There is no legal distinction between non-executive directors and executive directors. However, in practice, NEDs are fundamentally ‘outsiders’ to a company, detached from day-to-day operations and valued for their objective insight. This creates a very different dynamic within their role to that of an executive director and means they can offer a unique perspective towards corporate governance, risk management and succession planning, amongst other areas. A company must ensure that its non-executive directors complement the balance of skills and experience of the board.
This introductory factsheet explains the role of a non-executive director and how NEDs operate within a company. It provides an overview of the qualities sought from prospective NEDs and highlights the core skills possessed by HR professionals, which could make them suitable non-executive directors.
What is a non-executive director?
Over recent years the role and prevalence of non-executive directors (NEDs) in UK companies have increased significantly. The diversity of individuals being drawn into the governance regimes of companies spanning the corporate world is also increasing – ownership of a hand tailored chalk stripe suit is no longer a pre-requisite!
For the individual, non-executive directorships can offer lucrative recompense along with opportunities for broadening cross-sector exposure. However, the legal duties and responsibilities should not be underestimated, either by those considering such directorships or the companies seeking to appoint them.
There is no legal distinction between executive directors and non-executive directors (the definition under the Companies Act 2006 defines a director as including any person occupying the position of director, by whatever name called) therefore the legal duties, responsibilities and potential liabilities are the same for both; the distinction lies in the role that they perform. Non-executive directors usually stand back from the day-to-day running of the business, drawing alongside the executive team as required to facilitate the strategic decision-making process. Exactly what this entails will vary from company to company, depending on what is required at each stage of a company’s development.
In a new business, a non-executive director might act as an entrepreneurial mentor, whose regular presence in the office provides inspirational leadership and an experienced voice guiding the company round the common pitfalls that result in many companies failing to fulfill their potential. At the other end of the spectrum, a non-executive director of a listed PLC may just attend board meetings a few times a year.
A company must ensure it recruits non-executive directors that complement the balance of skills and experience of the existing board. A non-executive director does not necessarily have to know the industry in which a company is operating, as this knowledge and experience should ideally be provided by the executive directors. Rather, the value of a non-executive director at every level of the corporate ladder lies in their ability to identify and advise upon new challenges, initiatives and market opportunities, and to develop and refocus strategic plans.
Therefore it is important that individuals are chosen on the basis of what they can contribute to the company, i.e. their business experience, perspective and acumen. For example, a potential candidate (e.g. the former chief executive of a company listed on the Alternative Investment Market) may have a huge number of contacts of interest to a company wishing to enter a new market or seek a listing on a stock exchange. The serial entrepreneur with a string of successful (and not so successful) companies and a track record of bringing innovative new products to market may be just the person to mentor an aspiring company.
For this reason, it is unusual for a young person to be appointed as a non-executive director. Since 1 October 2008 under the Companies Act 2006 the minimum age for holding a company directorship is 16 years of age, but it is unlikely a NED would be this young in any event.
It is best practice for non-executive directors to be provided with formal written agreements stipulating the hours to be worked, expectations, key performance indicators (if appropriate) and the notice period. This provides a framework and ground rules for the relationship between the company and the non-executive director, clearly defining the boundaries in relation to control of the company. Whilst non-executive directors should be remunerated for time spent fulfilling their duties, the contribution this compensation makes to a non-executive director’s overall income should not be significant or their ability to be an independent voice on a company’s board may be jeopardised.
A director is an officer of a company and not an employee. However, it is possible that a director (non-executive or other director) might work under a contract of service making them an employee. It is important to evaluate the way that the relationship is going to operate to determine if the individual will be an employee and hence if employment rights are applicable.
Since the role of non-executive director varies from company to company, so do remuneration levels. Research carried out by The Institute of Directors found that an average salary for a non-executive director is £17,320, but this can vary, according to the size of the company, between £15,000 and £26,061. Though some organisations in the public and voluntary sectors do not pay a remittance, travel and some subsistence allowances are usually covered. Given the increased scrutiny and risk awareness over the last few years due to the economic crisis the workload for NEDs has increased and NEDs' fees were considered too low and had been steadily increasing.
All listed UK companies now have to have an approved remuneration policy in place with which all remuneration or termination payments to directors must be consistent.
As a result, many companies have stated that non-executive director (and chairman) fees will be reviewed annually and some have stated that any increases will not normally exceed inflation or the percentage increase offered to the employee population. Until now annual pay reviews have been unusual.
In 2014, fifty four per cent of the FTSE 100 adjusted non-executive director fees, compared to just over 30% who made adjustments to either Chairman or non-executive director base fees in 2013. The fee increases for non-executive directors were relatively modest with a median of 7% in the FTSE 100 and 6% at the median in the FTSE 250.
Whilst a non-executive director’s contract may be for a fixed or an indefinite period of time, the UK Corporate Governance Code (2012) ("the Code") (see below for more about the Code) advises that if a non-executive director has been advising the same company for more than nine years they should be considered for annual re-election and they may not be considered as independent. All non-executive directors’ terms and conditions of employment should be held at a company’s registered office and available for public inspection between 9am and 5pm each day.
Due diligence, induction and training
The principal purpose of due diligence is to obtain as much information as possible about a company to enable a prospective non-executive director to decide whether joining the company is as good an opportunity as it first appears! Due diligence is similar to undertaking an audit allowing the prospective non-executive director to assess the risks posed by involvement in a company, its governance procedures and financial management and its strategic aims and objectives. The exercise may reveal the main areas of input requiring the non-executive director’s attention. Alternatively it may provide some idea of just how much hard work will be required to kick things into shape!
Due diligence should also take into account the wider picture - the market a company operates in and its major competitors and the strengths, weaknesses, opportunities and threats inherent in the operating environment. Depending upon the type of business a company is engaged in and the role that a non-executive director is going to play in its future, it may also be advantageous to examine a company’s marketing initiatives, research and development, sales and production projections.
The amount and type of information that can be supplied to a prospective non-executive candidate will be limited for confidentiality reasons and candidates should not be surprised if they are asked to sign a confidentiality agreement before information is supplied. Even so, a lot of information may be gathered informally from existing directors, employees, managers, suppliers, customers, press releases and the internet.
It is important for a NED to consider the quality of the current NEDs in the organisation and the Executive Directors, the financial position of the company, its business plan and its reputation. A NED should also consider the governance of the company and investor relations and how the Company deals with risk management.
A full list of possible questions which could be asked is available from the Institute of Chartered Secretaries and Administrators (ICSA) website.
Joining a company’s board of directors means assuming a role in the control and strategic decision-making processes of that company thus dictating its future profitability and value, and determining the job security of all those employed by the company. A thorough understanding of the business is vital for anyone embarking on this task in order to ensure that they possess the capacity, capability and competency to fulfill the role.
A non-executive director is legally different from an executive director in name only - there is no legal distinction between the two. They are both subject to the same duties and potential liabilities, meaning that a non-executive director could also be disqualified
Induction and training
The 2014 UK Corporate Governance Code advises that all major shareholders should have the opportunity of meeting a new non-executive director. The practicalities of this will depend on how many major shareholders a company has, but there are good reasons for complying with the Code - meeting the owners of the company puts a personal face on the company, reinforcing the significance of the role. It will assist the new recruit in establishing his or her place on the team.
It is crucial that every company has an induction process for its directors and it is the chairman's responsibility to provide a full, formal and tailored induction for new non-executive directors in order to develop and update their existing knowledge. The chairman should also review and agree with each director their training and development needs. Even with full due diligence new directors will need to acquire a deep understanding of the culture of the company they are becoming part of. The induction might:
- build upon market-specific skills
- contextualise the company’s approach to risk
- impart the latest financial information
- examine the rules by which the board governs itself and matters reserved for its decision
- set out matters delegated to board committees and the terms of reference under which such committees operate
- review the company’s corporate governance, policies and insurance
- scrutinise the company’s business plan and performance against key indicators contained within the plan.
The Code states that it is the responsibility of the company secretary to facilitate directors’ inductions and assist with their ongoing professional development. This follows the recommendation that all directors should receive an induction on joining a company and that all directors should regularly update and refresh their skills and knowledge.
An induction and training programme should be appropriate to directors’ skills and experience. Regular skills audits are an recognised means of establishing whether the board has the requisite skills and experience. Such an audit should also review what resources a company has made available to train its directors. If nothing is in place or provision is inadequate, then this should be of concern to both prospective and current directors.
Overseeing the implementation of a proper training programme is a responsibility that could be properly assigned to an experienced non-executive director. Once needs are established, a rolling programme should be devised for each director, which may include external seminars, internal training and recommended reading of specific articles or publications. The programme should be reviewed at regular intervals in tandem with skills audits to ensure that changing needs are met. It is recommended that non-executive directors should have access to independent professional advice, provided at the company's expense, in order to discharge their duties.
What are the responsibilities and duties of a non-executive director?
Once again, there is no distinction between the standard of care that non-executive directors must meet compared to other directors. Although they may not spend the same amount of time undertaking company business as executive directors, the same level of commitment should be expected and shown. Every decision made by all directors must be in the best interests of the company.
The duties of directors have evolved over the years as the courts have interpreted legislation regulating UK companies. A comparison can be drawn between the role of directors and trustees since directors are entrusted with protecting a company’s assets, albeit for the benefit of the company. Consequently directors must demonstrate due skill, care and good faith in exercising fiduciary responsibility.
The Companies Act 2006 places new statutory duties on executive and non-executive directors alike. Sections 171 – 177 of the Companies Act 2006 state that all directors have:
- a duty to act within powers set out in the company’s memorandum of association,
- a duty to promote success of the company,
- a duty to exercise independent judgement,
- a duty to exercise reasonable care, skill and diligence,
- a duty to avoid conflicts of interest,
- a duty not to accept benefits from third parties, and
- a duty to declare interests in proposed transactions or arrangements.
Sections 170 to 181 (general duties of directors) came into force on 1 October 2007, and sections 175 to 177 (duty to avoid conflicts of interest, duty not to accept benefits from third parties and duty to declare interest in proposed transaction or arrangement) came into force on 1 October 2008. For more information see our Corporate Governance factsheet.
Finally, the Code gives some practical guidance specifically to non-executive directors, stating that:
'As part of their role as members of a unitary board, non-executive directors should constructively challenge and help develop proposals on strategy. Non-executive directors should scrutinise the performance of management in meeting agreed goals and objectives and monitor the reporting of performance. They should satisfy themselves on the integrity of financial information and that financial controls and systems of risk management are robust and defensible. They are responsible for determining appropriate levels of remuneration of executive directors and have a prime role in appointing and, where necessary, removing executive directors, and in succession planning.'
The Code recommends that one non-executive director is appointed as Senior Independent Director to provide a sounding board for the chairman and to act as an intermediary for the other directors.
What liabilities are non-executive directors likely to face?
Although non-executive directors are not responsible for a company’s day-to-day management, since they have the same legal responsibilities and duties as executive directors, they are similarly liable to disqualification under the Company Directors Disqualification Act 1986. If a company’s board of directors is investigated for ‘wrong doing’, then such an investigation will include the actions or omissions of non-executive directors.
In general, a director can be disqualified for general misconduct in connection with companies or for being unfit to act as company director. The maximum period of disqualification is 15 years. However, there have been a number of cases that show that the courts may exercise their discretion and apply a lesser period of disqualification in recognition of the role and relative responsibilities of non-executive directorship.
A consultation paper issued by the then Financial Services Authority (FSA) entitled Effective corporate governance (Significant influence controlled functions and the Walker review) published January 2010 stated that 'NEDs have a pivotal role to play in the active governance of firms. Where it appears to us that executives have persistently made poor decisions, we will look closely at NEDs’ performance if we feel they have not intervened in a timely and sufficient way….We are concerned that the existing guidance could be misinterpreted and taken to mean that we would not hold NEDs responsible for, for example, failing to intervene and challenge the executive. This is not the case, as we see such challenge and intervention as a key part of any NED’s responsibilities.'
What skills do NEDs need?
The following are the skills which NEDs need in order to perform their role:
- high ethical standards
- sound judgement
- willingness to challenge
- interpersonal skills
- understanding of how conflict occurs and how to deal with it effectively
- behavioural skills
- listening skills
- ability to communicate ideas
- sensitivity, openness and awareness of non-verbal communication
- leadership and self-awareness, ability to gain respect and attention
- critical thinking, creativity and strategic awareness
- business acumen, ability to identify new business opportunities
- forward perspective, willingness to embrace change and innovation
- an inquiring and inquisitive mind – with an ability to assimilate, assess and analyse information, especially financial information
- co-operation and teamworking
- facilitation skills
- the ability to take the wider, strategic view
- political astuteness and ability to play the ‘diplomat’
- determination, with the tenacity and drive to succeed
- keenness to gain new knowledge and skills to develop competences further
- availability to prepare for and attend meetings
- an ability to identify potential problems and deal with risk
- and finally, a sense of humour!
Non-executive directors and the structure of the board
As well as providing additional skills, expertise and perspective, the appointment of non-executive directors is an effective means of balancing interests in the board room. Non-executive directors bring a level of independence and detachment to discussions. The 2014 UK Corporate Gvernance Code (the Code) recommends that the listed public limited companies within the FTSE 350 should have at least half the board, excluding the chairman, as non-executive directors; companies outside the FTSE 350 should have at least two non-executive independent directors.
The Code further recommends that the Chairman of the board should meetthe non-executive directors separately from the other directors on a regular basis, and thatthey should also meet on an annual basis, without the Chairman, to review and appraise the Chairman’s performance. The nomination committees, responsible for evaluating, vetting and recommending the appointment of candidates for directorship, should alsocomprisea majority of non-executive directors.
Some of the provisions of the Code state that they arerelevant only to FTSE 350 companies, but in the absence of that qualification it is expected that listed companies comply with the Code; the company should consider carefully before departing from the provisions, and reasons should be given. Smaller listed companies may assess the Code and conclude that, given the size of the company, it is disproportionate to comply. It is recognised that alternatives may be justified if good governance can be achieved by other means. A condition of doing so is that the reasonsshould be explained clearly and carefully to shareholders. Most companies are encouraged to consider the Code as it sets out standards of good practice. The Financial Services Authority (now Financial Conduct Authority) handbook requires that all listed companies state in their annual report whether or not they comply with the Code.
In February 2005 the Commission of the European Communities published recommendations on the role of non-executive directors or supervisory directors of listed companies and on the committees of the (supervisory) board. The Commission recommended that non-executive directors of listed companies should provide independence to the board. Its aim was to promote the 'convergence of the national corporate governance codes which exist in the Member States so that investors can benefit from an equivalent level of protection and transparency throughout the community'.
In July 2007 the Commission reported on how Member States had applied its 2005 recommendations. The findings show that the UK complies with all the recommendations put forward save one. The full-text of the report is available on the Public Register of EU Council documents.
The Walker Review issued in November 2009, makes recommendations to directly affect and enhance the quality and effectiveness of NEDs. It recommends that NEDs:
- should receive sufficient training to ensure they have sufficient knowledge and understanding of the business and sector
- should have access to support to allow them to fulfill their duties
- should have an overall time commitment greater than in the past and time commitment should be clearly indicated in their letters of appointment
- should be ready, able and encouraged to challenge and test proposals
- should chair Risk Committees.
The final annual report on the progress made on each of the recommendations produced in the 2011 Women on boards report by Lord Davies was published in October 2015. The findings included:
- Women accounted for 31.4% of non-executive directorships in FTSE 100 companies, compared with 15.6% in 2010/2011.
- Women accounted for 24.8% of non-executive directorships in FTSE 250 companies, compared with 9.6% in 2010/2011.
The increases show that significant progress has been made since the reports began in 2010 and the fact that the numbers continue to increase year on year also indicate that the improvement is on-going.
More information on the 2011 report and the four annual progress reports on available on the GOV.UK website.
A 2014 report Appointments to boards and equality law by the Equality and Human Rights Commission stated that the European Commission's proposal for a new directive on improving the gender balance among non-executive directors of companies listed on stock exchanges has been drafted to accord with EU law on equality between men and women. The directive provides that the means to achieve the legally binding objective of ensuring that by 1 January 2020 at least 40 per cent of non-executive board members come from the currently under-represented sex must use ‘pre-established, clear, neutrally formulated and unambiguous criteria in selection processes'. It would be permissible under the directive to give priority based on gender to a candidate from the under-represented gender group where they are judged to be equally qualified in terms of suitability, competence and professional performance. However, the directive includes no other exception from unlawful discrimination.
What CIPD members can offer and finding a role
HR professionals have in the past not been sources of talent for NED positions, but with their skills and core competences relevant to board working, they have much to offer. Geoff Armstrong,then the Director General of the CIPD, is quoted in the Tyson review, saying ‘There is a vast pool of talent within the HR profession. Such individuals would bring a new dimension to the non-executive role and ensure that an organisation’s key driver of value – namely its people – is taken seriously at board level. They would bring a fresh and much-needed perspective to the decision-making process.’
The following are core skills possessed by HR professionals which would make them suitable non-executive directors:
- understanding that the key to a company’s success is its people
- focusing on the convergence and divergence of employee and management priorities
- communicating the link between people and profit - a committed and skilled workforce boosts profitability
- people management and development skills
- skills in remuneration, recruitment and development, human capital and corporate social responsibility
- communicating an 'employee's perspective' to the board
- handling budgets
- logical thinking
- being organised
- ability to challenge constructively
- good interpersonal skills
- team playing
- problem solving
- critical decision-making
- high ethical standards
- sound judgement
- willingness to challenge.
The task of finding candidates for private sector non-executive roles is often given to search firms and such roles may be advertised in the national press. The following organisations may also be of interest.
- FT Non-Executive Directors' Club provides a matching service for members seeking a non-executive position, access to networking events and various corporate governance resources (subscription required).
- Non-Executive Directors Association (NEDA) established in 2006 to 'represent non-executive directors and ensure they are properly trained and developed 'its member benefits include an Information Centre and a CV upload facility to aid finding a NED role.
- Non Executive Directorship Exchange provides help to individuals seeking non executive director jobs and recruitment services to companies seeking to recruit a non executive director. The website also provides articles about the benefits of non executive directorships for both directors and companies.