What Do We Really Want from a Non-Executive Director?
The public narrative around NEDs illustrates a real tension between a proper desire to hold directors to account and a lack of understanding of the nature and complexity of the NED role. Complaints about ‘cosy clubs’, ‘asleep at the wheel’ or ‘overpaid’ NEDs will often feature on front pages at times of crisis.
We might ask, therefore: What is the real point of a non-executive director? Do we need such a role and, if so, what are the reasonable expectations and standards against which we might measure performance and accountability? Reputation matters for qualified individuals, and if we fail properly to establish expectations and boundaries, fewer quality candidates will accept the role, particularly if rather than being overpaid, as per the popular narrative, the risk/reward ratio becomes a disincentive to accepting office.
There is also a clear distinction to be drawn between SMEs and large public companies, often with multiple subsidiaries and geographical locations. How much grasp of detail should be expected of NEDs? How much can NEDs reasonably rely on assurances from management or professional advisors? Are NEDs expected to know of every activity, or even error or fraud, in every small subsidiary in a complex corporate structure? Society must be clear if that is what is expected – and then not be surprised if few wish to accept the responsibility.
There is a clear disconnect with the public, policymakers and regulators, which has led to the emphasis on criminal liability. There is a reason why we have NEDs as part of the functions of corporate structure at the level that we do, namely the proper exercise of governance. However, we do need greater clarity over their role and the expectations of society.
4.1 Boards
The nature of boards is a central feature of corporate governance reviews and discussions. The tradition in the UK, at least for listed and significant private companies, has been for a unitary board containing both executive and non-executive directors. This contrasts with some European approaches to corporate governance, which feature a supervisory board composed exclusively of NEDs sitting over a board of executives. There have sometimes been suggestions that the UK should adopt a similar model. In company law there is nothing to prevent UK companies adopting that approach (at least notionally, even if legally there remained one board), but in practice they have not. Nevertheless it is an important principle that nothing in law or practice requires a director to function as an executive; indeed, there is something both distinctive and important in the very idea of a non-executive director.
The contention here is that boards, executives and NEDs are all more effective in their strategic and accountability roles if they sit on the same single board, in the same room, have the same information before them (although, as discussed below, in practice the executives will have more company knowledge and information at their disposal), interact with one another and hold one another to account.
The attractions of the supervisory board – with its inherent separation of structure, people and function and yet within a system that views all directors as equal – are illusory. Indeed, the existence of such a model with Volkswagen did not prevent the 2015 emissions scandal and little suggests it assisted with the response. There is no evidence that a supervisory board model results in more effective corporate governance than a unitary system.
A single unitary board also brings both executives and non-executives into regular contact with advisers (auditors and lawyers), which can only enhance the governance process. Boards have traditionally, of course, been the slaves of the shareholders. Although these still appoint or remove the board, there is increasing recognition of the importance of other stakeholders. A variety of personnel on a single board not only prevents the passing of responsibility to others who are not in the room, but can also ensure a mix of voices are heard at the table.
However, that is not to say the existing structure works perfectly. There are several improvements that would enhance the role of all directors but which have particular relevance for NEDs.
One question relates to the number of executive directors on a board relative to non-executives. It is revealing that the regular flow of governance reports saw a steady increase in the recommended proportion of NEDs. This went from one-third (Turnbull Report, 1999), to a majority (Higgs Review, 2003), to the practice that seems most common today, especially in larger companies, of only two executive directors on the main boards (the Chief Executive Officer and the Chief Financial Officer, although others such as the General Counsel may be invited to attend).
This trend carries a number of implications. First, there is a potential concentration of power in the hands of one or two directors, in particular a chief executive, who might easily dominate one other senior executive on a board. Even if others attend, the effect is to diminish the range of comment and expertise. This may also weaken the wider insight available to NEDs and render them more dependent on the chief executive, in detriment to their strategic role. Second, and related, the existence of a wider group of executives on the board can act as a constraint on the chief executive – there are more voices that might challenge and/or offer alternatives. There is always the contrary danger, of course, that executives might not challenge a chief executive, but formal board membership rather than an invitation to attend makes the wider responsibilities much more explicit to all parties. Consequently, a board is likely to be better advised and able to make better decisions.
This does also raise the wider question of board composition and diversity in relation to NEDs, which Section 4.4 below will consider.
In conclusion, the role of non-executive director is best discharged within a unitary board, with a minimum of one-third executive directors (although NEDs should remain in the majority). This would enhance not only the diversity of skills on a board but also the shared mutual responsibilities it bears. It is a structure that gives the maximum weight to ensuring the appropriate balance of expertise and experience.
4.2 Purpose and Independence
Clarity over the role and purpose of a non-executive director is core. There is a clear tension in the governance reports and the academic literature between the strategic and the monitoring roles of the NED. This goes to the heart of purpose. It is, perhaps, imbalance between these two roles that has led to unrealistic expectations among the public and policymakers, a confusion that might also lie behind the failure of some recent actions for disqualification, when the actual actions of directors are compared to legal duty and found wanting.
The NED is a long-term company steward if nothing else, and must therefore be both allowed and encouraged to focus on long-term strategy, alongside the expectations of monitoring, accountability and compliance. An effective NED will give weight to strategy, its development and assessment of progress towards achievement. This should lie at the heart of expectations.
As well as steward, Christopher Pass, noted earlier, sees the non-executive director as guardian. But steward or guardian of what? On a narrow basis we might argue that NEDs are stewards of the assets of the company, although that is not a responsibility specific to them but resides in the whole board. But the stewardship specific to a non-executive director goes much deeper. For Pass, the guardianship offered by the NED is of the corporate good of the company, although this still leaves the issue of definition. Some might argue that corporate good lies specifically in the maximisation of shareholder value, others that it should embrace a wider concern for stakeholders, for purpose and for society.
A few observations can be made. First, the NED role is long term. A recent report from PwC noted that the median length of service for a chief executive was five years. In addition, in the years reviewed (2000–18), although there were some longer-term CEOs there was also increased turnover. The report also noted a rise in ethical lapses and failures.[1] The NED can take the long view of a company, its history and wider purposes and what one might call the company’s well-being. Could we, then, see NEDs as long-term stewards of the company’s well-being and purpose?
Second, the NED role is, at least in part, strategic. We need to articulate, and have recognised in law, that a key role of a non-executive director is strategic oversight. Clearly, as the Higgs Review noted,[2] there is a balance to be struck between the strategic and monitoring roles, but an overemphasis on compliance may have the unintended consequence of directing NED attention away from strategy. Both are needed. Executives are focused on company performance, probably rightly; non-executives can place that in a broader context of strategic direction. This requires high levels of competence, independence of mind, vision and experience (see Section 4.4). The combination of the long-term and strategic aspects of the role of NEDs is essential to their very purpose, fundamental to the success of a company and foundational to the proper exercise of corporate governance in the social contract between business and society. It is for this reason that we need both greater clarity about the role but also more celebration of the NED.
Third, the NED is independent. This is more complex than it appears because some of the allegations laid at the door of NEDs concern actual or perceived threats to independence and the problem of loss of objectivity through long periods of service (that is, there is a degree of tension here with the long-term role of the NED). These are often issues of culture, and one function of an independent NED is to observe and, where necessary, challenge inappropriate cultures.
The NED represents an independent check on the executives, at one remove from the daily business of the company. He or she expresses the principle of independence in both approach and function. In terms of approach, their role is to bring an external view and an enquiring mind to the board. Their independence is born of both character and experience (again, more on this in Section 4.4). In terms of function, independence is in practice written into board structures through the particular roles and functions of NEDs, worked out in how they operate in respect of specific board committees. We see this in examples such as the nominations committee (appointing of board members), remuneration committee (setting remuneration, incentives and bonuses for senior executive) and audit committee (accounting and internal control oversight and liaison with external auditors). These are essential functions and activities of corporate governance, and the role of the NED is indispensable to their effective discharge. Society benefits from the external voice, the proper assessment of – and even constraint on – executive remuneration, the ensuring of good governance. These activities and responsibilities are key levers for the oversight of the company, its strategy, performance and key appointments, including advisers. In addition, NEDs play a central role in both the hiring – and firing – of the chief executive.
One of the complexities contributing to the confusion about role is the danger of overemphasis on monitoring, policing and compliance. Inevitably, the more weight put on this, the stricter will be the liabilities applied (‘Did the NED tick this box or that?’) and the less useful will be the role itself. There is an appropriate place for monitoring and accountability, but without the independent NED’s strategic, long-term stewardship of the company’s well-being and purpose, the corporate governance process will be the poorer and the flow of quality candidates reduced. Society will be less well served.
4.3 Time and Information
Time and information are central matters of concern in non-executive directors’ proper role and discharge of responsibilities. It has been shown that although the law recognises only one type of director, there are differences in the way directors’ duties apply, according to context. This was clear in discussion of Section 174 of the Companies Act and the various proceedings for potential disqualification under the Company Directors Disqualification Act. It was also noted that there is one general duty of care, skill and diligence, but that duty is limited by a general test of reasonableness and by the particular responsibilities and context.
Nowhere does this distinction come more into play than in the amount of time dedicated to a task by – and the nature of the information in the hands of – a non-executive director and an executive respectively. Any proper appreciation of the role of the NED requires evaluation of this difference.
The first issue is the time directors are able to dedicate to the business. The executive director is full time and their entire focus is on the company and their particular responsibilities. Hence the Chief Financial Officer, both in skill and role, will have considerably more expertise and capacity to acquire, process and indeed understand financial information. The same is true across the range of executive responsibilities. Contrast that with the typical NED, who might spend perhaps two days a month on company business. Not only is this a fraction of a full-time executive’s time, it may not be the NED’s only appointment. Consequently, the NED may feel they are always playing catch-up, needing to absorb and analyse information in a short timescale and possibly under pressure. Equally, the NED is always learning – no bad thing, but they have to contend with what is the daily beat of the executive with less time and potentially fewer direct skills.
This is not to excuse NEDs from their proper duties and responsibilities. Rather the intention is to expose the problem of the time gap between executives and non-executives.
It is largely for this reason that although the general duty still applies, it is unreasonable for the law to expect identical liabilities to accrue under such different circumstances. As was shown, the law does not so expect. A non-executive director cannot have full awareness of every issue or problem in a complex corporate structure. Perhaps corporate structures themselves have become too complex, impeding the flow of information (a topic in itself); in any event there needs to be greater understanding, clarity of expectation and proper responsibility in recognising the consequences of the time differential.
This issue is reinforced by the information challenge. Executives and non-executives are in possession of different information, at different levels of detail, for the very reason that their roles and time commitments are different. Hence it is more than possible for the volume of information to overload (a quantity problem) or even overwhelm (a comprehension problem) a non-executive director. This may result in poor decision-making if papers are not properly read, understood or weighed up, and if trends and material changes are not identified and assessed. Similarly, the outcome may affect the ability of the NED properly to discharge their legal duties and, indeed, their wider responsibilities to society.
As a result, what is important for the effective NED is not quantity of information but quality. They must have in their possession information that is summative, strategic and suited to the decisions in hand, as well as access to relevant company personnel and professional advisers. Information is also power, hence it is a further test of NED quality and independence that they be able to secure the most apposite information, presented to them in the most useful way for their purposes. Information must also be delivered to the directors – but especially the NEDs – in a timely fashion.
If the role of the NED is to make effective long-term strategic decisions in the best interests of the company, then the information received will inevitably be summative – covering key issues, backed by analysis, but avoiding excessive detail that might hamper effective decision-making. Nonetheless, the NED has a responsibility to press for the information they need to facilitate decision-making.
The question, then, is not whether the NED knows everything, or even made the correct decision, but whether they made a decision that a reasonable person could have made in the context.
There is also a gap between what information actors in media and public policy seem to assume NEDs have at their disposal and the reality – the nature of the information, its presentation and its digestibility. To define expectations of NEDs and appreciate their role, this gap needs to be closed – essentially, then, an education exercise (see Conclusions and recommendations below).
4.4 Character and Experience
It is clear that the role of the NED carries significant responsibility but also serves wider business and society. While debating role, function, purpose, independence and so on, there is something more intangible at the heart of the effective NED, namely character. The combination of high moral character with the experience acquired over many years of executive responsibility delivers the highest-quality NED who, other things being equal, will deliver integrity and honesty in all dealings.
We should not shy away from a debate around moral character, by which is not meant particular religious convictions or commitments to various personal behaviours, but something deeper. What are the values that form and shape the life of the particular individual? Do they reflect the central importance of integrity, honesty, transparency, objectivity, selflessness, accountability and leadership – in other words, the ‘Nolan’ principles of public life?[3] These values represent moral character and we should expect them in all walks of public life, including business, boards and NEDs.
Hence character is an important starting point, not least because it is about the inner person, before that is overlaid by other aspects of life within or without business. The effective NED does not lay moral character over other skills and experiences, rather it forms their very basis.
How might this character be expressed in the potential or actual NED? We would expect some combination of service and leadership but also curiosity and an enquiring mind. These are the characteristics that lead to asking the right questions, probing effectively and providing an outlook of long-term stewardship and strategic direction and decision-making.
But while character is central it is not alone in the formation of the NED. The most effective NEDs bring to the board experience, wisdom and insight gained from careers elsewhere in business, most often as executive directors.
This does, of course, raise again the question of board appointment and diversity. It is hardly surprising that corporate governance reports and academic reflection lend weight to the question of appointment, ensuring proper processes – rather than informal networks – and enhancing boards’ diversity. There are good reasons to welcome this trajectory – it would be strange to argue that boards do not benefit from a diversity of backgrounds. However, elevating monitoring over strategy is likely to result in recruitment of lower-quality NEDs, with insufficient weight lent to business experience and leadership.
The effective NED will be a person of moral character and relevant experience. They will be naturally inquisitive and curious, deeply imbued with the values and principles reflected in Nolan. The law does provide protection for acting in good faith, and when the director has acted honestly and reasonably in their decision-making. Perhaps we need to make these expectations of character and experience more explicit. This would make clearer the qualities necessary for effective discharge of the role.
4.5 Getting Liability Right
Company failures happen, alongside frauds and other misdemeanours. Most people consider it appropriate for society to hold individuals to proper account. In some cases there may be culpability, and the law can impose sanctions, from prosecution for criminal offences to civil proceedings for disqualification as a director. However, in other cases, instances of failure, insolvency or simply corporate difficulty are just part and parcel of the nature of the market economy.
In holding directors to account, the question arises whether society’s expectations of what boards and NEDs can achieve are out of kilter with reality, reflecting at the least misunderstanding. There is too the problem of the desire to apportion blame. The high bar (gross incompetency) in the case of official actions (for example, proceedings for disqualification) may be difficult to prove and not even accurate in law. Yet there is pressure to take action due to the mismatch of expectations. The burden of court proceedings can pressurise defendants to settle, which might not be entirely just. The government Insolvency Service has faced criticism from the courts for its handling of disqualification cases (see for example Farepak (2012) and in Re Keeping Kids Company (2021)). Liability must be about actual culpability based on fair evidence, not simply potentially arbitrary allocations of fault.
What is important is the nature of any potential liability. Recent cases have pursued what is generally known as a strict liability, and this may have significant consequences. It means holding a director liable for certain conduct or actions without regard to either their state of mind or the reasonableness of their actions. Thus in the case of Carillion, it was argued that the NEDs were strictly liable in the matter of executives’ misconduct in respect of alleged false accounting, regardless of their efforts to inform themselves. The consequence is that from the moment of appointment the director is strictly liable, assumed to be in possession of full information and knowledge of the company, its finances and all other aspects of its operation, without taking into account the reasonableness of their actions. Hence they may be subject to proceedings (for example for disqualification), irrespective of their actual role, knowledge or actions. This is not the law as it stands, nor should such a strict liability form part of the regulatory armoury – it would be damaging to the NED role, to business and to society.
The Insolvency Service, however, seems to have pursued exactly this policy in some recent cases. The aim here is not to debate the merits of recent failures and scandals or to apportion blame and culpability, rather to consider specific liabilities laid at the door of NEDs (leaving them exposed to disqualification proceedings), as well as implications for the role itself. Thus, in Re Keeping Kids Company (2021), Falk J made clear that the Official Receiver had failed to make out a single allegation against any of the directors. What is perhaps more surprising is that the mistake was repeated in the failed attempt to proceed against the NEDs of Carillion:
legal experts and defense counsel said the case was unclear, wrong in law and repeated mistakes made in the government’s failed attempt to disqualify the trustees of a charity in 2021, which was subject to criticisms over its handling of the case and for leaving defendants in the dark.[4]
The concept of a strict liability in respect of directors’ duties is and could not be the law in any reasonable assessment. This returns to the distinction between strategic and monitoring roles. The role of the NED is not essentially operational. It is to ask the right questions, probing, exercising skill and judgement and displaying curiosity, while not stifling management. The job is strategic oversight. As has also been shown, in terms of resources at their disposal, NEDs are disadvantaged relative to executives, auditors and other professional advisers.
In the wake of scandal, governments have to be seen to act. One temptation is to view everything through the eyes of criminal law, perhaps prompting draconian regulatory action. Hence a regulator views failure to prevent fraud – which may have multiple causes and not necessarily involve liability for directors – from an exclusively criminal or regulatory angle, which may not be to the general good: attempts to sanction directors, not least NEDs, for every failure or failing may have negative consequences for recruitment, retention and the role of NEDs. In a free and responsible society, not every action of a director that might be challenged, or for which a different decision could reasonably have been made, or that might be criticised or fall short of the ideal, should result in criminal or even regulatory action.
There is a rather fundamental mismatch of expectations. Directors cannot predict or know everything. The law recognises this, not however the political world, media and wider society. A narrative develops around what directors should have known, which then suggests that, as the chief architects of the company’s structure, organisation, policies and direction, directors may have been asleep at the wheel and hence should be held to account. The problem, though, is whether in law this constitutes a breach of duty and a liability, and whether in public policy it is a reasonable expectation of a non-executive director.
The danger is that we make British business an unattractive place to work, damaging aspiration and economic efficiency. This issue, again, is fundamentally one of education.
Notes to Chapter 4
[1] PwC CEO Success Study, 2018, https://www.strategyand.pwc.com/gx/en/insights/ceo-success.html.
[2] The Higgs Review, paragraph 6.2.
[3] ‘The Seven Principles of Public Life’, https://www.gov.uk/government/publications/the-7-principles-of-public-life. For their latest iteration, see The Committee on Standards in Public Life, ‘Upholding Standards in Public Life: Final report of the Standards Matter 2 review’, November 2021, Appendix 1 (p. 92), https://assets.publishing.service.gov.uk/media/617c02fae90e07198334652d/Upholding_Standards_in_Public_Life_-_Web_Accessible.pdf.
[4] Joanne Faulkner, ‘Axing Carillion Case Puts Watchdog’s Approach in Spotlight’, 25 October 2023, LAW360, https://www.law360.com/articles/1736763.