Outside Director or Non-Executive Director Definition
A non-executive director (variously referred to as an independent director, an external director or a director at large) is a non-working member of a firm’s board of directors who is not a member of executive management. As such, the responsibilities of a non-executive director are limited to planning, policy-making, and supervision of the activities of executive directors as a de facto representative of the shareholders.
A Little More on Non-Executive Director
A non-executive director is primarily entrusted with the responsibility of acting as both a monitor as well as a challenger of the management and performance of the firm, including its executive management team. The fact that non-executive directors are themselves not part of internal management has led experts to believe that such directors are typically more neutral and unbiased in their dispositions than executive directors. This greatly reduces the possibility of a conflict of interest arising between non-executive directors and stakeholders.
Furthermore, this lack of bias on the part of non-executive directors makes them suitable candidates for the firm’s public relations (PR) board. A non-executive director’s position in the society, philanthropic activities and an overall good rapport with stakeholders often works wonders for the image of the firm he represents. That said, both non-executive directors as well as executive directors are equally responsible for the success or failure of their firms.
Prerequisites of a Non-Executive Director
As a key responsibility area, non-executive directors are expected to uphold the core values of the firm and use their past experiences to enhance its performance. It is often observed that companies, especially startups recruit former CEOs and other high-ranking employees of successful companies as non-executive directors, expecting them to mentor the new undertaking.
A non-executive director is also entrusted with the responsibility of supervising the entire board of directors and holding it accountable for its activities within the company. The supervisory activities of a non-executive director include:
- Formulating and overseeing the company’s strategy.
- Devising a macroscopic viewpoint of company performance.
- Accounting for risks.
The non-executive director is expected to engage with executive directors, offering them cognizance of potential risk factors that are liable to pose a threat to the company and negatively affect profitability. He is also involved in formulating an independent and macroscopic assessment of the company’s performance and safeguarding stakeholder interest in the event of a management decision. Additionally, non-executive directors, especially those with financial credentials, are expected to oversee the fiscal performance of the company and suggest improvements.
Although a non-executive director is primarily involved with establishing and maintaining a good rapport with stakeholders, his role within the company is far from titular. In fact it is obligatory for a non-executive director to maintain an uncompromising focus on the administration of the company. In the event that a non-executive director needs to divert his focus to other commitments, he is expected to communicate his temporary unavailability and change schedules accordingly.
A non-executive director should also endeavor to enhance the company’s value by using his rapport with stakeholders and other contacts outside the company in ways that elevate the company’s business prospects.
References for Outside Director
Academic Research for Outside (Non-executive) Directors
- • Corporate governance and the role of non–executive directors in large UK companies: an empirical study, Pass, C. (2004). Corporate Governance: The international journal of business in society, 4(2), 52-63. This paper studies corporate governance structures in the UK and scrutinizes the role played by non-executive directors in fostering best business practices. The Higgs Committee was appointed to reevaluate the role of non-executive directors as a measure to determine whether companies were still conforming to best practice recommendations and if financial irregularities were taking place.
- • The contribution of non–executive directors to the effectiveness of corporate governance, Clarke, T. (1998). Career Development International, 3(3), 118-124. This paper scrutinizes the role of non-executive directors while emphasizing that it is in a company’s best interest to have outsiders in its board of directors. It also argues that shareholders cannot be considered viable counterforces to limit misuse of power by the board of directors. Finally, the paper reiterates the need to induct non-executive directors that add value to the business.
- • Board leadership, outside directors‘ expertise and voluntary corporate disclosures, Gul, F. A., & Leung, S. (2004). Journal of Accounting and public Policy, 23(5), 351-379. Gul and Leung sample 385 Hong Kong companies and subject them to regression analysis. As a result, the authors are able to establish correlations between: Board leadership structure in companies where CEOs also serve as board chairs (CEO duality). The percentage of specialist external directors on the board (PENEDs). Voluntary corporate disclosures.
- Length of board tenure and outside director independence, Vafeas, N. (2003). Journal of Business Finance & Accounting, 30(7‐8), 1043-1064. The author postulates and scrutinizes two opposing theories on the importance of the tenure lengths of non-executive directors. They are: The expertise theory, that prescribes extended service time on the board of directors as an indicator of loyalty, experience, and proficiency. The management‐friendliness theory, that hypothesizes that extended service time on the board of directors results in an unwarranted proximity between the non-executive directors and management, resulting in a compromise on shareholder interest.
- Boards of directors: Utilizing empirical evidence in developing practical prescriptions, Dalton, C. M., & Dalton, D. R. (2005). British Journal of Management, 16, S91-S97. The authors perform a comprehensive analysis of corporate governance mechanisms and present a correlation between board structures and fiscal performance of firms. Their study concludes that not all best practices embraced by corporate governance structures conform to practicable scrutinization. The authors offer the following suggestions that will strengthen the sovereignty of corporate boards: Appointment of independent directors. Creation of independent budgets for boards of directors.
- • Do outside independent directors strengthen corporate boards?, Petra, S. T. (2005). Corporate Governance: The international journal of business in society, 5(1), 55-64. This paper seeks to challenge the prevailing corporate governance assumption that the presence of a majority of external independent directors reinforces corporate boards by keeping a close watch on management activities and securing the interests of stakeholders during management decisions. The authors conclude that there exists no factual evidence of benefits offered by external independent directors in strengthening corporate boards.
- • Non‐executive directors: A question of independence, Clifford, P., & Evans, R. (1997). Corporate Governance: An International Review, 5(4), 224-231. The authors sample Australian corporate data and study disclosure requirements in an effort to determine attributes of non-executive directors. The study concludes that a third of the sampled non-executive directors were involved in undertakings with their respective firms that inherently curbed their independence. Such directors, coupled with insider directors together constituted a majority in their respective boards. This resulted in scenarios where internal management became the de facto controllers of the firms, in spite of there being a majority of external directors in the respective boards of directors.
- • Board composition, non–executive directors‘ characteristics and corporate financial performance, Grace, M., Ireland, A., & Dunstan, K. (1995). Asia-Pacific Journal of Accounting, 2(1), 121-137. This paper scrutinizes the performance of non-executive directors with a focus on their personal attributes and the overall composition of the board. The authors analyze samples of 86 Australian public businesses in order to draw a correlation between board structure and fiscal performance. They conclude that although a majority of the sampled non-executive directors was highly qualified, such attributes seldom affected the overall fiscal performance of the firms.
- • Non–executive Directors on Boards in Ireland: co–option, characteristics and contributions, O’Higgins, E. (2002). Corporate Governance: An International Review, 10(1), 19-28. The authors sample data of 26 non-executive directors and chairpersons in Ireland and analyze their attributes. Their study concludes that non-executive directors are predominantly co-opted through social and business connections. Successful non-executive directors displayed the following attributes: Insightful thinking and problem-solving abilities; Potential for performance, both within and outside the boardroom; Hand-on business knowledge and experience.
- • Board size, executive directors and property firm performance in Malaysia, Shakir, R. (2008). Pacific Rim Property Research Journal, 14(1), 66-80. Shakir samples several prominent public companies in Malaysia in the period following the Asian financial crisis of 1997. He conducts a pragmatic analysis of the correlation between size of the board of directors, percentage of executive directors and the fiscal performance of the firms. Shakir concludes that Malaysian markets typically favor small boards with a higher representation of executive directors.
- • The CEO, the board of directors and executive compensation: Economic and psychological perspectives, Main, B. G., O’REILLY, C. A., & Wade, J. (1995). Industrial and Corporate Change, 4(2), 293-332. This paper discusses the criteria evaluated by large U.S. corporations while setting compensation levels for chief executive officers (CEOs). Several economic theories equate the presence of an independent board of directors to effectual preservation of stakeholder interest with minimal management opportunism. However, the authors’ investigation concludes that social influence is a potent factor that often comes into play, resulting in CEOs drawing much higher levels of compensation than can be estimated by such theories.