How Have We Got Here?
The current debates around the roles, responsibilities and liabilities of NEDs are not occurring in a vacuum: as recently as October 2023 the Insolvency Service’s disqualification action against the NEDs of Carillion (on behalf of the Secretary of State) was dropped a few days before the trial was due to commence. The aim here is not to analyse individual cases but to understand the background issues and the implications in respect of NED duties and expectations more broadly. Not only are there relevant contemporary cases and challenges but also a history of reviews and reports on corporate governance, as well as academic reflection. In the short space available it is at least possible to summarise how we have got to this point.
2.1 Corporate Governance Reports
Corporate governance reports have been a feature of the British corporate and regulatory scene for many decades. They have been in more or less direct response to failure or scandal. As well as a regularly updated ‘UK Corporate Governance Code’[1] reflecting best practice there is also a history of reports that have specifically discussed the role of the NED. In addition, though beyond the main concern here, there have been proposals for a new governance regulator to replace the Financial Reporting Council (FRC).
This section will review the Corporate Governance Code and its guidance and also summarise the relevant provisions of previous corporate governance reports. Section 3 will return to legal and Section 4 to practical implications for this discussion.
The current Code, applicable to all UK companies with a premium listing on the London Stock Exchange and representing best practice for other companies, is the 2018 version published by the FRC. It has also published additional guidance, the most relevant being the ‘Guidance on Board Effectiveness’.
In 2024 the FRC published a revised Code that makes a number of amendments to that of 2018, particularly in relation to internal controls. The FRC also combined three elements of guidance, including ‘Guidance on Board Effectiveness’, into one document, the ‘2024 Code Guidance’, to which the online Code contains hyperlinks. The 2024 Code will apply mainly to financial years beginning on or after 1 January 2025.
The 2024 Code Guidance sets out the responsibilities of the various actors, including board chair, executive directors, the senior independent director and NEDs. Before turning to the specific roles and duties of the NED, it is worth noting what the Guidance says about directors more generally. Paragraph 69, dealing with the role of executive directors, states:
Executive directors have the same duties as other members of a unitary board. These duties extend to the whole of the business, and not just that part of it covered by their individual executive roles. Nor should executive directors see themselves only as members of the chief executive’s team when engaged in board business. Taking the wider view can help achieve the advantage of a unitary system, meaning greater knowledge, involvement and commitment at the point of decision. Executive directors are likely to be able to broaden their understanding of their board responsibilities if they take up a non-executive director position on another board.[2]
This paragraph recalls some of the basic principles of the roles and duties of a director and emphasises the importance of experience across the executive and non-executive roles. This is rather contrary to the perceived public narrative of ‘revolving doors’ – that is, of executives retiring from an executive role and immediately taking up a non-executive appointment – and a reminder of the educational theme at the heart of this publication.
The ‘Guidance on Board Effectiveness’ sets out several areas of guidance on board composition, roles, divisions of duties and other matters. The role of the NED is specifically commented on in paragraphs 75–78 and elsewhere. These points may be summarised as the importance of devoting sufficient time, demonstrating integrity, understanding the business and its culture and insisting on high-quality information. For example, the Guidance states in paragraph 76 that it ‘is vital that non-executive directors have sufficient time available to discharge their responsibilities effectively’.[3]
Paragraph 77 continues:
Non-executive directors need to insist on receiving high-quality information sufficiently in advance so that there can be thorough consideration of the issues prior to, and informed debate and challenge at, board meetings. They should seek clarification or amplification from management where they consider the information provided is inadequate or lacks clarity.[4]
The ‘UK Corporate Governance Code’ itself reflects a history of reports that have included the role of NEDs in wider reviews of corporate governance. The 1992 ‘Report of the Committee on the Financial Aspects of Corporate Governance’ (Cadbury Report) lays the foundation of the roles and responsibilities of NEDs in corporate governance. Paragraph 1.8 reinforces the position, now firmly established in both law and guidance, that ‘all directors are responsible for the stewardship of the company’s assets … [and] … whether or not they have executive responsibilities, have a monitoring role.’[5]
The Cadbury Report strongly advocated the unitary board system – that is, one single board (see Section 4.1) – and argued for the role of the NED in these terms: ‘the appointment of appropriate non-executive directors should make a positive contribution to the development of [the] businesses.’[6]
In paragraphs 4.1–4.6, Cadbury sets out its view that the roles of the NED are to:
- – bring a wider perspective to the business;
- – review board performances and effectiveness;
- – resolve conflicts of interest;
- – play a different role from executive directors even though equal in status.
A Remuneration Committee, consisting of NEDs, is an example of the last item in that the independent mind can reconcile the wider needs of the company with executive-director claims around pay, bonuses and other incentives, and ensure an alignment of interests between executives and members of the company.
Two other qualities the report brings out are independence and calibre. In respect of independence: ‘non-executive directors should bring an independent judgement to bear on issues of strategy, performance, resources, including key appointments, and standards of conduct.’
Naturally there are instances when such independence is threatened (for example, remaining on a board for too long or becoming too close to the executives), but sight should not be lost of the fact that Cadbury makes an articulated case and vision for the role and positive impact of NEDs in the conduct of business.[7]
Appearing in 1998, the Hampel Report[8] was another key building block in the development of the ‘UK Corporate Governance Code’. This reinforced Cadbury’s points on board balance, independence and the importance of the information supplied to NEDs – a recurring theme. Hampel also endorsed common duties for all directors but differed importantly from Cadbury in respect of the role of the NED.
Hampel argued that Cadbury overemphasised the monitoring role of the NED and insisted that NEDs ‘should have both a strategic and a monitoring function’.[9] This is an important corrective: in terms of public understanding of the NED’s roles, and indeed the media narrative, an overemphasis on monitoring at the expense of strategy has certainly been a feature of regulatory and legal actions against directors. Both Cadbury and Hampel argued for a substantial proportion of NEDs on boards.
A further piece of the framework came in 1999 with the Turnbull Report.[10] This focused principally on internal controls. The main points raised concerning NEDs are in respect of board balance. Turnbull argued that boards should be at least one-third NEDs and that no individual or group should exercise excessive power, and made other provisions, including in relation to audit committees and terms of office.
The Higgs Review of 2003, commissioned in the light of scandals and corporate failure, was specifically titled a ‘Review of the Role and Effectiveness of Non-Executive Directors’.[11] Higgs returns us to the strategy-versus-monitoring discussion and draws a distinction between US and UK developments, noting that: ‘the role of the non-executive director in this process contrasts with that of US regulators, who have tended to emphasise the monitoring role at the possible expense of the contribution the non-executive director can make to wealth creation.’[12] The report argued that lack of clarity around the role of the NED had been a recurrent theme in submissions to the committee.[13] Higgs reinforced the role of the NED around strategy, performance, risk and remuneration. The report also argued that at least 50 per cent of a board, excluding the chair, should be NEDs, hence a majority. One new feature was a recommendation that the NEDs should meet alone once a year.[14] Although some might argue that this introduces a division in the unitary view of a director, Higgs saw these as informal meetings that did not conflict with the wider partnership and trust across the board as a whole. The Review also picked up the question of diversity and the dangers of informality, and the use of personal contacts in the appointment process, which not only lacked rigour but tended simply to replicate the background of existing directors.
A final area of interest concerned the question of liability, which has become increasingly prominent. The overall position set out in Higgs has stood the test of time:
Although non-executive directors and executive directors have the same legal duties and objectives as board members, the time devoted to the company’s affairs is likely to be significantly less for a non-executive director than for an executive director and the detailed knowledge and experience of a company’s affairs that could reasonably be expected of a non-executive director will generally be less than for an executive director. These matters may be relevant in assessing the knowledge, skill and experience which may reasonably be expected of a non-executive director and therefore the care, skill and diligence that they may be expected to exercise.[15]
Consequently, there needs to be clarity around roles and expectations, appropriate induction and training and clear reasons given in case of resignation.
Higgs recommended a further review committee that would give prominence and guidance around the skills and experience needed to expand the pool of NEDs by identifying suitable candidates in the non-commercial sector. That came to fruition, also in 2003, as the Tyson Report,[16] which argued that: ‘Individuals with successful leadership careers in the non-commercial sector are likely to have attributes, skills and experience relevant to NED positions in the commercial sector.’[17] Examples included the chief executives or finance directors of large charities. Expanding the recruitment pool into the non-commercial sector was also likely to increase the representation of women. Tyson further recommended looking outside the domestic market.
2.2 Academic Considerations
Much of the discussion around non-executive directors in corporate governance codes draws on the academic literature, a review of which reveals three key aspects:
- 1. the NED’s acknowledged role and its development, as well as its increasing importance;
- 2. residual confusion over the role of the NED;
- 3. a variety of subsidiary issues, for example the pool of potential NED candidates.
The evolution of corporate governance has been shaped by a confluence of global changes and academic developments, each playing a crucial role in transforming governance structures worldwide. In the 1970s and 1980s, a seismic shift occurred, marked by more widespread shareholding, increased shareholder activism, hostile takeovers and leveraged buyouts, particularly in the USA. This period prompted a re-evaluation of corporate governance structures, emphasising the need to align the interests of shareholders and managers. While managers are tasked with maximising shareholder value (or at least acting in shareholders’ best interests), without adequate governance mechanisms they may make decisions that benefit themselves at the expense of shareholders. Simultaneously, in academic circles the 1970s saw the emergence of agency theory (though the ideas existed prior to the term), a foundational framework that scrutinised the principal–agent relationships within organisations. It refers to the idea that a principal actor (for example, the shareholders) appoints an agent (the board) to act on their behalf. This theoretical underpinning provided crucial insights into the conflicts of interest between shareholders and executives, laying the foundation for subsequent academic research and discussions on corporate governance.
The practical reforms in corporate governance gained momentum after the 1980s, not least with the many UK reports into it, the most significant of which, as they relate to NEDs, were discussed above. Consequently, the role of the NED became more prominent and was placed under more scrutiny, as a governance mechanism aimed at introducing objectivity and reducing potential conflicts of interest. Hence the global evolution of corporate governance has been influenced by both practical proposals and academic insights, representing an interplay between theory, regulatory responses and the ever-changing landscape of business practice.
The focus on agency theory has been significant. Each successive wave of scandal or failure has exposed divergence of interests between executives and shareholders, but also between business and society more generally. Mahmoud Ezzamel and Robert Watson summarised the thinking around independent directors, examining ‘the managerial and governance functions of the board of directors and the changes in terms of their composition and governance roles brought about by recent reforms’, and focusing on ‘the governance roles now expected of the non-executive directors on the board’:
In the US and UK, these part-time NEDs are now expected to undertake two distinct and somewhat contradictory roles. One the one hand, they are expected to be full members of the top corporate management team with exactly the same responsibilities for the formulation and management of corporate strategy as their executive board colleagues. On the other hand, however, they are also required to be independent of these same colleagues. This is because NEDs are also now expected to be primarily responsible for ensuring the quality and reliability of corporate information disclosures, keeping executives focused on the generation of shareholder value, via the design and implementation of appropriate employment and remuneration schemes, and the disciplining of their executive director colleagues that appear to be underperforming.[18]
The role of the NED has generally been affirmed in the literature. For example, Svetlana Mira, Marc Goergen and Noel O’Sullivan argue, albeit with perhaps an overemphasis on the monitoring role of the NED, that:
In the UK, over the past 25 years the board of directors has been emphasized as one of the most important instruments of corporate governance. Central to this has been an emphasis on the monitoring potential of non-executive directors, with successive governance codes stressing the need for significant non-executive participation on boards. Consequently, a majority of board positions in large UK companies are now held by non-executive directors. The expectation is that non-executives are able to actively monitor the behaviour of management, ensuring that corporate decisions are made in the interests of shareholders.[19]
Anup Agrawal and Sahiba Chadha found that the presence of independent directors and, indeed, good governance more widely, had a positive influence when dealing with accounting scandals.[20] Mira et al. found that ‘the non-executive labour market is efficient and rewards non-executives for good acquisitions’, by which they meant that a non-executive director associated with good board decisions is likely to have other future non-executive opportunities. Nevertheless, it is also the case that deficiencies in the role of the NED may be seen as contributing to the global crisis of corporate governance,[21] and that NEDs may be failing to make the executives accountable. There are also significant debates around appointment, not least the reliance on informal networks.[22]
A 2010 article by Alessandro Zattoni and Francesca Cuomo reviewed the literature on NEDs and concluded that:
- – Non-executive directors’ independence is a commonly recommended governance practice, the meaning of which differs widely among countries.
- – Non-executive directors’ competencies and incentives are not considered a governance issue to be regulated in detail.
- – Agency theory and the search for appropriate board demography tend to dominate the recommendations of governance literature and codes.[23]
In a sense this academic discussion reflects both the strengths and weaknesses of the public narrative around NEDs, which will figure more below. Independence is key, but also the idea of NEDs as guardians or buffers – stewards of the corporate good and a barrier between the executive directors and shareholders. Christopher Pass represented a more empirical approach in the literature with his study of 51 large UK companies and their boards drawn from annual reports.[24]
A further example of this empirical methodology came from John Roberts, Terry McNulty and Philip Stiles, who argued that too much of the academic literature on NEDs, governance and board effectiveness was dominated by agency theory and its underlying assumptions. Their study examined the effectiveness of boards and NEDs based on 40 interviews with directors commissioned for the Higgs Review, and concluded that board effectiveness was determined by conduct and behaviour more than governance and structure, though clearly these are not mutually exclusive. They argued that it is perceptions of board effectiveness, rather than the actual experience of directors, that might shape approaches to corporate governance reform.[25]
This swift consideration of the academic literature serves as a reminder of the conceptual basis on which the various reviews of corporate governance were built, and the continued importance of both ideas and practicalities.
Notes to Chapter 2
[1] Financial Reporting Council, ‘UK Corporate Governance Code’, London: FRC, January 2024; see https://media.frc.org.uk/documents/UK_Corporate_Governance_Code_2024_kRCm5ss.pdf.
[2] Financial Reporting Council, ‘Guidance on Board Effectiveness’, July 2018, paragraph 69, https://media.frc.org.uk/documents/Guidance_on_Board_Effectiveness_MmfcOrz.pdf.
[3] ‘Guidance on Board Effectiveness’, paragraph 76.
[4] ‘Guidance on Board Effectiveness’, paragraph 78.
[5] ‘Report of the Committee on the Financial Aspects of Corporate Governance’, December 1992 (Cadbury Report), paragraph 1.8, https://www.icaew.com/-/media/corporate/files/library/subjects/corporate-governance/financial-aspects-of-corporate-governance.ashx?la=en.
[6] The Cadbury Report, paragraph 3.15.
[7] The Cadbury Report, paragraph 4.11.
[8] ‘Committee on Corporate Governance, Final Report January 1998’ (Hampel Report), https://www.icaew.com/technical/corporate-governance/codes-and-reports/hampel-report.
[9] Hampel Report, paragraph 3.8.
[10] Internal Control Working Party of The Institute of Chartered Accountants in England & Wales, ‘Internal Control: Guidance for Directors on the Combined Code’ (Turnbull Report), September 1999, https://www.ecgi.global/publications/codes/internal-control-guidance-for-directors-on-the-combined-code-turnbull-report.
[11] Derek Higgs, ‘Review of the Role and Effectiveness of Non-Executive Directors’, January 2003 (Higgs Review), https://webarchive.nationalarchives.gov.uk/ukgwa/20121212135622/http://www.bis.gov.uk/files/file23012.pdf.
[12] Higgs Review, paragraph 1.12.
[13] Higgs Review, paragraph 6.4.
[14] Higgs Review, paragraph 8.8.
[15] Higgs Review, Annex A, p. 92.
[16] ‘The Tyson Report on the Recruitment and Development of Non-Executive Directors’, June 2003, https://web.actuaries.ie/sites/default/files/erm-resources/250_tyson_report.pdf.
[17] Tyson Report, p. 13.
[18] Mahmoud Ezzamel and Robert Watson, ‘Boards of Directors and the Role of Non-Executive Directors in the Governance of Corporations’, in Corporate Governance: Accountability, Enterprise and International Comparisons, ed. Kevin Keasey, Steve Thompson and Mike Wright, Chichester: Wiley, 2005, pp. 118–36.
[19] Svetlana Mira, Marc Goergen and Noel O’Sullivan, ‘The Market for Non-Executive Directors: Does Acquisition Performance Influence Future Board Seats?’, British Journal of Management 30:2 (2019), pp. 415–36, https://doi.org/10.1111/1467-8551.12290.
[20] Anup Agrawal and Sahiba Chadha, ‘Corporate Governance and Accounting Scandals’, The Journal of Law & Economics 48:2 (2005), pp. 371–406, https://doi.org/10.1086/430808.
[21] Jill Solomon, Corporate Governance and Accountability, 3rd edn, Chichester: Wiley, 2010.
[22] Jay A. Conger and Edward Lawler, ‘Building a High-Performing Board: How to Choose the Right Members’, Business Strategy Review 12:3 (2001), pp. 11–19, https://doi.org/10.1111/1467-8616.00179.
[23] Alessandro Zattoni and Francesca Cuomo, ‘How Independent, Competent and Incentivized Should Non-executive Directors Be? An Empirical Investigation of Good Governance Codes’, British Journal of Management 21:1 (March 2010), pp. 63–79, https://doi.org/10.1111/j.1467-8551.2009.00669.x.
[24] Christopher Pass, ‘Corporate Governance and the Role of Non-executive Directors in Large UK Companies: An Empirical Study’, Corporate Governance 4:2 (June 2004), pp. 52–63; DOI: 10.1108/14720700410534976.
[25] John Roberts, Terry McNulty and Philip Stiles, ‘Beyond Agency Conceptions of the Work of the Non-Executive Director: Creating Accountability in the Boardroom’, British Journal of Management 16:s1, pp. S5–S26 (2005), https://doi.org/10.1111/j.1467-8551.2005.00444.x.