The non-executive director and corporate governance

Non-executive director and corporate governance

Last December, Director magazine asked whether non-executive directors were too slow to act when crisis loomed in the banking sector. Here five experienced NEDs outline how their role should work and comment on the robustness of the relationship between non-executive directors and corporate governance in the UK

Sir Andrew Likierman
Professor, London Business School

Good non-executives are defined by what they achieve, not who they are. They will make an impact based on clear objectives, through the quality of their contributions and in their influence on decisions.

The question of what relevant skills and qualities they need to bring will depend on context. So, for example, “understanding of risk” is essential whether it is a multinational bank or a small local retailer. But the bank non-executive needs to understand the implications of Value at Risk in depth. For the local retailer it may be about which customers should be offered credit.

Knowledge of the impact of International Financial Reporting Standards is essential for banks, an eagle eye on cashflow for the local retailer. It could be that skills are best found in those who already have experience in an industry. The learning curve is less steep and experience helps to put discussion of issues in a familiar context. But such people may also lack the breadth of vision to be able to question long-held assumptions when strategy is discussed. And a board entirely comprised of industry insiders could fail to grasp the full context. What matters is the balance of skills and experience in the board as a whole.

The Higgs Report [on corporate governance] suggested that non-executives “…should be sound in judgement and have an inquiring mind. They should question intelligently, debate constructively, challenge rigorously and decide dispassionately. And they should listen sensitively to the views of others, inside and outside the board.” What’s needed to exercise that sound judgement has changed, and each company will need to look more rigorously at whether board members, individually and as a group, are able to do so.

Brian Count
Chairman, Ceres Power Holdings

Recent economic issues have put the spotlight on the performance of both executives and non-executives. At board level there has to be accountability of how business performs, and it is important that in the turmoil that exists we do not forget to reflect on how things happened and what lessons can be learned. There are three issues that need attention.

First, boards (and non executive directors) must spend more time understanding the risks in the business and need to be clear on what risk appetite the board is prepared to sanction to the chief executive and executives.

Second, incentive plans must be simpler, more transparent and reflect sustainable success. Remuneration committees need to be more resilient and take hard decisions to avoid rewarding failure, or mediocrity. If that does not happen it is likely that politicians will legislate and that would not be the optimum outcome. It is important to reward success and attract the best talent, but there is no doubt that if failure has been rewarded this has to be seriously addressed.

Finally, in terms of rewards for non executive directors the concept has been that the best form of independence is not to link remuneration to company performance. I am not convinced this is necessarily the case. It is interesting that private equity seeks to incentivise directors over performance whereas public equity companies look to break that link for NEDs but not executives.

Understanding the business and its risks are vital. This means a need for non-executive directors with relevant experience. Put in sustainable targets that are fair and pass the public perception test and align the whole board to successful performance. This is not solved by regulation but by getting the best talent on the boards, with skills relevant to the business.

Gren Folwell
A senior non executive directors at IT services provider SSP Holdings

I was a main board member at Halifax for 12 years before I retired in 2000. Our practice in accordance with good governance was not to permit retiring executive board members to become non executive directors and, specifically, not for the CEO to become chairman. The argument was independence, but there was also a feeling that the new CEO should not feel constrained by the old regime.

These guiding principles don’t always take into account the particular circumstances. For example, in a period of 12 months Halifax replaced its chairman, CEO and deputy CEO. The new CEO was promoted internally and subsequent non-executive director appointments had stature but also were largely from retail rather than banking backgrounds. With the benefit of hindsight, I am sure that it would have been wiser to retain some of the experience and background of retiring executive directors.

My experience in smaller firms is that there is an understanding that good corporate governance does ultimately reflect on the value of the company. The owners/VCs are often looking for a three-year exit strategy, and whether this is achieved through an AIM listing or a trade buyer it will be necessary to demonstrate a well documented trading history.

In the credit crunch environment, cash is king and the board’s primary focus is on its “going concern” responsibilities as sales slide and the banks are reluctant to renew, let alone increase, banking and overdraft facilities. In these circumstances, the company’s auditors and stockbrokers seek additional comfort that the board is in control of its business risks, and it is vital that the board understands the key drivers and covenants. For those companies without good business systems and controls, I suspect the game is already up.

Jim Leng
A KBC NED of the Year and board member at Corus, Tata Steel and Alstom

Because of recent events and circumstances, the role of non-executive directors has grown appreciably. I don’t entirely share the view increasingly held that more powerful non-executives are needed to keep a check on executives, but certainly the role they play will be that much more important and assertive. Like all appointments, it’s always the quality of the individual that counts.

In my view, non-executives shouldn’t tinker with details. They should ask obvious questions, and not be concerned with putting their foot in it. NEDs should put being respected above being liked and always give assistance in wanting to support the company to be more successful in the long term. These are the issues that should be in the front of the mind for a non-executive.

The context for this discussion is that non executive directors should fly higher than ground level and at an appropriate altitude to be able to see the bigger picture and ask the obvious questions. For example, in banking, how can you borrow money short term in the wholesale market (for six to 12 months) and lend it long term (for up to 25 years) for mortgages?

Surely there is something wrong when chairmen of banks (as was displayed in their evidence to the Treasury select committee) cannot understand or indeed explain some of the products they were selling. Surely the question here for the non executive directors was that if it was too complicated to explain, as it probably was, then it was not a business to get involved in. It is also important that the board encourages a culture where asking the simple questions will be accepted as good common sense.

Professor Janette Rutterford
The Open University Business School

“It’s difficult being a non-executive director of a company which makes products or provides services in a different sector from your own. I’ve been a non-executive director of a chemical company, and I’m not a chemist. But our board was made up of people with varying skills, and my job—as I saw it—was to ask awkward questions about financial issues. For example, about loss-making subsidiaries or investment plans and to chair the audit committee making sure we carried out an appropriate risk audit.

It’s more difficult still to be a bank non-executive director, especially with executive directors focused on shareholder value performance metrics. But one can still ask awkward questions such as ‘Do the executive directors fully understand the products they are investing in?’
When I gave a lecture to British bank and building society CEOs a few years ago at a seminar entitled “Banking in the twenty first century” I was horrified to find out that my audience did not understand what derivatives really were. They preferred to concentrate on strategy, return on equity, and remuneration policy, leaving it to subordinates to deal with such ‘technicalities’.

Does the risk audit consider risk in a holistic way? What kind of economic scenario planning does the bank carry out, or are risks all compartmentalised? Do executives just tick the risk boxes rather than consider what will happen if (a) more than one bank suffers at the same time or (b) more than one customer experiences problems?

Regulatory systems such as Basel II allowed banks to use their own models to quantify risk. Barclays, for example, uses more than 200 different models. But stress testing these models individually doesn’t give an indication of overall downside risk. There are many historical examples in financial services of misunderstanding ‘systemic risk’ or ‘contagion risk’.

Part of the problem is that it is easy for a board to concentrate on process rather than rethink well-oiled procedures. It doesn’t really matter where NEDs come from, so long as they have a questioning mind and are able to think outside the box.

May 2009 : Director Magazine

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