The Role of the Non Executive Director

Source: Stock Market Digital

Date :29/05/2007 11:34:53

Terry Carroll discusses independence, risk and reward and evolution in the role of the NED

On 22 March 2007, Naquib Kheraj resigned as FD of Barclays, quoted by Accountancy Age as being “sick of compliance”. As an Executive Director he was required to understand the same governance and regulatory matters as a NED. The role of NED is no sinecure, as the toll of legislation, regulation and compliance increases the risk premium for those who occupy the role. Whether or not reward and recognition have been motivators for NEDs in the past, the growing risk, diligence and compliance factors may now be pulling the other way.

By Terry Carroll

In the simplest terms, the NED is there to protect the interests of the owners of the business. But now, major considerations such as health & safety, derivatives, new companies and employment legislation and risk management have added immeasurably to the legal and practical consequences for the NED - and risks.

To the lay person NED remuneration may seem generous. Often it is the FTSE100 companies that hit the headlines. Not far below this level, NED packages are much more modest and while scale and complexity may not be as vast as for big companies, the weight of regulation and compliance remains the same.

The Higgs report created a wholesome debate about the composition and responsibilities of the Board. NEDs are now expected to play a more active role in the corporation, whilst being required to maintain their independence.

Two days a month is a reasonable expectation for a NED whose day rate may be equated to that of a management consultant. But how can any diligent person be expected to perform their board and committee duties, spend time in the company and keep up to date with the information that may land them in court in two days a month?

Risk and reward

“For some, the burden of being a NED in a public company is too onerous in terms of time and the potential financial or reputational risk. A point of inflexion is reached when good candidates say ‘no thanks’. In this increasingly litigious world, NEDs should be adequately rewarded for their effort in proportion to the risks they run” (Virginia Bottomley, Head of Practice for Odgers, Ray & Berndtson). So will we see the emergence of the ‘professional’ NED? A growing number are striking a balance between number of appointments and diligence. Enlightened companies encourage executive directors to accept NED appointments elsewhere to widen their perspective and personal development.

As the demands and the potential exposure grow, so there is a commensurate increase in the risk factor. Ignorance or incompetence are no excuse; insurance and indemnity only go so far. Remuneration should increase to recognise the risk factor and reward the professional.

Whilst NEDs are not responsible for, nor engaged in, the day to day management, they are nevertheless subject to similar legal duties and responsibilities as the executives and similarly liable for dismissal. Furthermore, it is also recommended that their remuneration should not be a significant proportion of their overall income.

Evolution of the role

According to Higgs, NEDs should:

• contribute to and constructively challenge development of company strategy;

• scrutinise management performance;

• satisfy themselves that financial information is accurate and ensure that robust risk management is in place;

• meet at least once a year without the chairman or executive directors;

• be prepared to attend AGMs and discuss issues relating to their roles; and

• have a greater exposure to major shareholders.

If only it was that simple. And according to Higgs, 60 percent of NEDs are recruited without a formal process.

NEDs are, however, increasingly being sourced through search & selection. Since Higgs, diversity has been a more significant factor. Many would-be NEDs may prefer to go into private companies, where there are fewer governance requirements and financial rewards can still be attractive. Also, government and public bodies have opened themselves to advertised selection but fees are much lower or even zero.

Executive secondment and private companies are a good proving ground. There is still, however, an apparent shortage of suitably qualified NED candidates.

Once recruited, the best boards will provide a formal induction and ongoing training programme, whatever the degree of experience. Key aspects would include strategy, governance and regulation, and of course the company itself, its key people, products and services.

This still leaves the onus on the individual: to keep up to date and prepare diligently. Some have the view that up to 30 days a year would be required.

Key issues

According to Ernst & Young’s annual survey in 2006, NEDs now spend up to 40 percent of their time on governance. The matters that most preoccupy them are:

• Understanding a new sector

• Audit & finance

• Overseas knowledge

• Technology & security

• Remuneration policy

• Reputational risk

Furthermore a MORI poll cited in the same survey suggested that people were less likely to accept a NED appointment and much less likely Chair of the Audit Committee than a year before.

Independence

Best practice and regulation dictate the need for independence. It’s not just about individual thinking, because teamwork between the NEDs and with the Executive is highly desirable. Share options as incentives are, however, actively discouraged for quoted companies and performance related rewards should be geared to the share price rather than profits or sales.

The NED is required to judge and act in the best interests of the shareholders yet ironically this starts by having the company’s best interests at heart. Those who seek personal reward or recognition as the result of their NED participation may not instinctively make impartial judgement where the company’s interests should prevail.

Above all, integrity, teamwork and trust across the board are paramount. Consensus is ideal, with a vote hardly ever needed. Consequently, the foregoing matter most of all in the selection of Chairman of the Board or Audit Committee.

Still interested?

The growth of governance may drive some prospective NEDs away. If Kheraj found life too onerous as an executive director, what price the many prospective NEDs? Others, increasingly professional, may be drawn by the challenge, complexity and variety, together with the intellectual and increasingly appropriate financial reward for a job diligently and well done.

Terry Carroll was Treasurer of Halifax Building Society and later Finance Director and Acting Chief Executive of National & Provincial Building Society (now part of Abbey plc). He has been chief executive or finance director of a number of unquoted service businesses and has undertaken a range of other interim management and consultancy assignments. He is the author of The Role of the Finance Director and The Risk Factor and is currently Finance Director of Eatonfield Group