INTRODUCTION
After the corporate scandals of Enron, Worldcom, Parmalat, Maxwell, BCCI and others corporate governance came into prominence and implemented in national laws.1 Corporate governance was created with certain reports include various kinds of recommendations. One of the recommendations for avoiding corporate failures and controlling the absolute power of management is to increase the significance of the role of non-executive directors who monitor the management of the company.2 Management’s power is crucial, because ‘power tends to corrupt, and absolute power corrupts absolutely.’3 This recommendation emphasised in several reports in the United Kingdom such as the Cadbury Report 19924 and the Higgs Review 20035 and modern role of non-executive directors became to fore with these reports.6 Before publishing of the Cadbury Report, the Bank of England evaluated the role of non-executive directors in 1984.7 This paper will critically evaluate the importance of the role of non-executive directors and its success for preventing corporate scandals.
NON-EXECUTIVE DIRECTORS
Firstly, it is important to evaluate certain causes of failure of the corporation to understand the role of non-executive directors, hence, The Financial Services Authority has stated certain points of failure on its board report which is published for the failure of the Royal Bank of Scotland. These points are; an ineffective board, a domineering chief executive officer, key posts held by individuals without the required technical competence, inadequate “four-eyes”8 oversight of risk and an inadequate understanding of the aggregation of risk.9 Some of the causes in the report also can be seen for the failures of Enron, Maxwell and other corporate scandals. In addition to points which were addressed by The Financial Services Authority, the Cadbury Report addressed that non-executive directors are one of the causes for corporate scandals.10 It is possible to define the non-executive directors' features as part-time, external, and independent.11
The Cadbury Report 1992 started a deep debate about effectiveness and responsibilities of non-executive directors because of the failure of Polly Peck, BCCI and Maxwell12 and after that, the role of non-executive directors was accepted in several reports as a monitoring mechanism for the corporations.13 This mechanism is a key point here because non-executive directors check the board and its actions. In other words, mentioned points above were tried to overcome by increasing the significance of the role of non-executive directors. Monitoring the board is the essential point here because the main reason for collapsing of American and British companies such as Enron, World.Com is accounting irregularities, which are manipulated accounting data and restatement of the accounts by showing profits as actual losses.14 Due to these reasons, the appointment of a non-executive component was important and this is the way to make difficult to manipulate the accounts by chief executive officers or external auditors.15 Related to this according to the Cadbury Report, non-executive directors should bring an independent judgement to bear on issues of strategy, performance, resources, including key appointments, the standards of conduct.16
One of the other problems whether or not non-executive directors are independent which means no business or family relationships among non-executive directors and top managers.17 The Cadbury Report stated that ‘given the importance of their distinctive contribution, non-executive directors should be selected with the same impartiality and care as senior executives’.18 The problem of 'old school tie' or 'old boys' club'19 was tried to avoid with this recommendation. Despite the Cadbury Report, according to subsequent survey, 70% of non-executive directors were selected by the way of 'old school tie'.20 The non-executive directors might lose their independence if they select with improper way.
The Cadbury Report also emphasised ‘the Committee believes that the calibre of the non-executive member of the board is of special importance in setting and maintaining standards of corporate governance’21. However as seen below, this recommendation is not found adequate by the Higgs, because the calibre of the non-executive member of the board is not preventing corporate scandals such as in Enron’s case one of the non-executives on the audit committee was a professor of accounting and former dean at Stanford Business School. Even after the Cadbury Report, the corporate scandals could not be stopped and other reports were published, besides Sir Adrian Cadbury already stated that the Cadbury report needs to be reviewed in the preface of the Cadbury Report.
The Higgs Review (2003) or Review of the Role and Effectiveness of Non-executive Directors was announced by the Department of Trade and Industry in 2003.22 Non-executive directors were described in the Higgs Review as ‘a non-executive director is considered independent when the board determines that the director is independent in character and judgment and there are no relationships or circumstances which could affect, or appear to affect the director’s judgment.’23 According to Higgs Review, the role of non-executive director's is as follows:
Strategy: Non- executive directors should constructively challenge and contribute to the development of strategy.
Performance: Non-executive directors should scrutinise the performance of management in meeting agreed goals and objectives and monitor the reporting of performance.
Risk: Non- executive directors should satisfy themselves that financial information is accurate and that financial controls and systems of risk management are robust and defensible.
People: Non- executive directors are responsible for determining appropriate levels of remuneration of executive directors and have a prime role in appointing, and where necessary removing, senior management and in succession planning.24
The Higgs Report recommends that the board need to consist of the majority, at least one-third, independent non-executive directors.25 The Cadbury had suggested that 'the board should establish an audit committee of at least three non-executive directors'.26 All these recommendations serve to monitor the board.
Additionally, the Higgs review recommended that one of the non-executive directors need to be appointed as a senior independent director and senior independent director should attend the meeting with several times.27 The main idea of the senior independent director is to make a connection between shareholders and the board and it is a significant role in the corporate body because shareholders sometimes have a difficulty to reach the board and this is the one factor for the failure of Maxwell and Poly Peck.28
The UK Corporate Governance Code 2014 based on reports and has similar recommendations with all reports such as the Cadbury Report and Higgs Review. It should not be forgotten, this is also a code and not legally binding. Finally, there is no distinction between executive and non-executive directors in the Companies Act 2006, it means the UK courts apply equally the same duties for both executive and non-executive directors. Contrary to this there is a strict distinction between non-executive directors and management in Germany that is a good example of Corporate Governance.29
CONCLUSION
Undeniably, all these attempts are very beneficial for corporate governance’s main aim, which is to prevent corporate failures. However, the main problem with these codes include recommendations for non-executive directors are soft law, in other words, these attempts are only a Code and compliance with it is voluntary.30 These attempts need to be a hard law for the best corporate governance and to hinder corporate scandals. Making code, which is not legally binding, is likely muted response after the corporate failures.31 The best example of the effectiveness of these codes, after a year that Higgs released, nine former non-executive directors of Equitable Life are sued for negligence and breach of their fiduciary duty in failing to take legal advice.32 Another point is board should reach decisions by the power of argument not by immediate resort to voting on issues, where the simple power of number would count.33 It being said that; to increase the number of non-executive directors may be not sufficient to reach a good decision for the corporation. Last but not least, separation of the duties in Companies Act 2006 would be beneficial because it is clear that non-directors duties are different in the respect of management’s duties. Making the duties clear in the Companies Act 2006 will increase the significance of non-executive directors like Germany. Besides dimension of the auditors, the increasement of legal responsibility of auditors might serve to avoid corporate failures.34
Lastly, it should not have been forgotten that, beyond all these solutions, non-executive directors ‘need to have intellect, integrity and courage. Of these qualities, courage is the most important, for without it the other two characteristics are useless’.35