Out-Law Guide | 05 Jul 2007 | 9:51 am | 7 min. read
This guide is based on UK law as at 1st February 2010, unless otherwise stated. It is part of a series on corporate governance.
The UK Corporate Governance Code sets out its own view of the role of the board. This can be summarised as:
(Note: the Code does not apply to all companies. See: The reach of the UK Corporate Governance Code, an OUT-LAW guide)
The Code recognises that there are some issues that can only be decided by the board. It states that: “there should be a formal schedule of matters specifically reserved for its decision” and that the annual report should include a “high-level statement of which types of decisions are to be taken by the board and which are to be delegated to management”. Guidance on drawing up a schedule of matters reserved for the board is available from the Institute of Chartered Secretaries and Administrators (ICSA) and from the Institute of Directors' book, The Effective Board.
The chairman leads the board, sets its agenda and ensures it is an effective working group at the head of the company. He must promote a culture of openness and debate and is responsible for effective communication with shareholders (but note the role of the senior independent director as well. (See: Composition and structure of the board, an OUT-LAW guide.) And he must ensure that all board members receive accurate, timely and clear information.
The Code says the roles of chairman and chief executive should not be held by the same person.
“There should be a clear division of responsibilities at the head of the company between the running of the board and the executive responsibility for the running of the company’s business. No one individual should have unfettered powers of decision” – main principle A.2.
The chairman may not always be a part-time non-executive: many are full time and describe themselves as executive chairman, but the roles of chairman and CEO are at least distinct. In addition to the responsibilities described above, the chairman ensures there is a good working relationship between the executive and non-executive directors and sufficient time to discuss strategic issues.
By contrast, the chief executive has responsibility for the day to day management of the company and putting into effect the decisions and policies of the board.
Any big public company combining the roles of chairman and CEO will have to persuade shareholders that the right checks and balances are in place. (See the case study on Marks & Spencer below).
Equally to be frowned upon, according to the Code, is the previously widespread practice of a chief executive stepping up to become chairman of the same company. Those against the practice argue that a new chief executive is going to have a next to impossible job if his predecessor stays as chairman, constantly looking over his shoulder and perhaps disagreeing with any departure from past policies. Those in favour sing the praises of a chairman who may have years of experience with the company, still has much to offer and who is quite capable of establishing a good working relationship with a new CEO.
The Code does concede that in exceptional cases the rule may be broken. Any board in breach should consult major shareholders in advance and set out its reasons for the appointment, both at the time and in the next annual report. Banks, in particular, have argued that only the incumbent CEO has the knowledge and experience of a large, multinational group’s operations to fulfil the chairman’s role.
This view received some indirect backing from the Walker Report, which argued for a greater emphasis on relevant industry experience among non-executive directors. And much play was made of the fact that of the three UK banks that failed in 2007–2008, RBS, HBOS and Northern Rock, none had a chairman with a banking background. In contrast, the chairmen of HSBC and Standard Chartered, which emerged relatively unscathed from the banking crisis, were lifetime bankers (and both had stepped up from the chief executive role).
Marks & Spencer is a rare case of a major company where the roles of chairman and chief executive have been combined.
In 2008, the chief executive, Sir Stuart Rose, was handed the chairman’s job as well – in contravention of principle A.2. Shareholders muttered that this was contrary to the Code, but the company stressed that the roles would be split again when Sir Stuart retired in 2011. In the meantime, the new chairman’s dominance would be counterbalanced by the senior independent director, who was given special responsibility for governance issues.
When a resolution was tabled at the July 2009 AGM calling for the early appointment of an independent chairman, it received an unusually high level of support, from 38 per cent of voting shareholders, but 62 per cent backed the board, and Sir Stuart remained in place. Despite that, a new chief executive joined in early 2010, and the roles were once again separated.
The Code clearly gives a strong role to the non-executives. Their job description includes:
The Walker Report has re-emphasised the constructive challenge part of the job, in the light of the perceived quiescence of bank directors faced by a dominant chief executive. And the role of the non-executives in setting pay in banks has been widened beyond the executive directors to include firm-wide policy and particular oversight for the pay packages of the most highly paid non-board members.
The non-executive directors should convene regularly, as a body, with the chairman, but without their executive colleagues; and at least once a year they should meet on their own under the leadership of the senior independent director to appraise the chairman’s performance. (See: Composition and structure of the board, an OUT-LAW guide.)
If the executive directors have a collective interest in any matter that goes to the board, the non-executives may effectively be left in control. This situation is commonly seen where a bid for the company is received from the management team, or from a private equity group with management involvement. The executives can play no part in the decision, and it will be for the independent directors to decide alone whether to recommend the bid to shareholders.
Walker also put a time commitment on the role in a major bank board: a minimum of 30 to 36 days a year for at least some of the non-executives. The Code says that all directors must be able to allocate sufficient time to the company to perform their responsibilities effectively. Less time will be needed for smaller companies and those with less complex businesses, but, with a norm of 10 board meetings a year, additional committee meetings and off-site visits, the job should be no sinecure.
The Code makes a distinction between non-executives who are independent and those who are not. To qualify for the former category, an individual must not only have the necessary independence of character and judgement but also be free of any connections that may lead to conflicts of interest.
The Code makes it clear that someone will not normally be considered independent if:
Ultimately, however, it is up to the board to decide who ‘qualifies’. The board is expected to consider the above – and, indeed, any other factors that may impair independent judgment – but none of them is to be thought of as grounds for automatic ‘exclusion’. It may be that an individual is judged to have the strength of character and integrity to remain unaffected by circumstances that, in theory, compromise their independence.
Sir David Walker, in his 2009 review of governance at major banks, argued for less emphasis to be placed on the independence of nonexecutive directors for the sake of it and for greater weight to be given to relevant financial industry experience. Independence in name was less important than ‘the quality of independence of mind and spirit, of character and judgement’.
When they appoint non-executives, and each year when reporting to shareholders, the members of the board have to identify who is independent and who is not. If they have decided that, despite previous and/or current connections with the company, etc, an individual may be classed as independent, they need to explain the reasons why.