THE FINANCIAL TIMES ON THE CHANGING ROLE OF INDEPENDENT DIRECTORS:
CAN THE JOB EVER BE DONE PROPERLY?
Ever-higher expectations of the board
The role of non-executive directors has become much more demanding –
but there are limits to what they can achieve, says John Plender.
Published: April 25 2002 19:52 | Last Updated: April 25 2002 21:18
In the light of the Enron scandal, the humbling of Marconi and the travails of Equitable Life, what is it reasonable to expect of non-executive directors? Precious little, according to Lord Young of Graffham, outgoing president of Britain's Institute of Directors.
Lord Young, a former chairman of Cable and Wireless and a minister in Margaret Thatcher's cabinet, told the institute's annual convention this week that boards would be better off without non-executives. In effect, he rubbished the approach initiated by the Cadbury Committee in 1992, which emphasised the role of non-executive directors in reviewing performance and resolving conflicts of interest.
Lord Young's advocacy of something that looks suspiciously like the Japanese corporate governance model is clearly a non-starter. But he raises good questions in a week when Sir Roger Hurn was forced to resign as chairman of Prudential because of his involvement in Marconi, and Equitable Life announced it was to sue 15 former directors.
These events confirm that pressures on both executive and non-executive directors have never been greater. Global investors attach growing importance to good governance, including strong representation of independent non-executives in the boardroom. Expectations in the press are also high.
Paul Coombes, a director of McKinsey in London, says this reflects a global shift in board role models. The traditional role was to rubber- stamp management decisions in which the board was not heavily involved. Boards would then act as firefighters when confronting problems such as consistent poor performance by the chief executive.
The current trend, says Mr Coombes, is for boards to adopt a more active approach, being independent from management and challenging performance and strategy.
It is worth distinguishing here between the active financial housekeeping function, which involves monitoring conduct and conflicts of interest, and the broader tasks relating to perform- ance and strategy. Non- executives ought to be able to make a valuable contribution to housekeeping. But they are unlikely to do so if they are not independent.
At Enron their objectivity was impaired because they engaged in lucrative consultancy work for the company. So it was not wholly surprising that the investigation led by William Powers, dean at the University of Texas Law School, found that the audit and compliance committee of the Enron board had failed to examine adequately the nature and terms of the related party transactions whereby debts and losses were hidden in special purpose entities off the balance sheet.
There are nonetheless limits to what can be achieved in this area. When the UK government announced that investment banker Derek Higgs was to conduct a review of the non-executive director's role, some in the press felt he was tarnished because he sat on the board of Allied Irish Banks, where a rogue trader inflicted severe losses.
Yet to assume that a non-executive director could or should detect a well concealed fraud that has eluded the executive management and the auditors stretches expectations to the point of absurdity.
It is also clear that non- executives are unlikely to become an effective check and balance on boardroom pay any time soon. Too many are chief executives somewhere else and have no interest in restraining a gravy train from which they benefit.
The criticism now being levelled at Sir Roger Hurn and the Marconi board concerns delays in informing shareholders of a sharp deterioration in trading. But what wrecked the company comes under the "challenging" function of non- executives in relation to executive performance and business strategy.
Changing big companies is difficult. And there is a myth, says Mr Coombes, about the strategic decision-making responsibility of boards. They can approve or reject strategy and the non-executives can shape the debate and focus the attention of management in this area. "But people who attend only 15 days in the year should not define strategy. That's management's job," he says.
Where Marconi is concerned, the question is whether non-executives could have prevented executive directors making ill-judged takeovers when the board was under enormous pressure from the City to do deals. It would have been extraordinarily difficult.
The same point could equally be made of Imperial Chemical Industries, where the balance sheet was damaged, among other things, by the purchase of Unilever's speciality chemicals business and where Sir Roger Hurn was also a director along with Lord Simpson, the former Marconi chief executive
In the Anglo-American capital market model, takeovers have an important part to play in recycling capital to more productive uses. But there has been a collective failure to appreciate their capacity to destroy value as well as create it. Even after the phenomenal write-offs at AOL Time Warner, Vivendi and Marconi, it remains to be seen whether the message has truly sunk in with managers and institutional investors
Even if you believe it is inappropriate for non- executives to second-guess executive directors on the strategy behind a deal, it ought to be possible for them to argue powerfully against an acquisition on grounds of imprudent financing. That said, the perfect system of corporate governance has yet to be invented. So has the perfect non-executive director. And there can be few ordinary business people who would relish the job of sitting on the board of an insurance company such as Equitable and questioning the executives about the actuarial soundness of an insurance product.
If others follow Equitable in suing former directors, it will not improve governance or deter would-be non-executives. A more likely outcome is a rise in their pay, with directors' and officers' insurance becoming an obligatory part of the package.
After the recent stock market bubble, it is hardly surprising that some companies are now in trouble. In considering the regulatory response it will be important to remember that failure is as vital to the workings of capitalism as success.