Higgs: triumph or time bomb?
| by Paul Moxey 02 Mar 2003 Topic: Corporate governance |
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Paul Moxey points out his concerns about the recommendations made in the recent Higgs report In January�s edition of accounting & business, I discussed the importance of non-executive directors (NEDs) in response to Enron and WorldCom, etc. I highlighted the fact that NEDs should have a strategic, as well as a monitoring, role in companies and outlined some of ACCA�s recommendations in response to the Higgs review of the role and effectiveness of NEDs. I warned that the current focus on the monitoring or regulatory role of NEDs creates the danger that boards will be divided and cease to work effectively as teams, and that NEDs could become less effective in their strategic role. Derek Higgs has now completed his review. His recommendations, published on 20 January, go wider than expected as he also produced a suggested revised Combined Code on corporate governance. On the same day, the Financial Reporting Council published the Smith report on audit committees. Both Higgs� and Smith�s recommendations have been covered extensively in the financial press and were initially well received. In this article, I take a different perspective and look at these recommendations in relation to the recommendations ACCA made in response to the original Higgs and FRC consultations. Most of our 20 recommendations are adopted in the Higgs report and, therefore not surprisingly, we support the majority of his recommendations. We are particularly pleased that both Higgs and Smith opted to continue the voluntary, code based, approach to corporate governance rather than call for new legislation. We are concerned, however, with some aspects and I will return to the warning we gave about the risk of undermining NEDs� contribution to strategy and the way boards work as a team. NEDs� role In our submission to the Higgs consultation, we argued that the effectiveness of NEDs� monitoring role needs to be improved without impairing their effectiveness in a strategic role. We set out ACCA�s view of NEDs� strategic and monitoring role and said that, as well as their strategic role, their role should include:
We were pleased to see that the role outlined by Higgs in the proposed revised Code is very similar to this. We also suggested that NEDs should make recommendations to shareholders on the appointment of auditors. Higgs and Smith have adopted this as part of their proposals for audit committees. Superficially then, the Higgs proposals on the role of NEDs are difficult to criticise. But if we look a little deeper below the surface there are other things which cause concern. We would have liked to have seen guidance describing the principles for NEDs� decision-making. We suggested that NEDs should exercise individual judgement but act primarily through the board or in committees rather than individually. Our reasoning is that NEDs would become more like executives if they regularly made decisions on their own which committed the company, or would be likely to do so. ACCA has, for some years, played a leading role in the world in promoting corporate and social responsibility (CSR). We argued that NEDs should act as the �Corporate Conscience� ensuring that social, environmental and sustainability issues receive an appropriate degree of board level attention. We also suggested NEDs should be sensitive to the public interest issues inherent in balancing long-term sustainable growth with the short-term financial demands associated with the recruitment, retention, motivation and reward of the executive directors. Higgs is silent on both these issues. We called for NEDs to prepare their own governance report to shareholders, as part of the annual report, explaining how they fulfilled their monitoring role, including the work of non-executive committees, such as the audit and remuneration committees. Smith partially addresses this through recommending that the directors� report includes a section describing the audit committee�s activities. Given the considerable debate recently concerning the risk to auditor independence of non-audit services, it is surprising that Smith does not call for audit committees to approve non-audit services. Smith instead only asks audit committees to disclose their policy on non-audit services. ACCA called for audit committees to give prior approval to any non-audit work and disclose to shareholders the reasons for awarding any non-audit work to the auditors. We were disappointed that Higgs has said nothing about NEDs� role in relation to small investors. Higgs recommends that NEDs should have more involvement with major investors. Institutional investors have been widely criticised for being too passive in relation to their investments. The Myners� review of institutional investment two years ago called for institutional investors to be more active but said nothing about small investors. Sir Richard Sykes, former chairman of Glaxo, who is to head an inquiry on relations between investors, companies and wealth creation, sparked controversy this February by suggesting small investors be banned from AGMs. This is alarming. ACCA has called for equity across the whole shareholder base and suggested to Higgs that NEDs include, in their governance report to shareholders, an assessment of the extent to which private investors receive equitable treatment, particularly in relation to access to, and timeliness of, information which could affect share prices. Independence Our greatest concern about the Higgs report is the recommendation that listed company boards should have a majority of independent NEDs. PIRC�s 2002 corporate governance review highlighted that about 50% of listed companies have a majority of NEDs. However, using PIRC�s criteria for independence, only 10% of boards have a majority of independent NEDs. Enron, in common with many large US companies, had a majority of NEDs - the only Enron officers on the board were the chairman and the chief executive. While not all of these NEDs could be considered independent, there is no hard evidence to suggest that having a majority of independent directors would improve corporate governance or business performance. We have two concerns about requiring a majority of independent directors. The first is about the practicality of finding approximately 5,000 competent new NEDs to make up the quota for the UK�s listed companies. The second is the effect of such a profound change in board structure on the working of the board. Boards should work as a team. Boards need NEDs to provide objectivity and an external view as well as to monitor. They can help a board see the wood through all the trees. However, if in future boards have a majority of independent NEDs, will they operate as well as a team and could business performance suffer as a consequence? Whereas the Cadbury Committee, in 1992, set out a simple principle for independence and said the board should decide if a director meets this principle, Higgs has given us a list of things which would affect independence. The list includes close personal ties with an adviser, director or senior employee yet does not include close personal friendships. This highlights why ACCA rejects the check list approach to assessing independence. According to Higgs, a director also ceases to be independent after having served on a board for 10 years, or if he or she has been an employee in the last five years. Cadbury said a majority of audit committee members should be independent and ACCA still feels this is right. Smith recommends that all audit committee members should be independent. In our view, directors with more than 10 years� standing can still be objective and can bring valuable experience to an audit committee. Many listed companies find it hard to recruit suitably experienced NEDs. Would it be in shareholders� interests to replace a competent NED, who fails one of the independence tests, with someone who is fully independent but less qualified? The Higgs and Smith reports are impressive documents and the authors are to be commended. Time will tell how effective they have been. Given that Higgs is likely to trigger a demand for new NEDs, ACCA members may be interested to know that, within its �Finding an Accountant� section, the ACCA�s website has a list of members interested in taking on non-executive director positions. If you would like to be added to this list contact Gira Shah, ACCA UK, on 020 7396 5895. Paul Moxey is head of risk management and corporate governance at ACCA. | |