In his review published in 2003, Derek Higgs described the role of a non-executive director as ‘custodian of the governance process. ’ A non-executive director (NED) sits on the board of company just as a normal executive director would do so, however a non-executive director does not form part of the executive management team of the company. Essentially they are not an employee of the company or affiliated in any way other than their role as an independent NED.
The distinction between a non-executive director and an executive director is illustrated in Equitable Life Assurance v Bowley  in which Langley J commented It is well known that the role of non-executive directors in corporate governance has been subject of debate in recent years…It is plainly arguable, I think, that a company may reasonably at least look to non-executive directors for independence of judgement and supervision of the executive management. ’ Essentially, non-executive directors are non-stakeholders in a company or organisation, and do not have day-to-day management responsibility, thereby rendering them independent of the executive board.
In the post-Enron era, this independence has become crucial for corporate governance, so much so that the Higgs report of 2003 commissioned to examine the role of non-executive directors recommended that a company’s board should comprise at least 50% non-executive directors. In 1992 the Cadbury Committee published a report to review the code of practice on corporate governance. The concept of corporate governance can be defined in a number of different ways because corporate governance potentially covers all activities that have a direct or indirect influence on the financial well being of a corporation.
As a result, many different definitions have surfaced. The earliest definition of corporate governance came from the Economist Milton Friedman. According to Friedman, corporate governance is to conduct business in accordance with owner or shareholders’ desires, which generally will be to make as much money as possible, while conforming to the basic rules of the society embodied in law and local customs. This definition is based on the economic concept of market value maximisation that underpins shareholder capitalism. Apparently, in the present day context, Friedman’s definition is narrower in scope.
Over a period of time the definition of Corporate Governance has been widened. It now encompasses the interests of not only the shareholders but also many stakeholders and workers as well. The year 2003 saw Derek Higgs and Sir Robert Smith produce reports aimed at examining the effectiveness of non-executive directors and the effectiveness of audit committees. It was the recommendations of the Higgs Report which led to the drafting of the Combined Code 2003 which replaced the previous Combined Code that was issued in 1998 by the Hampel Committee on Corporate Governance.
Higgs made a number of recommendations regarding the role of non-executive directors most which now form part of the Combined Code 2003 along with a minor revision by the Financial Reporting Council (FRC) in 2006. A further review of the Code has been prompted by changes in EU law, namely the implementation of Directive 2006/46/EC . The report was first published due embarrassing and very public collapse of the corporate governance process within major companies such Enron and WorldCom and thus highlighted the need for much clearer guidelines.
Non-executive Directors: The Combined Code 2006 The Combined Code on Corporate Governance 2006 supersedes the 2003 version however the changes made were not substantial. The purpose of the Code is to clearly define the standards of good practice in relation to companies and the composition of their boards of directors along with their ‘development, remuneration, accountability and audit and relations with shareholders. ’ The Combined Code is a set of principles and provisions. It is in essence a set of broad self-regulatory principles rather than a legally binding document.
It is now necessary for companies listed on the LSE to report on how they have applied the Code, and either to confirm where they have complied with the Code’s provisions and/or where they have not complied of they must explain the reasons why they have not complied. This contained in Listings Rules (LR 9. 8. 6) and to emphasise again, there is no legal binding, however if British pharmaceuticals plc were to enlist on the London Stock Exchange they need not comply with the Code, but must provide explanation as to why they have not complied.
There are numerous provisions now included in the Combined Code which provide guidance to companies with regard to their non-executive directors this essay will only examine those key provisions relevant to the case study scenario. There is a provision within the Code which suggests that at least half of the board should be balanced with both executive and non-executive directors. The Higgs Review recommended at least half of the board be made up of NEDs. The Combined Code 2006 where significantly smaller companies are involved, the board should have at least two non-executive directors.
According to provision A. 3. 3 a company board should also appoint one senior non-executive director. Where nominating new directors, such a nomination committee should be made up of and headed by a non-executive director. Provision B. 1. 3 regarding remuneration, recommends companies to assess the levels of remuneration with regard to non-executive directors on their time, commitment and responsibility that they afforded their role, however where required by the articles of association, the shareholders should determine the level of remuneration of NEDs.
A. 4. 4 provides that the terms and conditions of the appointment of non-executive directors should be made available for inspection. A. 5. 2 suggests that non-executive directors should be allowed access to independent professional advice at the company’s expense. A. 7. 2 of the Code suggests that NEDs are to be appointed subject to specific terms, subject to re-election and also subject to the provisions related to the removal of directors as stated in the Companies Act 2006.
It also suggests that non-executive directors serve no longer than nine years. In terms of British Pharmaceuticals plc’s plans to have a non-executive director on the board of the company, throughout the Combined Code there contains guidance as to the role of such a director and in Schedule B of the Code there contains specific guidance as to the liability of a non-executive director. Schedule B details liability of a non-executive director in terms of their duty of care, skill and diligence along with the level that is expected of such as director.
Although British Pharmaceuticals plc have a non-executive director already on board i. e. Mr Brown, it is not wise to appoint such a director simply because that person knows the Joint Chairman/CEO. It is essential that the individual that is chosen to occupy such a role is in fact chosen on the basis of what they can contribute to the board along with their experience and perspective and as of the 1st October 2008 the minimum age for holding a company directorship under the Companies Act 2006 will be 16 years of age.
Section 2 (i) of the Combined Code lists a number of provisions relevant to they way in which boards must accommodate non-executive directors and enable them to fulfil their duties such as setting out their period of appointment and time commitment. Section 2 (ii) makes suggestions as to what non-executive directors are themselves responsible for. ‘It is up to each non-executive director to reach a view as to what is necessary in particular circumstances to comply with the duty of care, skill and diligence they owe as a director to the company.
In considering whether or not a person is in breach of that duty, a court would take into account all relevant circumstances. These may include having regard to the above where relevant to the issue of liability of a non-executive director. ’ – The Combined Code on Corporate Governance 2006, Schedule B, s. 3. It must stressed that some of the provisions within the Combined Code 2006 only apply to companies listed as a FTSE 350 company, where this does not apply, companies listed on the LSE must still try to comply with the Combined Code.
If British Pharmaceuticals plc were to list on the LSE they should very arefully consider their actions. If they decide to stray from the provisions of the Combined Code 2006 as it is necessary to explain such decisions. Of course smaller listed companies can also use the Combined Code 2006 as guidance on corporate governance however, unlike larger companies, given the size of the company they can on occasions conclude that it world be entirely disproportionate to comply with some provisions. The Combined Code 2006 serves as excellent guidance on the setting of standards on corporate governance and it would be beneficial for British Pharmaceuticals plc to comply.
Non-executive Directors and The Companies Act 2006 The Companies Act 2006 which received Royal Assent in November 2006 and the UK finally saw the part-codification of director’s duties and seven new general duties were a major feature of the Act, although many of the new general duties are based upon the existing common law duties. Section 250 of the Companies Act Defines a director as any person occupying the position of a director, by whatever name called. There is no legal distinction under this Act between executive and non-executive directors; therefore the liability of a director is the same no matter what role a director may take.
The new general duties of directors also apply to non-executive directors. The fact that there is no legal distinction between directors has created somewhat of a paradoxical challenge due to the fact that non-executive directors on a whole are thought to be independent of the company in which they are operating and/or the related industry, would naturally spend less time with the company than an executive director would do so, are not party to executive management decisions and yet are still equally liable as any other director of that company.
They are also as stated in Schedule B of the Combined Code 2006 and as discussed above to exercise care, skill and diligence. Institutional Investors/Shareholders The allure of listing on the London Stock Exchange is often the advantages of attracting institutional investment. However, British Pharmaceutical plc should take into account the following information regarding institutional shareholder investment and corporate governance before considering such a direction for their company. Institutional investors are a permanent feature of the financial landscape, and there growth will continue at a similar or faster pace. The factors that underpin their development are far more transitory and in many cases have only just started having an impact. ’ – Bank of International Settlements, Annual Report (1998), p. 95. There has been a substantial increase in institutional investment over that last few years. As opposed to an individual investor, institutional investment occurs where money is professionally or institutionally managed.
Institutional investors include ‘private pension funds, state pension funds, closed-ended investment schemes, life assurance companies, non-pension fund moneys managed by banks and endowment trustees, and an ever-increasing range of new, financially innovative, professionally managed money pools such as open ended investment companies and unit trusts. ’ The globalisation of financial markets eventually brought with it institutional investors who throughout the world now own enormously large portions of equity in many different companies and therefore now play a key role in corporate governance.
Even the 1992 Cadbury Committee and 1998 Hampel Report identified the importance of the role of shareholders in corporate governance and it is now clear that institutional shareholders have a big influence on they way company is being managed with particular influence on the standards of corporate governance. In 2001 the Department of Trade & Industry published the Myners Report, a review of institutional investors in the United Kingdom. Commissioned by the Chancellor of the Exchequer, P.
Myners report was a result of confusion over institutional investors and investment decision making. The Combined Code 2006 and institutional investors/shareholders Part Two of the Combined Code 2006 concerns institutional shareholders. E1 of the Code suggests that institutional shareholders should hold dialogues with their company ‘based on the mutual understanding of objectives’ and should also abide by the Institutional Shareholders Committee’s statement of principles.
This statement of principles known as ‘The Responsibilities of Institutional Shareholders in the UK’ and these principles are an extension of those listed in the Combined Code. E. 2 of the Combined Code 2006, entitled ‘Evaluation of Governance Disclosure’ and suggests that when evaluating the governance arrangements of companies, those relating to the structure of the board of directors, all institutional investors would be wise to ‘give due weight to all relevant factors’ that are afforded them.
The Code also suggests that where a company strays from the provisions that the Code sets out, institutional shareholders should evaluate the reasons given by the company for their non-compliance and be prepared to enter into dialogue with the board where they do not agree with decisions. E. 3 of the Code states that institutional investors should make ‘considered use of their votes’. There are to make sure that their voting intentions are being put into practice, disclose to their clients any information regarding resolutions, and major shareholders should attend AGMs.
The Companies Act 2006 and Institutional investors/shareholders Sections 1277-1280 of Companies Act 2006 concern the exercise and disclosure of voting rights. The Companies Act 2006 has now given the government power which will require all institutional investors to disclose the way in which they have voted regarding specific shares that they have interest in or indeed own.
This power will be used where investors fail to voluntarily disclose such information. S. 278 lists the types of institutions which such disclosure applies to and includes ‘unit trust schemes within the meaning of the Financial Services and Markets Act 2000 (c. 8) in respect of which an order is in force under section 243 of that Act’ , ‘open ended investment companies’ and ‘pension schemes’ . The allure of institutional investment may seem lucrative, however such investors often wield an incredible amount of power especially where corporate governance is concerned and British Pharmaceuticals plc should be aware of this.