In recent years, a number of high-profile corporate collapses, have thrown corporate governance issues into sharp relief. In the US, the reaction to such events was the signing of the Sarbanes-Oxley Act of 2002, with the goal of improving investor confidence and restoring integrity to the capital markets. It is still too early to tell whether the requirements of Sarbanes-Oxley, including increased internal controls, certification of annual reports and stringent disclosure obligations, have succeeded in this aim, but it is clear that expectations in the area of corporate governance have risen dramatically.
Despite occasional speculation that the UK might adopt a prescriptive regime, corporate governance in that country remains largely an area of 'comply or explain', based on best practice guidance and procedure. That said, shareholders in the UK are demanding ever greater accountability from the boards of the companies in which they invest, and there is renewed focus on the way in which companies are managed and how those in control are rewarded.
Corporate governance guidelines require boards to have a sufficient complement of non-executive directors, and the responsibilities falling on such directors are increasing. In this environment, how can a company best attract high-calibre people willing to take on the challenging role of a non-executive director (NED), with all its associated risks?
What is the role of the non-exec?
Before any company can hope to persuade a prospective NED to serve on its board, it must appreciate what it is to be a NED in today's market.
Too often, the view of executive board members is that non-executive directors are a necessary evil, needed for the ticking of a box on the corporate governance checklist. Such an approach does a grave injustice to the NED, who can be a valuable source of knowledge, wisdom and objective advice.
Following publication of the findings of Sir Derek Higgs' review of the role and effectiveness of non-executive directors, the Financial Reporting Council published, in July 2003, a revised Combined Code on Corporate Governance which gives extensive guidance as to the role of non-executive directors.
It is a principle of the Combined Code that every company should be headed by an effective board, which is collectively responsible for the success of the company. As part of his or her role, the responsible NED will be expected to:
- constructively challenge and help develop proposals on strategy
- scrutinise the performance of management in meeting agreed goals and objectives
- monitor the reporting of performance
- satisfy him/herself on the integrity of financial information and that financial controls and systems of risk management are robust and defensible
- be responsible for determining appropriate levels of remuneration of executive directors
- have a prime role in appointing or removing executive directors, and in succession planning.
This is quite a job specification and requires the NED not only to support executive directors in their leadership of the business, but also to monitor and supervise their conduct. It is clear that such responsibilities cannot be discharged without a real understanding of the business and access to detailed information.
How can the rest of the team help?
So, what should executive directors and senior management be doing to assist their non-executive colleagues? Much guidance is given in the Combined Code, which provides a useful starting place for a company seeking to demonstrate integrity and persuade a high-quality NED to join its board.
Key areas include the following.
An obvious point, perhaps, but not every prospective NED will be blessed with the knowledge or time management skills necessary to carry out the role effectively. As with all appointments to the board, objective criteria should be applied to ensure that every NED is chosen on merit, following a rigorous, fair and open appointment process. This should help to address the limitations of the old boy network - widely acknowledged to have contributed to the lack of diversity in the skills, experiences and perspectives of UK boardrooms - and also help to ensure that only a candidate with sufficient time available to devote to the job is appointed.
It is always tempting to engage a big name, but if he or she holds too many other positions already, another candidate may be better placed to do the role justice and add real value.
You have found a NED with the experience, commitment and ability to make a valuable contribution to the company. The next step is to ensure that he or she receives a full induction on joining the board. A combination of written information, presentations and site meetings should provide a balanced and useful overview of the company and its operations. The induction process should seek to:
- build an understanding of the nature of the company and the market in which it operates
- build a link with the company's people
- build an appreciation of the company's main relationships.
The new NED should be encouraged to meet senior management and visit key sites, and should be briefed fully on the company's major customers and suppliers. Significant investors should also be offered the opportunity of meeting the new NED to encourage future dialogue and engender confidence.
Such an introduction will make it easier for the NED to play his or her part in discharging the responsibility of the entire board for developing an understanding of the views of major shareholders.
PROVISION OF INFORMATION
To be effective, a NED must be well informed about the company and the environment in which it operates. It is the chairman's responsibility to ensure that all directors receive accurate, timely and clear information sufficient to allow them to discharge their duties. Such information should be provided to the NED well in advance of board meetings to allow him or her thoroughly to consider the issues facing the board and, if necessary, request further information or raise questions.
To encourage openness and the chance to build a relationship of trust with fellow board members, the NED should be provided with effective channels of communication to other directors, in particular to the chairman, who should meet with the NED from time to time without the executive directors present. An open door policy will serve the company well here and give the NED an opportunity to demonstrate the value of his or her contribution to the team.
TRAINING AND DEVELOPMENT
The NED will be expected continually to develop and refresh his or her knowledge and skills. It is for the company to support the NED in such efforts by providing the necessary resources for developing and updating his or her knowledge and capabilities, being ready to cover the costs of doing so. Executive directors and senior management should be encouraged to give time to provide training to non-executive directors and should be proactive in circulating useful information, to ensure the NED is as fully informed as possible.
INTERNAL SYSTEMS AND CONTROLS
Much will be achieved in addressing the concerns of a NED about his or her exposure to personal liability if the company can demonstrate that it has appropriate systems in place to safeguard its assets and the investment of its shareholders. The role of stringent internal controls in risk management should not be underestimated, and, to be truly effective, these should be embedded in the culture of the company.
By way of example, the audit committee - which will generally be made up exclusively of independent, non-executive directors - should review the arrangements by which employees may, in confidence, raise concerns about possible improprieties. The objective should be to ensure that arrangements are in place for the proportionate and independent investigation of such matters. It simply will not do for an employee to be written off as a troublemaker and a complaint to be ignored. If a concern is raised, the executive directors and management team should assist the non-executives to get to the bottom of the matter and take appropriate follow-up action.
The board as a whole, and particularly the chairman, should see it as part of their role to ensure that the NED is enabled to fulfil his or her duties and is not hampered by a lack of support from the executive directors. Where a NED raises concerns about the running of the company or about a proposed action, the board should ensure that these concerns are addressed and, to the extent that they are not resolved, recorded in the board minutes.
Although it is no substitute for the measures set out above, the board should ensure that appropriate insurance is in place in respect of legal action against any of its directors, including non-executives. Each NED should have access to independent professional advice, at the company's expense, if he or she judges it necessary to discharge his or her responsibilities.
When it comes to executive directors, it is widely accepted that remuneration should be sufficient to attract, retain and motivate personnel of the quality required to run the company successfully. Although the time devoted by a NED to the affairs of the company will be significantly less than that of an executive director, the fact remains that executive and non-executive directors share the same legal and fiduciary duties and are, in many areas, exposed to the same potential liabilities.
The current rates of remuneration for non-executive directors seem rather low when seen in the context of the demands of the role. A fee which may have been adequate to reward a retired executive who was expected to make only a limited contribution to the board, may not be sufficient for the efforts of the modern NED. Essentially, levels of remuneration for non-executive directors should reflect the time commitment and responsibilities of the role. A company which is willing to pay a fair fee will be much more likely to attract high-calibre candidates.
Some companies favour share options as a way of providing incentives to even non-executive directors. Generally speaking, best practice dictates that options should be granted to non-executive directors only exceptionally and then in tandem with strict conditions. Such incentives should not be seen as a means of supplementing a low fee which, on its own, does not properly reward a committed and diligent NED for his or her contributions.
The role of a NED today is one which requires care, skill and diligence.
The type of person suitable to satisfy such requirements will, rightly, take his or her responsibilities seriously and be conscious of the potential risks of failing to discharge the legal and fiduciary duties of non-executive board membership. In seeking to attract accomplished non-executive directors who will make a valuable contribution to the board, a company must be willing to demonstrate high levels of respect, communication and openness.
It is clear that the NED who feels included, informed and valued is more likely to fulfil his or her duties effectively and, if the primary role of the NED is, ultimately, to promote corporate governance and monitor performance, this can only be good for the company and its stakeholders.
Melanie Wadsworth is a corporate lawyer in the London office of Faegre & Benson LLP. She regularly advises on the growing demands of corporate governance in the UK.
Tel: 020 7450 4500, E-mail: MWadsworth@faegre.com
Executive recruitment firm Korn/Ferry International's annual boardroom survey of FTSE 350 and private businesses, published in March, shows that recruitment to board positions remains a challenge for companies as the responsibilities, liabilities and scrutiny of non-executive directors continue to increase.
According to RVR Systems' UK managing director Toby Grey, skilled managers should not let added responsibility and scrutiny keep them away from important board positions. Instead, says Grey, non-execs and potential non-execs should be conducting thorough investigations of their own. NEDs should be assured that any company on whose board they sit is taking a comprehensive, strategic approach to corporate governance.
What to look for? Grey points to several key signals that should help mitigate the risk to NEDs;
- a published and actionable policy on corporate governance
- best practice internal control system
- involved senior management, including a CEO who is setting the tone from the top.