The Combined Code on Corporate Governance: The role of the
board and chairman
This article is based on UK law.
The role of the board
The Code sets out its own view of the role of the board. This
can be summarised as:
- providing entrepreneurial leadership;
- setting strategy;
- ensuring the human and financial resources are available to
achieve objectives;
- reviewing management performance;
- setting the company’s values and standards;
- satisfying itself as to the integrity of financial information
and the robustness of financial controls and risk management.
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
IoD publication, Standards for the Board.
The chairman
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.
This point met some strong vocal dissent when first made by
Higgs but survived through to the FRC’s Code. In practice, few
large companies today have one individual fulfilling the roles of
both chairman and chief executive. 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. The former leads the board, ensures there is a good
working relationship between the executive and non-executive
directors and is primarily responsible for communications and
liaison with shareholders. The Code also says the chairman must
ensure that the rest of the board receives “accurate, timely and
clear information” ahead of board meetings and other key decision
points.
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.
In those rare cases where one person does perform both roles,
the board will need to explain to shareholders why it thinks that
is right for the company. And, at the least, shareholders are
likely to insist on a strong senior independent director to
counter-balance the joint chairman/CEO.
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. Higgs took the view that you
could not have two popes in one company: a new chief executive was
going to have a next to impossible job if his predecessor was still
around as chairman, constantly looking over his shoulder and
perhaps disagreeing with any departure from past policies.
Defenders of the practice sang the praises of a chairman who often
had years of experience with the company, still had much to offer
and who was quite capable of establishing a good working
relationship with a new CEO. Higgs’s view prevailed, though 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. Barclays Bank and, more recently, HSBC,
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. Consultation and explanation can make a real
difference. This can be shown by the experience of Greene King –
see below.
Case study: Greene King – How the board can
get its way
In late 2004, the brewer and
pub owner Greene King announced that its chairman was retiring and
that, contrary to the Code’s provisions, he was going to be
succeeded by the chief executive. It advanced various reasons for
this: the chief executive had made it clear he would not stay in
his current role; the non-executives wanted both to retain his
experience and skills and avoid losing its top two at the same
time. Greene King had consulted its five largest shareholders, who
collectively owned about 25 per cent of the company, and they were
reported as being “supportive”. (The fact that the board undertook
to appoint two more independent directors, and that the company’s
share price had just hit a record high, no doubt helped.)
The Code says that a chairman
should be independent at the time of their appointment. Put simply,
this means having no “history”, no previous relationships with the
company. In theory, Greene King’s new chairman failed the
independence “test”: he had held an executive position at the
company and had long experience on the board. Nonetheless, the
company went ahead with the appointment, arguing that the new chair
made up for any lack of detachment by his “strength of character
and independent judgment”.
Independent non-executive directors
The Code makes a distinction between non-executives who are
independent and non-executives who are not. To qualify for the
former category, an individual must not only have the necessary
independence of character and judgment 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:
- they have been an employee of the group within the previous
five years;
- they have a “material business relationship” with the company
or have had one within the previous three years, including an
indirect relationship as a partner, director, senior employee or
shareholder of an adviser or major customer or supplier; (this
would catch a partner from, for example, the company’s audit firm
moving on to the board after retirement);
- they receive remuneration from the company in addition to
director’s fees or they participate in the company’s share option
or performance related pay schemes or they are members of the
pension scheme;
- they have close family ties with any of the company’s advisers,
directors or senior employees;
- they hold cross directorships or have significant links with
other directors through involvement in other companies or bodies;
(this works against the “old boys’ club” method of appointing
non-executives: George is finance director at company A and sits as
a non-executive on the board of company B; Harry is chief executive
at company B and sits as a non-executive at company A);
- they represent a significant shareholder;
- they have served on the board for more than nine years.
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. 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.
Two examples will show the freedom boards have in practice – and
the arguments that can be mustered against assumptions of
non-independence:
- Sir Derek Higgs, author of the Higgs Report and the principal
architect of the Code, was until 2006 a non-executive director of
British Land. In addition, he served as a non-executive at Jones
Lang LaSalle, who advise British Land on property matters. Despite
this, the company was happy to state that it classed Sir Derek as
an independent director because his other role at Jones Lang was
not an executive position, he was not involved in any British Land
related work there, and British Land paid less than one per cent of
its turnover in fees to the firm. A similar justification was made
in previous years in respect of Sir Derek’s senior position at UBS
Investment Bank, financial advisers and brokers to British
Land.
- Pearson, publisher of the Financial Times, trumpeted in 2005
that it had two nonexecutives with a combined total of more than 30
years on the board, clearly in excess of the nine years a piece
allowed by the Code. Both had continued to perform as “exceptional
independent directors” and had “continued to demonstrate a robust
independence and to make a substantial, constructively critical
contribution as directors”. Both eventually retired in 2006.
