Higgs review 'has led to increased diversity and independence'

20 January, 2010

Eight years ago, the Enron scandal rocked the cosy world of corporate governance. The energy firm, one of the biggest in the US, was found to have lied about its profits, indulged in shady deals and covered up debts. Investors and creditors fled as the extent of the scam unfolded and the company went bankrupt shortly afterwards.

The scandal shone the spotlight on corporate governance and prompted various hearings and investigations by the Senate committee on banking, housing and urban affairs and the House committee on financial services.

Over in the UK, the then chancellor Gordon Brown and secretary of state Patricia Hewitt appointed Derek Higgs to conduct an independent review of the effectiveness of non-executive directors in April 2002.

The result was the Higgs report, published in January 2003, and amendments to the Combined Code for corporate governance.

Among the key changes that emerged as a result of the review was the instruction that companies should aim to draw non-executive directors from a wider recruitment pool.

The report also stressed the need for increased neutrality of executives, so that more than half of the board should be "independent" as well as non-executive, meaning that they do not have financial or other potentially conflicting ties with full-time directors.

Good and bad practice

Six years on, the country is in the midst of the recession on the back of a major banking crisis which has again focused attention on the way boards oversee the running of major corporations.

Sir David Walker is currently leading an independent review of corporate governance in the UK banking industry, while the Financial Reporting Council (FRC) is once again undergoing a consultation process to determine views on the Combined Code and potentially propose changes to it.

So has executive recruitment changed in the aftermath of the Enron scandal and following the revisions to the Code?

"There's lots of good practice and there's lots of bad practice," says Chris Hodge, head of the corporate governance unit at the FRC.

However, he insists that there has been a "notable improvement" in the overall standard of corporate governance and executive recruitment not only since the Higgs report, but also following the implementation of the original code drawn up by Sir Adrian Cadbury in 1992.

"Certainly when you compare UK companies to other countries, it does seem to be having an effect. So the overall picture is a positive one, but that's not to say that it's not without its problems."

Flexibility

Mr Hodge credits the 'comply or explain' framework - which involves organisations voluntarily signing up to the Code rather than imposing any mandatory legal obligations - as one of the reasons behind this progress.

"That kind of flexibility means that you can set the standard for compliance higher, compared to regulation, where you tend to set the level at the minimum requirement for all companies," he explains.

"When you have that little bit of flexibility, you can set the standard higher and give companies more to aspire to in the hope that it will lead to them improving their practice over time."

Stephen Ramsay, company secretary and general counsel for International Power since 2000, explains that the accommodating nature of the Code has benefitted his company, as it has been able to opt not to comply in two areas while still living up the ideals of the Higgs Report.

International Power has chosen to contravene the recommendations in two areas for practical reasons and, as is required, has outlined its reasons for doing so.

The firm's non-executive directors decided that it would not be appropriate to comply with the 'majority' rule, whereby there should be more independent non-executive directors sitting on the board.

"To change that we would need to appoint two more non-execs and we're just concerned the board would become too large," Mr Ramsay explains.

"[It would become] too cumbersome and that would make decisions in meetings too difficult to take," he adds.

Another area where the firm has decided not to comply is the recommendation that the senior independent non-executive director should have a contact programme with shareholders.

The Board, including the senior independent director, felt that such a programme should be primarily between the chief executive officer (CEO) and chief financial officer, but shareholders are still able to contact the chairman or senior independent director if they have any issues regarding governance.

Mr Ramsay believes that this was the right decision, evidenced by the fact that there have not been requests from shareholders for meetings.

"[Mr Isaac] is a very visible person, he's identified in reports and accounts and no-one's ringing ourselves and requesting a meeting," he explains.

Living up to the Code's ideals

As well as drawing attention towards corporate governance generally, the aftermath of the Enron scandal also placed energy companies in particular under scrutiny.

Mr Ramsay insists that International Power has always recruited its board of directors in a way which reflects the vision of the Combined Code.

Although he cannot speak for other companies in the energy industry, the so-called old boys' network is not a factor at International Power, he says.

"I'm not sure it ever really existed to be honest, but it certainly doesn't exist now," he asserts.

Appointments from the top down at International Power are made on the basis of merit, not candidate contacts, Mr Ramsay says.

"Any recruitment is done on a proper basis - advertising, using an agent and getting the best person for the job.

"As a company, you want to make sure you've got the best talent and the only way you can ensure that is by testing the marketplace for it. I think we've always had that approach," he adds.

Mr Hodge agrees that the old boys' network seems to have disappeared: "The figures for overall independent representation suggest that it has gone up.

"It is more difficult to say how widespread the sources are from which people are recruited, but where there is evidence it does suggest that there has been more diversification," he says.

Responsible recruitment

Mr Ramsay explains that the process for recruiting non-executive directors at International Power generally involves using external head hunters, with the chairman, senior non-executive director and the CEO agreeing a specification for the candidate they wish to appoint.

Mike Cripps, managing director of executive search firm Cripps Sears & Partners, explained: "Corporates are increasingly looking to executive search practices to provide a transparent, exhaustive and neutral selection process to ensure that the best possible candidates are identified to bring balance and diversity to the board rooms."

From the group of potential candidates produced by the agency, the chairman produces a shortlist and those people are then approached.

Interviews are then conducted by the chairman, CEO and senior independent non-executive director before CVs and recommendations are passed on to a nominations committee for final approval.

When National Power was divided into npower and International Power in 2000, the latter inherited three non-executive directors from the original board.

"At that time we got one non-executive through a head hunting campaign and another was a contact of the new CEO who came in but since that appointment, everything we've done has been through head hunting," Mr Ramsay explains.
"I think the view was that it probably wasn't helpful to have that relationship at the board meeting so the chairman has always supported using a head hunter" he adds.

Mr Cripps added: "We are finding that whilst our clients are increasingly seeking diversity in shortlists for non-executive board positions, they also want people who can hit the ground running in terms of understanding the idiosyncracies of the energy sector."

"This will often mean the successful candidates will bring something unique in terms of their background and experience on top of that industry expertise," he said.

Fallout from the recession

Mr Ramsay says that the Higgs report has not changed non-executive recruitment practises for International Power, since it largely met the ideals of the Combined Code before it was produced.

"I think the Combined Code just represents good practice," he says.

Mr Hodge says that it is very likely the FRC will propose changes to the Code based on the review, although he is not willing to speculate on what they might be.

As for Mr Ramsay, he believes that Sir David Walker's investigation into governance in the banking sector is likely to have an impact as well.

"The main issue will probably be on risk assessment and analysis of risk at board meetings," he suggests.

"It won't be just the banking sector, something will be spread out across all companies we suspect. Although Walker is primarily focused on issues in banking we think it would be unlikely that it would just be contained within that sector, so there could be some change," he adds.

Mr Hodge confirms that the FRC will consider the Walker Report and make any amends to its own recommendations based on that.

However, not all of the elements of the report will be appropriate.

"Some of them are likely to relate to the systemic governance of the banks which doesn't necessarily apply to companies in other parts of the listed sector," Mr Hodge explains.

- Ends -

Established in 1973, CS&P provides international executive search services to clients in the energy and infrastructure sectors and to their professional and financial advisers. 
For more information regarding Cripps Sears & Partners Board Practice please contact Mike Cripps or Panny Skrivanos at

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