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Corporate governance is not wholly prescribed by the law regulating the activity of companies and directors, but corporate law is nevertheless an important element, not least so far as directors' duties are concerned. The Companies Act 2006 was notable for, amongst other developments, writing into statute the general duties of directors which hitherto had been provided for at common law and in equity. Directors' duties were clarified in statute on the basis of an enlightened shareholder value approach requiring directors, in good faith, to take into consideration a variety of factors which would most likely promote the success of the company for the benefit of the members as a whole. This is contained in CA s172 and so far as directors responsible for the governance of their companies is concerned is at one and the same time most deserving of attention and most difficult to interpret. It is a clause which will be considered in subsequent articles, but until it is tested in the courts its interpretation and understanding in practice by directors is likely to remain unresolved.
Corporate governance, therefore, embraces corporate law but much more. Various attempts have been made at a definition but perhaps the one most often in usage is drawn from the seminal 1992 Cadbury Committee Report on Corporate Governance where it is defined as "the process by which a company is directed and controlled". This too has limitations in that such shorthand fails to convey a real flavour of the crucial importance of people with the necessary skills, including interpersonal skills, individually and collectively, to good governance. Ultimate responsibility for good governance lies with the company's board of directors, irrespective of company size or status as private or listed. And it is to the effectiveness of that board and their decision making we must look to in order to be able to judge whether a company is well governed or not. And that is why governance matters. Decisions poorly made for whatever reason (for example inadequate input, insufficiently robust discussion) can spell disaster for any company.
The composition of a board necessarily has a bearing on its effectiveness but ultimately that effectiveness is dependent upon the leadership of that board by the chairman. The chairman's role is all important but that is not to diminish the important roles of individual board members. In subsequent articles consideration will in particular be given to the roles of the non-executive directors and company secretary in corporate governance in addition to the chairman's role, with brief case studies to illustrate the roles in practice.
Finally, a board is accountable to the company's owners, namely its shareholders, for the proper stewardship of the capital entrusted to them. The relationship with shareholders, engagement as well as reporting, will also be covered in subsequent articles.
Following some preliminary comments, this article focuses upon the composition and evaluation of the effectiveness of a board by taking as a case study Victrex plc.
The aim in building a board must be to pull together the right mix of skills, experience and personal attributes which address the company's needs at the then stage in the company's development. Boards need to be refreshed and to evolve along with the company's development. In other words, board composition is a dynamic issue, with changes made in response to the company's development. The achievement of a suitable board composition starts with a thoughtful analysis of needs before the recruitment process begins. For smaller quoted companies, under the UK Corporate Governance Code [See Financial Reporting Council - www.frc.org.uk] the requirement is for a minimum of two independent non-executive directors, one of which could be the chairman. As the company grows investing institutions are likely to be expecting the board to include two independent directors in addition to the chairman.
Evaluation of the effectiveness of the board is ultimately the responsibility of the chairman. Guidance in the Code is an annual evaluation and also the use of a third party facilitator every three years. The chairman has the responsibility for selecting the process of evaluation and, whilst engaging a third party has the advantage of bringing objectivity to the process, the necessary degree of objectivity is not necessarily lost if the process is conducted without the help of an external party. It is for the chairman to set the right ‘tone' to ensure that a review conducted internally is satisfactory. Most smaller quoted companies may opt for an internal review without a facilitator and, provided objectivity is preserved, this is entirely acceptable. As the company increases in size a third party facilitator at three-yearly intervals may be advisable.
Victrex is a leading global manufacturer of high performance polymers, comprising two divisions: Victrex Polymer Solutions that focuses on transport, industrial and the electronics markets; and Invibio Biomaterial Solutions for medical device manufacturers.
The company Victrex began as an MBO from ICI in the early 1990's and was floated on the main market two years later. Listed as a smaller quoted company, the board comprised the buy-out team (a chairman and three executive directors including the present CEO), a finance director recruited from outside the company, and two independent non-executive directors with plc company experience. Today the company is in the FTSE-250 index and in the year ended September 2011 Group revenue had grown to £216mio generating pre-tax profits of £94mio.
At flotation, aside from the two external independent directors, the board, comprised as it was of senior ICI managers and the recently recruited finance director, had no experience of being directors of a stand-alone entity. To meet the needs of a growing company from the late 1990's on, the composition of the board began to change with the introduction of necessary skills and experience including the appointment of a new chairman in 1999 with plc and bigger company background. Throughout this period and up until 2008 the board nevertheless continued to comprise four executive directors and three or four independent non-executive directors. By 2010 the number of executive directors had been reduced to two - the CEO and Finance Director.
Throughout this period a formal evaluation of the effectiveness of the board had been carried out annually, but in 2011 an external evaluation of the board was undertaken. The 2011 Annual Report explains the company's approach to board composition and board performance evaluation:
‘Composition of the Board
The board comprises a non-executive chairman, four other non-executive directors and two executive directors. The composition of the Board is intended to ensure that its membership represents a mix of backgrounds and experience that will enhance the quality of its deliberations and decisions. In looking for prospective directors, we have regard to the skills of the Board at that time and the needs to address longer tem succession and business priorities. The annual formal evaluation of the Board is instrumental in identifying any new skill requirements, as well as possible shortcomings, gaps or inefficiencies.
Board performance evaluation
The 2011 performance evaluation was conducted by an external facilitator. The external evaluation process concluded that the Board remains effective in fulfilling their responsibilities appropriately and that each director continues to demonstrate a valuable contribution. Actions agreed as a result of the Board evaluation included further development of the Group's strategic planning and talent management processes.'
In 2012 the Victrex board has the same composition of five non-executive directors (including the chairman) and two executive directors (the CEO and Finance Director), a total of seven. Arguably this is an appropriate number for a company the size of Victrex.
By Dr John Mellor, author of Practical Corporate Governance for Smaller Quoted Companies
The only book available that deals exclusively with such companies