New research has found that independent directors believe that they are less able to check chairmen and chief executives who own large stakes in their companies than they were. The number of independent directors who felt they could exert collective control over company bosses with large stakes was 20% lower than two years ago, according to the survey by Independent Remuneration Solutions (IRS), a consultancy, and Hanson Green, a recruitment company. Only 62% said they had the power to rein in owner-executives, down from 82% in 2003 but up slightly from a previously unpublished figure of 55% in 2004.
Peter Brown, IRS chairman, believes that, "The drop is a realistic reflection by non-executives of how their abilities are limited with regard to influencing or controlling chief executives and chairmen, especially if they also own significant stakes in the business." He adds that, "there is a feeling in some cases that, when push comes to shove, non-executives can't do the shove."
The issue of chief executive dominance was brought to prominence last year by a rift between Sir Ken Morrison, executive chairman of supermarket group Wm Morrison, and his deputy. Sir Ken, who owns 10% of the supermarket group directly and 18% with his family, had resisted attempts by David Jones to appoint more non-executives, before eventually relenting.
The seriousness with which institutional investors view the independence and effectiveness of non-executives on boards was illustrated at the beginning of this year. In January, Research, Recommendations and Electronic Voting (RREV), which reports perceived governance failings to UK institutional investors, issued a warning that corporate governance arrangements at business publisher Euromoney Institutional Investor remained poor. It argued that the composition of the board and its main committees are influenced by the significant shareholding of 70.64% held by publishing group Daily Mail and General Trust (DMG) Investment Holdings in the company. Furthermore, RREV only considered one of the six non-executives on the board to be independent.
Despite the importance that institutional shareholders and others place on non-executive directors, fewer people want to take on the role, according to the fifth Ernst & Young corporate governance survey. The annual survey of 124 board members among the UK's leading 500 companies, reveals that over 40% of respondents were sceptical about taking on a non-executive position, and one in three were less likely to take on the role. As one respondent put it, 'the responsibilities that a non-executive has are huge, but the reward for taking on that responsibility is tiny."
Despite such findings, Hanif Barma, partner at Independent Audit, a corporate governance consultancy, says, "In my opinion there has been a steady improvement in the quality and effectiveness of non-executives in both the public and private sectors. I'm a bit taken aback that non-executives feel that their influence has decreased."
Barma believes that, "the feeling that their influence has declined must be linked to high expectation. Non-executives may feel that they are not living up to what they think is expected of them in the boardroom, given the recent renewed focus on their role. However, there is no evidence that current non-executives are failing shareholders or companies through poor performance. I think non-executives are probably more independent now than ever before and are probably more effective than they give themselves credit for."
Barma also questions whether it is the duty of non-executives to 'control' chairmen and chief executives. "There is a very big difference between 'controlling' what course of action and what strategic views chairmen and chief executives may take and 'influencing' their decisions. Non-executives are there to challenge the board - not to control it," he says.
Sir Andrew Likierman, professor of management practice in accounting, believes that, "one cannot generalise about the quality of non-executive directors. I hope - and from my own experience, I think - that they are getting better and are taking their responsibilities more seriously. This includes asking more probing questions about strategy and challenging the executive more thoroughly."
He adds, "The idea that non-executives feel that they cannot control owner-managers mis-states what the role of the non-executive actually is. They are not there to control the executive: as part of the management team they are there to challenge it constructively."
What the combined code says
In theory, there should be no confusion about what the role and duties of non-executive directors are. The UK Combined Code on Corporate Governance spells them out in detail. It says that, in addition to the requirements for all directors, non-executives should 'constructively challenge and contribute to the development of strategy', and 'scrutinise the performance of management in meeting agreed goals and objectives, as well as monitoring the reporting of performance'. The combined code also says that non-executives should 'satisfy themselves that financial information is accurate and that financial controls and systems of risk management are robust and defensible'.
It states that non-executives should be responsible for determining appropriate levels of remuneration of executive directors and have a prime role in appointing, and where necessary removing, senior management and in succession planning. Furthermore, they should 'constantly seek to establish and maintain confidence in the conduct of the company' and 'should be independent in judgement and have an enquiring mind'.
The guidance further says that non-executives should build a recognition by executives of their contribution in order to promote openness and trust; be well-informed about the company and the external environment in which it operates, with a strong command of issues relevant to the business; insist on a comprehensive, formal and tailored induction; seek continually to develop and refresh their knowledge and skills to ensure that their contribution to the board remains informed and relevant; ensure that information is provided sufficiently in advance of meetings to enable thorough consideration of the issues facing the board, and understand the views of major investors.
Changing attitudes
Sarah Blackburn, an audit and risk development consultant who also serves as a non-executive for the UK Passports Service and for the Healthcare Commission, says that the calibre and abilities of non-executives has improved over the past couple of years. "There has been a rapid change of emphasis regarding the work and input of non-executives. Nowadays, non-executives are unlikely to take up the position unless they can be reassured that their views will be listened to."
Blackburn also says that non-executives have become much more active in requesting information from the board and those that report directly to it, such as the head of internal audit. "Non-executives are increasingly asking for specific information rather than for information by volume. They are also much more likely to contact heads of departments for clarification if they feel they need to."
Joyce Drummond-Hill, a non-executive director of an NHS trust, says that there are several reasons why non-executives might be ineffective. "If there has been a tradition of poorly performing and timid non-executives serving on the board, then executive directors are unlikely to pay them much attention or allow them much time to challenge executive decisions. Similarly, non-executives can only be as good as the organisation's attitude towards corporate governance. If its attitude is poor, there is little non-executives can do to change it."
She also points out that in the NHS and other public sector bodies, non-executives routinely serve for a five-year period, as opposed to the three-year period typical of private sector organisations. "The length of service can be a problem. It can lead to non-executives becoming complacent about their role, as well as result in their becoming too cosy with the board and losing their independence."
Sir Andrew believes that remuneration is an important factor. "If organisations don't pay people appropriately, there is likely to be a feeling that the organisation does not think that they are worth very much," he says. "That's a bad message for everyone. I don't believe there's a clear link between better performance and more money, but non-executives should be paid fairly for what they do."
- Neil Hodge is a freelance writer
IRS INDEPENDENT DIRECTOR SURVEY
The highlights of the 2006 report are:
- Non-executive director fees are increasing at around 8% a year. Most of this increase derives from additional fees for committee work. Most board committees now have at least one supplementary meeting a year and briefing papers for the meetings are more professional and substantial.
The amount of preparation and contact work prior to committee meetings has increased accordingly.
- Time commitment for chairmen and non-executive directors on main boards has effectively levelled off after significant increases in 2004 and 2005 following the introduction of Higgs' recommendations in 2003. Per diem rates are only just reaching 2003 levels, when both fees and time commitments were lower.
- Professional search consultants are increasingly used by companies of all sizes to access and evaluate suitable independent director candidates.
Three years ago, this was largely confined to the larger quoted companies, where percentages have increased from 40-50% to 90-95% over the period.
Companies in the smallest turnover categories are now using search consultants for over a third of their appointments.
- The percentage of companies preferring candidates to have previous non-executive experience and specific sector or industry experience has increased.
- Sixty percent of companies now review independent directors' fees annually, 12% more than in 2004.
- About 50% of the companies who claimed they were going to implement board evaluation reviews in 2005 have actually done so. The rest are planning to do so next year. There continues to be a very strong preference for the review to be headed by the chairman, with consultants possibly used as facilitators.
- A few respondents stated that, against a background of increasing pressure to comply, particularly from auditors, there is a growing need for strong independent directors who can identify and defend those situations where explaining is more suitable for the company than complying.
The survey, produced by Independent Remuneration Solutions in association with Hanson Green, price £100, is used by over 750 companies to review annual fees and to set board appraisal targets. Further information is available from IRS, Tel: 020 7836 5831.
