Consulting Journal: Trends - Non-executive directors

Trends: Non-executive directors

by David Blakey

What you need to know about non-executive directors, including a fee structure that I dislike.

[Monday 29 December 2003]

There are two times at which consultants can be involved with non-executive directorships. The first is when a consultant is asked to become a non-executive director. The second is when a consultant is asked to advise on non-executive directors. We shall look at both.

Becoming a non-executive director

There are several issues to consider if you are invited to become a non-executive director.

Liability

There are laws, regulations and rules that govern directorships in any of listed companies, non-listed limited liability corporations and non-profit-making organizations. You will have to comply with these. It is essential that you understand the duties and obligations of a director before you become one. In North America, Europe and Australasia the laws governing the duties and obligations of directors are similar. You should obtain copies of the relevant legislation. For listed companies, you should also obtain copies of the rules and regulations set down by the local governing body. The local Institute of Directors should be able to help, too.

Opportunities

If you think that becoming a non-executive director will give you opportunities for consulting assignments, you may be wrong. The company probably has to maintain a register of its directors interests, which includes consulting assignments performed by the directors. This is meant to ensure that directors do not award themselves consulting assignments unless the fees for those assignments are in line with those of other consultants. The board may wish to obtain comparative quotations for every assignment. If you were not a non-executive director, you might be able to obtain new assignments without any competition.

Restrictions

While you are a director of a company, with access to inside information, it would be unacceptable for you to work as a consultant for any competitor of that company. It may also be unwise to work as a consultant for a supplier or customer of that company. If you are a director of an electricity company, it is usually acceptable for you to work for a customer, especially if your assignment is unrelated to electricity. In many cases, however, consulting assignments involve the supply and demand chains, and it may be inappropriate for you to undertake them. In the example of an electricity company, it would be unacceptable for you to work for a major commercial customer on a consulting assignment to determine and negotiate the best market rates and tariffs for electricity supply.

Consulting on non-executive directors

You may be engaged as a consultant to advise on the appointment of non-executive directors. Here are some of the issues

Need

Some companies can benefit from the presence of non-executive directors on their boards. Some may not. It is often assumed that a company can solve many of its problems by appointing some (or more) non-executive directors. This may be true. You should be sure that it is.

Non-executive directors should be appointed to bring a particular expertise to the company. This must an expertise that works at board level. There is little point in appointing a marketing expert when what is really needed is more marketing experts at operational levels within the company. Anyone who is appointed as a non-executive director must understand the legal and governance issues involved in being a director.

Pay

I am strongly opposed to non-executive directors being rewarded in any other way than cash. Some companies have adopted rules so that their non-executive directors have to purchase shares in the company. I know of one company that insists that its non-executive directors use 50% of their fees to purchase the company's shares at market prices. I am opposed to this because it gives the non-executive directors an interest in the price of the company's shares. A director's primary responsibility is to the company, not to the shareholders. If non-executive directors are forced to buy shares, they have an incentive to try to keep the share price high. There may be occasions when there is a conflict between the best interests of the company and this incentive for a high share price.

This argument also applies to accepting a directorship.

If you accept a directorship that involves investing 50% of your fees in the company's shares at market prices, then an unnecessary conflict of interest may be created. Like any other investor, you will want the value of your shares to increase. Unlike any other investor, you will not be able to buy at low prices and to sell at high prices. Your contract will state that you will purchase shares to the value of x% of your fees within y days of the payment of those fees. The number of shares will be irrelevant to the contract: you will just pay a fixed amount at fixed intervals. The contract will require you to retain these shares during the period of your directorship. It will not require you to retain shares equivalent at current prices to x% of your fees to date.

Assume that I am paid $10,000 per month as a director. I have to purchase $5,000 of shares each month at current market prices. At the end of a year I will not necessarily hold $60,000 worth of shares. As I shall not dispose of any of these shares while I remain a director, their selling price does not interest me. Eventually, of course, the selling price will interest me. At that time, I shall want to have as many shares as possible, purchased at previous buying prices that were less than the selling price at the time that I sell.

Think about that. It will be to my advantage to purchase the shares that I am forced to buy at a lower price than their eventual selling price. I may hold the directorship for two years, which is a reasonable period for a non-executive director, appointed with a specific purpose in mind. So it will be to my advantage if the selling price of those shares at the end of the two years is greater than the buying price at any time during those two years.

Imagine a number of non-executive directors who are all making the same calculations. Ask yourself if this situation can really serve the best interests of the company.

When I have raised this issue publicly, I have been given two answers. The first answer is a denial that directors would act in this way. One chief executive suggested that I was libelling his board. The second answer is a reference to the fact that a number of other companies do the same thing. When I ask if this necessarily makes it a good thing to do, there is usually no other answer at all.

I am not suggesting that directors will behave unscrupulously. I am suggesting that boards should avoid placing their directors in a situation where they might act unscrupulously. I do not suggest that my colleagues are thieves, but I do not leave my favourite pen lying on my desk when I leave the office, either.

The argument that other companies have done the same thing is one of the weakest arguments that anyone can put forward. As consultants, we can recall many instances where ‘following the herd’ resulted in disaster. Even recently, failures in e-commerce, CRM systems and offshore outsourcing should alert us to the fact that what works for some companies will not work for all of them, and that following blindly in others' footsteps can leave us lost in the wilderness.

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