Learning Outcomes
By studying this article, you will be able to explain the main principles of corporate governance related to the composition and function of the board of directors. You will distinguish between executive and non-executive directors, analyse their respective roles, and describe the importance of board independence and best practice for board committees. You should be able to apply these concepts to typical ACCA exam situations.
ACCA Business and Technology (BT) Syllabus
For ACCA Business and Technology (BT), you are required to understand the composition of company boards and the associated governance roles. In particular, this article addresses:
- The distinction between executive and non-executive directors, including duties and expectations.
- The significance of board structure and the principles that underpin effective corporate governance.
- The importance of board independence and the recommended balance of board members.
- The function of major board committees, including the remuneration and audit committees.
- Methods for ensuring accountability, transparency, and stakeholder confidence at board level.
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- What is the main difference between an executive and a non-executive director?
- Why is independence of non-executive directors regarded as essential in effective corporate governance?
- Which board committee is responsible for reviewing executive directors’ remuneration, and who should serve on that committee?
- State two circumstances in which a non-executive director’s independence may be considered impaired.
Introduction
An effective system of corporate governance is fundamental to the sound management of a company. At its centre sits the board of directors, which controls, directs, and supervises company affairs. Good governance requires clear distinction and balance between those managing daily operations and those overseeing strategic direction. This article summarises the legal and practical principles for board composition in UK companies, particularly focusing on the roles of executive and non-executive directors (NEDs), the reasoning behind board independence, and the recommended structures to support accountability.
Key Term: corporate governance
The system by which companies are directed and controlled, defining relationships among the board, management, shareholders, and other stakeholders.
Board Structure and Governance Principles
Company law recognises the board of directors as a collective body responsible for directing a company’s activities. Most boards combine executive and non-executive directors to balance daily management with external oversight.
Executive and Non-Executive Directors: Roles and Distinction
Key Term: executive director
A director who is a full-time employee with direct responsibility for managing company operations.Key Term: non-executive director (NED)
A director who does not engage in the day-to-day running of the business but participates in board meetings and governance without executive duties.Key Term: independence (in governance)
A state where a non-executive director is free from relationships or circumstances that could affect their judgement.
The Role of Executive Directors
Executive directors hold specific operational roles (for example, finance director or operations director). They are:
- Senior employees of the company.
- Responsible for implementing the business strategy set by the board.
- Accountable to both the board and shareholders for performance.
- Involved in making key daily decisions.
The Role of Non-Executive Directors (NEDs)
Non-executive directors are appointed to provide:
- Independent, objective judgement on board decisions.
- Monitoring and challenge to executive directors’ actions.
- Scrutiny of business performance, risk management, and controls.
- Guidance regarding strategy and succession.
- Participation in board committees for key matters such as remuneration, audit, and nominations.
NEDs do not hold management positions within the business and should be free of conflicts that might influence their actions.
Why Board Independence Matters
Board independence mitigates the risk that directors will act solely in their own interests (the "agency problem"). An independent board is more likely to:
- Act impartially when making decisions affecting all stakeholders.
- Hold executive management accountable.
- Prevent domination of the company by a single individual or small group.
- Increase transparency and public confidence.
UK good practice recommends that at least half of the board (excluding the chair) in listed companies should be independent NEDs. Smaller companies should have at least two such NEDs.
Maintaining NED Independence
Independence may be threatened where a NED:
- Has been employed by the company in the last five years.
- Has or has recently had a significant business relationship with the company.
- Holds a material shareholding in the company.
- Has close family ties with directors or senior employees.
- Has served on the board for an extended period (typically more than nine years).
In such cases, companies should disclose and justify the appointment as independent or take mitigating actions.
Worked Example 1.1
Question: A listed company’s board consists of six executive directors and three non-executive directors. One NED has provided consultancy services to the company in the last 12 months. Is the board compliant with best practice for independence, and should the NED be regarded as independent?
Answer:
Best practice recommends that at least half the board (excluding the chair) are independent NEDs. Here, only three of nine directors are NEDs, so the board is not compliant. Further, the NED who recently provided paid services would generally not be regarded as independent during this period.
Appointment and Remuneration of Directors
Remuneration for executive directors usually includes a salary, bonuses, and benefits linked to performance, and is negotiated through procedures set by the remuneration committee.
NEDs are typically paid a fixed fee only (not performance-related bonuses, share options, or pensions), to help safeguard impartiality. Their pay should reflect the time commitment and duties of the role.
Remuneration and audit committees—made up solely of independent NEDs—are required in listed companies to improve governance standards.
Worked Example 1.2
Question: Can a non-executive director participate in the company’s executive share option scheme? Justify your answer.
Answer:
No. Participation in such schemes creates a financial interest tied to company performance and impairs the independence required for effective oversight and challenge. NEDs should receive fees only, to avoid conflicts of interest.
Board Committees and Oversight Functions
Committees enable effective monitoring and decision-making for matters requiring additional scrutiny:
- Remuneration Committee: Sets pay and incentives for executives. Membership limited to independent NEDs.
- Audit Committee: Oversees financial controls and liaises with auditors. Should also be staffed by independent NEDs.
- Nomination Committee: Manages appointments to the board and ensures balance of skills and diversity.
Committees provide channels for challenge and support, strengthening the accountability of the board as a whole.
Exam Warning
Overlooking the distinct roles of executive and non-executive directors is a common source of confusion in the exam. Always link NEDs with independent oversight and committee roles, never day-to-day management or operational control.
Board Chair, CEO, and Senior Independent Director
Good governance expects the chair and chief executive officer to be separate persons, with the chair leading the board and the CEO leading management. One of the NEDs may be designated as the senior independent director, acting as an additional point of contact for shareholders.
Departure from Best Practice
Companies choosing not to comply fully with standard governance guidelines must explain and justify their approach in their annual report ("comply or explain"). Shareholders and regulators may scrutinise such deviations closely.
Summary
Effective corporate governance depends on a balanced and independent board, with clear separation between executive action and independent oversight. Executive directors manage operations, while non-executive directors bring challenge, strategic guidance, and objectivity. Board committees, proper remuneration arrangements, and vigilant attention to independence underpin robust governance and strengthen stakeholder trust.
Key Point Checklist
This article has covered the following key knowledge points:
- Define and distinguish executive and non-executive directors
- Explain the significance of board independence and the recommended balance of directors
- Identify the threats to independence for non-executive directors
- Describe the purpose and composition of board committees (remuneration, audit, nomination)
- State the typical remuneration arrangements for executive and non-executive directors
- Understand why separation of chairman and CEO roles is recommended in governance best practice
Key Terms and Concepts
- corporate governance
- executive director
- non-executive director (NED)
- independence (in governance)