Non Executive Directors

Non-Executive Directors – Role in Corporate Governance Muhammad Saeed Babar Reg.# MM073003

Non Executive Directors – Role in Corporate Governance Who is a NED? A non-executive director (NED) is a member of the board of directors without executive responsibilities in the company. He is included in the BOD to bring outside knowledge, breadth of experience and impartiality in the decision making process. He has all the same fiduciary and statutory responsibilities that other executive directors have towards the company and other stakeholders.

Importance of NED An NED is supposed to be an independent director and as it has been assumed that good board is a pre-requisite to good corporate governance, in the same fashion, it has been taken for granted that representation of an INED on the board makes a board balanced or good. But this is a dangerous misconception. Mere presence of an NED does not make a board good or bad; it is his independence or his fair opinion on a particular issue without any influence of whatsoever that makes his presence truly important for a board to be good.

Why have NEDs? A function of non-executive directors is to improve the quality of decision making by the board by: 1. Bringing a range of skills and experience to the discussions and decisions of the board 2. Acting as a counter balance, where necessary, to the influence of the chairman or CEO over board decision making

Sources of Getting NEDs To be effective, a NED has to understand the company’s business but there appears to be a general consensus that the experience and qualities required of a nonexecutive director can be obtained from working in other industries or in other aspects of commercial and public life. Non-executives might therefore be recruited from individuals who: 1. Are an executive directors of other public companies

2. Hold non-executive director positions and chairmanship positions in other public companies 3. Have professional qualifications 4. Have experience in government, as politicians or former senior civil servants

Types of NED Following are the different types that are common in corporate world 1. Nominees / Representatives – these represent some interest in the company. These could be nominees of institutional investors or one major shareholders or nominee from the government. 2. Independent – NEDs are assumed to be independent.

Role of NEDs Higgs report of 2003 looked at the role of NEDs and it is as follows: 1. Strategy Formulation – NEDs should constructively challenge and help develop proposals for strategy. 2. Performance Evaluation – NEDs should scrutinize the performance of executive management in achieving agreed goals and objectives, and monitor the reporting of performance. 3. Risk – NEDs should satisfy themselves about the integrity of financial information and that the systems of internal controls and risk management are robust. 4. People – NEDs are responsible for deciding the level of remuneration for executive directors, and should have a prime role in appointing directors and in succession planning.

How many NEDs The 2003 revised Combined Code sets out differing requirements for large listed companies and for smaller companies. 1. Except for smaller companies, at least half of the board, excluding the chairman, should NEDs. 2. All NEDs are majority of them should be independent.

NEDs on Board Committees There are no legal requirements to establish board committees but three committees are recommended by the Combined Code: 1. A nominations committee 2. An audit committee 3. A remuneration committee

Independence of NEDs Non-executive directors are either independent or non-independent. A NED is not independent if his or her opinions are likely to be influenced by someone else, in particular, by the senior executive management of the company or by major shareholder. Independent non-executive directors are supposed to bring an independent view to the deliberations of the board. If a non-executive director is likely, for one reason or another, to take sides with the CEO, he or she is unlikely to bring the much needed balance of power to the board. Inducting NEDs to the board just to comply with the law is not a healthy practice. Companies should actively seek to avail the benefits of NEDs in order to improve the decision making by the board.

Measurement of Independence The independence of a non-executive director could be compromised, if the individual concerned: 1. Has a family connection with the chairman or CEO 2. Until recently used be an ED in the company 3. Until recently used to work for the company as a consultant 4. Receives payments from the company in addition to his fee as NED 5. Has material interests in the company such as a. Income from the company b. Stake in profits of the company or has interests in the movement of share price of the company 6. Has inter locking directorship with other directors 7. Has been on the board for quite some time

The Senior NED An independent NED recognized as the senior individual amongst the nonexecutives. It has been suggested that the board of directors of large companies should nominate an independent NED as the senior NED whom shareholders could approach to discuss problems and issues when the normal communication route through the chairman had broken down. It is also recommended that the NEDs should meet at least once in a year under the leadership of SID without the chairman being present, to discuss the chairman’s performance.

Criticism on INED Insufficient Knowledge The quality of decision making depends largely on the quality of information available to the decision makers. It is the responsibility of the chairman to supply timely information in a form and of a quality appropriate to enable NEDs to discharge their duties. However, the senior executives in a company control the information systems and so control the flow of information to the board. It is quite imaginable that the CEO or other EDs might have blocked the critical information from the board or it is presented in a distorted manner. The lack of this aspect of insider knowledge of EDs about business operations and having to rely on the integrity of the supplied information restricts the scope for NEDs to make a meaningful contribution to board decisions.

Insufficient Time NEDs often have executive positions in other companies and organizations, where most of their working time is spent. As a general rule, NEDs don’t have an office at the company HO and may spend one or two days a month on the company’s business. A further criticism of NEDs is that some individuals hold too many NED positions, so they can’t possibly give sufficient time to any of the companies concerned.

Overriding Influence of EDs Another criticism of NEDs is that if a difference of opinion arises during a meeting of the board, the opinions of the EDs are likely to carry greater weight because they know more about the company. NEDs may be put under pressure to accept the views of their ED colleagues.