Non-executive directors have recently been labelled as ‘yes’ men, too weak to challenge the CEO. But is this criticism fair considering their difficult role? asks Gary Ashton
The Treasury Select Committee’s 2009 report on the recent financial crisis exposed serious flaws and shortcomings in non-executive directors’ (NEDs) behaviour in the banking sector. As a result, NEDs have come under a lot of attack recently, being labelled as ‘yes’ men, too weak to challenge the CEO. Although this may be true in some places, this criticism is also somewhat harsh and unfair considering their difficult role.
NEDs are supposed to be both friend and critic to the CEO. But such a relationship can only be fraught with challenges. A CEO is expected to have a strong personality, be decisive and highly driven. However, s/he is then faced with NEDs, whose job is to ask awkward questions. So what NEDs perceive as healthy challenge, can be misconstrued as unnecessary interference by the CEO. The potential for conflict then is high and can be incredibly damaging. Remember Lord Young, chairman of Cable & Wireless, and the then CEO James Ross who were both sacked by the board when it became obvious that the pair were incapable of working together.
Equally damaging is the CEO who dominates NEDs to the point that they become ineffective. It has been suggested that this was the situation with several chief executives in the banking sector. They appeared to have dominated their boards to such an extent that the NEDs did not sufficiently challenge their organisation’s strategy or management of risk. One factor behind this behaviour can be when a CEO does not have sufficient respect for the NEDs. This could be for a number of reasons, including factors like they don’t believe they have sufficient expertise, or they just cannot keep up with the pace of change in the business.
This perception has been somewhat reinforced by the recent Treasury report that criticised those in the banking sector who were holding too many non-executive positions therefore unable to devote sufficient time to any given role, and for taking roles where they lacked expertise. According to Treasury Committee chairman, John McFall, “often seemingly eminent and highly-regarded individuals failed to act as an effective check on, and challenge to, executive managers, instead operating as members of a ‘cosy club’.”
On the other hand, there are boards where we have witnessed executives of the management team physically shrink before their domineering NEDs. What is seen as a healthy challenge from the NED’s perspective can be perceived as destructive interference from the executives. Where the NEDs believe they are doing their job in representing the shareholders, the executives just see them as putting a drag on performance and hence doing the shareholders a disservice. In these cases where a perceived destructive NED challenge is taking place, the CEO and his/her team can react by playing ‘battleships’ with their encrypted presentations that avoid dealing with issues they might be challenged on.
So if we are to help create a more healthy board environment, let us first remind ourselves of the role of the board.
Board role
According to the Higgs’ report on corporate governance (2003), The role of the board is to provide entrepreneurial leadership of the company within a framework of prudent and effective controls. It does this by setting the company's strategic aims, ensuring that the necessary financial and human resources are in place, and reviewing management performance. And it should set the company's values and standards, and ensure that its obligations to its shareholders and others are understood and met.
In fulfilling this role, we have a range of board styles regarding how they deliver this role, so there are few universal prescriptions. But what is key to all boards is how they get the balance of power right between both sides.
Diagram 1: Balancing the NED/Executive Relationship
Balancing Power
Where we have seen NEDs that are weak, they fail to fulfil their role of effectively challenging the CEO. Without the independent ‘reality check’ the CEO can become too dominant allowing their agenda to be pushed through unchecked. In these cases, the CEO only uses the NEDs merely to provide cover from the shareholders, in order to allow them to get on with running their business.
Where the NEDs are strong, they have the potential to move towards a ‘risk-averse’ set of behaviours – especially with the growing threat they are under of prosecution – which can restrict the executives’ flair and drive to the extent that acceptable risks are not taken.
It is only when both NEDs and CEO are strong and confident that they successfully fulfil their respective roles. But this requires each party to understand and embrace each others’ role. A productive relationship is one where the CEO accepts that the NED is a constructive support to driving through big strategic decisions (see diagram 1 above).
Strong, effective boards have built up a rapport between the two parties over time, where the board has an appropriate involvement in strategy development and where difficult challenges of the company are not necessarily tackled just in the boardroom, but also through dialogue with NEDs outside the formal board setting. These meetings, however, need to be managed carefully, to ensure that the executives still own the problem, and do not shift responsibility onto the NED. These meetings do not provide board ratification of the executives’ proposals.
Building effective boards
So how are effective boards built? The first step is appropriate selection of NEDs (see Paolo Moscuzza’s article on page 14). It is important to not only agree the level of industry expertise required to be able to challenge with authority, but also to have the right range of behavioural capabilities to challenge effectively.
Step two is getting NEDs and the executives to work together in a constructive manner working to an explicit set of rules of engagement that define the degree to which the NEDs can ‘kick the tyres’ of the organisation. The role of the SID in this aspect is becoming increasingly recognised as a vehicle for helping ensure a healthy relationship (see article on page 5).
ER Consultants’ Board Evaluation process (see below) can also be a mechanism by which the NED/executive working relationship, can be improved through a realignment of expectations of how they work together, so that the CEO and executives expect and seek NED critique. When that happens, we’ll see more NEDs standing up to the CEO and challenging the executive, without being labelled as either ‘weak’ or ‘interfering’.
Board Evaluation: Improving the Executive/NED Relationship
There are a number of dimensions to getting the executive/non-executive relationship right. It is about having clarity of roles, responsibilities and processes, and an agreed set of ways of working. In short we need:
Clarity of roles and processes
Balance of expertise and experience;
Appropriate NED involvement in strategy development;
Appropriate mix of formal and informal interactions;
Agreed expectations of each other and ways of working together.
ER Consultants’ Board Evaluation process ensures that both the formal and informal elements of an effective board are properly audited. The evaluation results can then be used to provide a constructive space for the board to reflect and develop how they work together. According to our clients, ER Consultants’ board evaluations have:
Allowed difficult messages to be heard and avoided offence being taken by others;
Differentiated opinions that are being held by many NEDs from those just held by singular/strident individuals;
Provided a good way to give feedback to NEDs and the Chair;
Raised collegiality of the board;
Allowed NEDs to put forward ideas and perceptions without causing offence;
Proved useful when a board problem needs tackling;
