As long ago as 1973, the Watkinson Report concluded that shareholders “have the responsibility that extends beyond actual buying and selling of shares. They must exercise this responsibility more fully in the future and be provided by the Board with appropriate information on which they can form a judgement”. Clearly, the principal control that can be exercised by shareholders rests in the ability to appoint and remove Directors. It is in their interests to satisfy themselves that the Directors they elect collectively form a Board that understands both the nature and purpose of the Company as well as bring a balanced, authoritative approach to corporate governance.

It has long been considered the case, particularly where the Chief Executive also acts as Chairman, that Directors may be unable to perform in an objective manner since they effectively become the Chief Executive’s subordinates. Many studies, both in the UK and the USA, support this argument suggesting that Executive Directors act primarily as Managers, often following the thinking of the Chief Executive. The split between the duties of the Chairman and the Chief Executive are now being closely examined and it is often necessary (some would say essential) that the Chairman disentangle himself from day to day management.

General Motors has introduced new guidelines for the role and composition of its Board of Directors. Throughout the 1980’s, Roger Smith as Chairman and Chief Executive Officer headed GM. Ross Perot, the former US Presidential candidate and one time GM Board Member, described other members of the Board as “pet rocks” because of what he saw as their lack of involvement. In 1992 the Non-Executive Directors of General Motors forced the removal of the then Chairman and Chief Executive, Roger Stempel, and replaced him with John Smale in the role of Chairman - Smale had led the battle from his position as a Non-Executive Director. The power shift in GM has hailed a new era in corporate governance, with a majority of Non-Executives on the Board. The guidelines published by GM, however, do not resolve the argument between separating the roles of Chairman and Chief Executive, arguing that the Board should be free to exercise choice on this matter in the best interests of the Company. The GM guidelines do, however, require Non-Executive Directors to evaluate the performance of the CEO and this assessment is to be taken into account by the compensation committee in settling pay for the position.

Meanwhile, on this side of the Atlantic, the 1980’s produced a considerable increase in management buy-outs and these became very fashionable. Institutional investors are now looking to see the benefits of these investments, many of which have suffered badly during the recessionary years of the early 1990’s. Driving the company forward to optimise on the original investment has become an essential task. At the initial stages in the life cycle of an MBO, the investors will have made an appraisal of the management team, the project and the marketplace to determine the level and type of financing required. The downturn in the economy, with the contraction of domestic and international markets, has made it necessary to re-assess these factors. The optimism that led to growth in the 1980’s has been replaced by a flat realism that positive strategic direction is required to survive recession. Decisions on strategy have to be made carefully, with expectations realistically assessed and a tight system of controls implemented throughout the organisation in order to achieve them. “Management by Objectives”, a now disregarded euphemism, has been replaced with “Management to Survive”. These factors alone present an adequate case for the appointment of Non-Executive Directors capable of presenting an independent viewpoint during Board discussions.

So what then is the role of the NED in developing a spirit of true independence? The Companies Act of 1985 indicates that a “Director includes any person occupying the position of Director by whatever name called” and the legislation presently in place seeks to ensure an appropriate balance between the Directors and Shareholders. The Act imposed a number of statutory duties on Directors, together with other requirements, which have been established through Case Law.

There is no distinction between an Executive and Non Executive Director, who must, at all times, act as “a reasonably diligent person”.

Directors must prepare financial statements for each financial year that give a true and fair view of the state of affairs of the Company and its profit and loss for that period. In preparing these financial statements, the Directors are required to select suitable accounting policies and ensure that they are applied consistently, make judgements and estimates that are reasonable and prudent, state whether applicable accounting standards have been followed (subject to any material departures disclosed and explained in the financial statements) and prepare the financial statements on a going concern basis. The Directors are responsible for maintaining proper accounting records with reasonable accuracy, to disclose the financial position, and have a duty to safeguard the assets of the company, taking reasonable steps to prevent or detect fraud or other irregularities.

Whilst there is no legal code of conduct as such for NEDs, it is clear that any Director has specific fiduciary duties of honesty and diligence. Enter the Insolvency Act 1986, which imposed an even greater test of “a reasonably diligent person”. The major business collapses of recent years have highlighted the Insolvency Act, which places a range of statutory tasks upon Directors, with fines, disqualification and even imprisonment as a deterrent to bad practice. It is important to recognise that there is no distinction between Executive and Non-Executive Directors, since they are held equally responsible for acting in good faith and applying their duties as “a reasonably diligent person”.

As a result of the more stringent requirements of the current legislation, many organisations have implemented liability insurance schemes for Directors and Officers, but all Directors need to be aware of the punitive punishment that can be handed out in the event of malpractice.

It is therefore essential that the Non-Executive Director has full and timely access to relevant financial information and they must be able - indeed they should be encouraged - to communicate regularly with the Auditors. The independence of the Non-Executive Directors is, of course, enhanced by their active involvement in the audit and remuneration committees and other sub-components of the Board. Whilst the role of the NED is seen very much as one of corporate governance, it is reasonable to assume that they should be able to contribute effectively to the ongoing strategy of the business. They should be able to bring to bear unique skills, experience and contacts not necessarily held by the Executive Directors.

There are of course many arguments placed against Non-Executive Directors and it has been suggested that the theoretical benefits may be unlikely to be seen in practice. Certainly, in days gone by, a Non-Executive Director may well have been considered as little more than an interesting name on a letterhead and, as the Sunday Times once put it, “scarcely more than a tame pensioner, sometimes a lap dog contributing to the atmosphere of complacence and non-enquiry characteristics of many Board rooms.”

It is also implied that the Non-Executive Director may be bereft of the time to assimilate the nature of the business and its external environment. Likewise, where the Chairman or Chief Executive Officer has a particularly bullish and high profile style, it may be that the Non-Executive Director is unable to proffer anything more than a cursory nod of approval at Board meetings. The dangers of recruiting in the likeness of the Chief Executive’s own image are clear and there are numerous examples of where Non-Executive Directors failed to spot warning lights: delay or inaction has been mooted in celebrated cases such as BCCI and Maxwell.

There are estimates of between 7,000 and 8,000 directorships within UK listed companies at the present time; there is evidence of a clear development taking place in the spread of these appointments and they are becoming less regarded as a hobby for retired executives.

The important role of the Non-Executive Director, whereby he makes a positive contribution to the business, is becoming subject to more serious consideration. The analysis of the experience and background of potential Non-Executives has moved away from informal talks with acquaintances, to a detailed assessment of the contribution that can be made in Boardroom discussions.

The metamorphosis of the role of NEDs has been apparent in the USA and, in the case of GM and several other cases, the spirit of independence became the focus for stimulating significant Boardroom oustings.

The selection and appointment of Non-Executive Directors underlines a critical phase in the implementation of proper and authoritative corporate governance. It is essential that the best available candidates be considered. There are a number of lists of executives available to undertake Non-Executive duties, and these are certainly worthy of consideration.

It has been suggested that a Non-Executive Directorship may be considered as part of the career development for a new generation of executives who have no direct Board Room experience - indeed, where an Executive has particular skills, an NED appointment with another organisation may bring benefits to both sides. Each appointment must be considered on individual and corporate circumstances.

Executive Search is a particularly effective way of identifying Non-Executive Directors. It is even suggested that senior executives who hold themselves out for Non-Executive appointments are effectively taking corporate governance in a backward direction.

The demand for true independence and positive contributions make it essential to target specific individuals. There are clearly instances where the Board will require a precise executive input, be it in the form of engineering excellence, specific marketing knowledge and so on. Executive Search enables the Board to zero in on individuals who are able to offer particular expertise.

Executive Search - more prosaically referred to as Headhunting in the parlance of today - has its origins in the post Second World War management shortages in the USA.

At one time, Search was regarded with suspicion in the UK, being seen as a form of industrial subterfuge and even a means of obtaining commercial secrets by deceit.

The scepticism surrounding Search work has rightly diminished as practitioners have demonstrated both integrity and professionalism. Search Consultancies are regulated in accordance with an Act of Parliament, which lays down minimum standards and requirements.

There are many thousands of Recruitment Consultancies in the UK (one report suggested there was one for every 7,000 people in the country) and nearly all probably claim to be Headhunters. In practice, though, there are only a handful of organisations that are pure Search firms. These organisations work within the framework of a professional code of ethics and it is important that the client organisation satisfies itself as to the professional competence and integrity of the consultancy.

Executive Search has become an established medium for senior executive recruitment and the majority of top posts are filled in this way. Search Consultants have a unique range of contacts at a senior level and are therefore particularly appropriate for sourcing Non-Executive Directors.

Consultants will undertake a full review of the requirements including any specific areas of interest beyond the now accepted areas of corporate governance. In targeting potential NEDs, the Search Consultant is able to adopt an independent approach and target the best available and appropriately qualified candidates.

The selection of the NED is therefore undertaken in a structured manner and the traditional form of the Chairman appointing old school chums over a gin and tonic at the Club is assigned to the realms of television soap operas.

On deciding to use a Search Consultancy it is essential to involve them at the earliest possible stage. They will, moreover, be in a position to offer constructive advice on the type of candidate to be approached and the remuneration level for the appointment. The Consultant will also be able to offer a realistic assessment of the time scale involved in producing a shortlist of potential NEDs.

Fees for Executive Search assignments vary depending upon the complexity of the appointment, but the cost of a bad appointment - worse still none at all - can be catastrophic, particularly where shareholders are seeking the commitment of the Board to progressive and responsible practices.

The significant demand for NEDs and the formality and discipline they bring to the Boardroom makes Executive Search an especially relevant facility for the selection of suitably researched candidates, and effectively ensures that the pool of potential NEDs is broadened.

Jackson Taylor Executive Search
London - 0207 828 9003
Darlington - 01325 363000

‘Labour can do nothing without capital, capital can do nothing without labour, and neither labour nor capital can do anything without the guiding genius of management.’

MacKenzie King 1917