7.3 About Board Composition

The Company Act does not make a distinction between executive and non-executive directors in the UK. Directors are nominated and elected at the AGM. The control over the slate of nominations of directors for election at the AGM can lie in the hands of executive directors. According to Boyd (1996:169), “there is obvious potential for corruption in this process, as a CEO can effect the nomination of directors who may further the board’s interest rather than the shareholders.” Boyd indicates three ways in which the nomination of directors who favor the interests of the CEO can be effected:

  • first, the CEO can nominate executive directors who are allied to the CEO;
  • second, the board can also nominate non-executive directors who are not only in favor of the CEO, but who are also financially dependent on the corporation;
  • finally, the CEO may nominate executive and non-executive directors for re-appointment due to the absence of a system that guarantees the rotation of directors. As such, it is possible for directors to become entrenched.

To avoid these problems, the first recommendation to appoint more non-executive directors to UK-boards was already made by the Watkinson Report of the Confederation of British Industry (CBI) on the responsibility of public companies in 1973. The report concluded that ”the inclusion on the board of public companies of non-executive directors is highly desirable . . . by virtue of the fact that unlike executive directors they are not closely involved in the day to day affairs of the company, and they are in a better position to see the company as a whole and to take a critical view of it” (quoted in: Tricker, 1984:187)[31].

The appointment of non-executives to boards of listed corporations has also been encouraged by the Institute of Directors (IOD)[32], the Governor of the Bank of England and other City institutions (Tricker, 1984). In 1980, the Bank of England, the London Stock Exchange, CBI and the British Institute of Management founded PRO NED to promote a wider use of non-executive directors (Charkham, 1994). More recently, the Cadbury and Hampel Reports strongly reinforced the position of non-executive directors. The voluntary Cadbury Code recommends that there should be a minimum of three non-executive directors in the board – of whom two non-executives should be independent of management and the company (Cadbury Code, § 4.11). On the independence of non-executive directors, Cadbury recommends that “An essential quality which non-executive directors should bring to the board’s deliberations is that of independence of judgement. We recommend that the majority of non-executives on a board should be independent of the company. This means that apart from their directors’ fees and shareholdings, they should be independent of management and fees from any business or other relationship which could materially interfere with the exercise of their independent judgement” (Cadbury Code, § 4.12).

The ICA proposed that references in the Cadbury Code to non-executive directors should be changed into independent directors. In addition, the ICA recommended more guidance on the criteria to be satisfied by non-executive directors when they are independent of management. The Hampel Committee followed Cadbury’s definition of independence: ”There was some concern expressed that we had ducked the issue of what was independence . . . We believe that Cadbury had defined independence in the best possible way and we could not improve on it” (Sir Ronald Hampel, quoted in: Financial Times, Jan 29 1998).

In the final Combined Code, the independence of non-executives is further explained. Provisions A.3.1 and A.3.2 of the Combined Code state: “The board should include non-executive directors of sufficient calibre and number for their views to carry significant weight in the board’s decisions. Non-executive directors should comprise not less than one third of the entire board [. . .] The majority of these directors should be independent of management and free from any business or other relationship which could materially interfere with the exercise of their independent judgement. Non-executive directors considered by the board to be independent in this sense should be identified in the annual report” (Hampel, 1998b:14-15). Seen from this perspective, the definition of board independence in the UK shows similarities with those of The Business Roundtable, ALI and ABA presented in chapter six on the corporate governance system in the US.

Table 7.1

Recommendations on the Independence of Corporate Boards

Governance Issues

Cadbury Committee

Publication December 1992

Hampel Committee (Cadbury II)

Publication January 1998

 

Separate CEO and chairperson:

recommended but not compulsory.

separation of roles is preferred and corporations should justify the combination of these roles in the annual report.

Lead director:

there should be a strong and independent element on the board with a recognized senior member.

there is a need for vigorously independent non-executive directors. A senior non-executive should be identified in the annual report.

Nomination of directors:

directors should be appointed through formal board process via nomination committees dominated by non-executive directors.

the use of nomination committees should be accepted as best practice, with the proviso that smaller boards may prefer to fulfil the function themselves.

Non-executive directors:

minimum of 3 non-executive directors.

minimum of one-third of non-executive directors.

Independence of directors:

majority of non-executives should be independent.

majority of non-executives should be independent – based on the same definition of Cadbury of independence! Boards should disclose in annual report who is considered to be independent.

Rotation of directors:

directors should be appointed for specific terms with non-automatic reappointment.

all directors should submit themselves for re-election at least every three years.

Pay and bonuses:

annual reports should reveal desegregated director’s pay; Remuneration committee of board should be dominated by non-executive directors.

the company’s annual report should contain a statement of remuneration policy and details of the remuneration of each director. Membership of remuneration committee should be exclusively limited to independent non-executive directors.

Independence of the auditor:

audit committee of the board should be formed, comprised exclusively of non-executive directors.

audit committee of the board should be formed, comprised exclusively of non-executive directors.

 

 

Table 7.1 continued

Recommendations on the Independence of Corporate Boards

Governance Issues

Cadbury Committee

Publication December 1992

Hampel Committee (Cadbury II)

Publication January 1998

 

Flow of information to the board:

boards should have a formal schedule of decisions; directors should have paid access to outside advice.

management has an obligation to provide the board with appropriate and timely information and the chairman has a particular responsibility to ensure that all directors are properly briefed.

Greater scope of auditing:

auditors should review compliance to the Code, including directors’ statements on going-concern and statements on internal audit effectiveness.

listing rules now require auditors to review statements on “going concern”, certain aspects of the directors’ statements of compliance with the Cadbury Code, and certain elements of the report of the remuneration committee. Additional prescribed requirements nor the removal of any existing requirements for auditor verification of governance is recommended.

 

Sources: Cadbury (1992); Boyd (1996); Hampel (1998a).

 

 


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Maassen, G.F. (2002). An International Comparison of Corporate Governance Models. A Study on the Formal Independence and Convergence of One-Tier and Two-Tier Corporate Boards of Directors in the United States of America, the United Kingdom and the Netherlands.

Maassen, G.F. (2002). An International Comparison of Corporate Governance Models. A Study on the Formal Independence and Convergence of One-Tier and Two-Tier Corporate Boards of Directors in the United States of America, the United Kingdom and the Netherlands. Amsterdam: Spencer Stuart Executive Search.