Non-Executive Directors and Corporate Governance

Introduction

Non-executive directors (NEDs) play a very important role in corporate governance. They control financial reporting and internal audit, determine executive remuneration, ensure effectiveness of risk management team and bring external views to a company. However, the advent of the current financial crisis and collapse of several corporations such as Enron, Maxwell and Parmalat, has raised serious concerns about the effectiveness of the NEDs. In this essay, it will be argued that the NEDs are not effective in improving corporate governance. This argument will be supported by the rigorous analysis of their function on the audit and remuneration committees. Afterwards, the maintenance of their independence in their role will also be assessed. This will be followed by the evaluation of the current system in the UK in regards to the appointment of the NEDs, and the role they play in the governance of limited companies. Based on this analysis, the key recommendations will be made in relation to the improvement of the current appointment procedure and NEDs’ role on the board. In conclusion, the key points based on the arguments in this paper will be summarised, and the main proposal will be made.

Audit Committee

Non-executive directors, acting independently from executive directors on an audit committee, are responsible for protecting interests of shareholders in relation to financial reporting and internal audit (Higgs, 2003). However, many historical facts indicate they often ignore fraudulent activities that occur in a company. An example of this can be found in the case of Maxwell Communication Corporation, which was named the greatest fraud of the 20th century (Stiles and Taylor, 1993). In this case, the non-executive directors completely failed to identify several unethical activities. For instance, despite being able to observe the transactions of funds from the pension fund to the company, which enabled Robert Maxwell to finance his other business activities, the NEDs didn’t inform executive directors about these transactions (Solomon, 2010, p.47). Similar example of the failure of the audit committee can be found in the case of Enron. The accounting function in Enron was opaque and unreliable. The internal auditors fabricated profits that never occurred in reality, in particular from collaboration with Blockbuster Video (Solomon, 2010, p.47). Moreover, the company’s financial accounts were fabricated to such an extent, that it had a drastic impact on other companies. For example, Arthur Andersen, one of the Big Five companies, went bankrupt partly because of the involvement in Enron’s auditing (Solomon, 2010, p.32). Overall, these examples show the non-executive directors failed to identify and report various fraudulent activities on several occasions. As a result, this led to severe consequences for major corporations such as Enron and Maxwell.