QUESTION

Non-executive directors are expected to focus on board matters and not stray ‘executive
direction’, thus providing an independent view of the company that is removed from a day-
to-day running. Non-executive directors, then are appointed to bring to the board
independence, impartiality, wide experience; special knowledge; personal qualities.

Discuss at length the role of non-executive directors, issues that are faced and
recommendation to move forward.
INTRODUCTION

Corporate governance is the arrangements of guidelines, practices and procedures by

which a company or organisation is coordinated ad controlled. It is purely concerns on the
relationship between the shareholders and directors. Corporate governance basically
includes balancing the interests of numerous stakeholder in a company. These incorporates
in shareholders, administration, clients, management, customers, suppliers, financiers,
government and the community. Further, corporate governance gives the framework on
how the company can accomplish its targets. This benefits the company in many ways. The
recent article which was published in The Hindu Business Line with the title of ‘Don’t look at
corporate governance as encumbrance’ states that the rules of corporate governance is
unavoidable in a global context which India is very ignorant about which may disadvantage
them in many ways.1

Who is a director? A director is an appointed member of the board of director of a

company. The director is responsible of determining and executing the company’s policy
and regulations. In addition, a director does not have to be a shareholder or an employee of
the company and may only hold the office of director. 2 Section 250 of the Companies Act
20063 attempt the definition of a director by stating that director includes any person
occupying the position of director by whatever name called.

There are two main types of directors which are the executive directors and the non-
executive directors. The executive directors are the people who take care of the company’s
business on a day to day base whereas a non-executive director do not have to work on a
daily basis for certain reasons which will be discussed below. As the question emphasises
on the role and responsibilities of a non-executive directors, the content of this answer will
be based on non-executive directors in order to obtain a better understanding.

1
http://m.thehindubusinessline.com/markets/dont-look-at-corporate-governance-as-encumbrance-
sinha/article7923997.ece (28/11/2015, 11.20 a.m.)
2
The general duties of a director is listed in the Companies Act 2006,part 10
3
Companies Act 2006, s.250
WHO IS A NON-EXECUTIVE DIRECTOR?

A non-executive director is someone who works on a part time basis. These directors
are usually the senior directors who has retired from the company. The term Non-Executive
Director merely focuses on what they are not rather than what they are4. They play a very
important role in managing the company’s system. Mostly large private and public
companies appoints a non-executive director. Based on a survey, approximately 40% of the
medium sized company appoints non-executive directors. Further, in the recent study it also
states that managing directors of small and medium sized companies has considered to
appoint non-executive directors but at the end felt it was unnecessary to do so. This shows
that there is a lack of confidence in the non-executive’s role.5 It is submitted that although
there is an issue of mistrust, non-executive directors benefits a company in many ways.

THE ROLE OF A NON-EXECUTIVE DIRECTOR IN GENERAL

A non-executive can convey crucial qualities to a developing business and qualities which
will stand it in great stead on the off chance that it is to be successful, whatever its stage in
the business lifecycle. First of all, a non-executive director has to monitor the performances
of the executive directors which is also called as overviewing. This helps to control the
power of executive directors so that their power is not abused. However, sometimes
overseeing a person performance who is more likely to be in a similar post would not be a
good idea as it may distract or annoy the other directors while they are working. Further, a
non-executive director has the rights to remunerate, appointing and necessary removing a
director or an employee of the company. This concept seems to be unfair as grudges and
anger on the employee or director may lead to an abuse of power by the non-executive
director.

4
‘outside director’ is a term used in United States which is not widely recognise in United Kingdom
5
Research report no.63 – The role of non-executive directors in United Kingdom SMEs by Aiden Berry and Lew
Perren commissioned by ACCA. (28/11/2015 – 12.33p.m.)
CADBURY’S REPORT (1992) 6
Sir Adrian Cadbury (chairman) who initially started a debate on the essential functions
and responsibility of non-executive directors in this report in 1992. It also emphasises that
contribution of a non-executive is important in proper running companies. The Cadbury
Report further stated “should bring an independent judgement to bear on issues of
strategy, performance and resources including key appointments and standards of
conduct.”7 Further, this clearly indicates that the report focuses mainly on the
independence of the non-executive directors.

Recommendations:

The major recommendation made by the committee was that the non-executive director
should act independently in giving judgements on issues of strategy, performance,
allocations of resources and designing the role of conduct. Further, a remuneration
committee with a majority of non-executive directors should decide on the pay of the
executive directors. In addition, a majority of directors should be independent directors i.e.
they should not have any financial interest or shares in the company. Moreover, this report
recommends the no executive directors should report on the effectiveness of the company’s
system of internal control. The non-executive cannot be bias towards anyone or anything
for any purpose. Therefore, these recommendations may not be easily established because
of a certain issues that arises.

Why the arguments over independence?

Weir et al (2001) stated that a non-executive director must be independent so that there
will be an effective monitoring system which will benefit the company in many ways. In
contrast, Sullivan and Wong (1999) states that the monitoring by the non-executive

6
This committee was set up in May 1991 by the Financial Reporting Council of the London Stock Exchange. The
committee published the report in December 1992
7
https://www.iod.com/MainWebSite/Resources/Document/roleofnxds_1006.pdf (28/11/2015- accessed at
3.27p.m.)
directors will be less effective as the non-executive director who would have served the
company for many years before retirement tend to have close relationship with the
executive directors which will then end up in a compromise rather than taking an action.
This supports the claim made by Cadbury report which states the non-executive director’s
independence may diminish as his board tenure increases. Therefore, this indicates that the
non-executive director will not be able to exercise independent judgement as their
monitoring role diminishes their act of independence. The possibility of this to happen be
only when an executive director of a company becomes a non-executive director after their
retirement. In addition, this also indicates that the presence of a non-executive director
does not guarantee an honest monitoring role and absence of fraud.

Further, Ghosh and Sirmans (2003) also affirms the suggestion that it is important to
appoint an independent director to reduce the ‘agency’8 problems in a company. There
have been a number of studies which indicated that non-executive directors on board
reflects the firm performance positive. But, Liang and Weir (1999) stated that majority of
non-executive does not necessarily result in a positive performance as compared to
dominating executive directors.

It is submitted that independence is a very wide and subjective perspective which is not
an easy attribute that a person can fulfil. An article by the title of ‘Non-Executive Director: a
task for which no one is qualified’ which also supports this view, states that the list of
characteristics required of a non-executive director is so ‘long, precise and contradicting’
that there cannot be a single person who fulfils it.

GREENBURY REPORT (1995)9

Sir Richard Green supports and developed the ideas of Cadbury report and inscribed a
growing concern about the level of director’s remuneration. This report came about as the
directors were paying themselves too much salary. For example, The British Gas has

8
Agency problems means a conflict between the company’s management and the stockholders.
9
was the result of committee by the United Kingdom Confederation of Business and Industry on corporate
governance.
announced a high increase in salary for the managing director at the same time as it
announced 2000 redundancies.10

Recommendations:

This report recommended to form a remuneration committee which consists of non-

executive director to decide the pay of the executive directors. In addition, it also stated
that only independent non-executive director should be give this authority to sit in the
remuneration committee so that they will decide the ‘right amount’.11 Therefore, this report

10
David Martin, corporate governance, 2006, Thorogood, page 15
11
Right amount is the rate of pay was perceived to be a figure that could be related to comparable company’s
rate.
is basically recommending that there should be a transparent and formal procedure in
executive remuneration developing procedure and no director can be involved in his or her
remuneration.
HAMPEL REPORT (1998)

Sir Ronnie Hampel was charged to check on how effective the recommendations had
been by Cadbury and Greenbury Report and how have the recommendations implemented.
Hampel report was based more on common sense and logical approach applying in different
situations rather than Cadbury and Greenbury Report’s box-ticking approach. The Hampel’s
approach seems to be fair and simpler to apply. This report recommended that there must
be a balance between the non-executive director and executive director and no single group
should be dominant. Further, Hampel also stated that it was too early to judge the impact
and value of the Cadbury and Greenbury Report.

Other issues