Transcript Board Formation: The UK Experience

OECD Russia Corporate Governance Roundtable
Moscow, 25–26 October 2012
Board Formation: The UK
Experience
Dr. Roger Barker
Head of Corporate Governance at the Institute
of Directors (UK) and Senior Advisor to the
Board of the European Confederation of
Directors Associations (ecoDa)
[email protected]
Co-sponsored by
Informational partner
Agenda
1. The UK boardroom context – key features of UK
corporate governance
2. The board formation process in the UK
3. Recent developments in board formation – proposed
changes to UK listing rules for companies with
controlling shareholders
4. Key lessons from the UK experience
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UK Boardroom Context (1) – Ownership Structure
•Large quoted companies in the UK are widely held, i.e. there is dispersed
rather than concentrated ownership
•Institutional investors are the main category of shareholder, although there is
more than 40% foreign ownership. Around 8% of UK equities are now held by
Sovereign Wealth Funds
•Some examples (as of H1 2012):
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Royal Dutch Shell (Blackrock: 6.6%; Legal & General: 4.2%). Market Cap $228 bn
GlaxoSmithKline (Blackrock: 5.6%; Legal & General: 3.7%). Market cap $98.6 bn
Vodafone (Blackrock: 6.0%; Legal & General: 3.6%). Market cap - $145.9 bn
BP (Blackrock: 5.9%; Legal & General: 4.2%). Market cap - $ 136.8 bn.
HSBC (Blackrock: 6.6%; Legal & General: 4.0%). Market cap - $181.9 bn.
All other shareholders own less than 3%
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UK Boardroom Context (2) – Directors’ Duties
•Company law defines fiduciary duties for directors. Directors are
required to promote the success of the company for the benefit of all its
shareholders (section 172, Companies Act 2006)
•However, there should not be a narrow focus on shareholders.
Directors should take into account a range of other factors when
pursuing the interests of shareholders, including:
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the likely consequences of any decision in the long term
the interests of the company's employees
the need to foster the company's business relationships with suppliers,
customers and others
the impact of the company's operations on the community and the environment
the desirability of the company maintaining a reputation for high standards of
business conduct
the need to act fairly as between members (i.e. shareholders) of the company
The ‘enlightened shareholder value’ concept
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UK Boardroom Context (3) – Board Structure
•UK companies have a unitary board structure, containing a mixture of
executive and non-executive directors
•There is a strong trend toward boards where the majority of directors are
independent non-executive directors. In the FTSE 350, 80% of companies have
boards where more than half the board is independent (excluding the
chairman)
•There is also a strong bias in favour of an independent chairman and a split of
the chairman/CEO roles. Only 11 companies in the FTSE 350 continue to
combine the chairman and CEO roles
•Employees are not typically represented on UK boards
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UK Boardroom Context (4) – Regulatory Approach
•Company law and listing rules define baseline requirements for corporate
governance
•However, most corporate governance requirements are prescribed in the UK
Corporate Governance Code – applied on the basis of ‘comply or explain’ by
Premium Listed companies. Key Provisions include:
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The roles of chairman and chief executive should not be exercised by the same individual. (A.2.1)
The chairman should on appointment meet the independence criteria set out in the Code. A chief executive
should not go on to be chairman of the same company. (A.3.1)
Except for smaller companies (outside the FTSE 350), at least half the board, excluding the chairman,
should comprise non-executive directors determined by the board to be independent. (B.1.2)
Evaluation of the board of FTSE 350 companies should be externally facilitated at least every three years.
(B.6.2)
All directors of FTSE 350 companies should be subject to annual election by shareholders. (B.7.1)
•Around 50% of companies in the FTSE 350 fully comply with all the Provisions
of the Code (up from 28% in 2005). Most of the remainder are non-compliant
with only one or two Provisions of the Code
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Anatomy of the UK Boardroom in 2012
•The average FTSE 350 board has 3 executive directors, 5.3 non-executive directors and
a non-executive chairman. (As recently as 2006, executive directors were still in the
majority)
•Average number of board meetings per year: 8.7
•Average age of a FTSE 350 director: 57.5
•15% of FTSE 100 directors are female. This falls to 10% in the FTSE 350 as a whole.
There are only 2 female chairmen
•25% of FTSE 350 companies had an external board evaluation in 2011
•70% of FTSE 350 companies annually elect their directors
•Average fee for a non-executive: £79,500 in the FTSE 100; £48,500 in the Mid 250
Source: Grant Thornton Corporate Governance Review 2011
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Appointment of Directors – The Legal Process
•Company law defines a key role for shareholders – appointment or dismissal of any
director is possible by an ordinary resolution (50%+1) of shareholders
•However, the Model Articles of Association for Public Companies (section 20) states:
Any person who is willing to act as a director, and is permitted by law to do so, may be appointed
to be a director—
(a) by ordinary resolution, or
(b) by a decision of the directors.
•In practice, almost all board members are initially appointed by a decision of the
directors, i.e. by method (b). Only afterwards is the decision ratified by shareholders
•Section 21 of the Model Articles states:
(1) At the first annual general meeting all the directors must retire from office.
(2) At every subsequent annual general meeting any directors—
(a) who have been appointed by the directors since the last annual general meeting, or
(b) who were not appointed or reappointed at one of the preceding two annual general
meetings, must retire from office and may offer themselves for reappointment by the
members (i.e. shareholders).
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The Role of the Nomination Committee
•The UK Corporate Governance Code states that there should be a “formal,
rigorous and transparent procedure for the appointment of new directors to the
board”
• It also recommends that there should be a nomination committee which
should lead the process for board appointments and make recommendations to
the board
•According to the Code:
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The search for board candidates should be conducted, and appointments made, on merit, against objective
criteria and with due regard for the benefits of diversity on the board, including gender
A majority of members of the nomination committee should be independent non-executive directors
The chairman or an independent non-executive director should chair the nomination committee - but the
chairman should not chair the nomination committee when it is dealing with the appointment of a successor
to the chairmanship
The nomination committee should evaluate the balance of skills, experience, independence and knowledge
on the board. In the light of this evaluation, it should prepare a description of the role and capabilities
required for a particular appointment. The terms and conditions of non-executive director appointments
should be available to shareholders
A separate section of the annual report should describe the work of the nomination committee, including the
process it has used in relation to board appointments. Its terms of reference should be publicly available
An explanation should be given if neither an external search consultancy nor open advertising has been
used in the appointment of a chairman or a non-executive director
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Effectiveness of Nomination Committees in
Practice
•Places the director appointment decisions in the hands of an ‘independent’ committee
comprised mainly or wholly of independent non-executive directors
•Purpose – to avoid domination of director selection by CEO (the main concern in the
UK) or a dominant shareholder (a common concern in many other countries)
•Seeks to prevent the board becoming a self-perpetuating ‘club’ or just a representative
body for powerful interests (management, controlling shareholders, etc)
•But the experience of the UK shows that supposed independence can be illusory:
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If so-called ‘independent’ non-executive directors are themselves part of the ‘club’ – in the
UK, independent directors are still drawn from a relatively narrow pool of candidates (male,
former CEO/CFOs)
Often a perceived need to support the CEO and the executive team – otherwise may be
seen as ‘disruptive’ or not a team player
May perceive an allegiance to those who nominated them
•As a result, UK boards may lack diversity, be insufficiently challenging of management,
susceptible to ‘groupthink’, inclined to consensus rather than rigorous debate,
insufficiently sensitive to wider stakeholder concerns
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Recent Developments – Dealing with Controlling
Shareholders
•New proposed changes to UK listing rules – published in October 2012. Public
consultation will conclude in January 2013
•Re-introduces the concepts of the ‘controlling shareholder’ and ‘independent
shareholders’ into the Listing Rules – response to increasing number of foreign
companies with controlling shareholders listing in London
•Relationship Agreements must be created between the company and the controlling
shareholder – must be published in the annual report or otherwise publicly accessible
•Companies with a controlling shareholder must have boards with a majority of
independent directors. A binding requirement – no longer to be applied on the basis of
‘comply or explain’
•Independent directors must be elected by a dual vote of both a) all shareholders and b)
independent shareholders. If the result of the two votes conflicts, a further vote takes
place on a simple majority basis after not less than 90 days – aims to give independent
shareholders time to engage with the controlling shareholder and reach a compromise
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Board Formation – Lessons from the UK
Experience
•“The objective should be to facilitate the creation of competent boards that are
capable of objective and independent judgement.” (OECD 2009: 9).
•But ‘independence’ and ‘objectivity’ in the board formation process are not
easy to achieve
•A nomination committee that fulfils formal independence criteria avoids some
obvious conflicts of interest – such criteria are worthwhile
•But formal processes will not guarantee a genuinely independent and objective
board appointments process – it could just be box ticking
•In addition to formal rules, policy makers should focus on:
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encouraging a high level of transparency with respect to the board appointments
process
director education and the development of a cadre of highly credible
independent directors
dissemination of best practices, including wider use of board evaluation
processes
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OECD Russia Corporate Governance Roundtable
Moscow, 25–26 October 2012
Disclaimer: The views expressed in
this presentation are those of the
author and do not necessarily
represent the opinion of the OECD
Russia Corporate Governance
Roundtable, the OECD or its Member
countries, or of the Moscow
Exchange.
Co-sponsored by
Informational partner