The necessity of non-executive directors

The role of non-executive directors (NEDs) in corporate governance has been well appreciated around the world. The corporate boards nowadays comprise executives who are an organisation's internal staff and non-executives who are external members. NEDs do not take part in day to day activities of the company, they attend company board meetings usually once or twice in a month and particularly look at the strategic issues including if the executives are taking proper care of the shareholders' money. NEDs are usually distinguished lawyers, university teachers, social workers, and other intellectuals who must be free from any undue influence from the management. The Cadbury Committee Report 1992 in the UK, and institutional shareholders' associations both in the UK and the US require every company listed with stock exchange to have NEDs in their board. Even the chairman of the board is an outside NED. In Bangladesh also, the BSEC (Bangladesh Securities and Exchange Commission) requires to do it but to our best knowledge, this is not universally complied with in the private sector. Because of the Bangladesh Bank regulations, the public sector banks only have NEDs in their boards.
GROWTH OF NON-EXECUTIVES: The concept of NED is new in Bangladesh; it emerged in the late 1990s. Even in the UK and the USA, the birthplaces of corporate governance, the role of NEDs started taking shape in the late 1980s.
To understand NEDs we need to know the uniqueness of public limited companies (plcs) compared to sole ownership and partnership business. In a plc, managers (the agents) run and control the business on behalf of the shareholders (the principals). That is, 'agency relation' or 'separation of ownership from control' is a unique feature of a plc. But in other businesses, owners and managers are usually the same persons. This unique feature has created a unique problem for these plcs -- managers can misuse shareholders' money. Millions of shareholders are far away from their business places and therefore management can take decisions for their own benefits and not necessarily for shareholders' interests. Some of these misuses cost excess salaries and benefits, lavishly donating for charitable and political purposes (not from own pocket but shareholders' money), being motivated by short-term benefits rather than taking adequate risks for long-term benefits of the business.
ROOTS OF NON-EXECUTIVES ARE IN PARLIAMENT: The parliamentary system began in the UK in 1295 with members of the king's council (House of Lords), particularly king's judges. The Upper House usually consists of knowledgeable citizens relatively of independent minds and socially more celebrated citizens. Indian Rajya Sabha has 12 MPs nominated by the President having knowledge in literature, science, and social science. In Singapore, a special select committee of the parliament invites the general public to submit names of nine persons who may be considered for nomination by the committee. The persons to be nominated must have rendered any distinguished public service or have brought honour to Singapore, or have distinguished themselves in any of the fields of arts and literature, culture, sciences, business and industry, and must be independent and non-partisan.  The Frankfurt parliament of 1848 was called the professors' parliament.
NON-EXECUTIVES IN UK PUBLIC SECTOR: Ministerial departments such as the Attorney General's Office, Cabinet Office and departments under different ministries are governed by both executives and non-executives. For central government, the HM Treasury and the Cabinet Office designed a code of good practices called corporate governance in central government departments in July 2011. Each department board (ministry) must have at least four non-executive members appointed by the Secretary of State with Cabinet Office guidelines. Non-executives must have experience in managing complex organisations with strong commercial expertise. They look at the accountability of permanent secretaries, mechanisms for assessing their performance, strategy and deliverability of policies, reporting from the department on performance and how well the department is achieving its performance, financial management, internal control, annual report and allocation of resources and give support and guidance for any operational business plan and recruitment of senior executives. As a last resort, if non-executive board members judge that the permanent secretary is an obstacle to effective delivery, they will be able to recommend to the Prime Minister and Secretary of State and Head of the Home Civil Service that the permanent secretary should be removed from the post.
BANGLADESH SCENARIO: The secretaries do not respond adequately to the ministerial standing committees in parliament and also to Comptroller and Auditor General's objections relating to their financial administration. Delay in taking effective steps in relation to audit objections ranges from 20 months to 140 months (my book on governance, Dhaka University, 2004, for details about serious lapses in their governance). Independent non-executives in various ministerial committees can help in reducing absolute power of the secretaries in their governance. The Secretariat instructions, 1996 (revised up to 2012) do not have any provision for non-executives in our ministerial committees. The Prime Minister, however, may appoint advisers (section 3B and 4B). Currently, only four advisers are there and they may attend the cabinet meetings. This scribe had raised this idea of non-executives in the ministry back in 2004 (in my book above), whereas the UK did it in 2011 (originally 2005). It should be remembered that non-executive position is an honorary position. They are given only a fee for attending the meetings usually two or three times a month. So this should not be a burden for our resource-stained economy.
NON-EXECUTIVES ARE MORE IMPORTANT IN THE PUBLIC SECTOR THAN IN THE CORPORATE SECTOR: The inclusion of independent experts from outside in various committees is more important in the public sector than in the private corporate sector. In the corporate sector, there are institutional shareholders who have large stakes in companies and, therefore, have higher incentives to monitor the management. But in the public sector, such an incentive for monitoring is largely absent. Also shareholders in the corporate sector can simply 'exit' by selling their shares, if the share prices are not satisfactory. Thus unlike the corporate sector, ministries and other government organisations do not have many control mechanisms for persuading the management for working in the citizens' best interests. Therefore, inclusion of independent experts from outside gives some hope for establishing good governance in the public sector.
LIMITATION: There are, however, limitations of non-executive positions in the sense that they have to be independent, that is, free from any influence from the management. This scribe in his Ph.D. thesis, found that if non-executives are not independent they can rather be dysfunctional for an organisation. British non-executive directors who were previously executives in the same firm were on a collision course with the executives (their friends) in increasing the latter's remuneration.
Dr. Dhiman Chowdhury is Professor of Accounting
at Dhaka University.
 dhiman_chowdhury@yahoo.com