Setting the standards

By Business & Finance
24 October 2014

Barry O’Connor outlines the importance of continual appraisal and assessment when it comes to improving boardroom standards.

Of late, there is growing evidence of more rigorous standards of appointment and performance of company boards, which helps to reassure all concerned that corporate malfunctions that occurred in the not too distant past will not be repeated.

There seems to be a more thorough understanding of corporate governance and fiduciary responsibilities, the overall legalities of the position of director and the ultimate implications of failing to uphold these statutory obligations. Board reviews, continual personal assessments and company performance analysis − the most vital of health checks − would appear to be markedly receiving greater prominence.

A less than professional approach to board management and lack of personal accountability, in good times, can go unnoticed.  However, when one looks at the global standards of corporate governance in the lead up to the financial crisis, we can see that we are awash with examples of how the process − when not adhered to − can create problems on a mammoth scale.

Non-executive directors

What is the function of the non-executive director?  The principal responsibility of any director is to look after the company’s assets and to run the company in a way that will prove most profitable and successful for the benefit of its shareholders.

According to Derek Higgs (author of the Higgs Report, 2000/2001) the board’s role is also to provide entrepreneurial leadership of the company within a framework of prudent and effective controls that enable risk to be assessed and managed.

A non-executive director does not have a contract of service and usually serves on a part-time basis only.  She or he does not have any management function in the running of the business, other than assisting in the deliberations of the board.

However, the legal powers and duties are identical to those of executive directors. Higgs states that a comprehensive, formal and tailored induction should always be provided to new non-executive directors and that the chairman should take a lead in providing this.

Non-executive directors should appraise their individual skills, knowledge and expertise regularly and companies should acknowledge that to run an effective board, they need to provide resources to develop and refresh the knowledge and skills of directors, including non-executive directors.

No to old school tie

A board performance appraisal gives the chair the information and authority to manage the board more effectively. If it becomes evident that a new appointment is not working, Higgs believes there should be an early ‘blame-free’ resignation.

Higgs points out that using personal contacts as a main source of candidates will tend to favour those with similar backgrounds. The old school tie was never appropriate.

The appointment process for a non-executive director should be a formal, transparent and structured process.  It should be managed professionally and independently, sourcing candidates that match the skills requirement and mix of the board.

The process is normally run by the chairman of the nominations committee or perhaps the senior independent director, advised by an appropriate professional executive search consultant.

Rotate to operate

The rotation of directors is key. The standard articles as contained in the Companies Act, 1963, provide that one third of directors, apart from the managing director, retire each year at the AGM and may, if they wish, offer themselves for re-election.

The Central Bank’s code for financial institutions requires that these institutions shall review board membership at least once every three years. Institutions are required to formally review the membership of the board of any person who is a member for nine years or more and it is required to document its rationale for any continuance and so advise the Central Bank in writing. The renewal frequency must take into account the balance of experience and independence sought.

A survey of board practice conducted by MERC Partners found that Irish board directors preferred a fixed rather than a rolling timeframe for board membership to be the most appropriate. The survey also found that the ratio of non-executives to executives on the board should be 2:1. Surprisingly, the term of office of the chairman should desirably not exceed 10 years and the maximum term for non-executive directors should be 12 years. One would suspect that these periods would perhaps be shorter.

With growing regulation, corporate governance becomes more complex and more demanding, virtually by the day. Boards are an essential feature of business infrastructure and, to be an effective and high performing board, continual appraisal including meaningful individual director and board assessment is an imperative.

Barry O’Connor is a partner with MERC Partners and leads its Non-Executive Director practice.