The present day role of non-executive directors in a single-tier board.

The role of non-executive directors was forced to change due to several large scale corporate governance failings. Solomon (2010) suggests that ‘deficiencies in the non-executive director role within financial institutions have been seen to contribute to the current global crises’. Crombie (2009) suggests that it is due to independent directors not being aggressive enough in making the executive accountable. The publication of various reports in Britain, such as the Cadbury, Tyson and Higgs reports on the back of these failings, outline better corporate governance practices at the non-executive director level. This essay will critically explain the present day role of non-executive directors in a single tier board considering how independent they can be, as well as discussing how, over the past twenty years, their role has been developed to encapsulate a wider range of responsibilities and as Davies (2008) states, ‘It’s no longer a matter of turning up for the occasional lunch.’

The importance of respectable non-executive directors can be described as a necessity in modern day business. The role and responsibilities of the board is debated due to several global businesses collapsing because of corporate failings at the boardroom level. The Cadbury Report (1992) states that, “Boards of directors are responsible for the governance of their companies”, and with the volume of corporate governance failings leading to the collapse of big businesses, it is evident that there was need for the traditional non-executive director role changing.

The first issue to clarify in this essay is how a single-tier board structure works and what duties the board undertakes. Businesses have boards who are appointed to make decisions that will reap the best rewards for the company and shareholders. The Combined Code of 2003, suggests that the boards role is to,

“Provide entrepreneurial leadership of the company within a framework of prudent and effective controls which enables risk to be assessed and managed. The board should set the company’s strategic aims, ensure that the necessary financial and human resources are in place for the company to meet its objectives and review management performance. The board should set the company’s values and standards and ensure that its obligations to its shareholders and others are understood and met”.

The board is responsible for setting the companies objectives and goals, they consider the appropriate methods in how to achieve these objectives, and then monitor the progress of the company in achieving these aims. Although the role of the board rarely changes from company to company, in their existence and objective, boards can have different frameworks for how they function. A company can either have a two-tier or single/unitary board structure. Solomon, (2010) suggests that in countries that have been influenced by an Anglo-Saxon style of corporate governance the single-tier board framework is the convention, and therefore the norm for British companies..

“Within Europe, the United Kingdom is a prominent country with a single-tier board system, consisting of executive and non-executive directors; other countries such as Ireland take the same approach”.

In a single tier board, the personnel that make up the board of directors can be categorised into two main groups, executive directors and non-executive directors, with a subsidiary group of committees such as audit, remuneration, risk and nomination. Together the executive and non-executive directors make decisions concerning the welfare of the company as a single entity. There are advantages and disadvantages of a single-tier board framework. A single-tier board will have better communication between all the executives on the board, which will in turn allows a greater flow of information to be exchanged. Perhaps the greatest advantage a single-tier board has over a two-tier board is that everybody on a single-tier board is working towards the same goal as they are effectively ‘in the same team’. Although there are advantages for a single-tier board, this method of boardroom governance also has failings. The one-dimensional nature of a unitary boardroom can cause difficulties if there is conflict of interest, or an inability to make decisions as a unified group. This could lead to a decision being made over the top of some executives as the dispute does not have secondary forum to be debated or resolved in.

“There are two types of director, executive and non-executive. There is no legal distinction made between executive and non-executive directors – the difference is that non-executive directors do not get involved in the day-to-day running of the business.”

Executive directors differ from non-executive directors in their general involvement with the company. Executive directors are in charge of the day-to-day running of the business on a full time basis. They also are in charge of managing employees. Conversely non-executive directors are not involved in the general running of the business and work on a part time basis instead. Pass (2004), proposes that,

“Non-executives are appointed on a part-time basis and perform various duties including (in some cases) acting as the company’s chairperson. Non-executives are seen as the “guardians” of the corporate good and act as “buffers” between the executive directors and the company’s outside shareholders, i.e. they monitor executive actions and question executive decisions and are required to ensure that the company is acting in a “responsible” way and in the best interests of the shareholder and other stakeholders”. (Pass, p 53)

Treadwell (2006) suggests that under the traditional viewpoint non-executive directors would typically work ‘about fifteen days per year to the role’. As stated non-executive directors work on a part-time basis and in a single-tier board they work alongside executive directors but their role is palpably different from that of an executive director. The Tyson report (2003), specifies the role of the non-executive director and suggests that there are four main responsibilities:

• “Provide advice to and direction to a company’s management in the development and evaluation of its strategy.”
• “To monitor the company’s management, in strategy implementation and performance.”
• “To monitor the company’s legal and ethical performance.”
• “To monitor the veracity and adequacy of the financial and other company information provided to investors and other stakeholders.”

The explanation given in the Tyson Report suggests that the role of a non-executive director is to monitor, guide, and use their experience and influence to look after the interests of the shareholders and positively represent the company. Whereas there are numerous reports that have been published that describe and desire “best practice”, non-executive directors have not always adhered to the suggestions laid out. The first development concerning non-executive directors on single-tier boards that has been developed is that the ‘old boy’ image has changed to become more diverse over the recent decades. Previously there would be a near total bias in what the typical non-executive director traits would be and the characteristics they possessed.

“Research commissioned by the Financial Times recently showed that the typical non-executive director is a 58-year-old white male with a background in finance. Such individuals are of course estimable but boards need a much wider pool of knowledge and experience.”

The traditional non-executive director would practically exclusively be a white, middle to senior aged male from the elite class, who would sit on numerous boards collecting an extremely healthy wage for minimal work. Burgess (2009) suggests that,

“There is a long-standing and widespread perception that non-executive directors of UK companies are drawn from a cosy coterie of former company executives all known to each other and a small group of head-hunters.”

Twentyman (2008) describes it as the ‘old boy network’. The Chartered Institute of Personnel and Development (CIPD), states humorously that ‘the ownership of a hand tailor chalk suit is no longer a prerequisite to becoming a non-executive director’. Although there has been clear development, in that minorities can be seen to be in executive positions now, it has not massively changed in terms of percentages. The Tyson Report mentions although there has been improvement in terms of minority participation in non-executive director roles, there is still a bias.

“In the survey of companies completed for the Higgs Review, non-British nationals accounted for only 7% of NED positions, while British citizens from ethnic minority backgrounds accounted for only 1% of such positions. The survey also found that although about 30% of managers in the UK corporate sector are female, women hold only 6% of NED positions”. (Higgs Report in Tyson Report, p5)

Whilst there is still a bias the divide is being slowly closed and the traditional outlook is changing as more minorities are now employed in these high earning positions than there were twenty years ago. This is a societal and cultural development as minorities who would historically not be involved in these top level positions are now found in these roles.

“The best boards are composed of individuals with different skills, knowledge, information, power, and time to contribute. Given the diversity of expertise, information, and availability that is needed to understand and govern today’s complex businesses, it is unrealistic to expect an individual director to be knowledgeable and informed about all phases of business. Thus, in staffing most boards, it is best to think of individuals contributing different pieces to the total picture that it takes to create an effective board.” (Conger and Lawler, 2001)

Conger and Lawler advocate a varied board from an eclectic range of people contrary to the ‘old boy network’. Pass (2004) suggests that cynics believe that non-executive recruitment depends on their “acceptability” by other directors and whether or not they are simply ‘yes-men’ agreeing with the board decisions, as would happen under the ‘old boy network’. He calls this “Cronyism”. Having a broader range of people from different minorities brings a more rounded and deeper knowledge base to the boardroom environment, although it is a long way from being completely proportional the percentages listed above do indicate development and change. Burgess (2008) suggests that in spite of recent efforts to broaden the boardroom gene pool that this “old-boy” network still pervades. By indulging in having a more varied board, the potential for non-executive directors to challenge and monitor the board as opposed to ‘cronyism’ would serve the company better as the non-executive directors would challenge, not lie down and serve their purpose more effectively. Margaret Mead (1935) states that,

“If we are to achieve a richer culture, rich in contrasting values, we must recognize the whole gamut of human potentialities, and so weave a less arbitrary social fabric, one in which each diverse human gift will find a fitting place.” (Mead, Sex and temperament in three primitive societies)

The next major development concerned with boardroom corporate governance is the recommended splitting of power in the board. Prior to the Cadbury and Higgs reports being published it was not uncommon that an individual could occupy both the role of the chairman and chief executive officer, although it remains possible, the Cadbury report, advises that it is ‘best practice’ for the roles to be split. Owen (2011) suggests that this splitting of roles is one of the biggest changes in corporate governance in Britain. The main reason for the Cadbury and Higgs report recommending that the positions be split is because by allowing an individual to fill both positions this could potentially lead to an individual having ‘Unfettered’ control over the rest of the board and this could lead to the individual not being objective. This of course is a problem if an individual has too much uncontested power, firstly because of the lack of objectivity, secondly because other board members may be too frightened to approach such an almighty figure out of fear and in effect not fulfil their role. With two individuals in separate roles, or a two-tier board, the executives may find it easier to approach one or the other, and this highlights the principal problem of the unitary tier board. A notable example of this was the Enron scandal, when Kenneth Lay was both chief executive officer and chairperson of Enron. The company collapsed as a result of a massive fraud and corporate governance failings at the executive level were clearly visible because the non-executive directors failed to detect or to do anything about the fraudulent accounting activities that were taking place. Solomon states,

“Unfettered power in the hands of the Chief executive officer is an obvious problem and one that characterised Enron’s management. Separation of the chairman and the chief executive role is not common in the USA, although it is starting to change. This is a technique that is so successful in the UK as a means of improving the effectiveness of a company’s board of directors that its application in the USA would benefit American companies and particularly American shareholders!” (Solomon, p 37)

Enron had multiple failings at the non-executive level and is a good example to use to highlight the problems of having weak non-executive directors in a company and how the various reports have influenced development and change at this level. Firstly the non-executive directors failed to detect fraud in the auditing of the company accounts and/or did not whistle blow, to alert relevant authorities as to the fraudulent activities that were occurring. Secondly the chairperson of Enron’s audit committee was not objective as her husband was a US senator who received financial backing to support his political campaign. The Cadbury report states that non-executive directors should be independent and free from any relationship which could materially interfere with the exercise of judgement. The report was published before the Enron scandal, which highlights extremely poor corporate governance. Solomon (2010) states that these examples, as well as many others within the Enron charade, shows that people in these important positions should have detected unethical behaviour, but because of interests other than in their forefront duties that they were not independent and this ultimately led to failure. Perhaps most importantly in the Enron case the people who were in director level positions were simply crooks and of ‘poor moral character’. Solomon (2010) bluntly states that, “If the leadership is rotten, how can the rest of the company succeed in the long run?”, and makes the analogy between a ‘good and well-governed board and the human heart’, suggesting that for successful business the board must be ‘healthy, fit and carefully nurtures for the company to run effectively’.

The Higgs report (2003), attempted to address the ineffectiveness of non-executive directors in light of the corporate disasters such as Enron. This can be described as another recent development concerning non-executives in corporate governance. The Higgs report reappraised the need for non-executive directors to be independent, as well as stating that non-executive directors had to bring more than simply ‘experience’ to the table, they had to have the ability and integrity to ask tough questions and whistle blow.

“A major contribution of the non-executive director is to bring wider experience and a fresh perspective to the boardroom. Although they need to establish close relationships with the executives and be well-informed, all non-executive directors need to be independent of mind and willing and able to challenge, question, and speak up.” (Higgs, 9.1) in Tyson

As discussed, the downfall of Enron can be blamed on the lack of independent non-executive directors and is a good example to highlight the importance for non-executive director independence. If a non-executive director has vested interests it will be difficult for them to perform their function properly, for if they do not ‘challenge, question, and speak-up’ and protect their interests instead they are not fulfilling their role. The agency problem is apparent here as people act in a self-interested manner to promote their own well-being. The Higgs report suggests that a non-executive director can only be described as independent when ‘there are no relationships or circumstances which could affect or appear to affect the director’s judgement’. If a non-executive director is not objective and independent in their decision making then judgements will be made on the basis of self-interest, which is evidently not healthy on the basis of the volume of big businesses that have failed. Method of remuneration has been considered also as before non-executive directors could, as part of their payment, be given share options which could impair their independence and function. Twentyman (2010), suggests that,

“In many cases, a salary is topped up with a shareholding in the company. But this can be controversial. Some argue that the NED’s independence can be impaired by having a shareholding in a company.”

In conclusion, with the volume of high profile companies collapsing there was a need for a shake-up at the non-executive director level. The role has been developed in several ways, now non-executive directors in single-tier boards are being selected from a more diverse group of people, unfettered power in the hands of one person has been diminished with the recommendation of the splitting of the chairperson and chief executive officer roles and possibly the most important development is the need for non-executive directors to be independent in their role. With the level of remuneration that a non-executive director receives for their ‘part-time’ role it is not unreasonable to expect the volume of expectation and the suggested characteristics as highlighted in the Cadbury, Higgs and Tyson reports for non-executive directors to abide by. If companies adhere to the suggestions made in these reports, this should prevent massive corporate failings such as the Enron scandal occurring again.

References

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• Anonymous, (2006) The Wisdom of Promoting Diversity. The Financial times (January 6th 2006).

• Anonymous. (2009), ‘Short Supply could lead to big rewards’, Financial Times (4th March 2009).

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• Combined Code on Corporate Governance (2003) Financial Reporting Council, London, July.

• Conger, J.A and Lawler, E. (2001) ‘Building a high-performing board: how to choose the right members’, London Business School Business Strategy review, Vol 12.

• Crombie, S (2009), ‘Standard Life chief executive appointed shareholders’ champion on RBS board’, The Times (23rd May 2009).

• Davies, D. (2008); Corporate Governance, “Celebrating NEDs who keep their heads”, Director, Feb 2008, 61, 7; ABI/Inform Global P.33

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• Jungmann, C. (2006), “The Dualism of One and Two Tier Boards in Europe”. Bucerias Law School; Hamburg.

• McIntosh, L. (2009), ‘Standard Life chief executive appointed shareholders’ champion on RBS board’, The Times (23rd May 2009).

• Mead, M. (1935), “Sex and temperament in three primitive societies”, Harper Perennial: London.

• Owen, G. (2011), ‘A Very British Split at the Top, Financial Times’(March 14th 2011).

• Pass, C. (2006), “The revised Combined Code and corporate governance, An empirical survey of 50 large UK companies”, Managerial Law Vol. 48 No. 5, 2006 pp. 467-478.

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• Twentyman, J. (2008), “Corporate Governance, Celebrating NEDs who keep their heads”, Director, Feb 2008, 61, 7; ABI/Inform Global P.33.

• Tyson Report. (2003), “The Tyson Report on the Recruitment and Development of Non-Executive Directors, report commissioned by the department of Trade and Industry following the publication of the Higgs Review of the role and effectiveness of non-executive directors in January 2003”, London Business School, June.