The need for the NED

Who do companies want as their non-executive directors, and are they available? Sarah Perrin reports

Your companies need you! According to recent surveys, many listed companies are falling short of the recommended levels of non-executive directors on their boards. Is this due to a shrinking pool of willing candidates, or simply the time it takes to meet new corporate governance requirements?

According to Deloitte, FTSE 350 companies would need to appoint at least 145 new non-executive directors (NEDs) next year in order to be fully compliant with the 2003 revised Combined Code of Corporate Governance. The Code requires that independent NEDs should comprise not less than half the board in listed companies. According to Board Structure and Non-executive Director Fees, published by Deloitte this autumn, 16% of FTSE 100 and 39% of FTSE 250 companies have boards where the proportion of independent NEDs fails to meet that 50% target.

“We anticipate that it may be harder to recruit non-executive directors in the year ahead as individuals are increasingly being put off by the risk, responsibilities and time commitment involved,” says Carol Arrowsmith, head of remuneration at Deloitte. “Companies may need to look further afield to recruit, as many companies still need to appoint more non-executive directors to fulfil the Combined Code’s requirements.”

Deloitte’s warnings are echoed in The Rise of the Non-Executive Director, a report published in October by UK training and development specialist Roffey Park, based on interviews and focus groups with NEDs and other board members. “What’s coming through is that there isn’t an adequate pool - there just aren’t enough people,” says report author Linda Holbeche. “That’s because boards themselves haven’t moved on. They are continuing to recruit in their own image. At best, you might get the odd slightly younger person getting onto boards and a few more women, but otherwise there’s not a vast change from three or four years ago.”

Holbeche believes part of the problem is that people who would have considered being a NED in the past are now deselecting themselves, put off by the size of the workload and the perceived personal risk. Non-executive directors have the same legal duties, responsibilities and potential liabilities as their executive colleagues. “It [being a NED] is now seen as a proper job of work rather than something where you go and have a sherry and sit through a meeting,” she says. “Conversely, we found that a lot of people who were desperate to become NEDs and wouldn’t mind the workload had tried and been rebuffed.”

Valid experience

Public sector candidates are most likely to be rebuffed. According to Roffey Park, private sector directors typically believe that public sector exposure, even in charities or NHS trusts, does not provide valid experience for becoming a listed company NED. “People are repeatedly told by headhunters that unless they have FTSE 100 or 250 experience, they are not interested,” Holbeche says.

Not everyone is downcast, however. Sarah Grunewald, director of the corporate division at Directorbank, a specialist in director recruitment, is distinctly positive about the availability of NED candidates. “We are not experiencing any shortage,” she says. “It’s a competitive market and we currently have to turn people away.” Prospective NEDs, in fact, have to sell themselves. “You need to win your place by being as interesting and dynamic as the people who work in that company every day,” Grunewald says. “As companies find they have to pay more for NEDs and take more notice of what they say, they will be more careful about looking at what NEDs can bring to the business.”

Grunewald concedes that the very largest companies may be finding it harder to find suitable candidates. “In the FTSE 50, maybe the reward has not kept pace with the risk,” she says. “But for the bulk of companies there is no shortage of people, who almost take a public service attitude to it. They see it as something that needs to be done and have confidence in their ability to do it.” Grunewald adds that NEDs who take their responsibilities seriously, and who “keep a good paper trail”, should not feel too concerned about litigation risk. So who is coming forward? “We are finding a lot of retired people with great track records who want to keep active,” Grunewald says, noting that Directorbank sees about three to four ex-Big Four auditors a month. “There are also some corporates who want to get board level experience for their rising stars.”

Finding the reality behind the conflicting messages from different sources is a challenge facing the Financial Reporting Council, which is currently reviewing companies’ progress in implementing the revised Combined Code. Whether companies are finding it hard to recruit enough NEDs of the right calibre is an issue it is exploring. “Some people are saying that the combination of an increased workload, the requirement that companies have 50% of the board being independent non-executive directors and a general concern about director liability are putting some pressure on the supply of non-executives,” acknowledges Chris Hodge, head of the corporate governance unit at the FRC. “We don’t know if that’s the case. A lot of companies we speak to directly are saying there may be issues about the quality of NEDs, but not about the number of people willing to serve.” It may also be that those willing to serve as NEDs are taking on fewer appointments. “Workloads seem to be increasing,” Hodge says. “Anecdotal evidence suggests that people are maybe more selective about which jobs they take on.”

The FRC, which is responsible for promoting high standards of corporate governance, understands that complying fully with the Code may take time. “We wouldn’t want people to appoint somebody to the board without the right mix of skills and experience, purely to meet the requirement in the Code,” Hodge says. “The important thing is to end up with the right balance and mix of skills and experience. We recognise that takes time.”

There is at least evidence of gradual improvement. Deloitte’s report found that the average FTSE 100 company now has eight NEDs, compared to four last year. FTSE 350 companies now have 50% more non-executive directors than executive directors, whereas two years ago they only had 30% more.

Market forces may also help to ease the situation, because fee levels are increasing. In its latest study Deloitte found that NEDs’ fees had increased by 10%, compared to 5.8% the year before. The median fees for non-executive directors now range from £32,500 in the smallest FTSE companies to £66,500 in the largest. “We are seeing a market that is transitioning to a higher level,” says Arrowsmith. She predicts significant fee rises again in 2006, but then a return to more normal rates of increase. NEDs with expertise qualifying them to join the audit committee may be able to command a premium in the market. According to Deloitte’s research, chairmen of audit committees earned higher fees than other committee chairmen in 39 companies.

As all NEDs begin to realise their worth in terms of higher fees, the workload and risk involved should become less of a barrier. But if a shortage of NEDs persists a couple of years from now, companies must surely then open their arms to candidates from a wider pool, including the public sector.

Sarah Perrin is an accountant and writer.