Visible behaviour

Independence is a virtue that all non-executive directors must maintain throughout their directorships. It is a key feature of good governance, which ultimately helps to avoid boardroom groupthink from taking hold. It also ensures that sound business decisions that fulfil the strategy of the company are being made.

Independence is frequently measured quantitatively – years served at one company, the amount of shares owned, or the number of directorships held at other similar companies. However, all these measures are naturally imperfect, especially when it comes to small and mid-cap quoted companies.

Being a non-executive director of a small and mid-cap quoted company usually involves rolling up your sleeves and getting more involved in a business than one might in a larger company. Smaller companies tend to be cash-strapped, under-resourced and look for advice frequently. This can mean that non-executives are paid partly or fully in shares and tend to be more entwined in the business. Although the board and the non-executive themselves may not see this as a problem, the outside world can perceive those non-executives as being more at risk of having their independence compromised because of these circumstances.

The Quoted Companies Alliance’s most recent PULSE survey of small and mid-cap quoted companies and their advisers demonstrates this. An overwhelming majority (93%) of small and mid-cap quoted companies believe that non-executive directors are sufficiently independent from management to provide an independent and critical voice to the running of their companies. On the other hand, only 64% of advisers agree that non-executive directors are sufficiently independent.

The good news is that the majority of people in the small and mid-cap quoted company sector believe that non-executives remain non-biased and that this is an improvement on when we asked this question of them two years ago. In 2013, 83% of companies and 53% of advisers agreed that non-executives are independent. The problem seems to be that companies and non-executive directors are not demonstrating their independence well enough to the outside world.

Small and mid-cap quoted companies and advisers agree that non-executives bring the most value to their companies through their broader business experience, providing checks and balances and helping to improve corporate governance. However, both companies and advisers want to see non-executives getting more involved in long-term vision and planning, providing valuable contacts and making more of their business experience.

Some of these activities require getting highly involved in the business. Others require individuals to step back from the day-to-day operations. This ultimately depends on the situation and task in hand. Therefore, if it is accepted that there is no hard and fast rule to the application of independence, then it must been seen as a state of mind which is hard to demonstrate and even harder to measure. Independence is critical at certain points and at others it stays in the background.

All of this complicates how non-executive directors demonstrate and communicate their independence. The QCA’s survey results suggest that this may be where the problem lies. Fund managers get direct access to the companies in which they invest, whereas private investors do not. Companies need to remember this when producing reports and other communications for the market. Governance structures and behaviour, such as the independence of non-executive directors, need to be visible to all stakeholders and not just to those that have direct access to a company’s board.

The report of the most recent QCA/BDO PULSE survey (Issue 14) is available online at: www.theqca.com/qcabdopulse

Tim Ward is ceo of Quoted Companies Alliance and Scott Knight is head of audit at BDO LLP