There are compelling reasons why a company should create a board - especially when a business nears a scale and complexity which is difficult for one person to direct.
A properly constituted board is key to a business reaching its full potential over the long term.
Structuring a Board
It should be noted that the requirements of the UK Corporate Governance Code only formally apply to listed companies. It is however important to emphasize that it is generally regarded as best practice for all companies whether they are large or small, public or private.
The vital characteristic of a successful and productive board is a balance of skills and experience. There should ideally be a mixture of executive directors and independent non-executive directors. The UK Corporate Governance Code 2018 recommends that at least half of the board should be independent directors – ideally with a diversity of backgrounds. The code also recommends that the chair should not be a former chief executive and that the roles of chair and chief executive should not be held by the same individual.
The way in which directors are appointed will be prescribed by a company's articles of association. These will also often set a minimum and maximum number of directors. The code itself does not specify a number of directors, simply that:
“The board should be of sufficient size that the requirements of the business can be met and that changes to the board's composition and that of its committees can be managed without undue disruption, and should not be so large as to be unwieldy”.
Boards of private companies
The following IoD guide lists some practical considerations as the boards of private companies develop over time:
Corporate Governance Guidance and Principles for Unlisted Companies in the UK
“During the early years of the company's existence, owner-managers may be uncomfortable about inviting outsiders onto the board. They may not yet be ready to share sensitive company information and decision making powers with external persons. Hence the board often consists of an owner-manager's colleagues, family members, or close friends.
However, this may result in the board lacking expertise in a number of key strategic areas, e.g. relating to strategy analysis, marketing, finance, human resources management, or international trade. As a result, it may make sense to create an additional advisory board, which can fill the expertise gaps in these areas.
An advisory board should only be regarded as an interim step. Over time, non-executives should be added to the main board. Providers of external finance are also likely to insist on non-executive directors joining the board.
As the company grows, more focus will be placed on the board, which is the key decision-making body of the company. As the success of the company will depend more and more on the board, it is in the owner-manager’s interest to get the best possible people onto the board.
The ability of the board and/or any form of committee to make decisions and exercise proper scrutiny becomes increasingly difficult at sizes in excess of 10-12 members. A smaller board size will improve the quality of communication and is likely to result in more focused discussions. They will also make board meetings easier to organise.
In an owner-managed company, it is likely that a single person will initially fulfil the roles of both chairman and chief executive (or managing director). A separate independent chairman may not be commercially justifiable. However, the person holding both roles should remember that the responsibilities of chairman and CEO are distinct, and should be viewed separately.
Boards should comprise people with different perspectives, backgrounds, and experience. Board renewal is important to ensure a flow of new ideas.”
Deciding the board composition
The IoD's Effective Board publication recommends considering the following questions when deciding the composition of a board:
- What will be the ratio of executive to non-executive directors?
- What are the likely future needs of the business and what knowledge and skills are current and prospective directors likely to need?
- Is there a proper process for appointing directors?
- What are the succession plans for the members of the board and senior executives?
- What are the procedures for appointing the chairman and the chief executive?
- What are the terms of reference for the nomination committee? Do they ensure that the range of potential candidates is wide enough? Is the selection process rigorous enough?
- Is the contribution of each director assessed in an annual review? Can individual development programs be arranged where necessary?
- Is a comprehensive induction program available for new members of the board?
The FRC report Guidance on Board Effectiveness (July 2018) recommends that:
“The boardroom should be a place for robust debate where challenge, support, diversity of thought and teamwork are essential features. Diversity of skills, background and personal strengths is an important driver of a board’s effectiveness, creating different perspectives among directors, and breaking down a tendency towards ‘group think’.”
Appointing non-executive directors
Corporate Governance Guidance and Principles for Unlisted Companies in the UK (see above) states that:
“Once a company reaches a certain size and level of complexity, an independent board, i.e. a board containing independent non-executive directors and not entirely composed of company or family insiders, becomes essential to the long-term success and survival of the company”
“A key stage in opening up the company to external scrutiny is taken by the appointment of independent (non-executive) directors. This signals a firm’s willingness to become more open and accountable in respect of its decision-making and performance assessment. The replacing of the owner-manager or founding entrepreneur by external managers can also be perceived as an important step in this direction”.
The role of the nomination committee
The UK Corporate Governance Code 2018 recommends that there is a formal, transparent and rigorous process for the appointment of new directors to the board. For public companies (and some large private companies) this process should be led by the nomination committee which will make recommendations or nominations: both to the full board and the senior executive level below it.
The FRC's Guidance on Board Effectiveness (referenced above) states that the nomination committee's work should be:
“…a continuous and proactive process of planning and assessment, taking into account the company's strategic priorities and the main trends and factors affecting the long-term success and future viability of the company”.
The nomination committee members usually mostly consist of non-executive directors. The chair is also usually a member of the committee and may preside over its meetings.
In smaller companies, the tasks of both the nomination and remuneration committees are often combined.
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