Ineffective Corporate Governance has been identified as a major contributor to the Irish and UK bank problems. The role of the Non Executive directors has been widely criticized even though a number of those directors still retain their office. The bank boardrooms consisted of exceptionally talented non executive directors with excellent business backgrounds whose inability to supervise the executives is hard to explain. Different commentators have suggested that the directors were bullied by their CEOs, that the directors were not independent of the CEO, that the Directors did not spend sufficient time on the bank’s business or they just enjoyed the journey. Yet, in all cases there were glowing Corporate Governance Statements in their Annual Reports which belied what was happening on the ground. It is necessary to understand the system of Corporate Governance practiced in Ireland in order to consider how it all happened.
In Ireland and the UK, we operate a mixed board whereby executive directors and non executive directors operate side by side. Both types of directors have the exact same legal responsibilities to the company, even though the level of their input is radically different. The executives appointed to the Board include the Managing director, the Finance Director, Operations director and possibly other key executive personnel. The Chairman of the Board is normally selected from the Non Executive Directors. The role of the Chairman is vital. The Chairman needs to rein in the executive team and still empower them to grow the business at a suitable level of risk. A strong chairman needs to keep aloof from his executive team, and should not take ownership of executive ideas. It seems obvious that the roles of the Chairman and Chief executive should be split and this is almost always the case. Incredibly however, in some cases the Chairman and the Managing Director has been the same person.
The role of the Non executive director is to give independent, expert and challenging input at Board level, protecting and enhancing the company interests at all times. The Non Executive Director needs to be assertive and skeptical of all proposals without being a naysayer. Accordingly, the non executive board needs to be well balanced with a wide variety of skills including finance, legal, marketing and production.
Regulation of Corporate Governance
Corporate Governance is regulated jointly by Companies Acts and by a Voluntary code of practice for listed Companies developed by the London Stock Exchange. This is known as the Combined Code. The Companies Acts provide a very basic level of requirements and it is left to the Combined Code to prescribe good practice. This code is drawn up specifically in the context of listed companies, but many of their principles can be equally applied to non listed companies in the interest of furthering best practice. The Irish Stock Exchange adapted the Combined Code in 1999.
It is a voluntary code which allows an enormous level of flexibility. Non compliance with individual regulations can be justified and it operates on the basis of Comply or Explain. In other words, a listed company reports annually on its level of compliance, and where it does not comply with a regulation in the code, then it must explain the reasons for non compliance. The principle regulations in relation to directors are: The role of the CEO and the Chairman should be separated. The CEO should not become the Chairman on retirement from his executive role. The board should have a balance of executive and non executive directors such that no individual or group of individuals can dominate the board’s decision making. Directors should offer themselves for re-election every three years & should not serve more than two terms of three years. The Remuneration of executive directors should be set by the Remuneration Committee, which should only be made up of Non executive directors. The Board should decide the remuneration of the Non Executive directors.
Irish companies have a lower than average level of compliance with the combined code. The best performing Irish Companies are those that have a dual listing on the London and Dublin stock exchanges. The most publicized breaches were where the CEO and the Chairman’s role were not separated in the case of Michael Smurfit , and where the CEO immediately moved up to Chairman on retirement in the case of Sean Fitzpatrick. This was a major contributor to the Anglo debacle. Fitzpatrick hung on to the Chairman’s role, offering the explanation that the new CEO, David Drum was young and needed mentoring. The inability of the regulators to impose effective sanctions was glaringly obvious in both these cases.
In most other respects, the code was complied with, and yet the directors were ineffective. The problem did not lie with the regulations or the quality of the candidate but rather to the execution of their duties.. How could four highly rated Accountants on the Anglo board not be aware of the risk involved in the concentration of their loan book on Development properties? How could suitably qualified directors on the Board of AIB and BOI approve the shift in strategy that saw their business module and lending practices ape those of Anglo in the early 2000s?
A major weakness in the existing Corporate Governance is that it relies on a Voluntary Code, where non compliance carries no sanctions. The Financial Regulator has clearly identified this weakness and his recent paper proposes to give statutory recognition to the Main principles of the code. In addition, the paper includes a number of radical proposals which already are upsetting existing Bank directors. These proposals envisage Banks reporting annually to the Financial Regulator on their compliance with the Code. Non compliance will become an offence. Directors may not hold in excess of five directorships so that they can comply with the expected demands of Board membership. There is a Whistle-blower provision for dis-satisfied directors. Boards will have a majority of Independent Non Executive Directors. The criteria for considering director independence and conflicts of interest is addressed.
If these standards were applied retrospectively, the make-up of the Bank boards would have been significantly different. The limit on the number of directorships would have eliminated many directors. The answer to their ineffectiveness may rest here. Directors who had full-time executive functions in addition to numerous directorships could hardly devote sufficient time to the Bank role. Someone had to lose out.
The criteria proposed for director independence is very interesting. For years, boards have been inhabited by associates of the Managing Director, and whilst they give the appearance of being independent, the operation of the board has been anything but. The Consultation paper sets out certain criteria to be considered when determining whether a Director is deemed to be independent; whether the person was previously employed by the financial Institution or a group company. Whether the person is a nominee of a significant shareholder. The length of time a person has served as a director of the company. Whether there are conflicts of interest through personal relationships, business relationships and common directorships.
It is hard to envisage a situation whereby cross directorships such as in the DDA and ANGLO would exist under newly proposed rules. Personal and business relationships had flourished in the small pool of directors used by listed companies in Ireland.
The consultation paper and subsequent discussion is to be warmly welcomed and will need to tangible improvements in Irish Corporate Governance. It also gives a glimpse of things to come for other overseers of Banks and financial institutions. It is time to move on and where better to start than in the Boardroom where True Leadership has been lacking for a number of years.
Christy Kearney
Kearneychristy@eircom.ne
