The state of independents

HEADNOTE

Corporate governance is yet again underthe microscope as the government launches another review. Ruth Prickett questions whether a better-defined role for non-execs will emerge from it

Businesses, shareholders,

professional bodies and governments around the world have been discussing the same question ever since the first board of directors was created: how can investors and employees be confident that their company is being managed efficiently, honestly and in their best interests? The collapse of Enron is the latest scandal to bring these issues to a head. If this crash can be attributed to poor corporate governance, it raises the attractive idea that the same sort of thing could be prevented from happening again. But is this realistic?

The government has launched yet another inquiry the fifth best-practice inquiry into corporate governance in less than a decade. This time Derek Higgs will be investigating the role of non-executive directors. Many organisations have welcomed the move. CIMA has argued that it will create an opportunity to enhance the role of non-execs, whom it sees as "central to ensuring robust corporate governance". The institute's written submission to the Treasury select committee investigating the financial regulation of UK public limited companies advocates a code of bestpractice for non-execs.

Other lobbying groups warn that further regulation is not the solution. "It's always tempting to reach for the statute book in the light of a disaster, responding to the `something must be done' outcry," said George Cox, director-general of the Institute of Directors, in a lecture to the European Business School in March. "But it's akin to calling for a rewrite of the laws or the Highway Code every time we pass atraffic accident, when the cause is almost invariably bad driving.

The number of regulations and guidance documents already in circulation is considerable. Where the UK has the Combined Code, Belgium has the Cardon report, France has the Vienot reports, the Netherlands has the Peters report and Germany and Switzerland are currently writing their own codes of best practice. The Organisation for Economic Co-operation and Development (OECD) set out general principles of corporate governance in 1999.

While all these regulations agree that independent judgment on the board is the key to effective governance, there is disagreement about what constitutes independence. The OECD principles state that: "Board independence usually requires that a sufficient number of board members not be employed by the company and not be closely related to the company or its management through significant economic, family or other ties."

It adds that boards should consider hiring a"sufficient" number of non-executive members who can exercise independent judgment where there is potential for a conflict ofinterest, and points out that non-execs' performance may suffer ifthey serve on too many boards.

In the UK the Combined Code adopted the loose definition of the 1992 Cadbury report, which said that non-execs were "independent of management and free from any business or other relationship that could materially interfere with the exercise of their independent judgment". It also supported the separation of the roles of chairman and chief executive. This is not true of many other European countries, for example France, where firms often combine thetwo roles.

A survey of corporate governance in Europe by KPMG found that definitions of independence varied. While 93 per cent of UK respondents said non-execs should not benefitfrom share options or receive remuneration based on the company's performance, this was true ofjust 17 per cent of Swiss firms. Similarly, 64 per cent of UK respondents thought non-execs would not be independent if they had been an employee of the firm for more than five years, compared with 18 percent of German firms.

Most Swiss and German companies had large numbers of independent directors and all UK respondents complied with the Combined Code by having more than a third oftheir board made up of non-execs. But respondents from the Netherlands and Belgium showed a far lower representation. While a large proportion of UK non-execs had financial expertise, only 39 per cent had skills in areas such as IT and R&D, compared with 65 per cent in Switzerland.

The National Association of Pension Funds has called for non-execs to spend one day a week in the company, and both the IoD and CIMA are urging them to seek more training. Inevitably, there are fears that increasing the demands ofthe job will discourage good candidates.

"Companies should have the scope to apply corporate governance principles flexibly and specific to the attainment of each company's objectives," according to Charles Tilley, CIMAs chiefexecutive.

But Lord Young, outgoing president of the IoD and a former trade and industry secretary, argues that independence is unnecessary if pay arrangements are totally transparent. "The biggest and most dangerous nonsense is the role we now expect non-executive directors to perform he told the IoD's annual convention. "Even if they spend one day aweek in the company, can non-execs ever know the business as well as the executives? No they can't. In that case, why bother with non-execs at all?"

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Further Information

Charles Tilley will be discussing these issues at CIMA's annual conference on 12-13 November. Visit www.cimaevent.com for more details