The governance landscape in almost every major economy continues to evolve, as questions about board independence lead to new legislation or publication of best-practice codes. For some boards, these changes represent a significant transformation; others, meanwhile, are merely refining some longstanding practices.
In the United Kingdom, the quest for board independence has been a 15-year journey, during which time UK listed companies have addressed the issue of director independence with the separation of chairman and chief executive roles and the introduction of the senior independent director (SID). This article looks at how the SID role has evolved and examines its function and responsibilities, drawing upon a recent series of interviews with current SIDs sitting on more than 20 FTSE 100 boards.
The evolution of the role
The 1992 Cadbury Report was famously the catalyst for the separation of the roles of chairman and chief executive in UK listed companies, presenting the case for “a clearly accepted division of responsibilities at the head of a company, which will ensure a balance of power and authority, such that no one individual has unfettered powers of decision.”
Sir Adrian Cadbury, former managing director and chairman of Cadbury Schweppes, recognized that this change to the structure of boards would take effect only gradually, and recommended that where the chairman also was the chief executive, “board members should look to a senior non-executive director, who might be the deputy chairman, as the person to whom they should address any concerns about the combined office of chairman/chief executive and its consequences for the effectiveness of the board.”
A number of UK companies already had recognized the value of appointing a senior non-executive director, while others would introduce the position in subsequent years. The Combined Code of 2000 went a step further by stating that a senior independent director (as it was by then
called) should be recognized by each board, regardless of whether the posts of chairman and chief executive were held by one person or by two.
However, it was not until the publication of the Higgs Report in January 2003 that the role of the SID came out of the shadows. In his report, Sir Derek Higgs acknowledged that “some saw the role as unnecessary or divisive” when responding to consultation. Nevertheless, he recorded a majority in support of the SID role so long as its duties were carried out with sensitivity. This did not stop a stream of criticism about what many saw as an enhanced, more pro-active SID role with the potential to interfere with, and undermine, the role of the chairman.
The revised Combined Code, issued by the Financial Reporting Council in July 2003, modified some of the recommendations in the Higgs Report and contained certain provisions that now form the commonly accepted framework for the role of the SID.
What do SIDs do?
For UK listed companies, the SID is expected to satisfy the criteria for independence fully, as set out in the Combined Code. When a company is in a steady state with the board functioning well, the role of the SID is straightforward, mostly reactive and not particularly time-consuming. The SID coordinates the performance evaluation of the chairman, taking into account the views of both non-executive and executive directors. The SID is required to chair an annual meeting of non-executives without the chairman present and be available to shareholders if required.
The SID also needs to be sufficiently informed about committee and executive activities to be able to deputize for the chairman at short notice and act primus inter pares should the non-executives collectively wish to raise sensitive concerns regarding the handling of board matters. It
is really only when there is an issue of chairman succession, or when the board is thrown into crisis, that the SID role starts to assume real significance and consume a great deal of time. Not all SIDs have formally articulated the parameters of their role with the chairman, although those who have done so have found the process helpful. Below we examine the main aspects of the role.
Performance evaluation of the chairman
The concept of a formal board evaluation is now widely considered of fundamental value and importance for maintaining a healthy board — it is viewed as one of the most positive outcomes of the Higgs Report and the Combined Code. The Code is not prescriptive about evaluation methodology and, consequently, a wide range of approaches have been taken involving external and internal facilitators. The Code is, however, clear that it is the SID’s responsibility to lead the evaluation of the chairman, taking into account the views of executives and, of course, fellow non-executives.
The evaluation of the chairman encompasses the general management and conduct of board meetings, the appropriateness of the agenda, the extent to which board meetings are focusing on the right issues, the quality of discussion and the chairman’s relationship with the chief executive. Chairman remuneration is seldom discussed, since a performance-related element rarely is involved.
Having first taken the views of executives (or sometimes the chief executive who will already have spoken to other executive directors), some SIDs elect to have an open debate at a meeting of the non-executives without the chairman present; others prefer to take individual soundings, issue a questionnaire or perhaps employ a combination of all these methods. We discovered that it is rare for the views of company secretaries to be taken into account, although, on reflection, several SIDs considered this worth pursuing in the future. The SID usually presents the find wings to the chairman alone, reporting back to directors on the results of the review.
Chairman succession
With the board chairman entitled to chair the nomination committee, the SID (or deputy chairman) is likely to lead the chairman succession process. This can be complicated if, for example, the chairman has strong views about his or her successor, or if the current chief executive is the preferred candidate. In the latter circumstance, the SID may have to take soundings from investors, not least because this runs counter to the Code and requires explanation.
Dialogue with institutional shareholders
The Higgs Report proposed that the SID should attend sufficient regular meetings between management and major shareholders to develop a balanced understanding of the themes, issues and concerns of shareholders. The Combined Code modified this, stating that the SID should “be available to shareholders“ if they have concerns which cannot be satisfactorily resolved through the “normal channels.”
Clearly, most shareholder contact will be with the chief executive and finance director. However, the Combined Code states that the chairman must “maintain sufficient contact with major shareholders to understand their issues and concerns.” If you then add the SID into the mix, there is a real danger of overkill.
It is important for SIDs to develop a rapport with shareholders without raising alarm. It helps if the SID has a track record in dealing with institutional investors, although in this context the SID’s focus primarily should be on governance and compliance issues rather than strategic or financial matters. Those SIDs who also chair the remuneration committee are likely to have reasonably regular contact with key shareholders, which will help if they are called upon in their capacity as SID.
All the SIDs we interviewed agreed that it was not their responsibility to seek out investors, but to make clear their willingness to meet if shareholders wish to do so. However, in reality, requests for meetings are relatively rare and several SIDs we interviewed had had little or no contact with shareholders since assuming their role.
Those who had met with shareholders in their capacity as SID had assumed the role of “active listener.” Rather than speaking on behalf of the board or the executive, they were there to understand shareholder concerns and take those concerns back to the board for discussion. Such meetings should, however, be a last resort. As one SID remarked, “if an investor telephones me because he can’t get any sense out of the CEO or CFO, then there’s something very seriously wrong.”
Committee responsibilities
Some of the SIDs we interviewed choose to be members of all board committees. Others attend, not as members, but to keep themselves informed, while others see the value in principle but prefer a division of responsibilities. Those who chair the remuneration committee have the benefit of a direct line to investors, and most people felt it wise for the SID to be a member of the audit committee. The critical thing is for the SID to be deeply integrated into the structure of the business, to be an active director with open channels of communication to the chairman and the chief executive.
Compensating the SID
Opinions were divided sharply on whether it was appropriate for the SID to be paid an additional fee, such as that paid to a committee chairman. Some boards, but by no means all, recognize the role with a top up to the standard non-executive director fee. Some SIDs feel that, since the burdensome aspect of the role only comes into play in a crisis situation, you should not pay people to handle a problem that may never occur. Of course, when a crisis requiring the sensitive handling of delicate issues does arise, the role suddenly can become hugely time consuming and absolutely critical to stability — not just of the board, but also of the business as a whole. Under these circumstances, there is undoubtedly a case for paying the SID on a “time and materials” basis.
Future of the role
With greater responsibilities and expectations placed at the feet of non-executives and an increased appetite for collective intervention, the role of the SID will likely develop further in the years to come. Much will depend on how the role of chairman evolves and what checks and balances may be necessary to ensure that the right dynamic exists among the chairman (now no longer classified as independent), non-executives and the chief executive. What is clear is that a well-run board with sound governance practices will require relatively little from its SID, beyond the basic tasks set out in the Combined Code.
Looking at the lead and presiding director roles in the United States
US companies, much like their UK counterparts, have answered the call for greater independence through the creation of the lead or presiding director role.
Today, 94% of S&P 500 companies have appointed a lead or presiding director — a 50% jump from just a few years earlier. This increase comes as no surprise given that both the
New York Stock Exchange (NYSE) and the NASDAQ now require listed companies to hold regular executive sessions of independent directors without management present and, in the case of NYSE-listed companies, to designate a director to preside over those sessions.
As for the specific responsibilities, regulators offer little guidance and the distinction between lead and presiding directors — if indeed, there is any distinction at all — remains unclear even to those who hold the titles. We recently surveyed 85 corporate secretaries to learn how boards are structuring the roles of lead and presiding director and their impact on board practices.
As might be expected, companies with a combined role of chairman and chief executive officer were much more likely to have a lead or presiding director than those with two people at the top. In fact, more than 90% of the companies with a combined chairman/CEO have a lead or presiding director, versus only 63% of companies that separate the roles.
Of the companies we surveyed, more than half have appointed a lead director, while nearly a third have appointed a presiding director. The top three responsibilities for both lead and presiding directors are:
- To chair meetings of independent directors
- Act as principal liaison between the independent directors and the chairman/CEO
- Help develop board agendas with the chairman
What appears to differentiate the two roles is the scope of responsibilities, according to our respondents. Lead directors’ responsibilities tend to be broader and more evaluative than those of the presiding directors. They range from advising the chairman on the quality, quantity and timeliness of information from management and interviewing board candidates to overseeing the board director evaluations and playing a formal role in the CEO’s evaluation. Presiding directors are less likely to be charged with these duties, according to our survey.
While the NACD Blue Ribbon Council recommends not rotating the role of the lead and presiding director, we found rotation to be a common practice, particularly among boards with a presiding director. More than half of the surveyed companies with presiding directors rotate the role versus just one-third of companies with lead directors.
As with the role of the SID in the UK, our interviews with US directors suggest that the value of the lead or presiding director often does not become apparent until the company is in a state of crisis. When things are running smoothly, the lead or presiding director’s responsibilities tend to be limited to the basic functions described above.
Other survey findings on the lead and presiding director include:
- Most of the roles were created in the past three years and nearly 75% were created in 2003 and 2004 after the NYSE rule requiring the designation of an independent director to preside over executive sessions came into effect.
- More than 80% of survey respondents say their independent directors meet at every board meeting. In addition, companies that have lead directors tend to hold more frequent meetings of their independent directors than those with presiding directors (86% versus 71%).
- In line with their broader scope of responsibilities, lead directors often spend more time carrying out their duties; approximately 40% of lead directors spend 11 hours a month or more compared with 25% of presiding directors, while 21% of lead directors spend five or fewer hours compared with 50% of presiding directors.
- It is more common for lead directors to receive additional compensation. Roughly twice as many lead directors receive compensation for their role, 52% versus 25% for presiding directors.
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