7.1.4 Higgs Committee

In 2003, the Higgs Committee published a report on the role and effectiveness of NEDs. The Higgs Committee aimed to develop the corporate governance framework – the Combined Code – further in the United Kingdom, which is based on the Cadbury, Greenbury and Hampel reports (Higgs Committee 2003: 1.2). Higgs makes several recommendations and the content of these recommendations span a broad range of subjects, among which the board in general, the chairman, role of NEDs, the senior independent director and independence.

With respect to independence, the Higgs Committee distinguishes two types of independence. The first type of independence is required for all directors – executive directors and NEDs – and comprises independence of mind,1 which means that they are willing and able to challenge, question and speak up (Higgs Committee 2003: 9.1). This form of independence resembles what is described in section 173 of the Companies’ Act 2006, which is described in subsection 7.2.1. The second type of independence is independence in a stricter sense, which is required for NEDs and applies if he has no recent or existing relationship with the company, other than his occupation as NED (9.2, 9.6). This stricter independence should apply to half of the board, excluding the chairman (9.5). This is a change with respect to the Combined Code and the underlying advice, which recommend that one third of the board should comprise NEDs of which more than fifty per cent should be independent. The Higgs Committee advises having a board of which at least fifty per cent comprises independent NEDs. The listing rules of NASDAQ and NYSE and the Bouton report in France have inspired this advice, as they all require having a board of which at least fifty per cent comprises NEDs (9.4, 9.5).

In addition to this recommendation about board composition, Higgs places remarks about the balance of the total board. A board should include both executive directors and NEDs, so that no group can dominate the board (Higgs Committee 2003: 8.2, 8.4). If the executive component of the board is too small, there is a greater risk of distortion or withholding of information, or a lack of executive representation in management debates (8.5). Therefore, Higgs recommends having a strong executive representation on the board (suggested Code provision A.3.2). This entails that the aim to have more independent NEDs must not lead to boards with a supermajority of independent NEDs.

Where the previous committees on corporate governance were of the opinion that a definition of independence was not necessary, the Higgs Committee does not agree. According to Higgs, there are a dozen definitions of independence with different criteria, which does not contribute to a clear framework that enables an easy assessment whether a NED is independent or not (9.8). Therefore, the Higgs Committee proposes a definition of independence, which comprises seven relationships or circumstances that would disqualify a NED from being independent, in suggested code provision A.3.4 (Higgs Committee 2003: 37). According to this recommendation a NED is independent if the board determines that he is independent in character and judgement. If the board decides that the NED is independent, whereas at least one of the seven circumstances or relationships apply to him, the board should state its reasons.

Higgs’ recommendations with respect to the separation of the CEO and chairman positions and the appointment of a senior NED are the same as earlier recommendations in the UK regarding corporate governance. With respect to maximum tenure, Higgs has views comparable with those of his predecessors. During the consultation period, the Higgs Committee received the suggestion that a learning curve for NEDs may be lengthy. Therefore, Higgs does not favour appointments of NEDs for periods of less than three year (Higgs Committee 2003: 12.2, 12.3). An extension of this three-year period is expected as well and beyond this period, re-election should be subject to careful consideration (12.3). Taking these issues into account Higgs suggests code provision A.7.3, which states that a NED should normally be expected to serve two three-year periods with a company. In some cases the tenure can be extended by an extra period of three years. After nine years, the position of the NED should be subject to annual re-election. The Higgs Committee does not make a recommendation about the length of service of a chairman, but mentions that it is useful to appoint him for three-year terms, which may be renewed (12.9). Earlier committees did not make any comments on the tenure or terms of appointment of the chairman.

The Higgs Committee also conducted some research on the role of the NED. Despite comments regarding tensions between monitoring and strategy roles of NEDs, research of the Higgs Committee claims that there is no essential contradiction between the monitoring and strategy roles of NEDs (2003: 6.2). For a unitary board structure it is important to establish a spirit of partnership and mutual respect, because ‘the key to [NED] effectiveness lies as much in behaviours and relationships as in structures and processes’ (Higgs Committee 2003: 6.3). To be really effective, the research of Higgs identified four required attributes: ‘integrity and high ethical standards; sound judgement; the ability and willingness to challenge and probe; and strong interpersonal skills’ (6.12).

In addition to the work of the Higgs Committee, the Smith Committee was asked by the Financial Reporting Council to make ‘suitable arrangements for their audit committees, and to assist directors serving on audit committees in carrying out their role’ (Smith Committee 2003: 1.1). Some of the principles in the Combined Code of 1998 were not appropriate for the listed companies, especially for smaller companies (1.3). Therefore, the Smith Report formulates requirements with respect to audit committees that every company should meet. Suggested code provision D.3.1 recommends having an audit committee with at least three members, who are all independent NEDs. At least one of the members should have relevant financial experience. The other suggested code provisions are not mentioned here, because they are not concerned with independence.