A catalyst for change: Causes for non-executive majority on boards

From a plethora of academic articles on non-executives one could easily draw some general observations:

1) Non-executives emerged due to the need for there to be a body of supervision in the company.

2) Their role and responsibilities have increased largely in response to company malpractice and recessions where we see numerous reports aimed at improving corporate governance.

3) As well as supervising, non-executives are also recognised for providing a strategic function

Research on non-executives has largely been dominated by agency theory as non-executives serve to control management. As Sir David Walker demonstrated, the argument goes that even though two thirds of equity capital is now in the hands of the institutions that should have enough clout to look after themselves; they are in fact frequently reluctant for fear of adverse publicity. Thus responsibility must fall on the non-executives who have the knowledge and power to act.

Thus, when corporate misfeasance came to light it is generally assumed that non-executives could not exercise enough control in the corporate governance framework. As a result Governance Codes are revised and reports produced to place more emphasis on the monitoring of the management.

It appears then that it is generally assumed the cause of boards being non-executives in the majority has been a response to corporate misfeasance based on agency theory.

However, there appears to be strong evidence out there that suggests revisions of Codes and Reports do little to alter the nature of the non-executive director. One would argue the primary reason behind their prominence on company boards today was a result of a number of factors such as technological advancements and deregulation that created a wider need for non-executives beyond that of monitoring, and caused companies to view non-executives as of use rather than with scepticism. Thus, the strategic function served as a catalyst for non-executives to emerge on boards in the majority.

It was in 1945 that the Cohen Report was published. It identified that there was not an active body of supervision within the company and suggested different methods of supervision. Today we can see that the body of supervision is the non-executives directors.

However, by 1972 a study by the British Institute of Management revealed that non-executives were rare and were mainly appointed because of connections. The position was viewed as a "job for the boys" and they were effectively "yes men" on decisions already decided. Fast-forward to 1986 and only 6% of top companies lacked non-executives and on 20% of those boards, non-executives were in the majority.

During this time the UK had joined the European Union in 1973 and during this period there were significant developments in the reduction of trade barriers. There were also developments in technology and the ultra vires rule (that companies could not act beyond what they set out to do, as it were) had continued its decline in significance evidenced in some part by the Companies Act 1985.

All these events allowed businesses to expand in to different markets more freely as well as in to different sectors. The requirement for knowledgeable people to facilitate this expansion was apparent. ICI was noted for appointing a prominent Japanese business man to its board as non-executive for the primary purpose of helping them expand in one of its most important markets Japan. Without the knowledge and experience of these people, survival would not have been likely.

So whilst the need for monitoring was greeted with scepticism, non-executives were welcomed with open arms when it came to facilitating expansion. Companies are unlikely to do something, such as appoint non-executives, if they have no legal requirement or benefit in doing so.

It is not to say that the monitoring role has not played a small part in the increase in their numbers. Legal rules and Listing Rules have changed to urge companies to appoint non-executives. The standard of their conduct has also altered culminating in s174 of the Companies Act 2006. However, the change in legal standard came around in 1986 and again was probably a result of their increased responsibility in strategic matters rather than a response to monitoring, although it may have appeared that way.  

Thus, it must cast serious doubt over agency conceptions that non-executives can enhance performance through monitoring of management. Any enhanced performance may be down to strategic advancement by appointing the right non-executives and this moves us closer to views established by Resource Dependence Theory. One suspects most appointments are made with the view of enhancing the company through strategic advice. Decisions predominately based on their ability to monitor are probably rare.

However, as the law recognised non-executives increased involvement, they must now be active monitors rather than passive "yes men" and the need to monitor is of much more importance to non-executives due to fear of liability.