Much has been written recently on the subject of boardroom effectiveness following the massive destruction in shareholder value both before and after the financial crisis, we provide a summary of the key points and examine creative ways to improve the effectiveness of company boards.
Improving effectiveness
Over the past 12-18 months, regulators across the world have been conducting reviews and passing additional legislation to reduce the potential for accounting manipulation and fraudulent behaviour by companies. Whilst certain penalties will reduce unacceptable behaviour, the nature of business is in taking calculated risks. Therefore it is essential that good practice takes precedence over a culture of over-regulation and mere box-ticking. As we observed with the downfall of Enron, companies can find ingenious methods to circumvent rigid rules to their advantage.
Good practice therefore implies a set of prescribed principles to which companies adhere. The quality and intensity of debate at board meetings must be enhanced and this is where independent directors must be more prominent. They should not rely exclusively on the information provided by the company and its advisors, but must look to independent advice to enhance the quality of questioning of the executive team, particularly during a major strategic or financing event.
We no longer require a board full of “Yes men”, but a board of individuals that will take a unified decision following intense discussion and debate. Saying “No” occasionally will be healthy and may also lead to improved decision making.
What makes a non-executive director effective?
There are three key functions of a non-executive director. Firstly, to provide guidance and strategic input to the management team using their experience and network, secondly to ensure that there are the systems in place to monitor the performance of the team and thirdly to strengthen the executive team in a timely manner.
In order to add value to the companies with which they are associated, non-executive directors must above all uphold the highest ethical standards of integrity and promote the best standards of corporate governance. They must support the executive directors in the execution of the agreed strategy of the business whilst monitoring their performance and remuneration on behalf of the outside shareholders. This is a critical role and a fine balance is required in order to maintain an open relationship between executive and non-executive directors.
Non-executive directors are typically appointed for their commercial experience in a given sector. Their main role must be to question intelligently and therefore to add substance to the boardroom debate. However, whilst being sensitive to the views of the other board members, they must challenge rigorously.
Finally, the non-executive director must gain the trust of fellow board members in order to be viewed as a key team player.
The debate on the Higgs Report in the UK
The report by the Higgs Committee in the UK on the effectiveness of non-executive directors was published in January 2003 following a six month period of consultation and analysis. The proposals are likely to be amended prior to inclusion into a revised Corporate Governance Code.
In order to avoid a rigid one-fits all system, Higgs proposed a “comply or explain” approach to governance. For such a system to be widely accepted in the business community, there has to be general compliance with the principles of the Corporate Governance Code and limited deviations. In particular, smaller companies with more limited resources have voiced concerns on the potential rigidity of the new proposals such as the limits on the years a non-executive director can serve one company. A box-ticking approach to corporate governance needs to be avoided, or else methods will be devised to circumvent the rules and regulations.
The appointment of a senior non-executive director with access to institutional investors is viewed by a large number of Company Chairmen as potentially devisive as they believe it will reduce their role and effectiveness. Many large UK companies already have a Deputy Chairman who can play the role of senior non-executive director. Providing shareholders with an additional channel of communication, especially when there are contentious issues, is a healthy development.
The non-executive or independent directors should constitute the majority of directors. The main issue relates to the cost and time involved in appointing the appropriate non-executives, particularly for the smaller companies. Clearly increasing the pool of quality non-executive directors with the necessary experience and training for their role is key and this should be supplemented by independent advice, particularly at times of major strategic change.
Higgs has made a recommendation that the Chairman of the Board should not chair the nominations committee. This is a direct attempt to reduce the power of the Chairman and has met with strong resistance and is unlikely to be included in the Corporate Governance Code.
The Higgs report has been generally welcomed as a way of improving the high standards of corporate governance in the UK. As discussed above, certain modifications will need to be made to obtain broader business approval.
Is Sarbanes-Oxley a role model?
Following the Enron and WorldCom scandals in 2001-2002, the US rapidly passed the Sarbanes-Oxley Act in July 2002. It remains unclear as to the exact ramifications particularly for international companies that are listed on US Exchanges.
The main focus on the Act is to strengthen the role of the audit committee, particularly through the appointment of experienced non-executive directors and the provision of truly independent advice. Auditors are no longer permitted to provide a range of financial advisory services for the Board and for the committees.
Chief Executive Officers and Chief Financial Officers are required to certify to the accuracy of the financial statements and all off balance sheet activities will need to be explained in the accounts.
With securities analysts playing an important role in reviewing and analysing the financial statements of companies, a clear separation is required between the analysts and the investment banking services that can be provided by their colleagues.
In contrast to the wider ranging Higgs Review, the Sarbanes-Oxley Act has been viewed as a rapid response to the major accounting issues associated with recent destruction in shareholder value in the US. It does not however address some of the more fundamental issues in US corporate governance including the potentially excessive powers vested in the combined Chairman and Chief Executive Officer and the overly prescriptive nature of the regulations which has led to a culture of complying with the letter rather to the spirit of corporate governance.
Conclusion
Clearly the vast majority of companies are well managed and comply with the high standards required of the governing bodies and regulations across both sides of the Atlantic. However, with the recent scandals and significant reductions in valuations of companies around the world in the last 2-3 years, improvement is required.
Non-executive directors must play a more influential role. They need to enhance the level of discussion and debate in the boardroom and on the board committees to pose the appropriate questions. They need to be supported by the company, but also by appropriate training and independent advice. Once this more rigorous debate has been completed, then a unified board can follow the agreed strategy. We no longer need “Yes men”, but non-executives that will be willing in certain circumstances to say “No”.
The views expressed in this newsletter are those of DC Dwek Corporate Finance Limited and are provided for information purposes only.
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