken to task if he has not acted in good faith and with the negligence. (Birmingham Post (England) 2005:21).
No doubt that corporate governance is adding more responsibilities and augmenting pressure of work on non-executives. Now, NED are entrusted with more responsibilities which leading to escalating tension. The fissure between conventional NED’s function which assures that the company has the apt leadership and correct strategy now transforms into ever increasing onerous policing and supervising role as required by higher extent of scrutiny as it is expanding.
According to Price Water House, companies in U.K should understand that the role of NED’s have changed and they have to recognise the significance of such change when contemplating the selection , fixing pay-packages , commitment of time and assessment of NED’s to retain the dynamism of boardrooms of leading U.K companies (Financial Management , 2001).
List of References
- (2001) ‘U.K non-executive directors burdened by new workloads.’ Financial Management. 1 March
- (2002).’Ban non-executive director’s.’Credit Management.
- (2005) ‘Director’s Claim Law Suit Aimed at E&Y.’ Birmingham Post (England) 21
- (2007) ‘So what is the Point these five Non-Executive Directors Sitting on BBC Board? ‘Evening Standard: 30.
- Heffes, Ellen M. (2005).Boards: independent directors seen more independent; Financial Executive.