The importance of non-executive directors, while sometimes questioned, is fairly well established. The guidelines for Jersey directors issued by the Institute of Directors (IoD) go as far as to suggest that boards composed wholly of full-time executive directors are potentially weak if they become insular, and that public companies should ideally have:
- a minimum of three or one-third non-executive directors for larger companies; and
- a minimum of two or one-quarter non-executive directors for smaller companies.
Similar considerations apply to private companies, particularly those with institutional investors.
Clearly the expectation is high: non-executive directors contribute something extra, something more, than executive directors alone. So what are the duties and responsibilities of non-executive directors in 2017 and do they need to be superhuman?
First and foremost – and perhaps surprisingly in light of the above – companies laws do not, on their face, generally distinguish between executive and non-executive directors when it comes to the duties owed to a company.
In Jersey, the Companies Law requires all directors of a Jersey company to:
- act honestly and in good faith with a view to the company's best interests; and
- exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.
While these statutory obligations are supplemented by the fiduciary duties imposed on directors by the customary law of the island (eg, the duty to exercise power for a proper purpose and to account for profits), the core duties apply to all directors, regardless of whether they hold an executive office in the company.
The first limb of this test is subjective. A director acting honestly and in good faith with a view to the company's best interests will not be in breach of this duty just because the court considers that what he or she did was not in the company's best interests.
However, the second limb of this test is objective. It is based on what a reasonably prudent person would be expected to do in comparable circumstances. This objectivity means that a professional person, for example, may be subject to a higher duty than a layperson when discharging the duty to exercise care, diligence and skill. Similarly, it seems that the steps that executive and non-executive directors are expected to take to satisfy this duty may vary depending on their different roles on the board.
This means, of course, that no two cases will be the same, because each will be judged on its particular facts. However, there are some general observations about what might be expected of a non-executive director.
As a starting point, English case law, which is not binding but tends to be persuasive in the Jersey courts, throws some light on where the emphasis typically lies for non-executive directors.
English cases unsurprisingly establish that all directors have a continuing duty to acquire and maintain sufficient knowledge and understanding of the company's business to enable them to discharge their duties (Re Barings plc v Baker, 2000).
However, it is clear that directors are also entitled, subject to the company's articles, to delegate particular functions to management and trust their competence and integrity to a reasonable extent.
While all directors have a duty to supervise the discharge of the delegated function, English case law emphasises this supervisory role when it comes to non-executives.
Thus, while non-executive directors can look to others to perform particular tasks, they retain residual non-delegable responsibilities for supervision and control, and a collective responsibility to manage the company. It is therefore essential for non-executive directors to ensure that they are properly informed about the company's affairs, both when they begin their appointment and while in office.
In terms of this information, although non-executive directors may rely to a large extent on information and explanations supplied by the executive directors and senior management, they should not do so blindly. For example, non-executive directors are expected to satisfy themselves, by calling for appropriate information, that actions proposed by the executives will be in the company's best interests.
These basic principles are supplemented in the United Kingdom by the Corporate Governance Code which applies to companies with a UK premium listing of equity securities, regardless of where they are incorporated. The code also serves as a barometer of good corporate governance more generally.
The code identifies the specific role of non-executive directors as being to:
- constructively challenge and develop proposals on strategy;
- scrutinise the performance of management in meeting agreed goals and objectives and monitoring the reporting of performance;
- satisfy themselves as to the integrity of financial information and that financial controls and risk management systems are robust and defensible; and
- determine executive director remuneration and play a prime role in succession planning, including appointing and removing executive directors.
When English law is mapped against the IoD guidelines for Jersey directors, similar themes emerge. The guidelines suggest that non-executive directors should:
- act as engaged sceptics and maintain an independent view;
- widen the horizons within which the board determines strategy (bringing wider general experience and specialist knowledge);
- encourage debate and question policy proposals and recommendations of the executive directors to ensure that decisions are properly thought out and justified;
- monitor management performance;
- ensure high standards of financial probity and risk management; and
- ensure that adequate systems are in place to deal with directors' conflicts of interests.
Stepping back from this, some fairly traditional themes emerge as the core focus of today's non-executive: independence, guidance, strategy, management oversight and financial and risk management. These remain the basic expectations and criteria by which non-executive directors are judged.
But is this really where the non-executive director truly adds value in today's society?
Around five years ago, the Korn/Ferry Institute carried out the survey "What Makes an Exceptional Independent Non-Executive Director". At the time, the report identified three new, specialised characteristics of the non-executive director of the future. While the role still involves testing, evaluating and probing, the report suggested that the complexity facing boards had increased and that the required competencies had evolved accordingly.
Risk The first of these three new specialised characteristics of the non-executive director of the future related to risk. This has been borne out in practice and is now firmly on the radar of non-executive directors under the UK Corporate Governance Code, the Jersey director guidelines and many other commentaries.
Boards are now faced with an increasingly complex regulatory and risk environment. Navigating the challenges that this presents requires not only technical know-how, but also the leadership skills to help drive a strong risk culture within an organisation.
Accordingly, operational, financial and reputational risk is increasingly at the forefront of the role played by non-executive directors in providing strategic oversight at board level. Part of the non-executive director's job has become to think the unthinkable, so that strategies can be developed to head trouble off at the pass.
Financial expertise The second of the new specialised characteristics of the non-executive director identified in the Korn/Ferry report was financial expertise. The general lack of financial expertise on many boards has repeatedly been cited as a contributing factor to the global financial crisis; thus, promoting the highest standards of financial integrity in an organisation has moved much higher up the wish list in terms of non-executive directors' contributions.
Again, this has been borne out, with more boards engaging non-executive directors with true financial literacy, who can understand financial complexity and respond quickly to volatile markets.
Technology The last of the three new specialist characteristics of the future non-executive director identified in the 2012 report related to technology. This means not just being computer literate or cybersecurity aware, but truly understanding the impact of technology in driving new business models and corporate strategies.
The report identified the need for non-executive directors with specific knowledge and experience to help frame the strategic discussion around information technology. It predicted the need for a rapid increase in non-executive directors who can spot opportunities, identify threats and increase board diversity.
However, a 2016 PricewaterhouseCoopers (PWC) report entitled "Directors and IT" looked at how companies currently manage information technology oversight.
PWC surveyed 800 public company directors and identified an "IT confidence gap" at board level. The report concluded that although many directors want to understand the risks and opportunities relating to information technology, they sometimes have an insufficient understanding and often lack a well-defined process to enable them to deliver truly effective oversight in this area.
And yet, arguably, there is an element of denial that this gap exists in the board room. Of the 800 public company directors PWC spoke to only:
- 37% believed that it is very important to have someone with information technology strategy expertise on their board; and
- 18% said that they spent more than 10% of their board and committee hours in 2015 discussing oversight of information technology risks and opportunities (down from 19% in 2012).
Instead, the report showed that information technology expertise was being bought in – with 45% of boards engaging outside information technology consultants, 80% of them on a project-specific basis.
Of course, there are arguments for and against committing a board seat to a director with information technology expertise, possibly at the cost of someone with a broader skillset and wider operational and leadership experience.
However, based on these statistics, it seems that many boards still do not regard information technology as a strategic competency that needs to be an integral part of the continuing corporate, financial and risk management matrix of their organisation.
This is surprising as, arguably, what happens online is fast becoming central to the governance equation. As such, it is likely that there will be more new-generation, tech savvy non-executive directors at board level and that their contribution will become key value add that stakeholders will expect their non-executive director base to bring to the table.
This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.