The Combined Code on Corporate Governance: Appointment of
directors
This article is based on UK law as at 1st April 2007, unless
otherwise stated.
According to main principle A.4 of the Combined Code, there
should be “a formal, rigorous and transparent procedure” for the
appointment of new directors. In other words, the days of putting
your friends from the golf club on the board are over.
The Code gives the recruitment task to a nomination committee, a
majority of whose members should be independent non-executive
directors.
There is no ban on the chairman or the chief executive being a
member – as is consistent with the committee’s role in making
recommendations for executive as well as non-executive
appointments. The chairman may chair the committee – though they
should stand aside when it comes to choosing their successor.
The committee is expected to:
- evaluate the balance of skills, knowledge and experience on the
board and, in the light of that, draw up a description of the role
it is seeking to fill and the capabilities required;
- use external search consultancies or open advertising in the
hunt for candidates for the chairman’s role and non-executive
posts. (Failure to cast the net this wide must be explained in the
annual report);
- make appointments only on merit and after assessing candidates
by means of objective criteria;
- ensure that candidates for the chairmanship and non-executive
roles will have the necessary time to devote to the company;
- set out the terms and conditions of the appointment of
non-executive directors – including the expected time commitment –
and make those terms publicly available.
Individuals who are non-executives in one company will often be
executive directors in another – and vice versa. It is generally
thought to be a good thing that an executive gets experience of the
workings of another company and another industry. However, it is
important that the demands on the individual are realistic – the
Code says that the board should not agree to a full-time executive
taking on more than one FTSE 100 company non-executive directorship
or the chairmanship of such a company.
Induction and training for directors
The authors of the Code believe that new directors have to be
properly trained. This means an effective induction process when
the director joins the board and an on-going programme of
professional development. In the words of main principle A.5,
directors should “regularly update and refresh their skills
and knowledge”. (If they do not they cannot possibly hope
to keep up with the pace of legislative and regulatory change. The
new code of directors’ duties in the Companies Act 2006 –
see the section on Directors'
duties – is only one recent development.)
“The company,” says the Code, “should provide the necessary
resources for developing and updating its directors’ knowledge and
capabilities”. Note also the obligation in Listing Principle 1:
“A listed company must take reasonable steps to enable its
directors to understand their responsibilities and obligations as
directors.”
The essential point is that directors must be given the right
“equipment” and get the right preparation to do their
jobs/discharge their duties. There is reference to “tailored
induction”. Thus the Code recommends that new non-executives get
the chance to meet major shareholders as part of their induction
process (A.5.1) and that “consideration should be given to
visiting sites and meeting senior and middle management”
(Higgs' Suggestions for Good Practice).
For all directors, the right “equipment” includes
“accurate, timely and clear information”. The
company secretary, under the direction of the
chairman, must, say the supporting principles, ensure “good
information flows within the board and its committees and between
senior management and non-executive directors”.
The words “clear” and “good” here are sometimes forgotten when
directors are first appointed. Companies can tend to overburden an
individual. As ICSA says in
its guidance notes on the induction process, “it has become
apparent that some newly appointed directors have been completely
overwhelmed with the sheer volume of documents and other papers
provided by the well meaning company secretary to such an extent
that some have been completely put off by it”. To avoid this, ICSA
suggests giving the director essential information only on their
appointment and providing further necessary information in the
subsequent few weeks. Subsidiary information can follow once the
first two batches have been digested.
The company should also be prepared to pay for independent
professional advice where the directors judge it necessary.
Performance evaluation
In the past few years, the idea of board-level appraisals has
become increasingly accepted. Thus main principle A.6 is that
“the board should undertake a formal and rigorous annual
evaluation of its own performance and that of its committees and
individual directors”.
As with any appraisal process, the intention is that strengths
are recognised and built upon and weaknesses are addressed – which
may mean, ultimately, asking a director to go. Questions to ask
will include:
- is the director’s contribution to the board an effective
one?
- do they demonstrate commitment to the role?
- are they giving the job the time it requires?
Once a year, the board should look at itself and assess what it
does, its failures and successes, and a similar process should be
conducted by the board for each of its committees.
The annual report needs to explain how these appraisals are
carried out. There is no guidance in the Code as to whether it can
or should be done in-house, though many boards seem to be reporting
the use of home-grown procedures based on one-to-one interviews
between the chairman and each director. Most human resources
departments will have experience of appraising employees, and some
of the same principles will apply here. Equally, there may be merit
in bringing in outside consultants to facilitate the appraisal
process. Ultimately, however, it will be the responsibility of the
board to draw conclusions from the process and to act upon
them.
The chairman does not escape. His or her performance should be
evaluated by the non-executives as a whole, under the leadership of
the senior independent director. But they need to consult the
executive directors and take account of their views.
Re-election
A poor appraisal may result in the chairman asking a director to
stand down. That will be an internal board matter. But what of the
shareholders? What power do they have to get rid of directors who,
in their eyes at least, have under-performed? Shareholders can pass
a resolution at a general meeting to remove a director if they can
muster more than half the votes cast. But in many companies, the
AGM also gives the shareholders the opportunity to vote on the
re-appointment of some of the directors. Many company articles will
provide that all new directors have to stand for re-election at the
AGM following their appointment, and that is a provision echoed by
the Code. Articles will commonly stipulate that a third of the
directors should retire and stand for re-election each year. The
Code expresses the same sentiment, but with a variation: each
director (executive or non-executive) should be subject to
re-appointment by the shareholders every three years.
Although shareholders have rarely used their power to remove
directors in this way, three Manchester United directors were shown
the red card at their 2004 AGM when American sports tycoon Malcolm
Glazer, who later bid for the company, took his revenge on those
coming up for re-election after he was refused access to the
company’s books. (Glazer owned 28.1 per cent of the club’s
shares.)
The shareholders may not be privy to the detail of the board’s
appraisal of individual directors but the Code does require the
chairman to confirm to them that, following an appraisal, the
performance of the director up for re-election “continues
to be effective and to demonstrate commitment to the
role”. Indeed, the board is required to tell shareholders
why it believes an individual director should be re-elected.
The non-executive’s letter of appointment needs to take account
of the requirement that he or she stands for re-election every
three years. The Code says that two three-year terms should be the
norm and a third, making nine years in all, should be
“subject to particularly rigorous review” and take
account of the need for “progressive refreshing of the
board”. Despite this, nine-year terms are very common, and
some institutional shareholders now seem relaxed about them. Many
companies would argue that there is little point in sacrificing a
director’s experience and knowledge of a group after only six years
because of an unjustified fear that they may have gone stale. Once
nine years are reached, the Code suggests that the director should
be subject to annual re-election.
