The long-awaited review of UK corporate governance carried out by Derek Higgs has recommended a wide-ranging shake-up in the way that boardrooms operate.
Higgs, a former investment banker and fund manager, has spent six months examining the roles and responsibilities of non-executive directors. His report was commissioned in August 2002 by the government in the wake of the corporate disasters such as Enron and Worldcom in the US.
His main proposal is that at least half a company's directors be entirely independent of its executives, a stipulation that at least a fifth of FTSE 100 companies would not currently meet.
Existing official guidelines on corporate governance only recommends there should be more non-executives on a board than executives. Many companies ignore this.
Rejecting the need to introduce a new raft of legislation, Higgs said that he wanted to build on the existing framework of UK corporate governance. He said that he hoped that companies would comply or be forced to explain to shareholders and in their annual reports if they do not.
"Effective boards depend on the best people and on their behaviours and relationships." He said. "My recommendations reflect this."
- Independent non-executive directors should make up at least half of the board. (The report defines an independent non-executive as having "no relationships which could affect, or appear to affect, the director's judgement." Non-executive directors may hold shares but should not have share options.
- Directors should be appointed by a nomination committee chaired by an independent director.
- The roles of chairman and chief executive should always be separate. The chief executive of a company should also not go on to become chairman of the same company.
- No individual should be chairman of more than one FTSE 100 company and no full-time executive should hold more than one non-executive role at another company.
- The performance of the board and individual committees should be evaluated at least once a year.
- Non-executive directors should be limited to serving two three-year terms except in exceptional circumstances.
- Prospective non-executive directors should carry out due diligence before accepting the job.
- The board should explain to shareholders the basis for non-executive appointments.
- The non-executive directors should meet at least once a year without any executive directors or the company chairman being present.
- No limit set for number of non-executive roles an individual can hold, though care should be taken that individuals have enough time to do as is expected of them.
- Appointment of a "senior independent director" as an ombudsman to deal with any conflicts arising between shareholders and executives.
- A non-executive director should attend regular meetings between executives and shareholders. Chief executives and finance directors often meet major shareholders for private briefings several times a year. Other directors have hitherto rarely taken part in these sessions.
Around 20 per cent of FTSE-100 companies do not currently have the required 50 per cent of independent directors on their boards. Supermarket group Morrisons has no non-executive directors at all.
About 20 FTSC-100 companies are would fall foul of Higgs' proposals by having one of their former chief executives as chairman, including British Airways (Lord Marshall) and Sir Clive Thompson (Rentokil). Lord Marshall is also in contravention of the Higgs proposals on chairing more than one major company. He is chairman of British Airways and Invensys, while Lord Stevenson chairs both HBOS and Pearson.
"My hope is that, taken together, the recommendation of this review will significantly raise the bar for board practice and corporate performance in the UK," Higgs said in a statement.
Broad support for the report
The Association of British Insurers (ABI), which represents many of Britain's investment institutions, gave its support to the key recommendations of the review. In particular, the ABI welcomed the proposals for non-executives to achieve better understanding of shareholder concerns, and for a regular evaluation process to ensure that boards are functioning effectively.
"This report contains a number of common sense proposals to help independent directors maximise their contribution by supporting sound strategic development and ensuring proper oversight of key issues such as audit, remuneration and the nomination," said Peter Montagnon, the ABI's head of investment affairs.
"It makes sense for the senior independent director to participate in meetings of the chairman and management with leading shareholders so that the board can take investor views fully into account. A credible evaluation process will also add to confidence that boards are functioning effectively as a unit."
But others expressed concern that insisting that half of the board were independent directors could create splits between 'company' executive directors and 'independent' non-executives.
While the Confederation of British Industry gave "strong backing " to the report, Sir Nigel Rudd, head of boardoom issues at the CBI, and Chairman of Pilkington Plc, warned that the Higgs proposals for non-executives to attend private meetings between chief executives and shareholders " could open the door significant problems".
Speaking to the Financial Times, Rudd also said that the proposals "could lead to multiple splits in the board which every man and wife could come along and exploit. And that would be a madhouse."
In a separate but related report by chartered accountant Sir Robert Smith, the Financial Reporting Council has also called for new powers for company audit committees.
The committees would be accountable for the accuracy of a company's accounting practices and financial statements and for the independence of auditors. They would be made up of at least three non-executive directors, with one having "significant, recent and relevant financial experience". Additional training would be made available to the others.
Chancellor Gordon Brown welcomed the two sets of proposals. "Stronger and more effective boards are essential to continue to raise standards of corporate governance in the UK," He said.
"Hand in hand with the stronger role for institutional investors recommended in the Myners Review, the reforms Derek Higgs and Sir Robert Smith envisage are crucial underpinnings of our ambitions for UK corporate and economic performance and for productivity. The test for Government will be the extent to which the business and investment communities rise to the challenge that has been laid down".