The Higgs Report promises the rise and rise of the non-executive director. Tim Russell asks whether they are up to the task
The Higgs Review is rarely on the front pages now, having been replaced by stories of ‘fat cat pay’ and recommendations of lower severance payments for executives dismissed because of underperformance. Non-executives look on with interest from the sidelines and the non-executive star is in the ascendancy. They will form the whole of the remuneration committee and, post-Higgs, the majority of many company boards.
In a talk on corporate governance in financial institutions earlier this month, Financial Services Authority (FSA) chairman Howard Davies referred to the Federal Reserve Bank of New York’s economic policy review, which concluded that the bigger the company board, the poorer the results. One wonders whether all the imminent changes will win investor confidence and improve shareholder value or not.
As Davies pointed out, shareholders are, or at least should be, “interested in the relationship between good governance and corporate success, rather than elegant governance per se”. But will the new Combined Code on corporate governance lead to companies making better decisions? Will directors think outside the box or yawn as they tick boxes to confirm they have ‘complied’ with best practice? Opinion is divided and the opinions and criticisms of many ‘executive’ directors and chairpersons have been well documented.
Where are we now?
Many of the Higgs recommendations have been well received, such as the structured appointment of more and better qualified independent non-executive directors. However, the former chairman of Dixons has described the Higgs Review as “ludicrous” and many have suggested that the new code is too prescriptive and will lead to a paralysis in the decision-making process due to the increased role of non-executive directors.
Peter Wyman, former president of the Institute of Chartered Accountants, has called for “blindingly obvious” provisions, such as paying higher director fees to attract good managers, to be swept away on the basis that they add nothing. The National Association of Pension Funds (NAPF), the Association of British Insurers (ABI), the Confederation of British Industry and the Institute of Directors have all raised objections.
The Financial Reporting Council still intends to amend “fatal flaws”, but when the dust settles on Higgs, questions are bound to remain: will entrepreneurial private companies be deterred from floating on the stock market?; will non-executives be prepared to take on new risks without new influence?; will executive directors be frustrated by non-executives involving themselves in the detail of management?; and will companies simply comply and shut up?
Executive directors have not embraced the recommendations with open arms. This is
not surprising when one looks down the Higgs wish list. If the current recommendations are implemented fully, non-executives will have far more control, increased contact with investors and shareholders, and will receive more money for doing it. Non-executives will have control of all the three principal committees – the audit committee, the nomination committee and the remuneration committee. They could outvote executive directors around the boardroom table because, for the first time, they may command a majority.
It will become harder to recruit non-executives and cost more to ensure their adequate induction and ongoing training. The non-executives who join are likely to ask more questions and require more information (at least more quality information) and yet will probably be more ‘risk adverse’, moving many decisions away from the hands of one or two key directors to a consensus vote. It is clear that, among executives, there is increasing disquiet at the likely impact of the Higgs Review.
Three specific examples highlight the issue. First, many executive directors are concerned about the proposed role of senior independent director (SID) in respect of monitoring shareholder views. Is this not the role already carried out by the chairperson? No one envisages that the SID should create a dual chairmanship, but will it do so in practice? And in any event, will it help the shareholders? Second, many chairpersons currently run the nomination committee and want to continue to do so. Third, there is concern about the implications of the recommendation that the chief executive should not subsequently become chairperson of the company – in many cases this does happen and there is often a good business reason for it. But is this in the interests of the company?
Executive directors want some assurance that the Higgs recommendations will not lead to ‘paralysis by analysis’ and the creation of unwielding boards. Higgs supporters would argue that most queries can be answered by recognising that companies do have a choice and the review was and is not meant to be a ‘one size fits all’ approach. Derek Higgs has emphasised that companies will not have to comply with all recommendations, even if the proposed amendments to the Combined Code are adopted in full. Few listed companies currently comply fully with the Combined Code, but detractors point out that the pressure on publicly-listed companies to comply will be great, whether it comes from institutional investors and other shareholders, the ABI, the NAPF, Pensions and Investment Research Consultants, or any number of public interest groups or others with corporate governance concerns. It is predicted that directors who fight against compliance will face criticism and potential legal action.
It is clear from a recent Norton Rose survey of non-executives that they are well informed: 70 per cent said they had read the Higgs review in full and felt they had a deep knowledge of it. They recognise the new responsibilities they are likely to have. However, a similar percentage want to see substantial changes before the Higgs proposals are implemented.
The main concern is the formal appointment of the senior independent director, which 60 per cent of respondents believe is likely to lead to splits in board unity. The majority are also unconvinced that shareholders will ultimately derive any tangible benefits from the proposals outlined in the Higgs Review and that the extra responsibilities for non-executives will make it less attractive to be a non-executive director in the first place.
Finally, nine out of 10 non-executives are effectively agreed on the fact that they should get higher remuneration and that there should be additional training. However, a similar percentage believes that whichever recommendations are accepted, future corporate governance is not simply going to be about ticking the boxes.
The Combined Code has never imposed a legal requirement and although annexed to the listing rules it has not been a part of them. In consequence there is no legislative requirement to comply. However, it seems clear that non-executives will be quite prepared to explain non-compliance in the company accounts – if so, this will lengthen any reports and there is a risk that future reports, will go into significant detail, in part to obscure some areas of non-compliance. It also shows that non-executives have an appetite for their new role.
We wait to see how non-executive directors are going to flex their muscles. Will this have an adverse impact on well-run and well-managed boards? If so, is this a price worth paying in order to move UK plcs into a new era and gain investor confidence? Some see a movement towards the European model of a two-tier part-executive, part-supervisory board (albeit stopping short of the Sarbanes-Oxley statutory provisions applying in the US) and the role given to non-executives as a threat rather than an opportunity. When the Cadbury review came out a decade ago, initial hostility was replaced by general acceptance – even grudging admiration – in a short period of time. But how will the Higgs Review be seen in the future?
For now, the Government is standing firm, but there is vocal criticism from all corners. Surprisingly, many non-executives share the uncertainty and even the criticism of executive directors, yet corporate collapses, often involving incompetence, excessive risk-taking, imprudent management and/or even bad faith, do need to be dealt with. Is the Higgs initiative a corporate governance code too far, or is the UK Government right when it says that UK plcs needs these new guidelines, however prescriptive some feel them to be?
One thing is certain: the days when non-executives were seen and not heard are likely to disappear.
Tim Russell is head of employment at Norton Rose