§ 7.43 p.m.
§ Lord Williams of Elvel rose to ask Her Majesty's Government what are their current views on corporate governance.
§ The noble Lord said: My Lords, I have to apologise to your Lordships for the fact that this Question, which is of great importance, arises at a late hour. I had hoped that it would be debated earlier. Indeed, when it was understood that the debate that has just terminated was going on for rather longer than expected there was a question as to whether I should take the Question off the Order Paper. In the end I decided to keep it on the Order Paper because the Minister has made an effort, in cancelling a number of appointments and obligations, to answer the Question. I felt that it would be discourteous to the noble Lord, Lord Hesketh, if I did not pursue the matter.
§ I cannot say that I am speaking to a full House. Indeed, looking around me I see that there are very few noble Lords in attendance, apart from those who will participate in this short debate. That is rather astonishing. The question of corporate governance is of great importance to many noble Lords who hold positions of distinction in companies in this country. I remember that when the Bill relating to audit committees came before your Lordships—a Bill which was taken through another place by the late Sir Brandon Rhys Williams—I spoke in favour of it from this Dispatch Box. A phalanx of noble Lords on the Benches opposite—chairmen of companies, finance 855 directors of companies—spoke against the Bill, which was designed to make audit committees statutory. I cannot see any of those noble Lords opposite today when we are debating the general considerations of corporate governance.
§ It is sad that we should be deprived of the benefit of the experience of noble Lords opposite who come to this House perhaps because they have persuaded their shareholders to contribute a great many funds to the Conservative Party—I know not why they come—when such matters are before your Lordships.
The Question originates from a statement made by Mr. John Redwood, who I believe is a Minister of State at the Department of Trade and Industry, on 7th December 1990. The statement is headed "Corporate Governance". Mr. Redwood said in that statement—and I believe he is quite right—that,
The quality and style of corporate governance is now moving high up the agenda".
§ As we read through the statement we see that some very interesting views were put forward by the Minister. It seemed to me that your Lordships would be interested in exploring exactly what the Minister meant by those interesting views.
§ I therefore compiled a list of questions that I wished to raise in today's debate, which I passed to the Government Whips' Office. I understand that they may have lost it or that the department lost it. I understand that in the course of time the list filtered through to the office of the Minister, and the Minister is prepared to reply. I wish to make it clear that I have given prior notice—at least 48 hours—of the questions that I shall ask. If the Government do not have a response to those questions it is not because they come out of the blue.
The Redwood statement—if I can use that shorthand expression—includes a number of rather odd expressions. I seek first to discover what is what is meant by the expression used by Mr. Redwood that,
A recent survey shows that the UK is top of the league in the performance of European major companies".
What performance? Are UK companies better in any respect—in terms of profitability or of productivity—than major European companies?
My second question relates to the statement made by Mr. Redwood when talking about corporate cleanliness and deterrence of fraud that,
Some of the dangers could be headed off if all companies had a sensibly structured board".
What is meant by "a sensibly structured board"? What view do the Government take about what is a sensibly structured board and what is an insensibly structured board?
Thirdly, Mr. Redwood says in his statement that,
A non-executive chairman has a special duty to look after shareholders' interests".
I contend that a non-executive chairman—whatever that may mean, and we shall come to that—has exactly the same duties as all other directors of a company. Not least he has a responsibility, a special duty, as do all directors under Section 309 of the Companies Act 1985, and I quote from that Act,
to have regard in the performance of their functions"—
these are the functions of the directors of a company—
[to] the interests of the company's employees in general, as well as the interests of its members".
So, by any reasonable interpretation of the Companies Act, the chairman has an obligation to look after the employees' interests as well as the interests of the shareholders.
§ On reading Mr. Redwood's statement I ask myself: by what virtue can a Minister claim that a non-executive chairman has a special duty to have regard to one class of people rather than another class of people when both classes in the Companies Act, under legislation passed by this Parliament, comprise an obligation for directors? Why is a Minister preaching what seems to me to be illegality?
The statement goes on:
The Government is keen to encourage the appointment of many more truly independent non-executive directors".
What is a "truly independent non-executive director"? There is no definition of a non-executive director in the Companies Act. During the passage of the Companies Bill 1989 we tried, when it was before this House, to introduce a definition, but the Government set their face against it. There is no definition. So we do not know what a non-executive director is, other than possibly a former Conservative Cabinet Minister. And we do not know what "truly independent" means. Is "truly independent" a non-executive director who has no relationship at all with the chairman and who can resign freely at his own discretion when something goes wrong to which he objects? If so, I should be grateful if the noble Lord can point out to me any non-executive director who is truly independent in that sense.
My fifth question relates to the statement by Mr. Redwood that,
The presence of non-executives on a company board may well scale down the more outrageous ambitions of chief executives and chairmen".
What "outrageous ambitions" had Mr. Redwood in mind when he made that statement? Are those non-executive chairmen—because the statement clearly distinguishes between chief executives and chairmen—also imbued with "outrageous ambitions"?
My sixth question relates to the statement that,
Non-executive directors should ask questions of company finance directors as to how long term their funding is".
Do the Government see that as a specific duty for non-executives? After all, I should have thought that it was a specific duty on all directors to determine for themselves and make a judgment of the gearing in the balance sheet and the finances of the company. That is not a special non-executive function.
My seventh question relates to the expression "evidence is rising". I apologise for the English of that expression but it is the language of the Minister, Mr. Redwood. I did not know that evidence ever rose. He says that,
evidence is rising that except in the very short term takeovers can all too often damage the wealth of shareholders of the bidding company rather than improving it".
The evidence has been there for a long time. It was there in the Green Paper of 1979 and was repeated in the DTI up-date on merger policy in 1986. There is no question of evidence rising. We all know what has happened.
My last question relates to the statement made by Mr. Redwood that,
The UK stock market usually gives the highest ratings and the best support to those companies which invest successfully in the future and in research and development".
What is the evidence for that statement? There is no evidence for it. On the contrary the market gives the highest ratings to takeover targets in anticipation of bids. That is the fact of the matter. There is no evidence.
§ I do not know the status of the statement. It is a ministerial statement. It was not made in Parliament but issued as a DTI press release. I do not know whether it has been debated in another place. It has certainly not been debated in this Chamber. It raises all kinds of issues which may simply be irresponsible. Maybe the Government have a considered view. I believe that the noble Lord, Lord Ezra, wishes to speak about non-executive directors and how that may dovetail into any European arrangements which may be made in the future. None of that is covered in this important statement on corporate governance. Is it not right that, if there is to be a government statement on this tremendously important matter, it should be properly prepared, properly debated in both Houses of Parliament and properly considered by all those noble Lords who are absent tonight?
§ 7.58 p.m.
§ Lord Ezra
My Lords, I am very pleased indeed that the noble Lord, Lord Williams, should have raised this Question for debate. Like him, I am extremely surprised that so few Members of your Lordships' House are present to debate it. The reason may be the phraseology—the somewhat grandiloquent phrase "corporate governance". Corporate governance means the framework in which boards conduct the business of companies, particularly public limited companies.
There is not the slightest doubt of the great importance of this issue. I should like to take the matter rather more widely than has the noble Lord, Lord Williams, who concentrated on the important press notice recently put out by the Government. I shall come to a number of the specific issues that he raised in due course.
First, I believe that it is necessary to consider for a moment the background against which companies have had to operate, particularly in the past decade. It has been a decade of dramatic changes in atmosphere and the circumstances in which companies have had to operate. In the early 1980s there was undoubtedly a dominance of takeovers, sometimes on a massive scale. In the USA in particular that gave rise to a reappraisal of the position of management in relation to shareholders. The name of T. Boone Pickens, for example, became a name that struck horror in the boardrooms of many large American corporations. As a result of the rush for growth, takeovers, and 858 defences against takeovers, many companies became over-borrowed. That happened not only in the United States; it was a phenomenon in this country as well. In due course the reaction set in. It was sparked off by the Stock Market crash in 1987. That was followed by a number of important company failures and accompanied by a serious weakness in the US banking system which was the other side of the corporate over-borrowing coin.
During that period of turbulent change in the circumstances in which companies had to operate, it is not surprising that serious attention was given to the way in which companies should operate and their structures should be organised. Many important bodies began to study the issue; in particular, Pro-NED—the body sponsored by the Bank of England and other organisations in the City and industry which is specifically concerned with the role of non-executive directors—the Stock Exchange, the Institute of Directors, the CBI, the Institutional Shareholders' Committee, the National Association of Pension Funds and the Association of British Insurers. They are only a few of the organisations which have examined the issue. While all that intensive study was taking place on this side of the Channel, on the other side of the Channel in Brussels there continued to be an attempt to find a way of harmonising European company structures. There are the latest amended proposals for the Fifth Directive on which the Government have been consulting all interested parties.
I believe that beginning to emerge from the study is the concept of a code of practice, either of a voluntary or legislative nature, for the conduct of the affairs of quoted companies. The document which most encapsulates that was issued by Pro-NED in April 1987 on the role of non-executive directors. Essentially, the problem that we are talking about is the relationship on boards between executive and non-executive directors. In Britain that has always been vaguely defined. The noble Lord, Lord Williams, is right in saying that in the whole corpus of the Companies Act there is no single reference to the existence of non-executive directors; all directors are considered to be equal.
As a result of all the studies and recommendations made, not least those in the press notice to which the noble Lord referred, a broad supervisory role is now being seen as the proper function of non-executive directors so that the interests of other stakeholders, shareholders and employees can be taken into account, in the words of the Act, and the effective co-operative of executives can be ensured.
We are told by all those who studied the issue in this country that what is necessary is a better balance between executives and non-executives on the boards of public companies. What is meant by a proper balance varies according to those who consider it. For example, Pro-NED considers that about one-third of a board should be non-executive. It would prefer the chairman to be non-executive and the non-executives to form the audit committee and remuneration committee which fixes salaries and can appoint executive directors.
859 Although most of the interested parties in Britain still strongly object to the concept of a two-tier board, it appears to me as though we are moving in that direction. I wish to quote from the latest annual report of Grand Met. Sir John Harvey-Jones, of ICI fame, is the non-executive deputy chairman of Grand Met. As a result of a statement from him produced in the company's annual report it appears that he is acting as the ex officio leader of the non-executives and he sets out what they do. He states:We are involved as non-executives in a whole range of key activities from the Audit Committee, the Management Development Committee and the Appraisal and Remuneration Committee to, and perhaps most vital of all, the long meetings held off-site at which we formulate our strategies and plans".He ends by stating:I am pleased to say that we believe that our board is at the forefront of best practice of corporate governance".That suggests that a fairly clearly defined supervisory role is allocated to the non-executive directors in that company.
In my opinion we are getting near to the Dutch system. In Holland there is a supervisory board and an executive board. I know something about that because for four years I served on the supervisory board of a Dutch company. Having had considerable experience of being on the boards of British companies either as an executive or, more recently, as a non-executive director, for the first time in my life I clearly understood my duties and responsibilities as a non-executive director. In fact, under this system the non-executive directors are ultimately responsible to the shareholders. They must take into account the interests of employees.
I must point out that under the Dutch system there are no employee representatives on the supervisory board, unlike the German system. At board meetings the chair is taken by the chairman of the supervisory board. His colleagues sit on one side of the table and the executive directors, under their executive chairman, sit on the other side of the table. They render account to the supervisory members of the board. Equally, the chairman of the supervisory board presides over annual general meetings. The chairman of the executive board makes a report to the assembled shareholders.
Before I turn to the legislative aspect, I wish to speak about the role of institutional shareholders in Britain. In spite of all efforts to widen share ownership the vast bulk of shareholdings in Britain are in the hands of institutions. They account for some 60 to 70 per cent. They are capable of exerting considerable influence on the affairs of companies, particularly during takeover battles and at times of special difficulty in certain companies.
There has been much debate about the alleged short-term approach of some institutional and banking organisations. I do not know what truth there is in that. I have come across institutions which have struck me as being short-term in their approach and others which have had a long-term approach. However, while considering the role of non-executive directors and other directors in companies, it might be appropriate to consider a code of practice for the role 860 of institutional shareholders in relation to companies in which they have funds invested. I understand that the Institution of Shareholders Committee is studying that matter.
All that leads to the role that should be played by government through legislation or other means. The noble Lord, Lord Williams, has reminded the House that in the whole range of companies Acts the only reference to the function of directors is in Section 309(1) of the 1985 Act which he quoted. It states that in the performance of their functions directors should have regard to the interests of the company's employees as well as to the interests of its members.
We know that on a number of occasions the late Sir Brandon Rhys Williams, to whom the noble Lord referred, sought to introduce into the company legislation more precision as regards the role and function of directors, in particular non-executive directors. In 1978 and 1987 he introduced Private Member's Bills to that effect. Although the Bills had considerable support they never got onto the statute book.
I suggest that, as the definition of the role of non-executive directors is developing, there is a consensus growing that they should exert a supervisory role, that there should be audit and remuneration committees and that preferably the chairmen of companies should be non-executive. Sooner or later we should have reference to that in legislation. Otherwise, we shall have an increasingly confused situation with some companies, such as Grand Met. whom I quoted, carefully following the recommendations of the various bodies to which I have referred and working effectively on the basis of having what amounts to a supervisory board, and other companies totally ignoring the situation and perhaps having no non-executive directors on the board at all.
The way in which the thinking is developing in Brussels, the emergence of the single market and a consensus of opinion on best practice in this country lend considerable support to the view that sooner or later this subject should be addressed by legislation.
§ 8.11 p.m.
§ Lord Donoughue
My Lords, I also wish to thank my noble friend Lord Williams of Elvel for giving the House this opportunity to discuss such an important subject. However, like my noble friend and the noble Lord, Lord Ezra, I believe it is a pity that more noble Lords on the Benches opposite, so many of whom in Who's Who (regular reading) state that corporate governance is their trade, have not in their wisdom decided to take part in this evening's debate. Perhaps some of them fear change or, understandably, are embarrassed because they do not understand their role as directors because of the ambiguities and vagueness with which it is defined or not defined.
However, we welcome the noble Lord, Lord Hesketh, who has joined our small party. I was once a partner in a stockbroking firm which acted as a broker for one of the Minister's corporate ventures. I reassure the House that that was very visionary and 861 exciting. Therefore, our debate may be small but it is experienced and cosy. As always, quality matters more than quantity.
The subject of corporate governance is wide. My noble friend Lord Williams covered its main aspects with his customary clarity and I look forward to the Minister's precise answers to his penetrating questions.
I wish to concentrate on two aspects of this subject: independent directors—already well touched upon by the noble Lord, Lord Ezra; and the role of auditors. I start with independent directors, as did the noble Lord, Lord Ezra, because they are at the core of corporate governance in the so-called shareholders' democracy. In fact, shareholders' democracy does not exist in Britain because of the defects of present corporate governance. Truly independent directors, where they exist, are best placed to defend the shareholders' interests, to expose the inefficiencies of cosy management and to give early warning of malpractice. Most of the recent highly publicised corporate scandals could have been avoided or exposed at an earlier stage by alert and truly independent directors. Unfortunately such animals are still too rare in Britain. The companies which have them, such as Grand Met., are usually the best run companies which need them least. Those which need them sometimes try to avoid them or choose tame ones—retired friends of the chairman looking for a sinecure. Those who fall in that latter category are unlikely to ask the necessary awkward questions.
Apart from the main board, there are two key roles for independent directors in any company: chairman of the audit committee and chairman of the compensation committee. Such independent scrutiny is essential if shareholders are to be protected, the company's finances scrutinised and executive directors are not left to pay themselves excessive compensation. There have been a number of such cases in recent times.
Such non-executive directors should be chosen independently. The American institution of the nomination committee could be a useful vehicle, selected by the wider shareholders and itself nominating the independent non-executive directors. That would help prevent or mitigate the common practice of the chairman selecting the non-executive directors to support rather than question him. I should add that representatives of the workforce should also be included on the key committees. Employees as well as shareholders need protection and representation.
The problem which we all recognise is how to secure the introduction of more truly independent non-executive directors. Under its wings the Bank of England has established Pro-NED, to which the noble Lord, Lord Ezra, referred, to advance the cause of non-executive directors. That is a very worthy and, on my observation, well run institution. However, it cannot claim great success. It has plenty of good candidates on its books but too few takers. Perhaps the Bank of England has not given it sufficient backing from the top. It should certainly try to do more.
862 The final responsibility for securing independent non-executive directors lies with the shareholders who should press for that. We know that individual shareholders are not well organised and are usually passive. Therefore, the department should accept that cause as a major departmental objective. It should campaign and educate on its behalf. It should press the Bank of England to do more. Above all it should look to provide statutory backing and definition to the role of independent director.
Large institutional shareholders should also be more aggressive—a matter to which the noble Lord, Lord Ezra, referred. They should insist that companies in which they invest have truly independent non-executive directors accountable to the shareholders. Perhaps they should issue ratings for companies according to the quality of their corporate governance.
Non-executive directors should be properly paid to do a proper job. At present they are often paid a small fee to do virtually nothing. I sympathise with my noble friend Lord Williams. They should be paid a high fee and expect to devote several days per month to doing the job properly. They should be provided with full facilities by the company and full access to financial information. Without that, they cannot do the job.
The second point on which I wish to touch, which has not arisen, is the role of auditors and the preparation of meaningful accounts. It has been apparent for many years that a company's audited accounts in this country may reveal much or very little. Often it requires an analyst—and I employed such people—with the skills and the scepticism of an MI6 Kremlinologist to interpret what is really happening in the company. Company accounting has in recent years generated a volume and spirit of creativity far beyond that achieved in artistic spheres under the remit of the Arts Council. Auditors sign off company accounts as representing a true and fair picture when in reality the financial picture is distorted beyond recognition. As an example of that, I believe that no UK clearing bank has shown a true and fair account of its financial position in its published accounts for the past 10 years.
Noble Lords will be aware that many of the highly publicised bankruptcies of recent years involved companies whose most recent accounts were signed off by distinguished auditors as being profitable and with apparently healthy assets. The heart of the problem is twofold. Currently, accountants are merely required to follow certain basic rules and have never been strictly required to provide shareholders with meaningful information about the company.
An even greater practical problem is that auditors are in a desperately competitive business. They want to retain the fees of their corporate clients and are reluctant to upset their chairmen and boards. In practice, they work for the executive board and not the wider shareholders. Consequently, at times there is great pressure on them to accept creative accounting designed to put the board in the best possible light.
863 Against that background, it was encouraging to read recently the proposals for reform of accounting procedures linked to the Accounting Standards Board and the Financial Reporting Council. It is not possible here—I am not fully qualified to do so—to comment upon those proposals in detail. However, the proposals to restrict off-balance-sheet financing; to make cash flow statements compulsory, and above all, to make it an overriding requirement that accountants explain to shareholders what is really happening in the company should be welcomed and encouraged. Such changes would restrict creative accounting. Had they operated in the 1980s we should have been spared the sad sight of so many of the great heroes of the Thatcherite entrepreneural spirit becoming multi-millionaires overnight and then going bankrupt the moment that interest rates rose.
I shall not detain the House longer. I am daunted to find that I comprise one-third of the debate. I hope that the Minister can reassure us that that issue will be considered seriously by the Government. The DTI should radiate urgency —a unique experience—towards the other relevant bodies: the Bank of England, the CBI, the TUC, and the Institute of Directors; but, most important, it must look again at company law to give definition and backing to the role and obligations of directors. Ultimately, we are discussing the efficiency of British industry, and hence the health of the whole economy.
§ 8.22 p.m
§ Lord Hesketh
My Lords, although we may be few in number I am sure that the content of this evening's Unstarred Question has been an addition to the annals of your Lordships' House.
The Government take a keen interest in corporate governance, and we have followed with interest the public discussion of issues relating to it over recent months. To ask for the Government's views on that vast subject is perhaps a little like asking for the Government's views on industry or on the environment; but I shall do my best to mention the main topics of interest, and particularly those that have been raised in this debate.
Corporate governance concerns the ways in which companies are managed and controlled, the ways in which the managers are accountable to the company and particularly to its owners, and to other interests such as creditors, customers and employees. Some aspects of those relationships are covered by the law. Others—the majority—are a matter of good common practice, or else practice which is appropriate to the circumstances of each company.
The Government can and do have views on good common practice, and I shall set out some key points. On the practice of individual companies I have nothing to say, since only they can be expected to understand their particular needs. But in neither case is there a need for legislation. In general, the Government's view is that where the law does touch on corporate governance it already provides the right 864 balance between the need to give directors the freedom to direct and the need to protect the other interests that I have just mentioned.
However, company law is constantly evolving, partly now through the pressure towards harmonisation within the European Community and particularly in the financial services sector where the handling of other people's money makes protection and regulation more important than elsewhere. Thus, the Government are always open to ideas for change when a convincing case is made, demonstrating a real need among companies generally. I have taken note of the suggestions made in the debate.
Turning to the social and cultural background to the British style of corporate governance, I do not believe we need be detained by such general matters as the objectives of the capitalist system, the purpose of a company, and the role of profits and dividends. They are and always will be the subject of academic debate, and I want to concentrate on matters upon which the Government's views may carry some weight.
The public debate on corporate governance has re-emerged on the agenda for a variety of reasons: notably, several recent major insolvencies and increased success in tracking down malpractice including fraud, insider dealing and market manipulation. At the same time, there has been a related debate on short-termism, which has been looking at the evidence—so far inconclusive—as to whether companies should be giving higher priority to long-term investment and, if so, what is preventing them from doing it.
Insolvency and malpractice often go together in the public mind, but the reality is that companies can and do become insolvent through bad luck or bad management. There can be lessons to be learned from insolvencies—and not only those which hit the headlines—and sometimes they can be lessons about corporate governance.
It is inevitable that managers will from time to time get things badly wrong. But that must be seen in the context of a survey by Director magazine which found that the UK is top of the league in the performance of major companies in Europe, with 27 out of the best 50 performers coming from the UK. We have much to be proud of in the corporate management field—
§ Lord Williams of Elvel
My Lords, perhaps I may interrupt. Will the Minister explain what is meant by that quotation in the Director magazine? What is the top—
§ Lord Hesketh
My Lords, I am surprised by the slightly unusual practice of the noble Lord rising during the reply to an Unstarred Question. I can assure him that I was coming to that point later. I have cancelled arrangements and Government business to be here tonight.
§ Lord Williams of Elvel
My Lords, I am grateful to the Minister. This will go on, because I have taken a great deal of trouble, and the Minister had taken a great deal of trouble, to ensure that we know what questions are on the agenda.
§ Lord Hesketh
My Lords, I made it clear to the noble Lord, outside your Lordships' House, that I would address the points which he has raised. I have gone to considerable trouble to be in your Lordships' House to do so.
§ Lord Hesketh
My Lords, Perhaps I may continue.
The view, with which the Government agree, that several non-executive directors can, if they are genuinely independent, provide a useful check on the executive directors of a company, is a view which is supported by experience as well as common sense. Separating the role of chairman and chief executive, and providing for a checking or auditing role within the board may also be desirable in many cases, especially as companies grow larger and more complex.
There is little point in requiring any of that by law, however, since accountability and good corporate governance require co-operation from those affected by it, and in some cases exceptions may be entirely justified. Shareholders and creditors are well able to ask questions and form their own views about the soundness of the regime in a company. Management which then ignores those views does so at its peril. That approach to the problems of corporate governance reflects our steadfast opposition to proposals, whether they be British or Community-inspired, which take the blinkered view that there is one perfect style that will fit any case.
That is not to say that British companies cannot borrow ideas from other countries to improve their performance as the noble Lord, Lord Ezra, said. Banks, for example, might wish to consider developing the sort of long-term close relationship with clients which appears to have gone out of fashion in the age of the syndicated loan. Non-executive directors can take a more critical view of company policies on acquisitions and mergers. Indeed, a more sceptical view of acquisition-driven policies and a greater emphasis on organic growth might well be beneficial. Here again, we are contemplating changes which could be made only with the active and willing co-operation of the company itself. Some companies show what can be done with acquisition-driven growth; other cases show the dangers. Judgment is needed by both directors and shareholders.
In the end, the Government cannot prevent companies becoming insolvent. Investors have to assess the quality and style of the management and decide whether the prospects and the risks offer an attractive balance. Nor, ultimately, can the Government prevent malpractice; but the law has developed and is enforced in ways which make it more difficult to get away with dishonesty, and so provides a deterrent. For example, the rate of compliance among companies in filing annual trading statements and balance sheets has risen, as a result of a Government campaign, from 40 per cent. to 80 per cent. in only a few years. This helps to ensure that investors and potential investors, creditors and others have the information which they need to make a proper judgment about the risks and prospects. We can be proud of this improvement, especially when we 866 look at the situation in many other countries where even such simple requirements as these are not laid down or enforced. But Government still intend the rate to go much higher, and are working to achieve this.
In short, this Government have worked hard at ensuring that there is a well-regulated and firmly enforced statutory framework within which companies can operate. This is an environment that gives companies the freedom to select the style and organisation of management that best suits their needs. It is up to them to take it from there. It is up to shareholders, directors and regulators to ensure that powers given by legislation are used.
I now turn to the questions asked by the noble Lord, Lord Williams of Elvel. He asked what survey the Minister (that is, me) was referring to. I apologise. That was the most appalling intrusion on the reputation of my noble friend. The Minister is of course my noble friend the Minister of State and not me.
§ Lord Williams of Elvel
My Lords, he is not the noble Lord's noble friend. He is the honourable friend of the Minister in another place.
§ Lord Hesketh
My Lords, the survey referred to was from The Director magazine of December 1990 which gave UK companies good points on a range of aspects of performance, combining a five-year weighted average of profit before tax as a percentage of shareholders' equity, an accounting rate of return with a five-year weighted average of operating profit as a percentage of turnover and a measure of ability to control operating costs together with four other ratios measuring safety and growth. On the scores used in this survey, the top two companies out of 50 European companies were both British, namely, Glaxo and Reuters, and another 25 were also British.
The noble Lord also asked about my right honourable friend the Minister's reference to "a sensibly structured board". A sensibly structured board is in general one which provides a range of skills appropriate to the business and where several non-executive directors are there to preserve competence and honest dealing.
Next we have reference to the non-executive chairman in relation to shareholders' interests. The Minister meant that a non-executive chairman was intended and has indeed the same duties as an executive chairman, but is in a special position because he can concentrate more easily on the interests of the shareholders by being less concerned with the day to day management of the company. As the noble Lord, Lord Williams of Elvel, pointed out, he also has a duty under Section 309 of the Companies Act 1985 to have regard to the interests of the company's employees as well as its members. That is the established law and the Government have no quarrel with it.
Then we have a "truly independent non-executive director". I would have thought the phrase was self-explanatory. The first requirement is that he should have no ties with the company or other board members which might influence his judgment. The second is that he should have an independent mind 867 and the ability to stand up for his own views. The Government's concern is to promote the idea of independence as an attractive feature in such cases. I am sure that the noble Lord, Lord Williams, will not suggest that there is anything wrong with that concept.
§ Lord Williams of Elvel
My Lords, perhaps I may make myself clear. There is nothing wrong with that concept. The question is whether it is ever put into practice. How do the Government intend that it should be put into practice? We have had many examples of non-executive directors who are friends of the chairman. They are put on the board because they are friends of the chairman. Once they are on the board it is very difficult to get them off.
§ Lord Hesketh
My Lords, the noble Lord, Lord Williams, requires certainty. The reality of legislation is to provide as close to perfection in balance as is possible. The Minister also mentioned the ambitions of chief executives and chairmen to which the noble Lord has just referred. It is a cliché in the commercial world that entrepreneurs who run businesses as personal fiefdoms can run into trouble when their businesses grow too large for detailed personal control to work effectively. At that point it is often useful for there to be other people on the board who can draw attention to the changing conditions and exert pressure on the chairman or chief executive to ensure that proper management structures are put in place.
Now we return to non-executive directors. Non-executive directors are in a better position to stand back from day-to-day management issues and question those like finance directors who have to deal with such issues. But as a specific duty of a non-executive director, directors are all equal under the law and the Government have no wish to change that, as was made clear several times in the debates on the Companies Act 1989.
The noble Lord also sought to question the Minister's reference to evidence on the results of takeovers. Evidence about the post-merger profitability of companies involved in takeovers was assessed in the 1978 Green Paper, which concluded that in roughly half the cases examined, the merger had had an unfavourable or neutral effect on profitability. It was recognised that there were problems of comparability, notably in relation to what profitability would hypothetically have been had the merger not taken place. Subsequent evidence has been considered by a number of empirical studies using different approaches.
It would take too long to give summaries of all of these, which are to be found in the DTI Blue Paper on mergers' policy, published in 1988. It is fair to say that most of them support the conclusion of the Green Paper, while the longer period covered and the use of varying methodologies give that conclusion greater authority. The Government do not draw from this the conclusion that takeovers should be made more difficult but that management should look at possible bids critically to make sure they are likely to be successful before launching them.
868 Finally, I refer to the stock market's ratings of companies which invest successfully in the future. "Successfully" is an important word here. The most familiar illustrations of the benefits of R&D investment to stock market ratings are the oil and pharmaceutical industries, both of which generally write-off their exploration and R&D costs against income, while enjoying high fee ratios. Glaxo and Wellcome shares have all typically traded well above the market average. The point is that, if they can do it, so can others. But it does not happen entirely by accident: keeping in touch with market specialists in the industrial sector, and underlining the competitive benefits of long-term development, are legitimate activities which far too many companies fail to do effectively.
The noble Lord, Lord Ezra, drew your Lordships' attention to the statement by Sir John Harvey-Jones in the Grand Metropolitan report as the leader of the non-executive directors. It states that the UK is moving towards a two-tier board. We believe that it is a good practice to encourage non-executive directors to have a supervisory role, but to make a formal legal distinction would confuse responsibilities. In Dutch companies the supervisory board represents interests such as employees or banks. In the United Kingdom the board is responsible to the company while taking account of other interests as necessary.
§ Lord Hesketh
My Lords, I did not say what the noble Lord, Lord Ezra, has accused me of saying. I did not say that the banks or the employees were on the board. I said that the supervisory board represented outside interests of which those were just two. There is a multitude of other outside interests and shareholders. All I am saying is that it is a different approach in this country to the one suggested by the noble Lord, Lord Ezra.
The noble Lord, Lord Donoughue, drew attention to an earlier relationship between the two of us a decade ago. I can assure noble Lords that my knowledge of the noble Lord, Lord Donoughue, and of his great experience in the City, convinced me that short-termism was not alive and well and I shall be eternally grateful to him. He also drew attention to recent scandals that could have been avoided with independent directors. I agree with him that their appointment would probably have helped in many cases. However, regardless of directors—independent or otherwise —and auditors and others, scandals will still occur for as long as activity of a financial nature exists within a market.
The noble Lord, Lord Donoughue, also referred to the selection of non-executive independent directors. I agree that shareholders should take more active interest in pressing for the appointment of independent active non-executive directors.
869 Perhaps I may close on this point. The noble Lord, Lord Williams, suggested there was something odd about the statement by the Minister for Corporate Affairs. The reality is that this statement has provided a healthy extension of the discussion and the debate that takes place. As the noble Lord, Lord Williams, drew from several examples through that statement, I felt that it had contributed to our seeing corporate finance a little more clearly.
§ Lord Williams of Elvel
My Lords, before the noble Lord sits down, I recognise there is advantage in the Department of Trade and Industry seeing the future a little more clearly than has previously been the case. Will the noble Lord answer a specific question? Does he think that in their annual reports companies are right to show directors as being executive and non-executive? Does he support the suggestion of the Institute of Directors that executive and non-executive directors should be specified when companies come to the market and to the Stock Exchange?
§ Lord Hesketh
My Lords, as I have abandoned the commercial world I am not in a position to answer that question with the accuracy that the noble Lord, Lord Williams, would desire. However, I shall ensure that a missive is dispatched to him in answer to his question.
§ Lord Selsdon
My Lords, before the noble Lord finally sits down, perhaps I may ask him from these rather confused heights whether in the interests of clarity he might seek to orchestrate, whether with the Bank of England, the CBI or others, the preparation of certain guidelines for directors. Many directors are now fairly confused as to their role and responsibilities.
§ Lord Hesketh
My Lords, I can certainly draw the remarks of my noble friend to the attention of the Bank of England. He would be slightly surprised if I were to issue a directive from Victoria Street to that effect.
House adjourned at nineteen minutes before nine o'clock.