March 2003 - Boardroom reform

It was difficult to ignore the chorus of complaints this week from the highest quarters of Britain's biggest companies, where chairmen have been queuing to take a swipe at the boardroom reforms proposed by Derek Higgs. Increasing powers for non-executive directors would divide boards and undermine the power of chairman, said most of those canvassed by the CBI.

Borrowing the immortal words of Mandy Rice Davies, I find myself suggesting: "They would say that, wouldn't they?" In fact, while some of the CBI findings are consistent with those gleaned by Russell Reynolds, the headhunting company, just two weeks after the publication of the Higgs report in January, overall opposition to the reforms appears to have hardened.

The Russell Reynolds survey, based on conversations with 30 FTSE chairmen, questioned about half the number that responded to the CBI survey and produced a far less hostile response to that registered in this week's report. But that was before most of the chairman had had the opportunity to find a collective voice.

In fact, the Higgs report was "warmly welcomed" by chairmen initially, according to Russell Reynolds. A month on, opinions have become entrenched.

Most complaints appear to have focused on the recommendation to appoint a senior independent director, widely regarded by existing chairmen as divisive, particularly since it involves reporting back to shareholders. In other words, chairmen are viewing this figure as a "shareholders' nark" who could undermine the unity of the board.

The sentiment is understandable but the shareholders deserve to have a more effective conduit to the board - a person who may be more sympathetic to their concerns than has sometimes been the case in the past. Even so, it would not help if the post were to lead to the emergence of hostile camps on the same board.

It is tempting to view the Higgs report as revolutionary in its attempts to create greater boardroom independence. Those who do might like to consider this statement: "The board will be stronger and more effective if it is genuinely an 'outside' board, the bulk of whose members have never served as full-time officers of the company."

Who said this? Patricia Hewitt, the UK trade and industry secretary, perhaps? In fact, it was Peter Drucker, writing nearly 50 years ago in The Practice of Management. "What is needed on a board is not people who agree with management anyhow, but people who are likely to see things differently, to disagree and to question," he wrote.

Mr Drucker was convinced of the merits of independent directors. "Both the large and the small business," he wrote, "need board members whose experience, outlook and interests are different from those of the management. This cannot be obtained by getting representatives of the company's bankers, suppliers or customers. It requires people whose entire background is different from management."

If Mr Drucker, one of the most highly respected commentators on the organisation of business, could have reached this conclusion in the 1950s, why should it cause so much boardroom anxiety today? Chairmen complained to Russell Reynolds that spreading the net to include lay directors could lead to "dumbing down".

A bit of dumbing down may be no bad thing if it results in simple, honest, even naive questions from at least one side of the table. Too often board members have been reluctant to ask the obvious question, either because they do not want to rock the boat or because they are afraid of appearing stupid.

A recommendation by Mr Higgs that a chief executive should not become chairman was described by 40 per cent of those questioned in the earlier survey as "too prescriptive". There might have been some merit in such a comment, had the Higgs report taken any other stance than its relatively liberal "comply or explain" approach.

"My worry is that too many companies will not take advantage of the opportunity to explain a decision that might appear contrary to the spirit of the recommendations. I suspect that most will fall into line behind the base recommendations," says Sean O'Hare, a partner at Mercer Delta Consulting, boardroom advisory consultants.

Therefore, the decision by Tesco last week to appoint David Reid, a former executive director, to the chairmanship should not be seen as defiance of Higgs, as long as the board has established that the move is in the best interests of the company. A sound rationale can demonstrate good governance - probably more so than blind compliance with a list of dos and don'ts.

One area of Higgs that may need revision, however, is the recommendations covering tenure of non-executive directors. It can take time for a non-executive director to become an effective member of the board. Just as these directors have reached their peak of effectiveness, they are expected to stand down. It seems a waste of expertise.

The Higgs report was always going to be good for consultants so we should not be surprised by the considerable interest in board evaluation emerging among headhunters . Many search firms already have board evaluation practices that grew with the rise in merger activity at the end of the 1990s. These same practices can now be directed towards carrying out evaluations of board competence. But companies would be prudent to avoid using the same people for evaluations as they have used for recruiting members of the board. Therein lies an obvious conflict of interest.

Whatever the outcome of the Higgs report, there seems little likelihood that companies will avoid costs associated with compliance, recruitment and pay for boardroom duties.

The biggest prize is the possibility of creating a broader population of independent-minded non-executive directors. Another benefit will be a more professional relationship between non-executive directors and the executive. But this is unlikely to occur without tensions arising from the added accountability of stronger governance.

For generations, companies have been at the heart of the capitalist system. It is in the nature of competition that some will go bust from time to time, sometimes spectacularly so. The art of good governance is to maintain checks and balances while leaving executives the freedom to make a business sing.

If the best of the Higgs report survives intact, chairmen of good companies will still remain "first among equals" but poor chairmen may find it harder to survive. Why should we worry about that?

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