Are your NEDs working for you?

Friday, 29th July 2016 12:06 - by Eric Chalker

For shareholders, the board of directors provides a company’s management.  Executive directors are there to carry out the board’s wishes.  Non-executive directors (NEDs) are there to keep what should be an independent eye on management, principally on behalf of the shareholders, the owners of the business.  But it doesn’t always work like that.

There is an excellent description of what should happen in the 2016 annual report of Royal Mail.  The chairman, Peter Long, has written, “It is the role of the Board to provide leadership to the Company; I lead the Board in reviewing long-term strategy, monitoring, supporting and, where required, challenging the executive team, whose job it is to manage the Company successfully day to day, driving performance of the business and creating value for our shareholders and other stakeholders.”  Note the emphasis, which is mine.  Non-executive directors who are not prepared to challenge the executives – including the chairman if he or she has an executive function – are not worthy of their position.

Making use of the AGM

The AGM is the place to test whether a company’s NEDs are working for you.  Many investors do not attend AGMs, perhaps thinking they are a waste of time.  Indeed, even a chairman of the UK Shareholders’ Association has been heard to say they should be abolished, but that is not and never has been my opinion.  On the contrary, AGMs provide the best possible opportunity to ask pertinent questions and make pertinent comments.  Much can be said about them, but in this article the focus is on the election and re-election of NEDs.

It is not generally the practice at AGMs to ask questions of individual NEDs when they are up for election, but there are sometimes very good reasons to do so and, if so, the NEDs should be made to answer.  At a recent AIM company AGM, which has yet to make a profit after 15 years, a non-executive director who had been in place for 11 years objected to being asked to justify himself, but it was an AGM and he was up for re-election so he was laughably wrong.  In another, similar instance, the one NED present at the AGM, not up for re-election, clearly resented being asked even to identify himself, so he probably resented even being there.  One cannot have confidence in boards of such companies, let alone in the individual directors.

On another occasion, at the first election of a new NED who was known to be representing the company’s second largest shareholder, when asked to explain why he was joining the board, gave a lengthy and highly informative explanation which the chairman afterwards said was news to the board.  This reflected well on the director, but very poorly on the other directors, including the chairman who was himself an NED.  For a board not to explore why a major investor of several years was suddenly seeking a place on the board, was surely a dereliction of duty, but it does demonstrate the power of an individual investor asking questions.

How many NEDs?

When a company suffers a serious loss of value, as in the banking crisis of 2008, it is surely right to ask what the NEDs were doing – in the words of Peter Long – to “monitor” and “challenge” the plans and decisions of the executives, in order to ensure that shareholder value was not put unjustifiably at risk.  Banks are one instance of where there may well be too many NEDs, because the bigger the forum the more difficult it is to make a single voice heard.  This may also have been the case at Balfour Beatty in the period during which it issued five profit warnings: 7 NEDs costing £750,000 pa evidently failed to ask enough questions, if indeed any, of the 3 executive directors.

While some boards are clearly over-populated, others have too few NEDs, or the wrong sort.  A single NED as chairman even, can find himself or herself completely unable to face down a CEO backed up by perhaps long-serving staff, so one important test in such instances is how much money that NED has invested in the company.  When a company is brought to the AIM, its “nomad” (its sponsor) will of course have selected one or more NEDs for the purpose, but will they be more than just window dressing to get the float away?  They may have seemingly relevant experience to support the executives, but will they have the independence and detachment, as well as the right characteristics, to act first and foremost as the representatives of the shareholders in monitoring the executives and, when necessary, challenging them?

This is why, for those who are able to attend AGMs (and not everybody is), the election or re-election of a non-executive director should be the occasion to consider asking one or more questions of the candidate before it is put to the vote.  Don’t be afraid to do so.  It is your right.

Eric Chalker, UK Shareholders’ Association Policy Co-ordinator & Director, 2012-2016