Introduction
Since the start of 1980s there has been a significant growth in importance of corporate governance. The drive for better corporate governance came from numerous high profile company collapses with the one of the most famous in United Kingdom being Maxwell Communication and Polly Peck (Arcot, et al., 2010). These institutions collapsed because of weak boards and the managements short-termism and personal greed (Micklethwait & Dimond, 2017). The need for better governance has led to formation of larger and more diverse non-executive directors board to cope with growing demand for good corporate governance (Micklethwait & Dimond, 2017). Corporate Governance itself has a rather broad definition but The UK Corporate Governance Code defines that corporate governance should facilitate efficient, effective and entrepreneurial management that delivers shareholder value over the long term. Poor corporate governance does not take shareholders best interest into consideration and might lead to poor performance (Financial Reporting Council, 2016). In this essay the author will examine the Corporate Governance code used in UK and what role NEDs play in establishing and maintaining the good Corporate Governance and moreover if their responsibilities are appropriate and sustainable.
The UK Corporate Governance code
Cadbury Report, which was produced in 1992 by the Cadbury Committee is the first version of the UK Corporate Governance Code (Financial Reporting Council, 2016). The need for the good corporate governance code came because after various scandals the public confidence was low and to encourage investments the Cadbury Report was introduced (Elliott & Elliott, 2015). In United Kingdom, the companies have to follow principles set out in The UK Corporate Governance Code. The code is published by Financial Reporting Council and reviewed usually every two years, the most current being 2016 version (Financial Reporting Council, 2016). The review part is important to keep the Code evolving as our society changes. Companies and other users of the Code have an opportunity to voice their opinions where they believe the Code can be improved (Financial Reporting Council, 2014). The Code sets out standard of good practises in relation to board leadership, effectiveness, remuneration, accountability and relations with shareholders (Elliott & Elliott, 2015). The UK corporate governance code has a principle-based approach, this means that the Code sets out broad principles and a recommended set of provisions or rules that are considered to be part of good governance (Arcot, et al., 2010). As it is a principle-based approach companies have an opportunity to either comply with the rules or explain to shareholders and stakeholders why they have taken a different approach (Arcot, et al., 2010). Elliott and Elliott (2015) state that having a principle based code also should drive the companies do more than the bare minimum required by law as opposed the rule based systems and moreover it should also encourage shareholders to actively participate in companies’ decision making. The Code also sets out that in United Kingdom the companies’ management should consists of executive directors and at least 3 non-executive directors, who under the collective responsibility lead the company (Elliott & Elliott, 2015). The difference between Executive Directors and Non-Executive Directors (NEDs) is that Executives run the company from day to day where NEDs are more of an part time advisory board overlooking the Executives work (Elliott & Elliott, 2015). Elliott and Elliott (2015) explain that the main function of non-executive directors is to ensure that the executive directors are pursuing policies consistent with shareholders’ interests.
The Code and good corporate governance is still relevant today as we can still see companies failing, with the most recent example of collapse of BHS in UK which cost 11 000 people their jobs and put more than 20 000 people pension under the threat (Ruddick, 2016).
Non-Executive Directors – their benefits and limitations
Micklethwait and Dimond (2017) find that independence of NEDS plays an essential role when it comes to establishing and maintaining good corporate governance. Micklethwait and Diamond (2017) elaborate that for NED to be considered independent, the person should not have material or individual relationship with the entity, moreover NED should have previous business experience and expertise and should also understand the environment where the business operates and general market conditions and risks. Also while a person is a NED in one company he/she can not be and executive director in other companies (ACCA, 2011). The Code addresses the independence in Section B, it also brings out that NEDs should make sure they can allocate reasonable amount of time for their work. Ross and Crossan (2012) explain that independence is the key issue as the non-executive directors should protect the shareholders’ interests, if this is not done the executive directors will run the company on their own interest. The independence was also an issue during the BHS collapse as it was found that people who were considered independent according to UK Corporate Governance Code where disengaged of key decisions (The Work and Pensions Committee, n.d.).
Section A in UK CG that addresses the leadership of the company as the Code understands that leadership should come from the top and trickle down to others (FRC), if the top managers set a precedent to act ethically and morally the rest of the company sees what is considered a normal working environment and will act is similar manner (Elliott & Elliott, 2015). NEDs should challenge Executive directors in their operations and also help them to develop strategies (Financial Reporting Council, 2016). Elliott and Elliott (2015) also bring out the connections and long standing business knowledge that NEDs often have, this can open up new strategies and better risk management for companies. Having a broad NEDs board also gives a wider area of shareholders and stakeholders to be heard (Elliott & Elliott, 2015). Elshandidy and Neri (2015) find that monitoring the boards behaviour is in correlation with transparency of the company for investors, but to be able to challenge the directors NEDs need to have a excellent understanding of corporate strategy and the communication needs to be transparent with the executives. If they don’t understand the strategy they will not be able to criticise the various practises. McNulty (2002) criticises the actual input the NEDs have, he argues that the influence can often be limited as the strategy meetings with NEDs are often infrequent and executive-led, moreover they are often only bi-annual. This often also causes information asymmetry and NEDs will be unable to challenge the executives’ strategy or riskiness of the decisions (Long, et al., 2005). Elliot (2017) also states that the problems might arise when NEDs receive too much information and will get overwhelmed or might start getting involved with actual day to day management of the company. Having no real opportunity to criticise the work of executive directors can have a significant effect on the overall governance, when lower step managers see the risk taking and short-termism they themselves will also adapt to the approach, but this might lead to poor long term performance. Also as NEDs are not actively and full time employees of the company they also might have a problem that they are not well aware of the market trends especially with the fast-moving entities like IT and finance. Part time commitment might also cause problems when it comes to caring out NEDs commitments and training to be able to actively participate in challenging the executives and helping the out with the strategy.
During and after the finan
cial crisis there was a lot of criticism towards NEDs as they were sitting on boards when they actually did not have any idea what their job was about so due to this they couldn’t also criticise the company. Notorious example for the accountability would be the collapse of Lehman Brothers, which to date holds the largest bankruptcy filing in history with over 600 billion in debt (Mamudi, 2008). Lehman Brothers NED board consisted of 10 people, where only two had financial backgrounds, rest were retired from various areas from Navy to theatre. It is clear to see now that the NEDs board did not have enough knowledge to decide the approaches the managers took (Micklethwait & Dimond, 2017).
Section C which concentrates on accountability addresses broadly the communication between the executive directors and non-executive directors. NEDs should understand the current state of the company and also the long term prospects, NEDs should also actively challenge the risk management of the entity and making sure the company is run in long term profitability in mind rather than short term.
The Code also addresses the remuneration the executives are entitled in section D. It is important that executives themselves can not decide their own salaries. If the decision of pay comes from NEDs it drives the executives to perform better especially as they know they are evaluated by the NEDs board.
The last part of the code, Section E cover the need for communication with shareholders as they are the real reason why the company exists
The section covering accountability understands the need for clear representation on accounts and also sees the need for risk management. As NEDs are also responsible for remuneration this drives the need to be ethical for directors. And the last section covers communication with shareholders. In recent years we have also seen a rapid growth in shareholders and stakeholders pressure where people have grown increasingly vocal that corporations would better their behaviour from philanthropy to paying the correct tax due.
Conclusion
In conclusion, the NEDs play an important role when it comes to establishing and maintain a good corporate governance. An effective non-executive director can strengthen boards by providing balance, independence of mind, additional skills and experience, an external perspective as well as greater scrutiny and challenge of CEO and other executives’ decision making. But for their role to be a success there has be a strong board who is independent, is aware of market trends and part of the board should have excellent financial background to critically assess all the information received by the executive directors. The UK Corporate Governance also helps to establish the sustainability of good governance as it is constantly reviewed and companies have the ability to either comply with the principles or the explain to shareholders and stakeholders why they have chosen as certain approach. If these conditions are not filled the NEDs part might be considered unsustainable in the long run as there is a chance in UK legislation that they are only there for their own self-interest.
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