Introduction
The role of non-executive directors (NEDs) in listed companies has long been a cornerstone of corporate governance frameworks in the UK, intended to provide independent oversight and ensure accountability in managerial decision-making. Section 174 of the Companies Act 2006 codifies the duty of directors to exercise reasonable care, skill, and diligence, a provision that applies equally to executive and non-executive directors. However, questions persist regarding whether this legal duty equips NEDs with the necessary tools to effectively control executive management and, by extension, enhance corporate governance. This essay critically examines the limitations of Section 174 in empowering NEDs to influence the management of listed companies, arguing that while NEDs play a theoretically valuable role, practical constraints undermine their ability to effect meaningful change. The discussion will explore the legal framework, the structural and cultural challenges faced by NEDs, and the broader implications for corporate governance, ultimately suggesting that while NEDs have the potential to contribute positively, Section 174 alone is insufficient to ensure their effectiveness.
The Legal Framework of Section 174 and Its Application to Non-Executive Directors
Section 174 of the Companies Act 2006 imposes a statutory duty on all directors to exercise reasonable care, skill, and diligence in their roles. Specifically, the provision stipulates that a director must act with the care and skill that may reasonably be expected of a person carrying out the functions of a director in that company, as well as with any additional knowledge or expertise the director possesses (Companies Act, 2006). For NEDs, who are not involved in day-to-day operations, this duty theoretically translates into a responsibility to oversee and challenge executive actions, ensuring strategic decisions align with the company’s best interests.
However, the application of Section 174 to NEDs is limited by its generality. The provision does not differentiate between the roles of executive and non-executive directors, failing to account for the structural differences in their engagement with the company. As noted by Moore (2013), NEDs often lack the detailed operational insight possessed by executives, which hampers their ability to scrutinise decisions effectively. Furthermore, the legal standard of “reasonable care” is subjective and often assessed in hindsight, which can result in a reluctance among NEDs to challenge executives for fear of personal liability (Bainbridge, 2012). Thus, while Section 174 establishes a baseline expectation of diligence, it does little to empower NEDs with the practical means to control executive behaviour.
Structural and Cultural Barriers to Non-Executive Influence
Beyond the legal framework, structural and cultural factors within listed companies further undermine the ability of NEDs to manage or influence executive actions. NEDs are typically appointed on a part-time basis, limiting their time and access to internal information compared to full-time executives (Klein, 2002). This disparity often results in an over-reliance on information provided by executives, which may be incomplete or biased. Indeed, as Higgs (2003) argues in his influential review of corporate governance, the effectiveness of NEDs is heavily contingent on the quality of information they receive, a factor largely outside their control.
Moreover, the culture of boardrooms can inhibit robust challenge. In many listed companies, NEDs are appointed through networks of existing board members, fostering a collegial rather than adversarial dynamic (Adams and Ferreira, 2007). This can lead to a reluctance to confront executives, particularly in high-stakes or contentious decisions. For instance, the 2008 financial crisis highlighted multiple cases where NEDs failed to challenge risky executive strategies, such as in the collapse of Royal Bank of Scotland, partly due to such cultural constraints (Walker, 2009). These structural and cultural barriers suggest that even with the legal backing of Section 174, NEDs struggle to assert meaningful control over executive management.
Impact on Corporate Governance
Given the challenges outlined, there is indeed reason to question whether NEDs can significantly improve corporate governance in listed companies. Corporate governance, as defined by the UK Corporate Governance Code (2018), encompasses the systems by which companies are directed and controlled, with NEDs positioned as key agents of accountability. However, if NEDs are unable to effectively influence or constrain executive actions, their role in enhancing governance appears limited. For example, while NEDs are tasked with monitoring executive remuneration—a critical governance issue—studies suggest that their influence in this area is often superficial, with executive pay continuing to rise despite governance concerns (Conyon and Peck, 1998).
Nevertheless, it would be overly dismissive to conclude that NEDs have no potential to improve governance. Their presence on boards can still provide a degree of independent scrutiny, particularly when supported by other mechanisms such as shareholder activism or stronger regulatory oversight (Mallin, 2016). Furthermore, high-profile governance failures have occasionally prompted NEDs to take more assertive roles, as seen in some post-crisis reforms. Arguably, therefore, while Section 174 alone does not ensure NED effectiveness, it can form part of a broader framework that, if strengthened, might enhance their impact.
Possible Reforms and Alternatives
To address the limitations of Section 174 and the broader challenges faced by NEDs, several reforms could be considered. First, legal provisions could be tailored specifically to NEDs, clarifying their oversight role and providing protections against liability when challenging executives in good faith (Bainbridge, 2012). Second, mandatory training and greater access to independent information could empower NEDs to perform their duties more effectively (Higgs, 2003). Finally, cultural shifts within boardrooms, supported by stricter governance codes, could encourage a more confrontational stance where necessary. While these reforms do not guarantee success, they highlight potential avenues through which NEDs might better contribute to corporate governance, even if Section 174 currently falls short.
Conclusion
In conclusion, Section 174 of the Companies Act 2006, while establishing a duty of care, skill, and diligence for all directors, does not sufficiently ensure that non-executive directors in listed companies can effectively control executive management. The provision’s generality, combined with structural limitations such as limited time commitment and access to information, and cultural barriers within boardrooms, significantly hampers NEDs’ ability to influence corporate direction. Consequently, there is a compelling case to question their capacity to improve corporate governance, as their role often remains symbolic rather than transformative. However, this does not entirely negate their potential; with targeted legal and structural reforms, NEDs could play a more meaningful role in governance. The broader implication is clear: while Section 174 provides a necessary foundation, it must be complemented by specific measures tailored to the unique challenges faced by NEDs if corporate governance is to be genuinely strengthened in listed companies.
References
- Adams, R.B. and Ferreira, D. (2007) A Theory of Friendly Boards. The Journal of Finance, 62(1), pp. 217-250.
- Bainbridge, S.M. (2012) Corporate Governance After the Financial Crisis. Oxford University Press.
- Conyon, M.J. and Peck, S.I. (1998) Board Control, Remuneration Committees, and Top Management Compensation. Academy of Management Journal, 41(2), pp. 146-157.
- Higgs, D. (2003) Review of the Role and Effectiveness of Non-Executive Directors. Department of Trade and Industry.
- Klein, A. (2002) Audit Committee, Board of Director Characteristics, and Earnings Management. Journal of Accounting and Economics, 33(3), pp. 375-400.
- Mallin, C.A. (2016) Corporate Governance. 5th ed. Oxford University Press.
- Moore, M.T. (2013) Corporate Governance in the Shadow of the State. Hart Publishing.
- Walker, D. (2009) A Review of Corporate Governance in UK Banks and Other Financial Industry Entities: Final Recommendations. HM Treasury.
- UK Corporate Governance Code (2018) Financial Reporting Council.
