Using Non Executive Directors to Improve Performance

a look at the role of non-executive Directors (NED’s) in varying sizes of business and what they can achieve. In this article the Trapnell brothers take a view on the role of NED’s in plc’s and SME’s and assess where the value is.

A view on the role and value of a non-executive Director in plc’s

Before getting into the detail I think it is worth looking at how and why the role of the Non-executive Director in Plc’s has grown to such importance over the last 20 years.

Although NED’s first started to appear on Boards in the early 1980’s it wasn’t until 1992 when the UK Code on Corporate Governance was produced by the Cadbury Committee, that the role really started to be taken seriously. The Code has been updated and expanded since then and the latest version was applicable from June 2010 and applies to all companies with a Premium Listing of equity shares, regardless of whether they are incorporated in the UK or elsewhere.

Cadbury defined Corporate Governance, quite simply, as “the system by which companies are directed and controlled” and its purpose is to facilitate effective, entrepreneurial and prudent management that can deliver the long term success of the company. I think this description applies equally to SME’s and Plc’s.

It is important to understand that the Code is not a rigid set of rules. It consists of principles and provisions. The Listing Rules require companies to apply the main principles and report to shareholders on how they have done so. The principles are the core of the code and the way in which they are applied should be the central question for a board as it determines how it is to operate according to the Code. This statement is at the heart of the NED role.

Apart from the more obvious monitoring of performance, a large part of the role is regulatory. In addition, NED’s need to satisfy themselves on the integrity of financial information and that financial controls and systems of risk management are robust and defensible. NED’s are also responsible, through relevant committees, for determining appropriate levels of remuneration of Executive Directors and have a prime role in appointing and removing Executive Directors and in succession planning.

NED’s do not generally get involved directly in operations or individual mentoring as they might in SME’s but it is, nevertheless, important to understand the business and the markets in which it operates. Most companies will organise visits for the board to different parts of the business, on a regular basis, which also gives the NED’s a chance to meet members of the company’s management team below director level.

The requirement for experience and knowledge of how Boards need to operate in today’s environment means that NED’s will have already had a successful career at main board level and therefore it is quite common to find retired Finance Directors, CEO’s and Chairmen of Plc’s in the role.

The recommendation is to have equal numbers of Non-executive and Executive Directors on the board and clearly this has cost implications for a small company and it can also become rather bureaucratic and slow down decision making.

The big question, of course, is do all these regulations and NED’s result in more successful companies? This is a difficult one to answer but it does, at least, give shareholders some comfort that their investments are more secure than they might otherwise have been. However, major issues that have arisen over the past 3 years or so in the Financial Services sector have demonstrated that there is no guarantee that things won’t go wrong!

A view on the role and value of a non-executive Director in SME’s

Unlike quoted companies there is no requirement for an SME to have NED’s. However the fact that an MD’s job is the “loneliest one in the World” seems to point to a clear need for a NED or business advisor.

Surprisingly NED’s are not that common in SME’s with a fifth having one in small companies (1-49 employees) and nearly half in larger companies (200-499 employees). Perhaps this low level is because it cannot be shown that companies employing a NED are more profitable than those who don’t? In fact most MD’s of SME companies with a NED report that they were helpful and added value to the business.
What NED’s are used for seems to vary with size of business, smaller companies tend to value their financial expertise whilst larger ones place more emphasis on outside objectivity, structured board procedures and having a prestigious name on the board. The main reasons for a company using a NED include:

• Outside objectivity
• Strategic planning process
• Finance expertise
• Operational expertise
• Network of contacts
• Structured board procedures
• Help with growth problems
• Brought market support
• Provided an ally on the board
• Reduce board conflict
• Gives confidence to financiers
• Prestigious name on the board
• Help with turnaround
• Provides customer information
• Provides competitor information
• Company floatation advice

Having identified the MD as having the loneliest job in the World this identifies an omission from the above list when considering the rest of the board. An effective NED can act as a mentor to individual board members at any time and fill skills gaps.
Having identified the reasons for having a NED companies who don’t use one identify the following to support their decision:

• Not necessary
• Cost
• Lack of inside knowledge
• Did not think of appointing one
• Difficulty in finding the right person
• Too time consuming
• Disruption of directorial team
• Breaches of privacy
• Loss of control
• Poor previous experience with NED’s
• Loss of board’s freedom
  
• Lack of expertise
• Unaware of NED’s

Corporate Governance is an area not often considered by the leaders of SME’s. Here the NED, as in quoted companies, can help giving guidance on:

• Board composition
• Remuneration
• Accountability
• Relations with shareholders

In considering the role of the NED in a SME it must not be forgotten that there are executives and other employees of the business who are paid to run it. The NED’s role is about:

• Challenging the MD and executive board
• Providing knowledge, insight and experience
• Raising standards of governance
• Advising on strategy
• Challenging business plans
• Mentoring
• Acting as a sounding board

These roles do of course have to be considered in the context of any NED’s statutory duty – which he / she shares with his co-directors – to promote the success of the company for the benefit of its members as a whole under the Companies Act 2006.
So what should an SME be looking for in finding a good NED? These include:

• Good interpersonal skills
• Ability to manage conflict
• Sound judgement
• The ability to influence through clear communication
• Integrity
• The conviction to say things that need saying
• To be commercially aware

The Ned’s approach should be to look at the company as a whole – take a “helicopter view” – and not get entangled in day-to-day operations.
Having said NED’s are not that common in SME’s trust comes fairly high on the SME shopping list for a NED. As a consequence SME’s tend to look for NED’s from family and friends, personal contacts, banks and accountants.

Conclusion

Clearly both quoted companies and SME’s have needs for NED’s. The issue is “are the executives prepared to take sound experienced advice?” The legal requirement of quoted companies removes the choice of having NED’s or not but doesn’t mean advice is taken or implemented. Another significant difference with the types of company is their approach to corporate governance. As stated earlier it is not thought to be very high on the SME agenda.

Undoubtedly NED’s have the ability to help executives achieve improved performance in both types of company, perhaps through a focused approach to problems. However, since a lot of companies don’t assess the value of living with a problem this can only perpetuate the view that the NED adds value to the business or is something that has to be there.
Used properly a good NED will help improve the performance of a business.