The Role of Independent Nonexecutive Directors - Case Study Example

In the highly competitive environment of global business, factors like accountability, responsibility and reliability have become critical elements of business so as to create a credible environment for their trade and investment. The serious scams like Enron and WorldCom had occurred because of lack of managerial control vis-à-vis corrupt practices in the higher hierarchy of management, financial fraud, malpractices in accounts and auditing, security of confidential information etc. The interests of various stakeholders and shareholders were compromised by the vested interests. Roberts, McNulty and Stiles (2005) have emphasized the importance of board members of the company who are endowed with huge powers that could be easily misused. The role of independent directors and non executive directors become significant as they are intended to serve as deterrent in the misuse and abuse of power by the vested interests, especially the senior management of the company. The paper would be broadly rationalizing the role of independent non executive directors within the broader parameter of corporate governance. Corporate governance is based on publicly acceptable values and code of behaviour for the higher echelons of corporate bodies (Haller & Shore, 2005). It can primarily be described as a set of well defined policies, rules and regulations and customs that effectively control the various internal and external processes of the business enterprises. They are, thus intended to create an environment that improves productivity, economic efficiency and protects the interests of various stakeholders through ethically delivered goals (Solomon, 2007; Mueller, 1996). Since the good corporate governance is dependent on effective policies and laws, the role of CEO and board of directors becomes crucial ingredient for their efficient implementation. In the various modalities and process that are incorporated within good corporate governance, the role of independent non executive directors in the company’s board has increasingly become key component of the success of the company. The recent cases of abuse of shareholders’ rights in the various countries have brought the role of corporate governance into the prominence. The increased risks to the interests of the various stakeholders have necessitated stringent code of conduct for the higher hierarchy of management. Chief Executive of the firm and board of directors, therefore become intrinsic part of corporate governance. They are endowed with the primarily responsibility for good codes of corporate governance and best practices within the organization that promote accountability. Boritz, (1990) has defined risks as possible loss due to uncertainty and exposure of the firm from inappropriate investment decision or a commitment. Thus, risks and need for more effective transparency within the system become vital postulates of CG whose implementation is overseen and guided under the strict vigilance of independent non executive directors. Independent non executive directors in the board provide the firm with independent, objective and creative inputs on the various processes and modalities of business operations. As they are basically from outside the organization, they are observed to be equipped with unbiased approach to the issues and factors that could have long lasting impact on the performance outcome of the company. Cadbury report (1992, p33) explicitly states that they bring in ‘independent judgment’ within the board. Their presence on board therefore is designed to discourage the vested interests against financial malpractices and fraud. This is one of the most important criteria that reiterated the importance of inclusion of independent non executive directors on the boards of the companies. UK has been a leader in setting up a Combined Code of Corporate Governance. UK boasts of a highly developed business environment with a vast shareholders’ base. The various financial institutions, big corporate houses, institutional investors and individuals with high stake in the market have a major role in the economy of the nation. Thus, Combined Code for corporate governance has been developed by UK Government as a quick response to avert financial scams. The government initiatives for promoting corporate governance are aimed at effective control measures to safeguard the interest of all its stakeholders, investors and business partners (Aguilera, 2005). Combined Code has defined the role of non executive directors in detail and has increasingly made the presence of non executive directors in the board as highly desirable postulates for the companies in UK. Du Plessis, McConvill & Bagaric (2005) have quoted Higgs Report (2003) which has emphasized that half of the board members of a firm, excluding CEO, should be independent non executive directors and has defined in details the criteria of an ‘independent director’. This has been incorporated within the Combined Code of corporate governance in UK. The Code is a guide to a number of key components of effective board practice (FRC, 2010). The non executive directors are appointed for fixed term and do not have any business or other relationship with the company or its stakeholders which could bias their judgment and independent approach. They are therefore free to apply independent judgment on key issues like business strategy, policies, performance appraisal, resource utilization, appointments etc. The independent non executive directors meet in group at least once a year and give their opinion on the vital issues of company affairs which are taken into account by the management to improve organization productivity. The role of independent directors in the board serves to enhance accountability within the business hierarchy. The Combined Code is very effective and therefore many of its guiding principles have been adopted by other global forums like OECD. But interesting, while UK has introduced some radical reforms in its company laws and promoted corporate governance, it has not yet made corporate governance mandatory. The non executive directors also often represent the interests of stakeholders like union, social activists, shareholders, government etc. While they are not full time directors but their presence in board becomes highly relevant when important issues and matters are discussed. The core competencies of the non executive directors give significant insight into the issues and helps monitors the progress of the various business operations with higher level of efficiency. Thus, the wide aspect of the role of independent non executive directors in the board would force the corporate bodies to become more responsible, accountable, efficient and indeed, profitable. The corporate governance module of Germany and US are very distinct in their modalities and operational efficiency. While US has made sweeping reforms within its laws for corporate governance which are mandatory, Germany has made compulsory a two tier board system for all its public corporations: supervisory; and management board (Du Plessis, McConvill & Bagaric, 2005). The supervisory board oversees the management of business operations but finds it difficult to distinguish supervisory and managerial functions of the two boards. But probably the most important issue is that of biased approach as supervisory board has members from the work force. The Corporation and Market Advisory Committee or CAMAC has proposed various recommendations and need for more formal definition of management functions of management board vis-à-vis policy making decisions. The independent supervisory board members in the super comprising of employees and other stakeholders tend to dilute the effectiveness of the same as they come with opinions that may be biased and representing the interests of only specified group. In America, all public companies come under Sarbanes-Oxley Act 2002 where the various stakeholders and shareholders interests are at stake. Sarbanes-Oxley Act is one of the most effective measures for implementing corporate governance rules through strict audit procedures. It provides the legal framework for good corporate governance with emphasis on disclosures of important information that would enhance confidence among the investors. Parker (2003) asserts that Sarbanes-Oxley Act makes sure that the auditors are expected to report their opinions on the effectiveness of their clients’ internal controls in their annual report. Indeed they offer important guidelines for the international business community to take into the considerations the interests of their various stakeholders. S-Ox also makes it mandatory for the companies to have independent auditors to evaluate their internal control system while their financial account are separately evaluated, making two of its senior executive personally responsible for its correctness! The role of independent auditors is almost same as independent non executive directors of board of company in UK and gives an independent overview of companies’ financial audits so that financial irregularities can be identified early and major scams like Enron averted. The rotation of independent auditors and rules that prohibit their employment in the auditing companies ensures that audits are fair. The SEC and NYSE rules also make it mandatory for companies to have more independent directors in the board who are not associated with the management in any capacity so as to influence managerial decisions (Mallin, 2007). This significantly enhances application of independent judgment on strategies, performance, appointment of persons in key positions and other policy matters. Thus they promote ethics, accountability and good practice at each level of organizational operation. The role of auditors and independent board members help to give credibility to the company’s performance and projected forecasts. Thus, one can conclude that the role of independent non executive members and auditors within the companies become strong facilitator of good practice and good corporate governance. (words: 1509) Reference Aguilera, Ruth V. (2005). Corporate Governance and Director Accountability: an Institutional Comparative Perspective. British Journal of Management, Vol. 16, S1–S15. Boritz, J Efrim. (1990). Approaches to Dealing with Risks and Uncertainty. CICA. Cadbury Report. (1992). Financial Aspects of Corporate Governance. The Committee on the Financial Aspects of Corporate Governance and Gee and Co. Ltd. Du Plessis, McConvill & Bagaric. (2005). Principles of Contemporary Corporate Governance. Cambridge. FRC. (2010). The UK Corporate Governance Code. Retrieved from: Haller, D., & Shore, C. (2005). Corruption. London: Pluto Press. Mallin, Christine A. (2007). Corporate Governance. Second Edition. Oxford. Solomon, J. (2007). Corporate Governance and Accountability. 2nd Ed. John Wiley & Sons, Ltd. Roberts, John., McNulty, Terry., and Philips. Stiles (2005). Beyond Agency Conceptions of the Work of the Non-Executive Director: Creating Accountability in the Boardroom. British Journal of Management, Vol. 16, S5–S26. Mueller, Robert K. (1996). Anchoring points for corporate directors. Greenwood Publishing Group. Sarbanes – Oxley Act 2002. Retrieved from: Read More