NEDs change face

UK listed companies look set to face a boardroom shake-up following Derek Higgs’ much-publicised review of the role and effectiveness of non-executive directors. The question on most people’s lips is whether British boards will work more effectively if Higgs’ guidelines are put into practice and where the new generation of NEDs will come from.

Last June the UK government appointed former investment banker Derek Higgs, to lead a review on the role of NEDs with a focus on listed companies. In launching the consultation paper Higgs said to enhance British productivity and competitiveness “the progressive strengthening of the role of non-executive directors is strongly desirable.”

The government has stated that an approach based on best practice rather than regulation or legislation is its preferred starting point. The review has prompted huge debate over what non-executive responsibilities should be, how much they should be paid, and how many such positions one person can hold. The National Association of Pension funds, which represents about 1,000 pension schemes, told Higgs in its submission that NEDs must be prepared to expose failures in corporate governance and resign if a board does not act on their concerns.

In his review Higgs focused on the balance of power within the board – recognising the pivotal role of the chairman in the effectiveness of the board and NEDs in particular. His recommendation that the chief executive should not go on to become chairman of his company is a controversial one, as many FTSE 100 companies fall foul of this. Higgs also suggests that at least half the members of a board, excluding the chairman, should be independent non-executives, free from potential conflicts of interest. This should give NEDs a much more central role in decision-making and accountability.

Higgs has also set out guidelines for the maximum number of non-executive roles any one director should hold. This should put an end to the “old boys network” of non-executive appointments and means the pool of effective and experienced NEDs will need to increase.

But in the light of recent corporate scandals, there is a worry that the supply of suitable candidates for non-executive roles will dry up. Many consider the pay of NEDs too low given the seniority of the position, the time commitment and the fact that an NED holds the same legal responsibilities as an executive director. And so companies may have difficulty attracting candidates of the right calibre without some kind of remuneration adjustment.

Higgs is encouraging a more rigorous process of selection and he also wants companies that are recruiting to look beyond the stereotypical male executive nearing retirement. Jane Tozer, co-founder of the IT Non-Executives Association (ITNEA), responded to Derek Higgs’ initial review in August 2002 and is amazed at how many CEOs and executive directors do not know what to look for in their non-execs. She says: “Many have appointed NEDs who will not get in their way or rock the boat. My only reservation to the review is that NEDs must be seasoned directors with relevant experience to the position to which they are appointed, and not ‘lay people’ as Higgs seems to suggest.”

For the VC world, the review is not going to have a major impact because in most cases good corporate governance standards are already in place. The question that arises from the current review is where public companies are going to find higher quality NEDs? The answer may be the private equity market, which employs thousands every year.

Nigel Read of law firm Lovells says: “Given the sort of qualities that are expected of NEDS now, companies will need to cast their net more widely and need to look at more areas and I think private equity houses are one area and also lawyers and ex-lawyers are another area.”

VC and PE houses use board representation as a central tool in the governance of portfolio companies and could provide valuable experience to NEDS of public companies. NEDs of a VC-backed company have to be of a high calibre in order to nurture the company and guide it towards a successful exit. Andrew Goodman, chairman of Renoir Partners, a global executive search firm, says: “In placing NEDs within private or VC-backed technology companies, Renoir Partners has a responsibility to ensure that these directors deliver. If the NED is unable to put corporate governance processes and structures in place, the likelihood of the exit strategy failing increases significantly.”

In order to be implemented formally Higgs’ proposals need the approval of the UK listing authority. Nigel Read says: “The changes are a more radical proposal than people expected. I think it will take a bit of time, but there will be an onus on quoted companies to comply and I believe over time shareholders will become increasingly dissatisfied if companies aren’t changing their ways. From all intents and purposes one can assume that the die is cast and changes will take place. I don’t think the fact that formal changes aren’t in place yet will make a lot of difference.”