Ken Rushton

responsibility for decisions. Although that might be the legal position, investors and the media will point the finger at the audit committee when there is any whiff of a financial scandal. So the committee chairman needs to be resilient and unlikely to buckle in the face of criticism. It is surprising that it is not more difficult to find non-executive directors who are willing to take up the position. When the day comes when a chairman of an audit committee is sued by investors we may find this position changes.

Similarly, the chairman of the remuneration committee must be able to manage investor reaction when it is necessary to gain acceptance for a controversial incentive scheme. The committee chairman also needs to be able to defend the pay packages of his executive colleagues. Sometimes, he will be required to support the Chairman in facing down the excessive pay demands of a greedy Chief Executive. It is not surprising that the senior independent director often chairs the remuneration committee. The decision of the Financial Reporting Council to amend the Combined Code and allow the Chairman to be a member of the remuneration committee was welcomed by Chairmen. It recognises the reality that Chairmen are highly influential in determining the pay and conditions of board members, and particularly those of the Chief Executive. The Chairman is also a key player in appraising the performance of his board colleagues.

Using board committees effectively

Chairmen seem generally content with the existing structures of board committees and believe that the appropriate issues are being considered. They appreciate that service on these committees requires a greater commitment on the part of the non-executive directors. However, such committee work is seen as a positive way in which non-executive directors can add value.

A number of Chairmen seem to attend meetings of the audit committee, which have become an increasingly important part of the board’s programme. If the company is in an industry which is highly regulated, the audit committee meeting may be nearly as important as the board meeting and can last even longer. It is unrealistic to expect the audit committee to be a guarantee against fraud or other financial irregularity, although this appears to be the expectation of some investors. Where there is a fraud or financial scandal, it is often the audit committee that is called upon to supervise an investigation. This places a heavy burden on part-time non-executive directors, and Chairmen I spoke to who had experienced such investigations were not always complimentary about the contribution of their audit committees. Also such responsibilities confirm to management that non-executive directors are expected to behave more like policemen.

One Chairman told me how he was able to energise his benign audit committee by bringing in a new committee chairman who was an experienced Chief Financial Officer. The committee chairman set about rebuilding the internal audit team, visiting sites and talking to management. He upset a number

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The role of the Chairman

of managers by the many procedural changes that quickly resulted from his appointment. The Chairman considered it was his job to encourage his audit committee chairman while reassuring the management that the changes made were in the best interests of the company.

Another Chairman, who was concerned about the unrealistic expectations investors had of his audit committee, said the blame for failure should lie with management unless the audit committee had failed to ask for proper information or had not asked the right questions.

Although a good deal of attention has focused on audit committees, some Chairmen consider it is the remuneration committee where the non-executive director can make the most valuable contribution. There have been too many examples of Chief Executives being able to negotiate excessive pay and incentives. Sometimes the excesses are tucked away in pension benefits but investors are getting wise to this tactic. A Chairman should look to the remuneration committee for support in striking a fair bargain with the Chief Executive. Should the Chief Executive fail and be asked to leave, the world will be looking to see what severance terms are agreed and whether the Chief Executive is required to mitigate any compensation for loss of office. Payment for failure will always be a hot topic but the board’s main concern will be to remove a failed Chief Executive as quickly as possible even if to do so means reaching agreement on departure terms that appear to be generous. There is a tension between treating a failed Chief Executive decently while making sure he is replaced speedily. The handling of such a situation requires effective teamwork on the part of the Chairman, the chairman of the remuneration committee and the senior independent director, where he is not also the chairman of the remuneration committee.

Most remuneration committees take advice from specialist consultants whose contribution is particularly valuable for the design of complex incentive schemes. The Chairman, however, will want to be sure that the committee’s recommendations for board and top management remuneration are consistent with the needs of the business and not just competitive with the company’s peer group. This is an area where experience matters and I expect that service on a remuneration committee will become an increasingly attractive selling point for non-executive directors.

Protecting the unitary board

When the Cadbury Committee reported, it stressed that the unitary board was a strength of the UK corporate governance system. The Committee did not wish to see its proposals for creating board committees and additional responsibilities for non-executive directors as undermining the unitary board. Successive revisions to the Code have reinforced the monitoring role of board committees and non-executive directors adding to the threats to the coherence of the unitary board.

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Ken Rushton

Most Chairmen see it as part of their responsibility for managing an effective board to protect the integrity of the unitary board. Some feel this fight is being lost. One said:

I think we are almost creating a two-tier complex within our unitary board for which we used to pride ourselves, but now we have snoopers, patrollers and policemen, with the non-executive directors spending far too much time being policemen, and insufficient time being concerned with the strategic direction of the company. We also now have a fragmentation of the nonexecutive directors with the senior independent director spying on the nonexecutive Chairman and being entrusted to deal with the shareholder.

In the same discussion, another Chairman expressed what I believe is the more popular view:

it seems to me that the main job of the Chairman is to get the board working as a team . . . I have seen situations where board committees have really gone off on their own, doing something that the rest of the board doesn’t approve of because of slavish adherence to the rules rather than using their common sense. I think it’s the Chairman’s job to get everyone to understand that, while the Code has to be followed, at the same time we have to run the company. That is what we are accountable for and a lot depends on using our common sense.

If anything similar to Sarbanes-Oxley legislation were to be enacted in the UK, I believe the unitary board could be seriously threatened. One Chairman, who is also a director of a US company, told me that, following Sarbanes-Oxley, US board meetings had doubled in length and most of the meeting was attended by the company’s legal advisers. That part of the meeting he regarded as being more of a box-ticking exercise. In a UK context, we would expect most of this compliance-driven business to be delegated to board committees but we could reach a point where the business of the committees became more onerous and more time consuming than that of the board.

Another Chairman, while confirming that it is his responsibility to protect the unitary board, did not feel that board committees threatened its coherence. He regarded the committees as looking after governance and, in any case, they report to the board. In practice, he said, the board did not generally have to review what was being done in the committees, and executive directors were encouraged to attend the audit committee when the quarterly results were being considered.

A further threat to the unitary board could come from shareholders seeking to exercise their rights to nominate their own directors. Chairmen run their boards as collegiate teams and this would become more difficult if the board itself had not chosen the team. UK Chairmen will be monitoring developments in the US in this area.

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The role of the Chairman

Creating a climate of trust

I found it reassuring in my conversations with Chairmen that they put great emphasis on their responsibility for ensuring that board relationships are built on trust. For them, personally, a trusting relationship with their Chief Executives is essential. Equally important is the need for the non-executive directors, collectively, to trust the executive directors and the management. Unfortunately, there are examples where trust breaks down when matters go badly wrong in a company. The Chairman needs to pick up the early warning signals by using his antennae and then nip the problem in the bud. To my mind, breakdowns in trust in companies are not usually the result of any betrayal but are more often caused by poor communications. One Chairman who had experience of such a breakdown on his board gave me a copy of a speech he read to his executive and non-executive directors in two groups. He was not sure that it had been effective but I believe it is worth quoting from extensively: ‘An exemplary board’, he wrote, ‘is one which is a robust, social grouping of individuals which is capable of challenging one another’s conclusions through open communications in an atmosphere of respect, trust and candour.’

This captures the spirit of the board as a collegiate team.

He goes on: ‘You have to guard against your executive directors interpreting the governance guidance as “management is not to be trusted” or “the board’s responsibility is to police management on behalf of the shareholders”. If this is communicated to a management team from the behaviour of the Chairman . . .

then you destroy all hope of a unitary board.’

Although Chairmen feel they need to be aware of any sign of a lack of integrity amongst management, there are more subtle ways of picking up such signs than behaving like policemen. The encouragement of whistle-blowing procedures is a positive feature now introduced into most large organisations.

The Chairman, in his speech, then identified problems that can arise for a Chairman. For example:

where his predecessor dominated the board and there was an unwillingness to dissent from his view

where the Chief Executive does not trust the board enough to share information

where a whistle-blowing report is suppressed

where management is nervous about communicating ‘near misses’ in safety reports

where non-executive directors develop individual lines of communication to management because they receive insufficient or unreliable information or have their own agendas

where ‘political’ factions develop on the board.

This is a good list of signals of a breakdown in trust, many of which have poor or ineffective communications as their source. Many can be resolved by

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