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SECTION 3, PART 5
CORPORATE GOVERNANCE, MANAGEMENT AND
INCENTIVISATION
CORPORATE GOVERNANCE
1. INTRODUCTION
Corporate governance is the system by which companies are directed and controlled.
It deals largely with the relationship between the constituent parts of a company - the
directors, the board (and its sub-committees), the shareholders, and occasionally
other key stakeholders. The governance of Government owned businesses should,
wherever possible, reflect commercial best practice — namely the principles of the
Combined Code on Corporate Governance.
1.1. Combined Code on Corporate Governance
The Combined Code contains general principles and more detailed provisions
relating to the corporate governance of listed companies. The Code is appended to
the Financial Services Authority's (FSA) Listing Rules which place a regulatory
requirement on companies, in their annual report and accounts, to:
i. report on how they apply the principles of the Code; and
ii. confirm that they comply with the Code's provisions or, where they do not,
provide an explanation.
This is known as the 'comply or explain’ principle which, if applied effectively,
underpins informed dialogue between directors and shareholders. The code sets out
standards of good practice in relation to issues such as:
board composition
roles and responsibilities
appointments and remuneration
accountability and audit; and
relations with shareholders
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The Combined Code was revised in 2003 following the Higgs Review, an
independent review commissioned by the then Trade Secretary, Patricia Hewitt and
Chancellor, Gordon Brown, which looked at the role and effectiveness of non-
executive directors. The revised code includes some useful suggestions for good
practice from the Higgs report, including guidance for non-executive directors, duties
of committees and checklists for due diligence, inductions, and performance
evaluation.
The full document can be accessed via the link below:-
http://www.fsa.gov.uk/pubs/ukla/Ir_comcode2003.pdf
1.2. Key principles of the Combined Code on Corporate Governance
The Code sets out a model of governance for listed companies, which is based on
the ethos of informed dialogue between all parties. It could be represented by the
model below:
The Code contains 14 main principles for the corporate governance of companies,
which are supported by 48 code provisions. It is these provisions to which
companies must confirm that they comply, in their annual reports. More detail on the
provisions and principles of the code are explained in the following sections and in
the Management Incentivisation section of Section 3, Part 5.
2. CORPORATE GOVERNANCE FOR GOVERNMENT BUSINESSES
2.1. The Shareholder Executive model of corporate governance
The Government intends to operate as an intelligent and informed shareholder. For
its businesses to succeed the government, as shareholder, needs to apply a
consistent approach across the portfolio. In developing a model for managing the
government's shareholdings ShEx examined a number of private sector
comparators. While no single shareholder model is applicable in its entirety, the
government's position as a significant (in most cases 100%) shareholder means that
many features of the private equity model are relevant to the management of
government shareholdings. ShEx has therefore adapted this model to recognise, in
particular, the longer-term nature of the government's financial interest in its
businesses and the non-commercial policy objectives it sets.
Recognising that it may not be suitable to use a one size fits all model, the following
principles for corporate governance should be followed for all ShEx businesses:
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— should be compliant with the Combined Code, unless there are specific
reasons to deviate in individual cases
— must fit the needs of the shareholder and the business
— must provide clarity of roles and responsibilities
— should be based on an ethos of informed dialogue between all parties
The rest of this section sets out more specific principles to guide behaviour of the
government as shareholder — the ‘Government Shareholding Principles’ which
incorporates how the Government intends to operate as a Shareholder, and what it
expects of its businesses, as summarised below:
1. How the Government intends to operate as shareholder
The basic shareholder model as set out below summarises the key actions of the
shareholder and its interactions with the businesses.
Picking up the principles which are particularly concerned with the governance of the
business, the following framework provides a basis upon which ShEx should work to
apply a consistent approach to governance across its portfolio.
Governance Framework
i. Shareholder teams should set out, for each business, a single document
(“governance letter” or similar) describing the rights and levers held by the
shareholder, and how they intend to use them, as well as any specific
requirements arising from the businesses legal framework, government
ownership and policy objectives. The document should also set out the rights
and responsibilities that have been passed to the board.
ii. Shareholder teams should adopt a systematic approach to encouraging
business to apply best practice corporate governance.
Section 6.2.4 below goes into more detail on governance documents and provides
examples which can be used as a template.
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2. What Government expects of its businesses
Government set out nine key principles which the government expects to govern the
behaviour of businesses in government ownership. These principles are grouped
under the themes of Communication, Financial, Shareholder Value, Strategic, and
Social, ethical & environmental. Those which have particular relevance to the
Corporate governance of a business are replicated below.
Principle 1 Businesses should seek an honest, open and ongoing dialogue with
the government as shareholder. They should clearly communicate the plans they
are pursuing and the likely financial and wider consequences of those plans. Ideally,
goals, overall plan and progress should also be made public and discussed in the
annual report and accounts.
Principle 2 Businesses should operate a “no surprises” policy ensuring that the
government as shareholder is informed well in advance of anything potentially
contentious in the public arena.
Principle 5 Businesses should have performance evaluation and incentive systems
designed cost effectively to incentivise managers to deliver long term
shareholder objectives and shareholder value.
Principle 8 Businesses should have and continue to develop coherent strategies for
each business unit. The approach to reviewing strategy should be a dialogue
between the board and the shareholder. The focus of the dialogue should be set
by the primary goal of the board to deliver the business's objectives, which will
include key commercial, financial and non-commercial goals, including the
maximisation of shareholder value consistent with the non-commercial objectives.
Strategies should include a market and risk analysis, benchmarking, relevant
sensitivity analysis, contingency plans and an outline of how the proposed strategy
takes account of lessons learned from previous performance.
For the full text on the ‘Government Shareholding Principles’ see the ShEx Annual
Report 2004-05, Annex D via the link below:
http:/www.shareholderexecutive.gov.uk/publications/pdf/annualreport0405.pdf)
2.2. The role of the Shareholder and ShEx
The role of the shareholder, in respect to a company's corporate governance, is
principally to ensure that it is satisfied with the governance arrangements, and that
such arrangements are compliant with the Combined Code (where appropriate).
The Combined Code includes provisions for the duties of institutional shareholders,
principally that they ‘should enter into a dialogue with companies based on the
mutual understanding of objectives’, and that they should undertake to evaluate
companies’ governance arrangements, giving due weight to any relevant factors
drawn to their attention.
The Corporate Governance objectives of Government, when a shareholder, are the
same whether ShEx is acting in an ‘Executive’ or ‘Advisory’ role. As set out in
Section 2 (‘The Shareholder Executive Offering’), however, the ability for ShEx to
fully apply the controls and levers in this area, may be diluted when working through
a separate Shareholding Department.
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As acknowledged in the 2007 NAO and PAC reports, ShEx is most effective in an
executive role and accordingly ShEx is seeking a full Executive role, with full
ownership of all shareholder levers, including governance or, where in an advisory
role, recognition and acceptance from the shareholding department that they will
comply with ShEx best practice in such areas as governance.
2.3. Peculiarities of Government businesses
The nature of some Government businesses may lead to inconsistencies with the
principles of good corporate governance. The sections below, copied from section 1
“Introduction” to the ShEx Handbook, outlines the corporate governance frameworks
for each type of Government business:
i. Trading Funds
The relevant Minister is ultimately responsible to Parliament for the performance of
the trading fund. For most trading funds, the ShEx objective has been to bring
corporate governance in line with commercial best practice through the appointment
of non-executive Chairs and ensuring the quality of other non-executive directors.
The boards are then given collective responsibility for the performance of the
business. It should be noted, however, that unlike under the Companies Act
framework, it is the relevant Chief Executive, rather than a collective board, who is
the ‘Accounting Officer’ for each of the trading funds, personally responsible to
Parliament for the ‘propriety, regularity and value for money’ of all expenditure. The
ShEx seeks to ensure that the corporate governance arrangements are not in tension
with the personal responsibilities of the Accounting Officers, though some of the
CEOs find this difficult which can make it a potential inhibitor of the ShEx governance
model effectiveness. The flipside of the trading fund model is that board members,
other than the CEO, do not have formal accountability for performance or operation
of the fund, although they are personally and morally responsible by nature of their
appointment.
ii. Companies Act Companies
Governance as any Companies Act company. The ShEx would expect the
businesses to be compliant with the Combined Code (see section 6.1.2), where the
company is managed by a Board, presided over by a Chairman and includes
executive and non executive directors. Collectively, the Board is legally responsible
for the success of the company and the Directors have personal financial liability.
The relevant Departmental Minister is still responsible for the Govco as a
departmental asset.
iii. Statutory Corporations
Governance as set out in the legislation for each Statutory Corporation, but would
normally be similar to the Companies Act model where the management of the
company is delegated to the Board, presided over by a Chairman. Broadly, the
Courts would regard Board members as having the same fiduciary responsibilities as
the directors of a Companies Act company. There are, however, some oddities
within the ShEx portfolio: British Waterways, for example, has an entirely non-exec
board, and Channel 4’s board are appointed by the regulator, Ofcom.
For example the Channel 4 legislative basis for corporate governance is set out as
follows, in the Broadcasting Act 1990:
http://www.opsi.gov.uk/acts/acts1990/ukpga_19900042 en _3#pt1-ch2-pb2-l1g23
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Channel 4
23. The Channel Four Television Corporation
There shall be a corporation to be called the Channel Four Television Corporation (in
this Part referred to as “the Corporation”).
The Corporation shall consist of—
a Chairman and a deputy Chairman appointed by the Commission; and
such number of other members, not being less than eleven nor more than thirteen, as
the Commission may from time to time determine.
The other members referred to in subsection (2)(b) shall consist of—
persons appointed by the Commission; and
ex-officio members of the Corporation;
and the total number of members appointed by the Commission under subsection (2)(a)
and paragraph (a) above shall exceed the number of ex-officio members.
Any appointment made by the Commission under subsection (2)(a) or (3)(a) shall
require the approval of the Secretary of State.
For the purposes of subsection (3) the following persons shall be ex-officio members of
the Corporation, namely—
the chief executive of the Corporation; and
such other employees of the Corporation as may for the time being be nominated by the
chief executive and the Chairman of the Corporation acting jointly.
Schedule 3 to this Act shall have effect with respect to the Corporation.
iv. Public Private Partnerships
The PPPs that ShEx are involved in, are Companies Act companies and will
therefore be subject to the relevant standard legislation, although there may be
bespoke Shareholder Agreements that impact on the Governance as well. For
example, on NATS on Working Links there are shareholder representatives on the
Board and who, arguably, are not truly independent NEDs from a Combined Code
perspective.
2.4. Communicating the governance framework
The documents which set out the corporate governance framework for a business
are a key component of the ShEx governance approach. Taken together the
documents should:
1. Clearly set out the purpose, role and objectives for the business + HUG
strategic intent (where relevant);
2. Clearly communicate the role and responsibilities of all parties involved in
governance of the business, including (but not limited to) the Board,
Chairman, Chief Executive, Shareholder Department and and ShEx;
Set out the Government's Shareholding Principles (see Section 1)
Describe the governance rights and levers, and how they will be used
Describe the policy and financial framework within which the business is
constrained e.g. Ministerial consents, reporting requirements, liabilities,
dividend policies etc.
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Corporate Governance documentation will normally be additional to the Articles of
Association which all Companies Act have, and which set out how the company is
organised and how it works. Ideally a complete set of governance documents will
include:
1. Chairman’s letter
Description of the responsibilities of the Chairman, personal objectives (e.g.
reform the Board) and top level strategic objectives for the business. Should
include a description of the wider governance framework.
2. Governance letter
Detailed description of the governance arrangements for the business and
further detail on the policy and/or financial frameworks.
3. Shareholder relationship or Delegated remit letter for ShEx (where
appropriate)
Formal delegation of responsibilities to ShEx from shareholding department.
More explanation of the Chairman’s letter can be found in section 6.5.1. The
appendices include a proforma which can be used as the basis of a governance
letter, framework document or shareholder relationship letter. The following examples
can also be used for guidance, and are located in the appendices in hard copy form.
Outline governance letter / framework document
Outline governance
letter framework do
UKAEA Chairman letter
Example UKAEA,
Chairman letter.tr5
Royal Mint Chairman letter
Example Royal Mint
Chairman letter. tr5
DSTL framework document
Example DSTL
framework document
Royal Mint delegated remit letter
Example Royal Mint
ShEx delegated remit
Actis Shareholder relationship letter
Example Actis
Shareholder Relation:
3. BOARD COMPOSITION, ROLES, & RELATIONSHIPS
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3.1. Board composition
The Board is collectively responsible for the success of any company. It should
include a balance of executive and non-executive directors (and in particular
independent non-executive directors), which should ensure that no small group can
dominate the board’s decision making. The Combined Code specifies that in all but
small companies at least half the board, excluding the Chairman, should be
independent non-executive directors. A smaller company should have at least two
independent non-execs.
One of the key actions of ShEx when taking on responsibility for Government
businesses has been to appoint a non-executive Chair and directors to reflect the
Combined Code principles, particularly for businesses such as Trading Funds which
have often in the past had Boards made up solely of Executive directors.
The starting point for board appointments should be an agreed vision between ShEx
and the Chair of the mix of skills and experience for the board as a whole. This will
depend on the business and the nature of the challenges both in the short term and
long term, but some suggestions of core competencies for Chair/CEO/FD can be
found in the appendices.
3.2. Roles & Division of responsibilities
The principal Board roles and their key responsibilities are:
Chairman - responsible for establishing and agreeing broad strategy with the
key stakeholders;
- responsible for managing the Board and making changes when
and where required;
Non-Execs - responsible for scrutinising performance of executive team in
delivering agreed stategy;
- responsible for determining appropriate levels of remuneration for
executives and supporting Chair in appointments and/or changes to
the board;
MD/CEO - responsible for implementing the agreed strategy and managing
the executive team on a day to day basis;
FD - responsible for financial management of the business and
producing appropriate financial information on a timely basis;
One of the key principles of the Combined Code is that there should be a clear
division of responsibilities at the head of the company between the running of the
board and the executive responsibility for the running of the company’s business.
ShEx should also seek to ensure that businesses follow other related provisions in
the code, in particular around the independence of Chairmen.
It is the Chairman’s responsibility to lead the board, and ensure it is effective in its
duties. It is also the Chairman's responsibility to ensure effective communication with
the shareholder, and therefore it is normally the Chair with whom ShEx will have
most contact. Good working relationships between ShEx and the Chair are vital to
ensure successful implementation of the shareholder model.
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Division of responsibilities should be clearly set out in the Chairman's letter, and also
in Governance letters, where appropriate — see section 6.2.4.
3.3. Shareholder Relationship with Board
There should be regular communications between the board and the shareholder.
ShEx would want to have a good working relationship with the board via direct
communication, even where working in an Advisory capacity. ShEx will seek to have
direct communication and access to all the key Board members, such as Chairman,
NEDs, CEO and FD, so that there is a broad understanding of different perspectives
and that ShEx’s understanding of the business and its performance is not filtered via
a single relationship with the Chairman, or CEO.
3.4. Board Representation/Observer Status
In general, ShEx does not appoint members of its team directly to the Board of
Government-owned businesses. This avoids potential conflicts of interest between
ShEx’s shareholder role and the fiduciary duties held by any director of a business.
ShEx can seek, subject to the individual business governance arrangements, to
attend board meetings as an Observer, which has the advantages of:
i. ShEx being able to observe the Board in action and the dynamics and
contribution of the Board and its members;
ii. Being close to key issues and discussions and not having information filtered
or sensitised prior to ShEx receiving it;
iii. Avoids duplication for the management team i.e. having to review
performance both with the Board and then ShEx;
iv. Allows closer relationships to be established with the Board.
4. OBJECTIVE SETTING
Shareholding teams should systematically, and in consultation with management,
identify and, where possible, publish objectives for their businesses (except where
there is commercial sensitivity, which may be agreed and documented separately
with the Board)
Shareholding teams should take responsibility for resolving any conflicts and trade
offs between the government's objectives and this is an area that is more fully
covered in Section 3, Part 4 (Framework, Strategy and Objective Setting).
Chairs and senior non-executives should share the shareholder’s view about the
objectives for the business. Incoming Chairs should meet the shareholding minister
to discuss these objectives before taking up their appointments.
As above, ensuring the board has absolute clarity of objectives from the shareholder
is a key role and function of ShEx and is covered more fully in Section 3, Part 4.
5. BOARD APPOINTMENTS
The starting point for board appointments should be an agreed vision between
shareholder teams and the Chair of the mix of skills and experience for the board as
a whole (see para 3 on board composition). A board nominations committee, or
appropriately constituted appointments panel comprising the Chair, an independent
member and one or more Government representative, should be used to recommend
specific appointments to the shareholding minister. This process needs to mirror
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OPCA requirements (see below), which therefore usually takes precedence over the
role of the Nominations Committee, particularly if there is any conflict between the
two.
The key appointments to a Government owned business are Chairman, Non-
Executive director(s), CEO, and FD. The ShEx team will/should be fully involved in
the recruitment of all these key appointments which will encompass:
i. thinking about the needs of the business and an appropriate specification of
the target candidate;
ii. agreeing the right recruitment/selection process that meets relevant Public
sector guidelines (see section xx);
iii. agreeing to and/or procurement of appropriate consultants to conduct the
recruitment, where necessary;
iv. ensuring appropriate incentive arrangements are approved and in place to
secure an appropriate candidate;
v. participating in the interview/selection process;
vi. ensuring that appropriate objectives are in place for the appointed candidate,
aligned to the agreed framework & objectives for the overall businesses.
5.1. Chairman
The role of the Chairman
There are various descriptions of the Chairman role. Appendix X is an extract from
the Combined Code on Corporate Governance, the ShEx reference model for
Governance, which provides a summary of the role. This guidance note can be
attached to the Chairman appointment letter for reference purposes, particularly
where the appointee is new to the Chairman role and/or the ShEx team has not
worked with the individual previously.
Note: the whole document can be found at:-
Combined Code on Corporate Governance. PDF
When appointing a Chairman and setting appropriate objectives, etc, the ShEx must
always be mindful of the wider duties and legal obligations that a Chairman might be
under via the Companies Act or other legislation specific to that Government owned
business and that the ShEx’s requirements should not be in conflict with these wider
responsibilities. This is commented on further below.
Chairman Recruitment
Section 5.4 provides information on management selection and recruitment. This
includes a list of suggested core competencies for a Chairman and some sample
interview questions for testing their fit against the competencies although these will,
of course, vary from business to business.
The Chairman role and the impact of the Government Legal Entity
As highlighted in Appendix 2 of Section 1, the Introduction to the handbook,
Government owned businesses exist in various forms of legal entity. As described in
section 2.3 the context for the Chairman role may vary between businesses, partly
dependent on the type of legal entity the business falls within.
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Despite the historical corporate governance peculiarities of some businesses ShEx
has endeavoured to introduce a model of corporate governance based on best
practice seen in the private sector — that is, a board led by a non-executive Chair and
composing a mixture of executive and non-exec directors who are jointly responsible
for the performance of the business.
Chairman Appointments
ShEx can have a large impact on the effectiveness of the Chairman appointed by
ensuring that:
i. Acomprehensive briefing or introductory pack is prepared about the
business, its activities, its financial performance and communication of the
ShEx assessment of the key issues and actions required;
ii. A smooth introduction to the key members of the executive management
team and that any issues in this respect are addressed by ShEx rather than
faced by the Chairman alone;
iii. Aclear set of objectives are established for the Chairman by which they will
be assessed. These objectives should be reviewed annually and potentially
updated to ensure that any new external of internal issues or priorities are
factored in to a revised set of objectives.
iv. An agreed monitoring or meeting schedule so the Chairman knows how often
he/she will be meeting the ShEx team and the basis for any performance
review.
Chairman Appointment letter
The Chairman Appointment letter is a key component of the ShEx governance
approach for the following reasons:
i. It provides a focus to ensure there is a clear communication of the objectives
that have been established for the business and/or the process by which the
objectives will be agreed if not already in place;
ii. It clearly articulates what is expected of the Chairman;
iii. It is a means by which the performance of the Chairman can be judged and
facilitates action in the event of underperformance, if required;
iv. It sets out the relevant formal aspects of the appointment, encompassing pay,
contract period, conflicts of interest (where Government may take a more
aggressive view of what constitutes a conflict that the private sector), etc;
v. It sets out the context of the wider governance arrangements for the business
and hence where the Chairman role fits within this.
A proforma appointment letter can be found at Appendix XX which sets out the main
sections of a standard letter and a number of real examples that have been used on
the portfolio. It should be noted that legal advice should be taken on any specific
letter prior to issue to ensure compliance with the latest best practice and legislation
at that time.
* «)
Proforma Chairman Example Royal Mint Example Soottish
Appointment Letter.t Chairman letter.tr5 Water Chairman lette
Chairman Monitoring and Review
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The suggested monitoring and review process for each Chairman appointed by ShEx
is as follows:
- a formal annual review to assess progress versus the agreed objectives, with
revised objectives established for the following year, if appropriate;
- a quarterly or half yearly review meeting, to discuss the business and
management performance and key issues either from the ShEx of the
Chairman's perspective. In so doing, ShEx can form a judgement on whether
the Chairman is on top of all the issues, whether they are action orientated
and assess whether they are happy with the Chairman input and role in the
business. This would be enhanced if a ShEx representative attended
some/all Board meetings (e.g. as an Observer), to see how the Chairman
managed the Board;
- adhoc phone calls and meetings as appropriate.
The level of contact may need to be increased when there are specific projects or
issues facing the business such that the ShEx is more hands on and needs a closer
working relationship with the Chairman.
The appendices provides a checklist of evaluation questions for NXDs that has been
extracted from the Combined Code). This can be used as a basis for the formal
review with the Chairman that should take place on an annual basis, as a minimum.
el
Non-Executive
Director Assessment.
Changing a Chairman
At times the ShEx will need to change Chairman, either because of
underperformance of the incumbent; because a new candidate is required as a result
of a fundamental change in the business (e.g. a privatisation is taking place and
someone with quoted company experience is required) or simply as part of a ‘refresh’
process in line with the Combined Code.
Where an existing candidate is to be replaced, it is important that ShEx takes legal
advice regarding the contractual and employment rights of the Chairman. Key
questions would include:-
- Are there notice provisions?
- What compensation rights does the Chairman have in the event of loss of
office?
- Is there any threat of a claim for unfair dismissal?
In addition to the legal position, there may also be moral considerations and if the
Chairman is to be removed for performance reasons, then the termination meeting
should not be the first time that they have heard of any issues in relation to their
performance in their role.
Chairman - Summary
The Chairman appointment is a key component of the ShEx model and significant
attention must be paid to:
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i. Establishing the specification for the Chairman role. Whilst there will be a core
component that is consistent to every Chairman appointment, there will also be
a large variable component in terms of personality fit with the management
team and sector or situational (turnaround, PPP, etc) experience that will need
to be assessed on an appointment to appointment basis;
ii. Ensuring the right incentive mechanisms are in place to secure the best
candidate;
iii. Managing the selection process to attract the right candidates;
iv. Selecting and appointing the right candidate;
v. Introducing the candidate to the business and establishing clear objectives and
framework for the role;
vi. Monitoring and assessing performance versus the agreed objectives.
This is an active process, requiring sufficient time and resource to ensure the right
Chairman is appointed and retained who delivers what the ShEx expects in terms of
performance.
5.2. Non-Executive Directors (NXDs, or NEDs)
NXDs are a key addition to the board of any business. From a Companies Act
perspective, NXDs are directors of the board and have the same fiduciary duties and
responsibilities as the executive directors. As set out in the Combined Code, the role
of the NXD has the following key elements:-
Strategy - NXDs should constructively challenge and help develop proposals on
strategy.
Performance — NXDs should scrutinise the performance of management in meeting
agreed goals and objectives and monitor the reporting of performance.
Risk — NXDs should satisfy themselves on the integrity of financial information and
that financial controls and systems and risk management are robust and defensible.
People — NXDs are responsible for determining appropriate levels of remuneration of
executive directors and have a prime role in appointing, and where necessary,
removing executive directors and in succession planning.
The NXDs may achieve these objectives both through their attendance at formal
board meetings, but also through participation in one or more of the key board
committees which, depending on the company, may include:-
- Audit
- Heath and Safety
- Remuneration
- Nomination
The Combined Code has further information regarding the briefing of NXDs as part of
their recruitment process, details of the roles of the key committees and also a
sample non-executive director appointment letter. This will have many of the same
features as the proforma Chairman Appointment letter included in 5.1 above.
From a ShEx point of view, whilst the Chairman may often wish to lead the review
and appointment process for NXDs, the team will still wish to ensure that:-
- there is clarity on the specification for any new appointee with a view to
establishing any key functional (e.g. former FD), technical (e.g. knowledge
of nuclear) or personal qualities that the successful candidate should have;
- _ itis involved in forming the shortlist of candidates and the subsequent
interview and selection process (i.e. sitting on the relevant selection panel)
- there is the right blend and mix of experience and skills on the board
overall;
- ensuring that the NXD candidate(s) are appropriately briefed on key areas
where ShEx has concerns or which form the key objectives of the board;
- there is an ongoing process of formal and informal communication between
ShEx and the NXDs to ensure that ShEx fully understands the NXD’s point
of view and key concerns and that ShEx can, in turn pass on their own
views.
NXDs performance should be reviewed as part of the wider board review process, as
set out in section 6.6.
5.3. Board selection
The appendices for this section provide some useful aids that cover:
i. suggested core competencies that the ShEx might seek in a Chairman and
CEO recruitment process;
ii. useful interview questions — aligned to the core competencies for the
respective roles;
iii. a proforma specification for an FD core competencies.
_
‘Suggested core Competency based Outline FD
competences for Che interviewing - sample specification. tr5
5.4. Recruitment processes
The process for appointments will vary depending on the nature of the business and
the specific role. There are 3 sets of guidelines and/or regulations which ShEx must
be aware of when making senior appointments:
i. Cabinet Office guidance
ii. The OCPA process
ii. The Civil Service Commissioners
Most ministerial appointments (i.e. those where Ministers make the ultimate decision
on the appointment) must follow the process and guidance issued by the Office of
the Commissioner for Public Appointments, or OCPA. The section below outlines
more specifically the OCPA remit, as not all ministerial appointments are required to
follow the process. For example Trading Funds are not ‘public bodies’ and therefore
do not technically fall under the OCPA remit. However Cabinet Office has confirmed
that the OCPA appointment process should be followed as a form of best practice.
Appointments and recruitment to the Civil Service are the responsibility of the Civil
Service Commissioner who oversees the appointment of Senior Civil Servants. More
detail is provided below.
The flowcharts in the appendices show the processes which are usually followed for
Exec and Non-exec appointments for different types of businesses. However, it is
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difficult to make any definitive classification as there are exceptions and peculiarities
in most cases. The Articles of Association and/or associated legislation will normally
detail what level of ministerial engagement is needed and so on.
i. Cabinet Office Guidance
The Cabinet Office provides guidance on ‘Making and Managing Public
Appointments’:
http:/Awww.cabinet-office.gsi.gov.uk/public/documents/pdf/public-appt_guide.pdf
This document provides detailed guidance on all stages of the recruitment and
appointments process, and gives an overview of all the processes which may be
involved in a public appointment (including OCPA & CSC).
ii. OCPA: The Office of the Commissioner for Public Appointments
The Office of the Commissioner for Public Appointments, or OCPA, supports the
work of the Commissioner for Public Appointments, whose role is to regulate,
monitor, report and advise on appointments made by UK Ministers & Welsh
Assembly Government (Scotland & Northern Ireland have their own Commissioners
who follow similar procedures).
The Commissioner's Code of Practice covers all ministerial appointments to the
boards of executive and advisory non-departmental public bodies, NHS bodies,
public corporations, nationalised industries, and utility regulators. The basic principle
of the OCPA appointment process is that the position is openly competed, and that
the process is transparent and fair.
Within the current ShEx portfolio the following businesses have certain roles which
are ministerial appointments to which OCPA principles apply: Channel 4; British
Waterways Board; Covent Garden Market Authority; BNFL; NDA; NLF; UKAEA; FSS;
NIW Council. A full list of the appointments which must follow OCPA principles is
available from the OCPA website: www.ocpa.gov.uk
The Commissioner has issued a detailed Code of Practice for government
departments which defines and interprets the Commissioner's seven Principles of
Public Appointments:
1. Ministerial responsibility
2. Merit
3. Independent scrutiny
4. Equal opportunities
5. Probity
6. Openness and transparency
7. Proportionality
Departments are allowed some flexibility in how they apply the Code of Practice but
they must adhere to the principles. The full details of the OCPA Code of Practice are
available here:
http:/Awww.ocpa.gov.uk/upload/assets/www.ocpa.gov.uk/codeofpractice_aug05.pdf
Selection processes are monitored by OCPA in two ways:
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«by independent scrutiny during the selection process. No appointment can
be made unless it has first been scrutinised by an Independent Assessor.
These assessors are independent of the department. Their role is to act as
the Commissioner's observer, to ensure that the selection process complies
with the Code and Practice, and that candidates reaching the final stage are
chosen on merit. In practice, the assessor does this by sitting as a member
of the appropriate panel;
=" by annual audit. Each year independent auditors visit a number of
government departments and audit a sample of appointments. The audit
round is arranged so that every government department is visited at least
once every three years.
When commencing a ministerial appointment process ShEx is required to follow the
principles set out in the OCPA Code of Practice. In addition to ensuring that the
procedures used in advertising and selection for a public appointment follow the
principles of open and fair competition, merit and probity, ShEx will also be required
have an Independent Assessor during the selection process. OCPA maintain a
central list of IAs who are available to use on request (see contact details on OCPA
website).
The following flowchart outlines the OCPA appointment process.
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OCPA appointment process
Initial planning Strategic forward plan of public
appointments
¥ Agreed by policy lead. NOPE and
Timetable and project plan Independent Assessor (IA)
Draft role and person Agreed with HR. policy lead and
specification and criteria NDPB
Ministerial inout and agreement
of final role and person
specification
Candidate search (including
publicity)
Long and short listing sifts Including IA
Comprises SCS policy official, IA,
NDPS chair (for members) or
independent (for chair)
Interview panel
Panel report with
recommendation submitted to I Agreed by all panel memders
Ministers
Appointment made
(OCPA process from internal research report by ADP group, 2007)
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Civil Service Commissioners
The Civil Service Commissioners (CSC) are responsible for recruitment within the
Civil Service, ensuring that appointments are made on merit. Their remit includes:
= issuing a Recruitment Code;
= ensuring compliance with the code;
= Chairing and overseeing the process for selection of senior civil servants;
The Commissioners are appointed directly by the Crown under Royal Prerogative.
They are not civil servants and are independent of Ministers.
Approval of CSC is required for appointments for all top 200 posts within the Civil
Service. This includes all posts at Pay Band 2 (or at least those that are external
recruitments), Pay Band 3, DG, and Permanent Secretary levels. A Commissioner
will Chair the process for selection for posts at these levels. Some examples of posts
which are overseen by CSC are CEO of ShEx, Chief Executive of UKHO, and CEO
of the Royal Mint.
The diagram below outlines the recruitment process, as envisaged by the Civil
Service Commissioners: (Annual report 2006-07,
http://www.cscannualreport.info/web-resources/resources/3 1d3ded0496.pdf).
More information is available on the website:
www.civilservicecommissioners.gov.uk
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Check list of Recruitment Procedures
Decide whether open competition in consultation with, as appropriate, Ministers,
First CS Commissioner, Cabinet Office and HMT.
Plan recruitment process
> early involvement of Commissioners Options
> early briefing of search consultants > preliminary interviews
> consider selection process and timetable ‘> assessment centre
> identify board members > psychologist interviews
> visits/meetings with department
Specify requirements
> agree job/person specification
> criteria for selection
Publicise vacancies
> national press/specialist media (AP
> ‘in-Service’ notice > where appropriate, consultants initiate search
Issue application packs including ethnic monitoring form.
Check eligibility of candidates. gy notify those ineligible
Carry out long/short listing
> provide papers/applicant summaries in good time
> same panel for sifts/interviews
> establish criteria derived from publicity
> long-list 12/15 for preliminary interviews
> short-list 3/4 realistic candidates > notify unsuccessful candidates
> record reasons for inclusion/exclusion > take up references with candidate's permission
> invite final shortlist to interview
Carry out interview
> record each candidate's performance
> prepare summery report of outcome
Convey outcome
> inform candidates of result at earliest opportunity subject to Ministeral/departmental approval
> hold reserves until lead candidate has accepted
5.5. Employing consultants (headhunters)
Executive search consultants are often used to facilitate a recruitment process.
Consultants are used to conduct a search for a candidate, therefore they should be
involved at the earliest possible stage. They should demonstrate a good knowledge
of the nature of the role, and should ideally have experience of the relevant sector or
market, as well as experience of public sector appointments where appropriate.
The Cabinet Office have a framework agreement or ‘call-off contract with a list of
consultants which can be requested from their Corporate Development Group (the
document is confidential). This is a list of consultants who can be contracted to
provide recruitment advice and services without having to go through a full
competitive tender process. However, it is good practice to approach a number of
companies to investigate their suitability for the particular process, and run a ‘mini’ or
informal competition and ensure competitive pricing.
For some of ShEx businesses it will be the business themselves who are making the
appointment and therefore contracting the services of the consultant. In these cases
the normal Government procurement processes may not need to be followed and
therefore consultants who are not on the Cabinet Office call-off list can be procured
by the company. As public bodies, however, the rules will still apply to most of the
businesses. Even where ShEx is making the appointment, it will still ask the
business to fund the process, where possible, on the basis that the recruitment is,
ultimately for the business’ benefit.
The Management Incentivisation section that follows, includes more detail on the
contract with Hay for remuneration advice which is linked to recruitment processes.
In addition Appendix 2 of Section 5 (Exit Management and Advisory) provides more
detail on the appointment processes for Consultants and Contractors, which is
common to the recruitment advisers, as well as exit or corporate finance advisers.
6. BOARD REVIEW & EVALUATION
6.1. Introduction
A key part of the ShEx model is monitoring the performance of the business,
including that of the Board and acting on any underperformance. The purpose of this
note is to highlight when a review of Board performance should be undertaken, how it
can completed and the areas that it should cover and then the actions and outcomes
that might result.
As a minimum, this section refers to the formal review process that is undertaken by
the Board of the company, either internally led by the Chairman or Company
Secretary for example, of external by a specialist consultant and which forms part of
Governance best practice, as identified in the Combined Code. There may also be
other situations that prompt a one off Board review, that are also discussed.
In addition, ShEx will also be continually undertaking its own review of Board
performance, both of the individual executive and non executive directors and their
performance in their functional roles and the Board, collectively, and how they work
together. ShEx will then incorporate their analysis and comment in the annual
Investment Review or use as part of its routine assessment of the business and its
performance and whether any changes need to be undertaken.
6.2. When to undertake a Board review
There are a number of different situations where a Board review may be
appropriate:-
(a) Pre-handover of business to ShEx
- in order to assess strengths and weaknesses of team and their ‘fit for
purpose’ versus ShEx view of key business tasks and objectives;
- looks for gaps in management team.
(b) Formal annual review
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- part of ‘normal’ ShEx governance process e.g. included as a question in
Investment Reviews;
- may be yearly or biennial;
assessment versus standard benchmark (see appendix for extract from
Combined Code;
identifies Board’s own view of its collective competence;
more likely to be led by Chairman of business as an internal process, but
ShEx should insist on a review the output.
(c) Ad hoc review based on performance issues
will be typically used where there are underperformance issues, which,
ultimately come down to management even where the stimulus might be
external, such as sudden market change;
will be focussed on key weaknesses and issues to be addressed and outputs
may focus on management change of some sort — normally at Chairman,
CEO or FD level.
(d) Planning for change in business circumstances
- looking at the question of do we have the right management team to take the
business forward;
- is being proactive, rather than reactive;
- might be in response to clear challenges ahead such as a move from a
Trading Fund to Govco to PPP status and assessing whether we have the
right blend of skills to be successful in a fully commercial environment?
- Will often be expected or seen as a normal part of the process by private
equity investors and hence completing prior to PPP may save time later in
process and allow ShEx to address perceived management weaknesses
before they impact on perceived value.
6.3. What should a Board review cover?
The following is a suggested list of areas that could be covered by the Board review
and should be factored in when drafting a terms of reference involving and external,
third party supplier such as an HR consultant. It is not a complete or definitive list, as
each business will require a specific review. Consideration needs to be given
whether the review covers both executive and non-executive directors and to what
depth in the management team i.e. board level only or second tier as well. At the
very least, the effectiveness of the working relationship between executive and non-
executives will need to be incorporated.
The reviews may be extended to look at the effectiveness of individual sub-
committees (e.g. audit, remcom, etc), as well as the Board overall.
i. Governance
Are appropriate board processes in place? Does the board meet regularly, with
papers presented in a timely manner, minutes taken and decisions recorded?
Does the board receive an accurate and timely supply of financial and other
information appropriate to the needs of the business and presented in a format that
allows effective decisions to be made?
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Are the matters reserved for board review/decision clearly set out and does the board
keep to those areas?
Has the board established an appropriate set of sub-committees covering, for
example, audit, remuneration, health and safety?
ii. Board Effectiveness
Does the board set the strategy /long/medium term direction of the business and
does it monitor progress against a defined and measurable set of objectives?
Is there evidence that the board has/is able to take effective action to remedy
underperformance or react to external opportunities/threats?
Is the interaction between executive and non executives directors effective? Do the
NXDs challenge the executive in a robust but constructive way?
iii. Board Competence
Do the directors have the correct skills and competences to carry out their duties?
This may require that a skills review mapped over the business plan requirements be
produced.
Are there any significant gaps in board competence? If so has the Chairman
identified the gaps and are steps in place to remedy them?
Do the non-executive directors review the material sent to them and are they able to
contribute effectively to decision making?
Do the non executive directors have a sufficient grasp of the detail of the business
and the issues facing it to allow them to contribute effectively, appropriate to their
level of responsibility?
iv. Stakeholder representation
Do the chairman/non-executive directors/board members have a clear understanding
of the shareholders/stakeholders requirements?
Does the board act to maximise shareholder value/in accordance with agreed
shareholder priorities?
Do they communicate effectively with shareholders/stakeholders?
Does the shareholder(s) communicate effectively with the chairman/board? Have
clear, measurable targets and priorities been set for the board by
shareholders/stakeholders and does the board report progress against those
targets?
6.4. Appointing External Consultants
Appendix X provides a proforma tendering letter to use with prospective advisers and
consultants, when seeking external input to a Board review.
ie)
Proforma Instruction
letter for External Bo:
The appendices include some introductory comments from Egon Zehnder and ER
consultants re their approach to board reviews, the former in a private equity
capacity. Neither of these consultants are, necessarily, recommended to undertake
work for the ShEx, but provide illustrations of approach and some considerations to
be factored into a board review process.
ie)
ER Consultants Egon Zehnder
briefing note re Boart Management Apprais
Board Review - Summary
A board review is part of the due diligence process that ShEx can use as a tool when
reviewing a business, in the same way that an accounting or market due diligence
exercise by external consultants can be used to review those specific assets of the
business.
In addition to using it at specific times, such as when portfolio problems occur, it
should also be seen as part of good governance, as recommended in the Combined
Code, where the review may be more of an internal led process led by the Chairman.
6.5. CHANGING MEMBERS OF THE BOARD
As part of its ‘Action on Underperformance’ (see section [xx]), ShEx will potentially
seek a change in management of one of the portfolio in order to improve
performance. There are, however, also process considerations in
removing/changing directors, both non executive and executive.
This is an important area for the following reasons:-
(a) there may be legal issues that might be relevant to ShEx and the portfolio
business to ensure that any threat of unfair dismissal or a legal claim for
compensation from the employee is mitigated;
(b) there may be reputational issues and ShEx will wish to be seen as fair, as
well as commercial, in protecting the best interests of the shareholder, in
order to avoid negative PR and the incremental work associated with
management change that is poorly managed.
To achieve these objectives, ShEx will use the following processes when involved in
management change:-
(i) ShEx will ensure that there are clear business objectives that the
management know it is trying to achieve and this will then be translated to
individual management objectives for the key team members, notably the
Chairman, CEO, FD and Non Executives. Reputational and legal issues
are likely to be avoided if ShEx and/or the person leading the
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management change (e.g. the Chairman for the CEO) is able to
performance management against agreed objectives;
(ii) Ensure that there is regular feedback to the relevant individual. Ideally, a
move to change a director should not come as a surprise, but be the
culmination of a consistent feedback re performance that needs to be
acted on;
(iii) If there is a need for management change, where possible ShEx will seek
to work through the Chairman, rather than get involved in the change of
executive management change directly.
(iv) Prior to acting on the management change, ShEx will ensure that legal
advice has been taken to ensure that:-
a. There is a full understanding of the contractual position of the
relevant individual;
b. That any relevant labour legislation has been taken into
consideration.
In so doing ShEx will ensure the business’ legal and reputational
position, as well as that of its own, is protected.
Note
It should be noted that, particularly in relation to the Chairman and NEDs, both
OCPA and the Combined Code comment on the need to regularly refresh the
Board as an objective in its own right. This has merits in bringing in fresh
perspectives and challenge to the Board and also breaking up any ‘cosy’
relationships between the executive and non executive directors. However,
such change, for change sake, may also be inappropriate where the Board is
working well and where ShEx is extremely happy with the relevant Directors
and the overall performance of the business.
The OCPA and the Combined Code assumption and recommendation is that
Directors serve two-three year terms, with the presumption that a new
appointment is then made to refresh the Board. However, in exceptional
circumstances, ShEx may seek to argue that, notwithstanding the
recommendations of OCPA, that in fact no change may be necessary or
warranted. In this situation ShEx can lead a renewal process where a
competition does take place for a new appointee, as per OCPA guidelines, but
where the current appointee is one of the candidates despite having already
fulfilled 2 term appointment. ShEx will need to argue the merits of the case
appropriately.
SUMMARY OF APPENDICES TO SECTION 3, PART 5 : CORPORATE
GOVERNANCE
Proforma outline Governance letter or Framework Document
Example: UKAEA Chairman letter
Example: Royal Mint Chairman letter
Example: Royal Mint ShEx Delegated Remit letter
Example: Actis Shareholder Relationship letter
Proforma Chairman Appointment letter
Example: Scottish Water Chairman letter
Non-Executive Director assessment checklist (performance evaluation)
Chairman/CEO suggested Core Competencies
Competency based interviewing sample questions for Chairman
Competency based interviewing sample questions for CEOs
Proforma FD role specification
Extract from Combined Code: Performance Evaluation guidance
Proforma instruction letter for external Board Review
ER Consultants briefing note on Board Evaluation & Development
Egon Zehnder Management Appraisal private equity users’ guide
Additional appendices provided separately
Example: DSTL Framework document
Flowchart: Processes for approving Exec and Non-exec appointments
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