Non-executive directors' changing role

During the last few years, corporate scandals, one after another, have forced the financial and government circles to question what has suddenly gone wrong with the corporate governance, which has shaken the confidence of the shareholders.
This has also raised questions, regarding the effective role played by the directors, auditors and institutional shareholders.
In the United Kingdom, Higgs Combined Code was finalised and implemented last year to improve the corporate governance. Though the report itself is fairly comprehensive, the most important proposal, which needed attention and discussion here, is the restructuring the board of directors by appointing non-executive directors.
The proposal also went to the extent that the number of non-executive directors should be in majority as compared to the executive directors. This being, an important change in the corporate culture, resulted in a lot of opposition from the corporate and industrial sectors.
This meant that the original concept that the companies should be controlled by the shareholders themselves, who happen to be the real owner of the business, is no more acceptable to the regulators and the minority shareholders.
This change of culture has been the result of the giant corporations failures, where it was felt that the directors representing the majority shareholding did not perform their duties effectively as desired by the legal framework or the changing corporate culture.
The failures of corporate entities have not only restricted in the Western economies only, it also happened in Pakistan, where most of the financial institutions like National Development Finance Corporation, Bankers Equity and Mehran Bank collapsed due to unprudential behaviours by giving liberal loans to ill managed companies.
The only difference between the two cases is that in Pakistan, the financial institutions were hurt directly due to old fashioned laws which made it impossible for them to dispose of assets of these companies compared with the West, where it was easier to get hold the defaulting corporations.
These are just the few examples of collapses, which resulted due to ineffective role played by the executive directors.
The success or failure of any corporate entity clearly lies with the directors. Unless directors perform effectively and discharge their responsibilities as they are expected to perform, there is no guarantee that the corporate failures will not be repeated again.
So, having this in mind, most of the regulators in their countries are trying to shape up their regulations to improve the performance of the directors to meet the expectations of the institutional and minority the shareholders.
It is yet to be seen, if these suggested changes would produce the desired objectives and bring the improvements, which are being sought. But there is no doubt in the mind of financial and investment circles, that these changes would not be beneficial for every country and every company and some way would have to be found to get the best results through tailoring these proposals for country to country or for industry to industry.
That's why Higg's Combined Code has not been made compulsory for every listed company.
The Combined Code required that if the companies do not wish to implement these proposals, the directors should give reasons in their annual report.
The selection and appointment of non-executive directors on the board, is being debated these days all over the world.
It seems that there is a unanimous view that this change should result in better performance as a whole, but at the same time, it has been acknowledged that unless the selection and appointment is made with due diligence and care, it could prove ineffective and disastrous.
It is not an easy task and must be carried out carefully by the talented professionals, who should be able to understand not only the requisite industrial knowledge but also have leadership qualities required to unite the board that performs effectively as a single entity.
The appointment of non-executive directors, if applied carelessly in countries like Pakistan, may prove fatal.
The Securities and Exchange Commission of Pakistan has devised certain guidelines in this respect and have proposed that all listed companies shall encourage effective representation of independent non-executive directors, including those representing minority interests, on their board of directors so that the board as a group includes core competencies considered relevant in the context of each listed company.
The minority shareholders as a class are facilitated to contest election of directors by proxy solicitation.
The guidelines further provide that the board of each listed company includes at least one independent director representing institutional equity interest of a banking, non-banking or an insurance company.
As per the guidelines provided by the rules, an independent director is one who could be reasonably perceived as being able to exercise independent business judgement without being subservient to any apparent form of interference.
These guidelines are somewhat more relaxed than proposed by Higg's report, which stated that to ensure that the non-executive directors provide an effective role within the corporate sector, they should not only provide entrepreneurial leadership, but set the company's strategic aims and values to ensure that its obligations to its shareholders and others are understood and met.
This objective cannot be met in reality if there is only one non-executive director on the board as per the SEAP directions.
It is arguable if one director could play an effective role in the decision making process or to question or challenge the policies of the companies.
From the guidelines provided by the Securities and Exchange Commission of Pakistan, it seems obvious that the purpose of the guiding rules is not to look after the corporate strategic values and performance on a long term basis but is based upon protecting investor's interests in seeking out maximum value for their investment in shape of higher dividends and payouts.
The directors seem to be less interested in ensuring that as a whole good corporate governance is being ensured on a continuous basis.
This is visible from the facts that we see government appointed directors on the state owned corporations having absolutely no knowledge of the business for which they have been assigned.
Only recently, an appointment of a retired government secretary has been made to head a financial institution in Punjab. It is pity that; our policies and actions do not seem to correlate each other.
If we feel that the retired personalities are so good that their services must be used for the country, then, they should keep on performing their jobs and the retirement age should be abolished.
If we look at the board structures of state controlled corporations where the government is trying to appoint non-executive directors, it is surprising to see how the selection and appointments are made.
An effective change would be brought into the corporate culture, by moving from one position to another? Does this mean that there is a shortage of young professionals to bring in the requisite experience needed to run these institutions on a competitive and more effective manner? Or we are being victim of our old-fashioned management style, where we are not willing to change to reward those who happen to be our closest.
The important issue involved here is to justify, how the non-executive directors are selected and appointed on the various boards? Who has this authority? If these are ministries and bureaucrats, then we should not expect any improvement in the system.
The present practice will promote the brain drain as is happening in these days. This is largely because the talented young professionals are not being considered for any responsible jobs, instead only old faces keep on revolving from one place to another.
An appointment of high-level committee is needed to hire talented professionals to bring in the desired structural change with in our corporate culture.
In Companies, where the government has appointed its nominees as institutional directors, their presence on the board has been mostly ineffective except where the companies virtually enjoyed monopolistic conditions and where the operational inefficiencies were hidden under the massive profits which resulted due to government controlled prices or some other protections given to these institutions.
These included, almost all companies operating under Oil and Gas production and distribution sector.
The Securities and Exchange Commission of Pakistan appointed managing directors and few non-executive directors for the board of Karachi and Lahore Stock Exchanges.
It is difficult to comment, how the selection was made? Was there any pool of professionals available, from which this selection was made or it was just a random pick up from some known friendly personalities, who may know nothing about how the bourses work or who are not supposed to be interested to question the wisdom behind the decisions being made.
If the list is fully scrutinised, it seems apparent that those, having vested interests are on the board as non-executive directors.
It is pity that no serious effort is ever made to avoid any conflict of interest while making appointments of this nature.
It is also surprising to see that most of these appointees are already performing full time directors in other companies. How they would be able to justify their positions and play an effective role to concentrate on issues of strategic development, monitor the reporting of performance, ensuring that the financial information is presented accurately to minimise the risks involved and recruiting the best manpower available for the jobs for future growth of these companies.
Appointing non-executive directors, who have no knowledge of the type of business, they are being asked to monitor in the board meetings and if they have enough time to spend without any payment to monitor the performance and progress of the companies.
Will they not end up in the same manner, where the big giant companies like Enron, Marconi and Cable & Wireless suffered overnight, because their non-executives did not play an effective role regarding the operations of these companies?
It is essential to determine, if these institutions are being run efficiently compared with other institutions in the same industry by discounting the protections available to this institution.
As we understand, currently, the investment policies are prepared, reviewed and implemented by the same group of executives and no independent checks and balances exists from non-executive directors. This practice has led to wrong investments decisions made in the past.
We need a code of corporate governance, which is suited to our requirements, which is acceptable to our culture and before any drastic change is proposed, the non-executive directors need to be provided adequately on the job training and this should be the responsibility of the corporations, on whose boards these individual are placed.
Their duration of office should be fixed and they should be paid adequately to get proper assistance for the office maintenance and evaluating the policies of the company to be an effective member of the board.
We should not expect miracles from a group of people not fully equipped with resources to spend time on company's affairs effectively. They should be properly compensated for their office cost as is being done in those countries where these codes are being introduced.
They should be provided with all the necessary information that is being provided to an executive director. It should be mandatory that if the non-executive director in the performance of his role as a director asks for any detail, that detail or explanations must be provided on a timely basis.
The changing role of non-executive director must be acknowledged as he is going to be responsible in the same manner as any other executive director regarding his accountability.
(The author is writing a research essay on Corporate Governance, at the Law School of University of North Umbria at Newcastle upon Tyne, United Kingdom).