Finance: A time for more independents in the boardroom

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The Independent Culture
The latest review of corporate governance proposes changes in the roles of directors. Anthony Carey suggests they do not go far enough.

Good governance is about promoting both prosperity and accountability, Sir Ronnie Hampel's Committee on Corporate Governance said. Everyone would surely agree. But as committee members sift through responses to their preliminary report after the end of the comment period, it will be apparent that views differ on how these objectives can be achieved.

The primary responsibility for ensuring good governance in a company must rest with the board of directors. It is critical that the right board is in place and that it functions in the most effective manner possible. Directors are in the best position to prevent problems arising; others such as shareholders can generally only take action once difficulties have started to emerge. So Hampel's suggestion that boards might wish to consider monitoring their collective performance and that of individual directors is welcome.

The way in which directors are selected is crucial. When a director is to be appointed, companies should establish a nomination committee. The membership should be mainly independent non-executive directors.

Increasingly, large listed companies are using headhunters to identify possible candidates, which is a positive development. The committee's view that people from a wider range of backgrounds than currently represented on boards could make a real contribution as non-executive directors deserves strong support.

There should be an appropriate separation of roles at the head of a company. The chairman is responsible for running the board and the chief executive for managing the business. Those are separate roles and should not be combined in listed companies, save in exceptional circumstances, since such a combination represents a very substantial concentration of power in the hands of one member of the board, creating the risk that they will exercise undue domination over decision-making. In recent years, substantial progress has been made in separating the roles of chairman and chief executive.

The Cadbury Committee's "Report on Compliance with the Code of Best Practice", for example, found that more than three-quarters of the top 1,550 listed companies now did so. One would wish to see more, not fewer, companies keeping the positions separate in the future. The final report of the Committee on Corporate Governance needs to place greater emphasis on the importance of this happening.

Another matter deserving more attention in the final report is the need for companies to have a strong cadre of non-executive directors who are independent of their executive colleagues. The word independent should be included at the beginning of the requirement in the Cadbury Code which states that the board should include "non-executive directors of sufficient calibre and number".

Guidelines should be laid down by the Committee on Corporate Governance for inclusion in the Cadbury Code, or its successor, on the definition of an independent director. Companies will naturally have to decide whether an individual satisfies the relevant criteria but it would not, for instance, be reasonable to regard former executive directors or those with close personal relationships with executive directors as independent. Moreover, independent directors should not be financially dependent on the remuneration received from the company and should not have other business relationships with it.

The membership of the audit committee should be required to be made up wholly of independent directors: currently it is required to have a membership comprising not less than three non-executive directors, at least two of whom must be independent. More discussion of the role audit committees can play in promoting good governance could also be helpful.

There is currently confusion in the business community about the relationship between the new statement of principles proposed by the Hampel Committee and the existing Cadbury and Greenbury Codes.

The preliminary report recommends that a statement be included in the annual report setting out how key corporate governance principles have been applied. In practice this would, however, only be likely to lead to "boilerplate" disclosure in many instances. The present structure of the codes, primarily based on exception reporting and given formal backing by the Stock Exchange Listing Rules, has worked well and should be retained. A case has not been made for deleting existing provisions of the present codes.

Hampel's view that account should be taken of the concerns about the law on liability by those taking decisions on changes in the law is welcome. Corporate governance would be considerably strengthened under a system of proportional liability where all parties involved in managing and advising a company took a fair share of risk and liability. This would be a powerful incentive for those parties to improve their performance and for shareholders to take a more active role.

If the non-statutory approach embodied in the Cadbury and Greenbury codes is to be successful over the long term, the successor code needs to retain the widespread confidence of shareholders, employees, government and others. It must be robust and durable, effective in recessions as well as in periods of prosperity.

Anthony Carey is secretary of the Corporate Governance Group of the Institute of Chartered Accountants in England and Wales.