Director and its kinds

Introduction

This paper explores the term director and its kinds. It further discusses board and its composition. It will also briefly describe the term corporate governance, but the main emphasis of this paper remains the role of the directors in context with the Combined Code contains broad principles.

Every company listed on the London Stock Exchange is under an obligation of an annual report the application of the main principles of the Code, and a confirmation that the Combined Code provisions are complied with. It further explains how an effective board is established and how the role of the directors plays a fundamental role in good corporate governance.

This essay then critically explores that the board of directors plays a pivotal role in an effective corporate governance model.

Directors

A study on corporate governance cannot be concluded without discussing the role of directors. For this purpose Section 741(1) of the Companies Act 1985 defined the term director as,

“Director … Includes any person occupying the position of director by whatever name called”. (Section 741(1) of the Companies Act 1985)

An individual can be a director even without bearing the title. Directors also known as ‘council members' or ‘trustee' or ‘governors' etc in companies limited by guarantee. This essay briefly describes the kinds of directors as follows,

  1. Executive And Non-Executive Directors

According to Kate Sandison, there is no difference between the non-executive directors and executive directors. Non-executive directors are appointed by the directors who do not perform any administrative tasks and attend the board meetings. Non-Executive directors ensure that the executive directors perform their responsibilities effectively.

(Non-Executive Directors' by Kate Sandison and Ashurst Morris Crisp, ELN July 2002, 99, 1 July 2002)

Non-Executive directors are able to focus on wider issues as compared to executive directors, who are liable to become entangled in the routine operations. Daren Higgs in the Review of the role and effectiveness of non-executive directors recommends that the non-executive directors must be expert having appropriate knowledge to discharge their responsibilities. In addition to this non-executive director should be well informed about the business and its environment, which also include knowledge of market and the full understanding of the environment where the company exists. Mr. Higgs further suggests that the aforementioned awareness cannot be gained while confining merely in the boardroom.

  1. Shadow Director

Shadow director is defined in Section 741(2) of the Companies Act 1985 as, “a person in accordance with whose directions or instructions the directors of the company are accustomed … a person is not deemed a shadow director by reason only that the directors act on advice given by him in a professional capacity”.

(Section 741(2) of the Companies Act 1985)

Lewison J states that a shadow director is a person on whose directions the board discharges its duties.

(Ultraframe (UK) Ltd v Fielding and others Northstar Systems Ltd and another v Fielding and others and other actions - [2005] All ER (D) 397 (Jul))

Peter V Duzer in Companies Act 2006, A Guide for Private Companies' is of the view that though the shadow director in not an appointed director but is considered as a mind that is actually directing the company and the actual directors.

(Jordan Publishing Limited Bristol, 2007, p. 64)

  1. De Facto Director

Martin Webster argues that section 251 of the Companies Act 2006 defines the term de facto director as a person who is not properly appointed as a director, but used to attend the board meetings, articulates and participates in the elections of the board meetings. (‘Companies Act 2006: Directors' 30 CSR 22, 169, 21 February 2007)

Board And Its Composition

Combined Code on Corporate Governance June 2008 at page 5, defines the term board as “Every company should be headed by an effective board, which is collectively responsible for the success of the company.”

(Available at: http://www.frc.org.uk/images/uploaded/documents/Combined%20Code%20Web%20Optimized%20June%202008(2).pdf)

University of Cambridge Working Paper No. 261 suggests that the corporate board of a small corporate organization consists of top managers and the directors from outside the firm. The Board organization in the UK is of or pertaining to or involving the use of units and is composed of executive and non-executive directors. Executive directors are regarded as fulltime employees of the company and should be updated with the information and the activities of the companies. However, the non-executive director is concerned with planning the policies of the company.

(‘The Effect of Board Structure on Bidder Shareholders' Wealth: Further Evidence from the UK Bidding Firms' ESRC Centre for Business Research, , By Charalambos Th. Constantinou and Costas; available at: http://www.cbr.cam.ac.uk/pdf/wp261.pdf)

Corporate governance

Cadbury Report on the Financial Aspects of Corporate Governance Published on December 1, 1992 defines the term corporate governance in Para 2.5 as “system by which organisations are directed and controlled.” (available at: http://www.ecgi.org/codes/documents/cadbury.pdf)

This term is further defined in July 2003 by the Chairman of International Corporate Governance Mr. Alastair Ross Goodby as “Corporate Governance is only about reducing the cost of capital …”

Corporate Governance Developments In The United Kingdom

Polly Peck and Maxwell one of the leading case is considered as a start of developments of corporate governance in the United Kingdom, these developments started in the late 1980s and early 1990s. These developments include,

  1. Cadbury Report 1992 presented by Sir Adrian Cadbury
  2. Rutteman Report 1994 established by the Institute of Chartered Accountants in England and Wales, and by the Institute of Chartered Accounts of Scotland led by Sir Rutteman.

  3. Greenbury Committee established in 1995 headed by Sir Richard Greenbury.
  4. Hampel Committee (January 1998) headed by Sir Ronald Hampel, was established to review the findings of the Cadbury and Greenbury Reports.

  5. The Combined Code (June 1998),
  6. Turnbull Committee (1999),

  7. Higgs Report (2003),
  8. Smith Report (2003),

  9. UK Directors' Remuneration Report Regulation 2002,
  10. Revised Combined Code (2003),

  11. Internal Control: Revised Guidance for Directors on the Combined Code (2005),
  12. Combined Code (June 2006) and the most recent code known as

  13. The Combined Code on Corporate Governance (June 2008).

Role And Duties Of The Directors And Board

The Combined Code on Corporate Governance of June 2008 discusses the entrepreneurial leadership and effective control of the company by the directors enabling the assessment and management of the risks.

Further to the above the code suggests in A1 supporting principal that, “the board should set the company's strategic aims, ensure that the necessary financial and human resources are in place for the company to meet its objectives and review management performance. The board should set the company's values and standards and ensure that its obligations to its shareholders and others are understood and met.”

(Available at: http://www.frc.org.uk/documents/pagemanager/frc/Combined_Code_June_2008/Combined%20Code%20Web%20Optimized%20June%202008(2).pdf)

This paper discusses some of the main duties of the board and the directors to take the debate further to the importance of role of board in good corporate governance, main duties of directors or board are as follows,

  1. Duty To Act Within The Powers

Section 171 of the Companies Act emphasized that the director must “act in accordance with the company's constitution, and only exercise powers for the purposes for which they are conferred.”

Nicola Bridge in an article ‘Directors behaving badly' states that the directors are under obligation to discharge their duties by using the powers in accordance with the constitution of the company.

(154 NLJ 774, 21 May 2004)

Therefore the directors are only empowered to act within the limits defined by the company's memorandum and articles of association or liable otherwise.

  1. Duty To Promote The Success Of The Company

Section 172 of the Companies Act states that, “A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole…”

Preamble of the Combined Code on Corporate Governance June 2006 advocates that the directors of a company should act in the interests of the company, it further emphasize on the objective decisions from the directors.

  1. Duty To Exercise Independent Judgment

Section 173(1) of the Companies Act 2006 states that, “A director of a company must exercise independent judgment.”

Different scholars argue that though the judgment should be independent but should be discharged in accordance with the agreement confining the discretions of the directors to exercise their powers in the best interests of the company and the constitution of the company should be complied with.

According to Cadbury, independent judgment by the directors is an essential quality and further suggests that discharge of the responsibilities from the directors should be without prejudice and impartial.

(‘Who carries the can?' by Professor Frank B Wright, 156 NLJ 1092, 7 July 2006, available at LexisNexis)

The Combine Code on Corporate Governance June 2008 further suggests in the Code Provision A.3.1 that the board is to determine the director's independence in judgment. (Available at p. 8)

Dan Mace suggests that directors can avoid conflict of interest and opinion by exercising independent judgments.

(‘Helping Directors Direct', (2000) 7 JIBFL 247, 1 July 2000, available at LexisNexis)

  1. Duty To Exercise Reasonable Care, Skill And Diligence

Section 174(1) of the Companies Act 2006 requires the directors of a company to act with reasonable care, skill and diligence. It further defines the word reasonable in length, and the same principal was established in City Equitable Fire Insurance Co Ltd. ([1925] Ch 407, p. 428)

Reviews and the reforms further suggest that the directors should be devoted to the performance of their functions. The Review of the effectiveness of the Combined Code by Financial Reporting Council suggests different issues for reconsideration; it suggests that the board should make sure that all the members of the board have relevant experience, skills and expertise to discharge their duties effectively.

(Available at p 10 of the Review: at http://www.frc.org.uk/documents/pagemanager/frc/Combined_Code_2009/Web_changes_to_2009_REview_of_the_Combined_Code_July_2009/Combined%20Code%20review%20progress%20report%20July%202009.pdf)

Different scholars are of the view that better results can be achieved if it is made sure that the directors are exercising reasonable care, skill and diligence in performing their duties.

  1. Duty To Avoid Conflicts Of Interest

Companies Act 2006 suggests that the directors have to avoid the situations if there are chances of a direct or indirect conflict of interest with the company's interests. (Section 175(1) )

Boardman and Another v. Phipps [1967] 2 A.C. 46, p. 124 discussed the rule of conflict of interest as ‘… no one, having such duties to discharge, shall be allowed to enter into engagements in which he has, or can have, a personal interest conflicting, or which possibly may conflict, with the interests of those whom he is bound to protect.'

  1. Duty Not To Accept Benefits From Third Parties

Section 176 of the Companies Act 2006 states that a director of the company is not supposed to accept benefits from any third party as it may effect his independence.

  1. Duty To Declare Interest In Proposed Transaction Or Arrangement

The director of a company is under obligation to declare his interests to the other directors except otherwise provided by the Companies Act 2006, and this declaration should be in the board's meeting.

(Section 177 of the Companies Act 2006)

Significance Of Role Of Directors In Corporate Governance

Consultation Paper published by the Financial Reporting Council states that the combined code remained unable to discuss the role and responsibilities of the board and further suggests that further review expected in October 2009 should address the role of the directors in detail, so that the directors can discharge their duties properly ensuring that the board is operating effectively.

(Progress Report and Second Consultation published by Financial Reporting Council in July 2009)

Conclusion

Different scholars have reacted the role of the directors discussed in the Combined Code in a different manner; some are of the view that the Combined Code has discussed the role of director at length and there is no further clarification required but some of them seem critical toward the insufficient debate on the role of the directors and the board suggesting that the discussion in the code is helpful to the extent of non-executive directors, but it requires a further explanation to clarify the role and limits of the executive directors.