“Corporate governance is the process of supervision and control intended to ensure that the company's management acts in accordance with the interests of shareholders (Parkinson, 1994).” Corporate governance maintains a balance between internal and external operations. Markets will classify companies that do not maintain their governance principles. Moreover, by increasing corporate transparency and credibility, corporate governance will determine the sustainability of an organization. Good corporate governance will reduce conflicts among stakeholders, avoid repeat failures and gain investor confidence.
A non-executive director is a member of a company's board of directors who are not part of the executive team. A NED does not engage in the day-to-day management of the organization but is involved in policy-making and planning exercises. In addition, non-executive directors' responsibilities include the monitoring of the executive directors and acting in the interest of the company stakeholders.
This report will focus on the role of the NEDS. Following this, the second step is to analyze the needs of NED through the finance scandals. Finally, the challenges that NEDs need to confront in order to increase their accountability to shareholders.
I. Role of Non-executive directors
1. The UK corporate governance code
The UK Corporate Governance Code was established in 1992 by Cadbury Committee after series of catastrophic financial meltdowns. The collapse of the Bank of Credit and Commerce International (BCCI) in 1991, British notorious corporate scandals involving the Mirror Group and its owner - Robert Maxwell and Polly Peck International (PPI) forced a rethink on Corporate Governance throughout the 1990s. The code sets out standards for the companies, which listed on the London Stock Exchange, on board composition, effectiveness, remuneration, shareholder relations, accountability, and audit. The UK code embodied the findings a trilogy of codes: the Cadbury report (1992), the Greenbury report (1995) and Hampel report (1998). The need for boards of directors in listed companies to be effective is what the Cadbury report highlights. The Cadbury Report reviewed the structure of the board and the responsibilities of company directors, making recommendations for best practice. The report recommended that company boards should meet frequently and should monitor executive management. The Code is a part of UK company law which is published by the Financial Reporting Council (FRC). It was lately revised in June 2016. These revisions are imposed on or after 17 June 2016 for all publicly listed companies in the U.K (FRC, 2016).
Figure 1. Development of corporate governance in the UK
The primary purpose of UK Corporate Governance Code is to monitor all corporate operations and staffs to protect investors’ interest against misconducts and unethical behaviors. The UK Corporate Governance Code has five main principles demonstrated as leadership, effectiveness, accountability, remuneration, and relation with the shareholder. The Code operates under the principle of ‘comply or explain’, with listed companies required to either comply with the provisions of the Code or explain to their shareholders in the next annual report why they have not done so.
The UK Corporate Governance Code requires a board to have four committees: remuneration, audit, risk, and nomination. All of these committees should have terms of reference, and these should be publicly available (usually on the company’s website).
2. The main roles of NEDs
a. Agency problem
The relationship between the manager and the investor is an agency problem that was discussed in depth in some of the studies by Berle and Means or Jensen and Meckling. The shareholder (investors), who is the owner of the company, delegates day-to-day decision making in the company to the directors, who are the shareholders ‘agents’. The agency problem is derived from the separation of ownership and control. Directors are entrusted with the management of the shareholders’ funds and they are expected to make decisions, which should bring the greatest possible benefit for the shareholders
The problem is that the agents do not necessarily make decisions in the best interests of the shareholders. The agency problems, including a lack of effective control, misuse of corporate assets by directors, and accountability of directors' action, contributed to some financial scandals in the UK.
b. The Role of NEDs
This paper focuses on the role of NEDs as a key factor in today’s composition of Boards of Directors. From an agency theory, the presence of NEDs on company boards reduce the notorious conflicts of interest between shareholders and company management, because they introducing an independent voice to the boardroom. The UK Code is shown the specific functions that NEDs perform, such as determining challenging the work of the board and participating in strategy decisions. It should be noted that NEDs have an important role in achieving the right balance between external and internal activities. Following Byrd and Hickman (1992): “The inside directors provide valuable information about the firm’s activities, while outside directors may contribute both expertise and objectivity in evaluating the managers’ decisions.” Besides that, NEDs participate in a number of committees, such as the remuneration committee - in charge of defining the executives’ remuneration; in the nomination committee, as well as in the audit and risk committees.
A non-executive director does not participate in the daily management of the firm. NEDs is usually involved in planning and policy-making and is sometimes included to increase credibility to the firm due to his or her standing in the community. Therefore, the role of NEDs as a key factor in the Board of director members, their presence on the board of directors could be more effectively to achieve better accountability of the director to the shareholders.
Following the UK Corporate Governance Code, the main role of non-executive directors (NEDs) in a unitary board is assisting in generating strategic plans. NEDs have four main roles (Kaplan, 2017):
i. Strategy role: Non-executive directors should constructively challenge and contribute to the development of a strategy. As an external member of an organization, the NED may have a clearer or wider view of possible factors affecting the company and its business environment, more-so than executive directors.
ii. Performance role: Non-executive directors should scrutinize the performance of management in meeting agreed goals and objectives and monitoring and, where necessary.
iii. Risk role: Non-executive directors should satisfy themselves that financial information is accurate and that financial controls and systems of risk management are robust and defensible.
iv. Directors & Managers role: Non-executive directors can benefit the company's and board's effectiveness through outside contacts and opinions. Helping the business and board connect with networks of useful people and organizations become an important function for the NED to fulfill. NEDs are liable for the appointment and remuneration of executives along with ensuring proper succession planning.
3. Individual experience and knowledge of NEDs
A Non-Executive Director needs a qualification of Post Graduate Diploma in NED courses and an experience of more than 10 to 12 years. A NED need some experiences related with financial background. NEDs must take some strategic proposals and executing strategy so they need a lot of industry knowledge and strategic visions. Moreover, they have to set some Intelligent questioning for the company’ current activities and show all the challenging of a Board- assumed direction, to take accurate strategies. NEDs need be well-informed about the company and the operating environment to have a strong command of issues relating to the company. They need insist on a comprehensive, formal and tailored induction, continually develop and refresh their knowledge and skills to ensure that their contribution to the board remains informed and relevant. A NED must ensure that they know all the information in advance of meetings to investigate all issues that the board facing. Besides that, NEDs need to uphold the highest ethical standards of integrity and probity.
II. The need of Non-executive Director
III. The challenges that Non-Executive Directors face in carrying out their role
NEDs would assess the market based on the current condition, rather than based on what will happen within a long period of time. NEDs only works 2 days a month and NEDs are obliged to acquire the information they need. Therefore this is the first burden is on them and its effects on the decision-making job of NEDs, namely their remoteness from the company’s daily operations. NEDs spend between 30 and 40 days per year on average being engaged in the job, therefore it is considered a part-time position and in most cases, they have their other main profession. This fact does not allow them to be in charge of all the internal processes of the companies they monitor while they are expected to participate effectively in decision-making processes. The second challenge of non-executive director is the independence of NEDs. NEDs are entrusted to monitor those with whom they are colleagues. The question here is how objective and effective the monitoring role they can perform over the people they have close relationships. So need to define a more accurate and clarified supervisory role of the NEDS. This would improve their accountability function to shareholders.
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