Board Formation: The UK Experience

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Board Formation The UK Experience
OECD Russia Corporate Governance
Roundtable Moscow, 2526 October 2012

• Dr. Roger Barker
• Head of Corporate Governance at the Institute of
  Directors (UK) and Senior Advisor to the Board of
  the European Confederation of Directors
  Associations (ecoDa)
• roger.barker_at_iod.com

Co-sponsored by
Informational partner
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Agenda

• The UK boardroom context key features of UK
  corporate governance
• The board formation process in the UK
• Recent developments in board formation proposed
  changes to UK listing rules for companies with
  controlling shareholders
• Key lessons from the UK experience

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UK Boardroom Context (1) Ownership Structure

• Large quoted companies in the UK are widely held,
  i.e. there is dispersed rather than concentrated
  ownership
• Institutional investors are the main category of
  shareholder, although there is more than 40
  foreign ownership. Around 8 of UK equities are
  now held by Sovereign Wealth Funds
• Some examples (as of H1 2012)
• Royal Dutch Shell (Blackrock 6.6 Legal
  General 4.2). Market Cap - 228 bn
• GlaxoSmithKline (Blackrock 5.6 Legal
  General 3.7). Market cap - 98.6 bn
• Vodafone (Blackrock 6.0 Legal General
  3.6). Market cap - 145.9 bn
• BP (Blackrock 5.9 Legal General 4.2).
  Market cap - 136.8 bn.
• HSBC (Blackrock 6.6 Legal General 4.0).
  Market cap - 181.9 bn.
• All other shareholders own less than 3

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UK Boardroom Context (2) Directors Duties

• Company law defines fiduciary duties for
  directors. Directors are required to promote the
  success of the company for the benefit of all its
  shareholders (section 172, Companies Act 2006)
• However, there should not be a narrow focus on
  shareholders. Directors should take into account
  a range of other factors when pursuing the
  interests of shareholders, including
• the likely consequences of any decision in the
  long term
• the interests of the company's employees
• the need to foster the company's business
  relationships with suppliers, customers and
  others
• the impact of the company's operations on the
  community and the environment
• the desirability of the company maintaining a
  reputation for high standards of business conduct
• the need to act fairly as between members (i.e.
  shareholders) of the company
• The enlightened shareholder value concept

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UK Boardroom Context (3) Board Structure

• UK companies have a unitary board structure,
  containing a mixture of executive and
  non-executive directors
• There is a strong trend toward boards where the
  majority of directors are independent
  non-executive directors. In the FTSE 350, 80 of
  companies have boards where more than half the
  board is independent (excluding the chairman)
• There is also a strong bias in favour of an
  independent chairman and a split of the
  chairman/CEO roles. Only 11 companies in the FTSE
  350 continue to combine the chairman and CEO
  roles
• Employees are not typically represented on UK
  boards

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UK Boardroom Context (4) Regulatory Approach

• Company law and listing rules define baseline
  requirements for corporate governance
• However, most corporate governance requirements
  are prescribed in the UK Corporate Governance
  Code applied on the basis of comply or
  explain by Premium Listed companies. Key
  Provisions include
• The roles of chairman and chief executive should
  not be exercised by the same individual. (A.2.1)
• The chairman should on appointment meet the
  independence criteria set out in the Code. A
  chief executive should not go on to be chairman
  of the same company. (A.3.1)
• Except for smaller companies (outside the FTSE
  350), at least half the board, excluding the
  chairman, should comprise non-executive directors
  determined by the board to be independent.
  (B.1.2)
• Evaluation of the board of FTSE 350 companies
  should be externally facilitated at least every
  three years. (B.6.2)
• All directors of FTSE 350 companies should be
  subject to annual election by shareholders.
  (B.7.1)
• Around 50 of companies in the FTSE 350 fully
  comply with all the Provisions of the Code (up
  from 28 in 2005). Most of the remainder are
  non-compliant with only one or two Provisions of
  the Code

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Anatomy of the UK Boardroom in 2012

• The average FTSE 350 board has 3 executive
  directors, 5.3 non-executive directors and a
  non-executive chairman. (As recently as 2006,
  executive directors were still in the majority)
• Average number of board meetings per year 8.7
• Average age of a FTSE 350 director 57.5
• 15 of FTSE 100 directors are female. This falls
  to 10 in the FTSE 350 as a whole. There are only
  2 female chairmen
• 25 of FTSE 350 companies had an external board
  evaluation in 2011
• 70 of FTSE 350 companies annually elect their
  directors
• Average fee for a non-executive 79,500 in the
  FTSE 100 48,500 in the Mid 250

Source Grant Thornton Corporate Governance
Review 2011
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Appointment of Directors The Legal Process

• Company law defines a key role for shareholders
  appointment or dismissal of any director is
  possible by an ordinary resolution (501) of
  shareholders
• However, the Model Articles of Association for
  Public Companies (section 20) states
• Any person who is willing to act as a director,
  and is permitted by law to do so, may be
  appointed to be a director
• (a) by ordinary resolution, or
• (b) by a decision of the directors.
• In practice, almost all board members are
  initially appointed by a decision of the
  directors, i.e. by method (b). Only afterwards is
  the decision ratified by shareholders
• Section 21 of the Model Articles states
• (1) At the first annual general meeting all the
  directors must retire from office.
• (2) At every subsequent annual general meeting
  any directors
• (a) who have been appointed by the directors
  since the last annual general meeting, or
• (b) who were not appointed or reappointed at one
  of the preceding two annual general meetings,
  must retire from office and may offer themselves
  for reappointment by the members (i.e.
  shareholders).

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The Role of the Nomination Committee

• The UK Corporate Governance Code states that
  there should be a formal, rigorous and
  transparent procedure for the appointment of new
  directors to the board
• It also recommends that there should be a
  nomination committee which should lead the
  process for board appointments and make
  recommendations to the board
• According to the Code
• The search for board candidates should be
  conducted, and appointments made, on merit,
  against objective criteria and with due regard
  for the bene?ts of diversity on the board,
  including gender
• A majority of members of the nomination committee
  should be independent non-executive directors
• The chairman or an independent non-executive
  director should chair the nomination committee -
  but the chairman should not chair the nomination
  committee when it is dealing with the appointment
  of a successor to the chairmanship
• The nomination committee should evaluate the
  balance of skills, experience, independence and
  knowledge on the board. In the light of this
  evaluation, it should prepare a description of
  the role and capabilities required for a
  particular appointment. The terms and conditions
  of non-executive director appointments should be
  available to shareholders
• A separate section of the annual report should
  describe the work of the nomination committee,
  including the process it has used in relation to
  board appointments. Its terms of reference should
  be publicly available
• An explanation should be given if neither an
  external search consultancy nor open advertising
  has been used in the appointment of a chairman or
  a non-executive director

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Effectiveness of Nomination Committees in Practice

• Places the director appointment decisions in the
  hands of an independent committee comprised
  mainly or wholly of independent non-executive
  directors
• Purpose to avoid domination of director
  selection by CEO (the main concern in the UK) or
  a dominant shareholder (a common concern in many
  other countries)
• Seeks to prevent the board becoming a
  self-perpetuating club or just a representative
  body for powerful interests (management,
  controlling shareholders, etc)
• But the experience of the UK shows that supposed
  independence can be illusory
• If so-called independent non-executive
  directors are themselves part of the club in
  the UK, independent directors are still drawn
  from a relatively narrow pool of candidates
  (male, former CEO/CFOs)
• Often a perceived need to support the CEO and the
  executive team otherwise may be seen as
  disruptive or not a team player
• May perceive an allegiance to those who nominated
  them
• As a result, UK boards may lack diversity, be
  insufficiently challenging of management,
  susceptible to groupthink, inclined to
  consensus rather than rigorous debate,
  insufficiently sensitive to wider stakeholder
  concerns

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Recent Developments Dealing with Controlling
Shareholders

• New proposed changes to UK listing rules
  published in October 2012. Public consultation
  will conclude in January 2013
• Re-introduces the concepts of the controlling
  shareholder and independent shareholders into
  the Listing Rules response to increasing number
  of foreign companies with controlling
  shareholders listing in London
• Relationship Agreements must be created between
  the company and the controlling shareholder
  must be published in the annual report or
  otherwise publicly accessible
• Companies with a controlling shareholder must
  have boards with a majority of independent
  directors. A binding requirement no longer to
  be applied on the basis of comply or explain
• Independent directors must be elected by a dual
  vote of both a) all shareholders and b)
  independent shareholders. If the result of the
  two votes conflicts, a further vote takes place
  on a simple majority basis after not less than 90
  days aims to give independent shareholders time
  to engage with the controlling shareholder and
  reach a compromise

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Board Formation Lessons from the UK Experience

• The objective should be to facilitate the
  creation of competent boards that are capable of
  objective and independent judgement. (OECD 2009
  9).
• But independence and objectivity in the board
  formation process are not easy to achieve
• A nomination committee that fulfils formal
  independence criteria avoids some obvious
  conflicts of interest such criteria are
  worthwhile
• But formal processes will not guarantee a
  genuinely independent and objective board
  appointments process it could just be box
  ticking
• In addition to formal rules, policy makers should
  focus on
• encouraging a high level of transparency with
  respect to the board appointments process
• director education and the development of a cadre
  of highly credible independent directors
• dissemination of best practices, including wider
  use of board evaluation processes

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Disclaimer The views expressed in this
presentation are those of the author and do not
necessarily represent the opinion of the OECD
Russia Corporate Governance Roundtable, the OECD
or its Member countries, or of the Moscow
Exchange.
OECD Russia Corporate Governance
Roundtable Moscow, 2526 October 2012
Co-sponsored by
Informational partner