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ACCA Research Report No. 63

Berry and Perren, 2000

Executive summary

‘.. it is now widely accepted that boards gain from a combination of the breadth of view of outside directors and the depth of knowledge of the executive directors.’ (Cadbury, 1994, page vii)

‘... particularly in smaller companies, NEDs may contribute valuable experience not otherwise available to management.’ (Hampel, 1998, page 25)

This study identifies how prevalent non-executive directors (NEDs) are in small and medium size companies (SMEs) and what effects the size of the company has on the likelihood it will have a NED. It looks at the ways in which NEDs are found, how they are appointed, what roles they play and whether there is any clear connection between the performance of the company and the existence of a NED on the board of directors.

The results reported in this study arise from the analysis of responses to a questionnaire that was sent to the managing directors of 5,279 United Kingdom SMEs that were randomly selected from the Companies House database. 1103 questionnaires were returned representing a 20.9% response rate. This research report is based on the 640 responding businesses that were independent and not subsidiaries of larger businesses.

Findings

• There is a high level of awareness of NEDs. Only 5% of respondents stated that they were unaware of the existence of NEDs.
  
  
• Most managing directors of SMEs without NEDs had considered appointing one, but in the end felt they were not necessary.
  
  
• There is some mistrust of the NED role (for example, disruption of directorial team, breaches of privacy, loss of control and freedom). However, this should be balanced against the finding that only 2% of respondents felt that NEDs had actually harmed their company.
  
  
• The majority of SMEs do not have NEDs. The prevalence of NEDs within SMEs is directly related to the size of the company with approximately a fifth of smaller companies, i.e. those with fewer than 50 employees, having NEDs. As companies get larger they are more likely to have NEDs, with nearly half the companies that employ between 200–499 employees having NEDs.
  
  
• The point at which a company decides to engage an NED relates more directly to the number of employees than to the turnover or the age of the company. The break point appears to be at around 50 employees when SMEs become more likely to engage a NED.
  
  
• 80% of managing directors (MDs) who had NEDs felt that they were helpful.
  
  
• NEDs provided a range of contributions to individual boards and there was no clear pattern discernible. In the case of specific contributions nearly 75% identified outside objectivity as a contribution that the NED brought to the business. This would appear to support the view expressed by Cadbury in the quotation above.
  
  
• NED contributions were found to be multi-various and mapped across the range of SME board functions. An NED will need to be matched individually for each SME’s needs; nevertheless there are some broad patterns that should be taken into consideration by policy-makers and advisers. Smaller scale SMEs appear to value financial expertise, whereas larger scale SMEs place more emphasis on outside objectivity, structured board procedures and having a prestigious name on the board. This suggests that slightly different NED competency profiles may be needed at different stages of SME development. Indeed, an SME may need to change its NED as its development progresses to take into account the different challenges faced by the board.
  
  
• NEDs spend on average eighteen days per year on their SME’s business, but there was a wide variation in the responses. The results show that the extent to which NEDs become involved in the operation of the company also varies considerably; there is no clear difference between large and small firms.
  
  
• There is clear evidence that more educated managing directors are more likely to have NEDs on the board.
  
  
• There is no significant difference in the performance (profitability or growth) between businesses with NEDs and those without NEDs. However, this should be tempered with the finding that the majority of managing directors felt that their NEDs added value to their business.
  
  
• SMEs are most likely to acquire NEDs through informal personal contacts rather than through more formal means, such as advertisements or NED registers. The smaller scale SMEs in the 1-49 employee band rely even more on family and friends for finding an NED, than the larger scale SMEs in the 50-499 employee band, who relied more on their bank or accountant. It appears that SMEs are more likely to listen to suggestions from trusted sources, such as their family or accountant, than they are from more distant sources such as NED registers or Business Links.
  
  
• Managing directors called upon a broad range of business advice and mentorship. The favourite mentors with managing directors were fellow directors, outside accountants, their spouses, bank managers and business friends. When a managing director had access to an NED then they ranked near the very top of mentors just below other inside directors.
  
  
• These findings add weight to the argument that those who have them perceive their NEDs to have positive rather than detrimental effects on SMEs. The high awareness of NEDs by managing directors and the low take-up suggests, however, that simple campaigns to promote the role of NEDs are unlikely to be effective.

Policy implications and recommendations

Although it has not been possible through this research to demonstrate a link between the presence of an NED and profitability or growth, the research has shown that where NEDs are used, managing directors in SMEs generally see them as adding value. The research has also highlighted the high level of awareness of NEDs and the fact that their roles are multi-various and relate to both size and stage of development. Therefore, if it is shown that NEDs do provide value for money, policy makers should have regard to some of the key findings and their implications for policy.

• As there is already a high level of awareness of NEDS simple campaigns to raise the awareness of them are likely to have little effect. Instead, if NEDs can be shown to provide value for money, campaigns should be aimed at convincing MDs and boards of SMEs that NEDs can make valuable contributions.
  
  
• The research showed there was a break point at around 50 employees where SMEs become more likely to engage NEDs. This suggests that policy makers should target NED support at SMEs that are emerging or have recently emerged from the 1 to 49 employee band.
  
  
• The research findings suggest that the task of encouraging the take up of NEDs is more likely to be successful if done via trusted sources, i.e. the bank and the accountant. There could be a role for policy makers in encouraging the education of banks and accountants to fulfil this new role.
  
  
• Although the research found that the role of NEDs is likely to be multi-faceted there are some broad patterns that need to be taken into account by policy makers and advisers. These are that smaller SMEs appear to value financial expertise in their NEDs whereas the larger scale SMEs place more emphasis on outside objectivity, structuring of board procedures and having a prestigious name on the board.
  
  
• The finding that smaller SMEs have less formal procedures for dealing with their NEDs, including those related to appointment and removal, suggests that policy makers should beware of imposing procedures that are too formalised for smaller scale NEDs.

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