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. |
