The Role of Non-Executive Directors in Corporate Governance and Firm Performance

Introduction

Corporate governance is a linchpin in effective organizational management. It is gaining

unprecedented attention for its role in aligning managerial actions with shareholder interests.

Additionally, it ensures overall organizational performance. This essay critically evaluates the

role of non-executive directors (NEDs) in corporate governance and its impact on firm

performance, by drawing on theoretical frameworks primarily the agency theory, supplemented

by stakeholder theory. Both executive and non-executive directors are required by law to

perform various obligations under the Companies Act of 2006. These include operating within

the company's memorandum of association's authority and fostering the company's development.

Along with preventing conflicts of interest, they are also tasked with

practicing impartial judgment, reasonable care, skill, and diligence (Haan, 2023).

Theoretical underpinnings are examined, with a focus on important research and a

discussion of criticisms, most notably those made by Tricker (2018). The regulatory environment

in the UK is a key point, with particular emphasis on the UK Corporate Governance Code of

2018. In addition to reports like Turnbull and Greenbury, this regulatory framework establishes

requirements for board composition and highlights the critical function of NEDs. This

paper recognizes the dynamic character of corporate governance as it delves deeper into the

complex network of relationships that define the duties of NEDs. The amalgamation of

theoretical frameworks, regulatory expectations, and empirical facts paves the way for well-

informed recommendations aimed at augmenting the effectiveness of NEDs in contemporary

corporate environments.

Theoretical Framework
 i. Agency Theory

The Agency theory is a fundamental framework through which to examine the function

of non-executive directors (NEDs) in corporate governance. Jensen and Meckling's (1976) key

work inspired this theory. Agency theory investigates the issues and solutions associated with the

assignment of responsibilities from principals to agents in an atmosphere of competing interests

(Linder and Foss, 2015, p. 344). According to the theory, shareholders act as principals while

management acts as the owners' representatives (Jensen and Meckling, 1976, p. 308).

Shareholders aim to enhance their assets, while managers aim to raise their salaries, not the

wealth of shareholders (Jensen and Meckling, 1976, p. 308). As a result, an impasse occurs,

resulting in an agency dilemma in the principal-agent relationship (Younas, 2022, p. 80). NEDs

are meant to alleviate these conflicts of interest as shareholders' representatives by scrutinizing

managerial conduct while offering unbiased supervision.

Financial economics and organizational governance both rely heavily on agency theory.

It is, however, not without criticism. For example, managerial theorists point out that agency

theory has a somewhat narrow theoretical scope. The majority of agency-based research focuses

on specific board procedures and company performance. Analysis at the level of specific

concerns rather than the board or organizational level (Tricker, 2015, p. 62). In a similar vein,

agency theory has come under fire for focusing solely on the agent aspect of the "principal and

agent problem." This view is not concerned about the principals who mislead, avoid, and take

advantage of the agents. In addition, the agents are unwittingly forced into a dangerous

workplace with little room for incursion, where principals take advantage of situations (Panda

and Leepsa, 2017, p. 79). Furthermore, the theory presupposes a limited or infinite future period

of unknown contractual understanding between the principal and agent. Although the theory
suggests that contracting can solve the agency problem, in practice there are several obstacles to

overcome, including logical thinking, fraud, asymmetric information, and transaction costs

(Panda and Leepsa, 2017, p. 80). Although they have a limited influence in the company,

shareholders' main goal in the company is to optimize their earnings. Only supervising the

managers is the extent of the directors' responsibilities; their other tasks are unclear. As a result,

the theory disregards the managers' skills and views them as opportunistic.

ii. Stakeholder Theory

Stakeholder theory broadens the focus of corporate governance above the interests of

shareholders, thereby complementing agency theory. This theory was posited by Freeman (1984)

who argued that rather than putting shareholders' interests first, firms should take into account

the demands of all stakeholders, including vendors, consumers, employees, and the larger

community. In this view, a stakeholder is any person or group that can influence or be impacted

by the accomplishment of the company's goals (Freeman, 1984, p. 46). According to Parmar et

al. (2010, p. 208), the stakeholder theory marks a radical break from the conventional view of

business as a means of maximizing profits for capital owners. Non-executive directors play a

crucial role in reconciling the diverse interests of stakeholders, ensuring a more balanced and

ethical approach to corporate governance.

While agency theory is largely concerned with resolving conflicts of interest between

shareholders and management, stakeholder theory broadens the governance approach. Under the

umbrella of stakeholder theory, NEDs are more than just management monitors; they are

champions for an equitable strategy that takes into account the needs of all stakeholders. The
incorporation recognizes that long-term value creation extends beyond maximizing of

shareholder capital. However, from its conception, the stakeholder theory has been called into

question as to whether it is truly a "theory" (Freeman, Phillips, and Sisodia, 2018, p. 218).

Nevertheless, one should be satisfied with the idea that this was a (interrupting) rearguard

behavior in the thought process of the theory that appears to have had minimal impact on its

popularity, intellectual growth, or results, since the question of whether a theory is a theory

causes little impact. Furthermore, the same feelings have been stated about the field of strategic

management as a whole for years (Freeman, Dmytriyev and Phillips, 2021, p. 1759).

Through the synthesis of agency and stakeholder theories, the roles of NEDs become

more comprehensively understood. Both views have an impact on how NEDs balance keeping an

eye on management behavior with advocating for a more comprehensive, stakeholder-centric

strategy for corporate governance. This synthesis offers a more comprehensive framework for

assessing NEDs' efficacy in modern business environments.

Regulatory Framework

a. UK Corporate Governance Code 2018

The 2018 UK Corporate Governance Code is an exhaustive set of rules and guidelines

intended to direct company conduct. It focuses especially on the makeup and efficiency of

boards, giving special attention to the function of NEDs. The code stresses the value of unbiased

thinking and promotes harmony between executive and non-executive directors. The Code states

that to prevent any one person or small group of people from controlling the board's decision-

making, the board should have a suitable mix of executive and non-executive (especially,

autonomous NED) directors (Financial Reporting Council, 2018, p. 6).

 The code also outlines the standards used to assess the autonomy of non-executive

directors. This emphasizes how important having a separate voice in board decisions is. This is

consistent with the agency theory's focus on conflict of interest mitigation. Furthermore, the

Code mandates that non-executive directors whom the board deems to be impartial should make

up at least half of the board, except for the chair (FRC, 2018, p. 7). To act as an intermediary for

the chairman and a go-between for the other directors and stakeholders, the board ought to

designate one of the impartial NEDs as the senior autonomous director.

Supplementary reports like the Turnbull and Greenbury reports provide additional

information on particular facets of corporate governance. With an emphasis on executive

compensation, the Greenbury report offers recommendations for guaranteeing executive pay

equity and accountability. The Greenbury Report suggests set fees for non-executive directors

based on the time commitment for the position. It also advises against establishing performance-

based compensation. This shows that non-executive directors have a stewardship perspective on

their function, which is different from the Greenbury Report's position on executive

compensation, which is deeply rooted in the agency theory (European Corporate Governance

Institute, 1995, p. 17).

The Turnbull report, on the other hand, discusses risk management and internal control.

As a component of the board, NEDs are in charge of guaranteeing the efficiency of internal

control mechanisms to reduce risks. This is consistent with the agency theory's focus on

oversight and management. In many domains, risk management is a well-established aspect of

corporate governance. However, cooperation, shared values, and coherence in regulations or

coverage are frequently absent from present methods in investment assessment, safety

management and the ilk (McCrae and Balthazor, 2000, p. 35). To alter this, the Turnbull report
particularly holds directors, especially NEDs, responsible for creating company-wide risk

management strategies and putting harmonious, inclusive, and flexible risk management

strategies into practice.

Application to NED Roles

a) Board Independence

Non-executive directors are crucial to maintaining board impartiality, according to the

UK legislative framework, particularly the Corporate Governance Code. The agency theory's

objective of reducing conflicts echoes this focus on a balanced board structure that includes a

sizable number of independent directors (Panda and Leepsa, 2017, p. 76). According to the code,

NEDs are supposed to contribute impartiality and unbiased judgment to board discussions.

b) Strategic Oversight

The code's recommendation for committee formation gives NEDs a formal framework

within which they can participate in strategic oversight. NEDs frequently have a significant

impact on strategic decisions about executive compensation through their crucial involvement in

panels like the Remuneration Committee (Scholtz and Engelbrecht, 2019, p. 22). In line with

stakeholder and agency theories, the code subtly supports NEDs' strategic guidance

responsibility.

c) Risk Management

The regulatory framework, which includes the Turnbull report, emphasizes the

significance of NEDs in supervising the internal controls and risk management. This is consistent

with the agency theory's focus on executive control and surveillance (Panda and Leepsa, 2017, p.
76). By participating in risk committees, NEDs enhance the organization's ability to withstand

potential risks and promote long-term sustainability.

Evaluation of Case Studies

I. Kirin Holdings

It is clear from looking at The Kirin Holdings Company Limited that NEDs are beneficial

when it comes to corporate governance. The company exhibited a dedication to board

independence by having a significant percentage of independent directors, which is in line with

the UK Corporate Governance Code's standards. Notably, two seasoned and well-known NEDs

for the company were recently interviewed, which demonstrated their efficacy ( ). The fact that

the CEO and the NEDs have a strong mutual trust makes it possible for them to have a non-

executive director-led CEO appraisal process. Non-executive directors can monitor as well as

evaluate the CEO and his group's contribution to the company's worth throughout the short- and

long terms. For instance, the NEDs ensure that the company has a precise plan for the future and

is actively striving to realize it through initiatives in the future and the development of human

resources. This is consistent with empirical research showing a favorable relationship between

board independence and business performance (Fuzi, Halim, and Julizaerma, 2016, p. 460).

Nonetheless, I see difficulties developing in the NEDs' strategic supervision function.

Despite their independence, the NEDs are ill-equipped to make meaningful contributions to

strategic choices because they do not possess industry-specific knowledge. Interestingly, while

having extensive expertise, neither of the two NEDs has previously worked for a company that

has diversified its operations or even its countries of operation. This case emphasizes the vital

role NEDs play in maintaining board independence, but it also emphasizes how crucial industry
experience is for NEDs to enable efficient strategic supervision. The instantiation highlights the

need to supplement industry-specific factors with legislative requirements to maximize the

contribution of NEDs) to strategic decision-making.

II. The Role of Non-Executive Directors in Government

In contrast to Kirin Holdings, the UK government has difficulties with risk management

and internal control. Interestingly, not much is known about the roles of NEDs or their influence

on government business, even though they have been operating in their current form for thirteen

years. Furthermore, a growing number of reports indicate that NED selections are allegedly

politicized (Public Administration and Constitutional Affairs Committee-House of Commons,

2023). These government NEDs have come under fire for not doing enough to question

management choices, which prevented effective risk reduction. This is consistent with the

agency theory, which states that having a larger number of non-executive directors on the board

is typically believed to help monitor performance and curb managerial opportunism (To et al.,

2020, p. 154). Which in this case is the politicians.

This case demonstrates that regulatory standards requiring NEDs do not ensure the best

possible risk oversight. NEDs must actively participate in and possess the necessary skills for

effective risk management. The legislative framework highlights the significance of non-

executive directors (NEDs) in internal control, as does the Turnbull report. This case, however,

highlights a discrepancy between the expectations of regulations and their actual application. It

highlights how important it is for businesses, and even governments, to foster a culture that

motivates NEDs to actively participate in corporate governance in addition to adhering to

regulations.
 Recommendations and Conclusion

The two case studies highlight how corporate governance is dynamic and dependent on

several variables, including the efficacy of non-executive directors. The regulatory framework

offers the required framework, but businesses' determination to go above and beyond compliance

determines whether or not it is successful. Companies need to put board diversity first if they

want to improve the role of NEDs. Prioritizing different viewpoints on boards and making sure

non-executive directors contribute a variety of abilities and experiences are important for

organizations. This is consistent with the stakeholder theory, which emphasizes taking into

account the interests of different stakeholders. Organizations must also guarantee that NEDs

possess industry-specific knowledge. Organizations ought to give NEDs with experience in a

particular industry top priority in light of the potential difficulties Kirin Holdings may encounter.

This is consistent with the larger stakeholder paradigm and improves their capacity to make

significant contributions to strategic decisions.

Additionally, organizations need to work to promote an engaged culture. Organizations

must cultivate a culture that promotes non-executive directors' active engagement and

involvement to address the issues raised in both case studies. This goes above and beyond legal

requirements, highlighting the significance of proactive governance. Encouragement of ongoing

training and growth is also necessary. Organizations should engage in ongoing learning and

growth initiatives for non-executive directors, given the dynamic nature of contemporary

corporate settings and governance concerns. This guarantees that they have the knowledge and

abilities required for efficient supervision and stay current with market developments.

In conclusion, non-executive directors are essential for corporate governance. They

supervise strategy, function as watchdogs, and help with risk management. Stakeholder and
agency theories combined offer a comprehensive framework for comprehending their diverse

functions. Although regulatory frameworks provide fundamental standards, proactive

governance measures within the firm are required for maximum efficacy. In the constantly

changing world of corporate governance, businesses can improve the impact of non-executive

directors on risk oversight, strategic planning, and overall company performance by embracing

plurality knowledge, and an engaged culture.

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