Stevenage Accountant T: 0845 643 1825 | E: info@eebusiness.uk.com


Corporate governance – more detailed areas

THE ROLE OF DIRECTORS

Directors have a fiduciary duty, meaning a position of trust.
Directors could, for example, use their position for personal gain.
Their fiduciary duty is:

  • To disclose all information held.
  • To disclose any personal profits made from their position as director.
  • To disclose any potential conflicts of interest.

Non-executive directors:

A non-executive director, or NED for short, is not involved in day-to-day direction of the company, unlike the Executive Directors. The roles of the NEDS are:

  • to contribute to company strategy
  • to monitor the performance of the Executives
  • to monitor risk management and financial reporting
  • to appoint, remove, and decide the remuneration of the executives.

Independence of NEDs:

Anyone in a monitoring role needs to be independent of what they are monitoring. For NEDs this means having no connection with any part of the company:

  • Not an employee within the last 5 years.
  • No business relationships within the last 3 years.
  • Only remunerated with a fee for director duties – no profit share or share options.
  • No close family ties to the company.
  • No cross-directorships – this is where the directors of 2 companies sit on each other’s boards as non-executives. Whilst there may be sensible business reasons for this, to promote links between 2 companies, it means that 2 directors are closely linked, and that both may favour one of the 2 companies over the other.
  • Any NED who has been on a Board for >9 years is assumed to no longer be independent.
  • Any NED representing the views of a major shareholder would be deemed not to be independent.

    If a director is not independent, it does NOT mean that they must leave the Board! It simply means that for Corporate Governance purposes, that director will not be considered an Independent NED … so an additional Independent NED may have to be added to ensure the correct balance.

 

The chairman and CEO roles:

  • Historically, many companies saw the promotion of a CEO to Chairman as the final promotion someone could get.
  • In other companies, especially in the USA, the lead director would often be called Chairman & Chief Executive, as many companies preferred to have a single person in charge making decisions.

The modern view is that there should be NO links between the Chairman and CEO:

  • Not the same person.
  • The CEO of a company should not become Chairman.
  • There should not be other links between the 2 people (eg close family relationship).

    By having 2 powerful people on a Board who are independent of each other, it should ensure that no one director is able to dominate the Board.

 

THE NOMINATION COMMITTEE

  • Role is to monitor the Board and Committees and ensure appropriate membership.
  • Have to decide type of people needed to ensure balance and skills on the Board.
  • May use outside “executive search” agencies (headhunters) to approach potential candidates.

 

BOARD OF DIRECTORS – PERFORMANCE REVIEW

  • At least once a year, the Chairman must organize an appraisal of the performance of:
    • The Board.
    • Each Board Committee.
    • Each individual Director.
  • Many companies do this internally – although this creates some problems, as all of the directors end up appraising each other!
  • As such, some companies use outside experts in the process, to try to make it more objective.

 

REMUNERATION OF DIRECTORS

Director remuneration needs to be:

  • Enough to attract, retain and motivate directors
  • But should not be excessive
  • It must also be fully disclosed, with all detail, on a director by director basis in the Annual Report.



There are 5 key elements to a remuneration package for Executive Directors:

  • SALARY – which will be based on similar salaries in the Industry, and at similar size companies, and on the skills and experience of the individual director.
  • PENSION SCHEME CONTRIBUTIONS – which are typically a % of the base salary.
  • BENEFITS – such as company car, travel expense allowances, health care etc. In some companies benefits may increase based on performance, but in many companies they are fixed.
  • BONUS – typically based on annual performance measures, to motivate short term performance.
  • LONG TERM SHARE OPTIONS – to motivate in the longer term. The more directors can drive up the share price, the more reward they will get.



The balance of this package needs careful thought, as there are plenty of potential problems:

  • Salaries need to fit in with the salaries of others – or jealousy is likely.
  • Benefits should be company-related. Directors who travel a lot would be more likely to get a company car, for example. Directors who attend many public events may get a clothing allowance.
  • The annual bonus could lead to manipulation of the Financial Statements, or a deliberate attempt to inflate short term profit (which may harm long term profit). It would be sensible to link the bonus to several measures, and not just those that are aimed at financial results:
    • Profit
    • Market share
    • Growth
    • Reduction in staff turnover
    • Reduction in customer complaints
    • Reduction in pollution.
  • Share Options, if very profitable, could result in a director retiring the moment they are exercised! Often directors will not be able to take all of their gains in one go, to try to tie them to the company for at least another year or two!

 

INSTITUTIONAL SHAREHOLDERS

Traditionally, institutional shareholders (e.g. pension schemes) have been “conservative” by nature:

  • They would often have such large amounts invested in companies, that they preferred to let the directors make short term mistakes, as long as they still trusted them in the long term
  • They would often allow directors to grant themselves large pay rises, because compared to their billion pound investment, a few extra million on a salary is immaterial



With their shareholdings being large, and their votes therefore considerable, corporate governance regulations have tried to target institutional shareholders to encourage them to be more active, and to use their votes wisely.

If a Board is underperforming, one large shareholder could create change, whereas smaller shareholders may not have enough “weight” to achieve anything.

In recent years, institutional shareholders have indeed become much more active:

  • Partly because corporate governance has encouraged them
  • Partly because many have seen that improved governance leads to increased share prices
  • Partly because those whose funds they are investing are putting more pressure on!



Institutional Shareholders are likely to intervene in a company if:

  • Company is consistently under-performing
  • Company’s reputation is poor
  • Directors are failing to communicate with shareholders
  • They have lost faith / trust in the directors
  • Company’s strategy appears too risky / not risky enough
  • Consistent failure in company systems
  • Repeated fraud.