The role of the non-executive director

needed to make about an investment. The discussion had gone on for two hours when the former Chief Executive made his first contribution to the meeting by shouting loudly across the boardroom table at the young Chief Executive: ‘Good God, sonny, it’s ing obvious, just do it.’ After the meeting the Chairman had a quiet word with the new NED and this turned out to be his first and last board meeting, as he had clearly crossed the line between being an executive and a non-executive director.

Challenge and support

The essence of effectiveness of an NED comes from skilful challenge which stimulates action by executives and forces them to reflect on their future actions. Such challenge should set standards for executive performance and conduct. For example, when executive directors are preparing investment proposals to the board, they are more likely to be of a higher quality if they know they are going to be skilfully challenged by the NEDs. Effective challenge by NEDs has to be seen by the executive directors to be well informed, and needs to be motivated by a concern to enhance executive performance and not to promote the NEDs’ egos.

Independence and involvement

NEDs’ independence is viewed by executives as their having the ability, as outsiders, to see things differently: an independence of mind that allows NEDs to challenge executive thinking on the basis of their external experience. This independence offsets the potential capture of NEDs’ thinking by executives. Boards never function optimally when everyone thinks along similar lines. Independence should encourage greater openness which should lead to the full use of NED experience and judgement.

Barriers to NED effectiveness

Research undertaken for the Higgs Report identified two major barriers to NED effectiveness. These were that 25 per cent of NEDs believed the main barrier to their effectiveness was their own lack of time or commitment to the company; and that a lack of knowledge or understanding of the company was cited by 10 per cent of NEDs and 19 per cent of executive directors as a barrier to effectiveness.

This first point leads to two very important questions for NEDs and companies. How much time does it take to be an effective NED? Is it worth it?

The 2006 Independent Chairman and Non-Executive Director Survey from Independent Remuneration Solutions (IRS) sheds some interesting light on these questions as shown in Table 3.1. IRS estimates that the amount of time NEDs are spending on their duties has increased by approximately 20 per cent since the publication of the Higgs Report in 2003. Typically for an NED, the

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Table 3.1 The number of days spent by non-executive directors at company meetings

Source: IRS, ‘Independent Chairman and Non-executive Director Survey’, 2006.

time commitment can be estimated as two days per month, broken down into one meeting per month plus one day’s preparation. Chairmanship or membership of board committees or attending strategy development sessions would be additional.

The amount of time depends on a number of circumstances. Cranfield research has shown that an executive director becomes ineffective as an NED if, in addition to executive duties, he also has more than two NED appointments. The general rule of thumb is that if you are a full-time NED then five, possibly six, appointments are doable. However, this is based on the assumption that the companies are all performing satisfactorily. If one or more of the companies gets into difficulty, then management of the NED’s personal diary becomes an issue. Numerous directors in this situation suddenly find the need to cancel holidays. There are significant pitfalls if you do not devote sufficient time to the role of an NED as the following example shows.

One NED, who had many such appointments, frequently read the board papers during the journey to the meeting. On one particular day he caught an early train for a board meeting and during the journey felt he had familiarised himself with the papers. The first item on the agenda was a review of the previous month’s performance. The NED challenged the Finance Director about an aspect of the company’s performance. The FD appeared to have difficulty answering the NED’s questions. The more the FD was unable to respond the more intense became the questioning from the NED. The atmosphere was becoming distinctly uncomfortable until another NED, who was sitting next to the assertive questioner, leaned across him, looked at his board papers and said: ‘It would appear that you have the board papers for another company.’ In his haste to catch his train, the NED had picked up the papers for his next board meeting, two days hence. Needless to say, he contributed

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The role of the non-executive director

Table 3.2 The remuneration of NEDs in relation to size of company

Company sales £M

P= Private company, Q = Quoted company.

Source: IRS, ‘Independent Chairman and Non-executive Director Survey’, 2006.

little to the remainder of the meeting and had to work very hard to regain his credibility.

Is it worth being an NED? The simple answer is that in purely financial terms it almost certainly is not worth it. Table 3.2, again taken from the IRS 2006 Survey, shows the remuneration of NEDs in relation to size of company sales. In the quoted company sector, NED fees have increased significantly in recent years to attract the increased number of independent NEDs required by the Higgs Report recommendations, and to compensate for the greater risks associated with the position. In the unlisted sector, remuneration is lower, with the equivalent of £1000 per day being a good rate for the job. However, IRS believes that the rate of increase in NED fees in private companies has been catching up with that of quoted companies, reflecting the growing awareness of the importance and responsibilities of the role.

It is still a reasonable conclusion that the financial rewards for NEDs do not match the risks and liabilities associated with the position.

The second barrier to effectiveness, concerning an NED’s lack of knowledge or understanding of the company, highlights one of the problems of being an NED: the potential for a difficult relationship with the executive directors. Cranfield research has shown that executive directors dislike professional NEDs.

A significant, and probably most important, part of the Chairman’s role is to ensure effective functioning of the whole board. In many cases the linkage between the executive and non-executive directors is at best weak or even nonexistent. Executives feel that NEDs do not have the same commitment to the company as they do and consequently that they are not objective. In many cases, executives believe that they run the business while NEDs are responsible for all the corporate governance ‘stuff’ which the executives perceive as a hindrance to effective management.

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The senior independent director (SID)

The role of the senior independent director was first proposed in the Hampel Report in 1998 and its value was reiterated in the Higgs Report to the extent that it is now enshrined in the Combined Code. Prior to the Hampel Report, there had been a number of situations where boards had been in dispute and one of the NEDs had taken the initiative to work with the members of the board to resolve the conflict.

A good example of this was Sir Peter Middleton at United Utilities during 1997 when a serious dispute over executive remuneration arose, not only in the board but also between the board and the institutional investors. Sir Peter worked diligently, mainly behind the scenes, to resolve the dispute. This prompted a number of institutional investors to lobby the Hampel committee to propose the role of the SID. Previously the duties of the SID may have been carried out by the Deputy Chairman but the institutional investors wished to have a role which carried greater independence. So what is the role?

In simple terms, it is an alternative to the Chairman, particularly where there is a possibility of the Chairman’s thinking being captured by the executive directors, thus potentially compromising the effective working of the board. The SID should be available to shareholders, if they are concerned that they cannot resolve issues through the normal channels of contact with the Chairman or Chief Executive. Additionally, the SID should chair meetings of non-executive directors when the Chairman does not attend.

NEDs and board committees

A significant time commitment for NEDs is membership of the principal board committees – nomination, remuneration and audit. Nearly all companies in the FTSE 350 have these committees and they are growing in number outside that sector. Similarly, private companies, especially those which are private equity or venture capital backed, are introducing audit and remuneration committees.

Both remuneration and audit committees have had increased scrutiny in recent years: remuneration committees because of the media’s fixation with the ‘fat cat’ syndrome and audit committees because of their responsibility for the accuracy of the company’s annual report and accounts. Greater scrutiny of audit committees has been created by the Sarbanes-Oxley Act, which led to much greater oversight of published accounts.

The Smith Report into audit committees, which was released at the same time as the Higgs Report, states that the audit committee should consist of at least three independent NEDs, one of whom should have significant, recent and relevant financial experience. These requirements, together with the greater scrutiny caused by Sarbanes-Oxley, have affected the willingness of NEDs to serve on audit committees. In the Ernst & Young Corporate Governance Survey published in January 2005, two-thirds of NEDs stated that they were less likely

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