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Home > Corporate Governance Best Practice > Identifying the Right Nonexecutive Director

Corporate Governance Best Practice

Identifying the Right Nonexecutive Director

by Terry Carroll

Executive Summary

  • In the past, some have seen NED posts as a sinecure.

  • Risk, diligence, and compliance factors may have changed this.

  • Companies and prospective NEDs need the role to be seen as more professional.

  • Remuneration for the right NED should reflect the increased “risk premium.”

  • NEDs should protect all stakeholders and apply sound corporate governance.

  • Independence is paramount.

  • Governance regulations and best practice continue to evolve.

  • Successive Companies Acts have growing impact and change demands.

  • The “right” NED needs wider skills and relevant business and sector experience.

  • A range of sources exists, but thorough evaluation and selection are required.

  • The quantity of candidates may reduce but the quality should increase.

Introduction

The “Credit Crunch” has thrown up many challenges and controversies. The extraordinary losses at Société Générale were reminiscent of the Barings debacle. The unaccountable losses suffered by many banks, especially in America, also beg serious questions about nonexecutive directors (NEDs). Never have times been tougher, or the challenges greater—and not just for banks but for all companies. Never has there been a clearer need for the right NEDs.

This article examines the challenges for all companies from a British perspective and suggests some key characteristics that are needed in the “right” NED. It also looks at wider aspects of the role, and where and how suitable candidates may be found.

Governance and More Governance

On March 22, 2007, Naguib Kheraj resigned as finance director 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.

In the past, some saw the role of NED as a sinecure. Now they may be rethinking that jaundiced view, as the toll of legislation, regulation, compliance, and the globalized economy increase the risk for those who occupy the role. There may still be some who approach the task altruistically, but, in general, to attract the best this increased risk should be reflected in higher remuneration.

Whether or not reward and recognition have been motivators in the past, the growing risk, diligence, and compliance factors may now be more important considerations in the mind of a prospective NED.

The Role of the NED

In its simplest terms, the NED is there to protect the interests of the owners of the business. But now, major considerations such as health and safety, derivatives, new legislation concerning companies and employment, and risk management have added immeasurably to the potential legal and practical consequences for a NED—and, correspondingly, to the risks. These are in addition to the economic and commercial challenges that may have been the greatest for years.

To the layperson, the remuneration a NED receives may seem generous. Often it is the FTSE100 companies that hit the headlines in this respect. Not far below this level, NED packages are much more modest, and, although the scale and complexity may not be as vast as for big companies, the weight of regulation and compliance is similar.

The 2003 Higgs Review1 drew on many of the strands of corporate governance that had been developing since the Cadbury Report in 1992.2 It 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, while being required to maintain their independence.

Two days a month is a reasonable expectation for a NED, whose day rate may be equal 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 information that, if ignored or overlooked, may land them in court, in two days per month?

Combined Code of Corporate Governance

Every company needs NEDs, but not all can afford them. The law is pretty much the same for most companies; governance and guidance vary little except for small companies and quoted companies. It would do no harm for more companies to embrace the standards of the Combined Code,3 whether or not they are required to. It would improve any company and is a useful starting point to guide any prospective NED.

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 at Odgers Ray & Berndtson

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

While NEDs are not responsible for, or engaged in, the day-to-day management, they are nevertheless subject to legal duties and responsibilities similar to those of the executives and are similarly liable for dismissal. Furthermore, it is also recommended that their remuneration should not be a significant proportion of their overall income.

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.

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