The Role of Non-Executive Directors in Company

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Table of Contents

Introduction
Company Background
The Role and Importance of Non-Executive Directors
Risk Management Tools
Conclusion
Bibliography

Introduction

Many companies hire non-executive directors to receive a professional advice and develop strategic goals and perspectives for the company. That is, non-executive directors make the right decisions and use influence to get the decisions implemented. In making decisions, non-executive directors decide how to plan, organize, staff, lead, and control resources in order for the goals to be achieved. The final desired output of the entire management process is goal achievement. In a word it is performance. The key to high level management performance, then, is to make the right decisions, those that best use the resources available so that the desired goals can be achieved. Non-executive directors know that they depend on many people in the organization for their success. When making decisions to best utilize resources they know that their bosses, subordinates, organization, and themselves each will have a role to play. Furthermore, these non-executive directors can inspire others for high performance in their respective role.

Company Background

Marks & Spencer is the United Kingdom’s leading retailer and most admired company due largely to its simplicity. A $10 billion-a-year company selling everything from lingerie to baked beans under the St. Michael private label, Marks & Spencer was ranked the number one company in Britain by The Economist in 1991. Other areas receiving a number one ranking were ability to attract and retain the ablest employees, long-term value, and community and environmental responsibilities (Marks and Spencer Home Page. 2008). The company is also acknowledged, as it exports more than any other British retailer. Furthermore, it is admired because it has been so profitable. In the past ten years, it has tripled pretax profits. Marks & Spencer has 679 stores throughout the United Kingdom, Ireland, continental Europe, North America, and Hong Kong. Major franchising benefits realized are high returns, rapid accumulation of market knowledge, and strengthening of Marks & Spencer’s international corporate image. In addition, franchising allows the company the opportunity to expand its global presence and establish the St. Michael name in new markets, with minimal capital. A disadvantage of St. Michael franchising is the possibility of a company buy-out where the initial test marketing proves positive. Marks & Spencer must alter its operations when the company moves to the European Continent. For example, changing rooms are not offered in the United Kingdom but are essential in Europe. Another way the retailer alters its business is by opening smaller suburban stores that sell only food. This helps prevent market saturation by their typical stores while continuing to command the area. At the three hundred U.K. stores, almost 50% of sales came from food. In continental Europe, food only averages 12% of sales (Marks and Spencer Home Page. 2008).

Marks & Spencer feels that the European markets’ represent one of the best areas for progress and growth. Because of this, they hope to increase the number of stores on the Continent to forty, focusing on France, Spain, Belgium, the Netherlands, Germany, Italy, and Switzerland. Another reason that Europe is targeted so heavily is because the company has had difficulty entering U.S. and Canadian markets. In contrast to these two weaker markets, Spain and Germany have retail sales volumes comparable to those in the United Kingdom. Marks & Spencer plans to quadruple its continental retail footage in the next five years. Michael Marks as a peddler, to its present state as the leading retailer in the United Kingdom. Michael Marks, and later his son Simon, both used determination and dedication to make Marks & Spencer what it is today. The members of this company know how to utilize their knowledge and how to study trends in order to do just what the consumer wants. The high quality and fair price of their merchandise exemplify this dedication to their patrons (Marks and Spencer Home Page. 2008).

The Role and Importance of Non-Executive Directors

In Marks & Spencer, the key role of non-executive directors is to advice the board of the directors and management. Decision-making, along with leadership and communication is one of the top three attributes a successful manager needs. Decision-making is directed to reaching a goal/objective. It is about the how, what, why, when (and where) of a course of action and of how to overcome obstacles and to solve problems. Decision-making is what turns thought into action: it implies change and requires a decision to be made against a background of uncertainty and risk. Non-executive directors need to be able to choose the action or course of action that is the best for organization to meet its objectives (Burkun 2005). An effective decision is one that produces the goods, ie gives the desired end result. It is important to be able to project ahead, to take the expected and unexpected into account, to have contingency plans in case events intrude in such a way as will turn a good decision into a bad one. There are usually several different decisions that can be taken and pressure to decide. Setting goals establish the pathway to positive results. Deciding what it is that Marks & Spencer’s non-executive directors want to do is the goal-setting stage, doing it is the process, and accomplishing goals is the outcome or result. The manager’s responsibility is to produce positive results. Setting clear, challenging goals and then doing what is necessary to accomplish them is the daily process. Success will be in measured by the degree to which a goal is accomplished, but alas, life is not this simple (Badiru, 1993).

In Marks & Spencer, goals may not help, and they may even harm performance, at the early stages of learning a complex task on which there has been no prior training or inappropriate training. Strategic management is a philosophy that describes how to manage an organization. Through the selection of appropriate mission goals and objectives, an organization can attain its purpose. In other words, strategic management means deciding what Marks & Spencer’s non-executive directors want to do as an organization and then doing it. It is a results-oriented philosophy in which managers decide what non-executive directors want to do and then establish the strategies to accomplish goals. Those strategies are the heart of the results-oriented philosophy (Drucker, 2004). Without a defined purpose and mission, it is folly to think that an organization can effectively achieve any collective goals. Non-executive directors can fill the day with activity and yet accomplish nothing. If an organization lacks a clear sense of purpose and doesn’t know what its primary objectives are, it is not likely to achieve them. Through its vision (purpose, mission, philosophy, and goals), an organization defines its values and results.

In Marks & Spencer strategic management should permeate every organizational level. Its function is to create a shared sense of identity and culture that resonates even down into the boiler room. Top management infuses a shared sense of purpose by establishing organizational goals and objectives. Thus, strategic management is the responsibility of the chief executive officer. The CEO can’t do it alone, however; strategic management requires the cooperation of the entire top management team. These individuals are in a position to see the organization as a complete entity. The top management team also experiences firsthand the relationship of the organization to the external environment. The CEO and the top management team focus attention on internal and external environments in order to establish critical goals that will produce vital long-term results (Badiru, 1993).

If top managers do not think strategically or feel there is no need to do so because the organizational environment is stable, they will find that their organization is standing still–or even moving backwards–as its competition passes it by. Strategic management will focus organizational efforts. It is a way to move forward and fashion the future. Strategic management is a results-oriented philosophy of management. It is a philosophy of focusing the activities of an organization so as to achieve success. It is not a technique but rather a belief with a clear purpose, philosophy, mission, and goals. People will respond well to molding the future, as it is a natural human characteristic to strive for meaningful goals and objectives. Strategic management is a philosophy about results, attitudes, and perspectives. It formalizes a stream of actions that result in clarity, consensus, and commitment to a basic purpose for the entire organization (A Guide to the Project Management 2000).

For Marks & Spencer, the more challenging the goal, the higher the performance level and the greater the rate of success. Integrity suffers when managers demand or expect from their subordinates an exaggerated personal loyalty to mission–the kind of sentiment that makes people lie, cheat, or steal. An extreme emphasis on performance as a criterion of success may foster an atmosphere of raw striving that results in brutality, be it profit, competition, status, money, or whatever. When results become an end in themselves, the manager has overstepped the bounds of human dignity–the moderator is integrity. People are perceptive. Once a manager is judged, or even perceived, as lacking integrity, he or she is in trouble (Blanchard and Johnson, 1983).

Risk Management Tools

In attempting to gauge the profitability, the Marks & Spencer’s non-executive directors may take a higher volume and a higher price and consider this to be the best of all possible worlds. To complete the picture, a lower volume and a lower price than the most likely volume and price are selected for the worst of all possible worlds. This then provides measures of profitability for the most likely, the best, and the worst of all possible worlds–yet these are all measures of impossible worlds (Newbold1998). There has never been a time in history when a factory operated in a free market environment with the price of the goods, and the volume of goods produced, remaining exactly at one value for twenty years. The one thing that can be said about the most likely of worlds is that it fairly represents the manager’s best assessment of average volume and average price over a long period of time. The conventional measure of risk as an undesirable or unacceptable rate of return is not the actual risk faced by businessmen. The fact is that a firm can survive a low return as long as there is sufficient cash reserves to fund shortfalls in revenue generation. The reality of business life is that a firm flush with cash can easily endure bad times when there is a low rate of return. Survival is threatened when there is insufficient cash generation or reserves to pay the bills. If bankruptcy is the true risk of conducting business, then the threat of bankruptcy should be the measure of risk (Frame, 2002).

Interest rates and foreign exchange can be assessed with the help of simulation models. Although the risk of a less than desirable return is concomitant with an inability to pay bills, the two do not necessarily go hand-in-hand. One can have an unsatisfactory level of profits and still have enough money in the bank to keep creditors at bay (O’Neill and Fletcher 1998). To a manager, and to the shareholders of a corporation, low returns may be disappointing, but are not necessarily fatal. There is a major difference in the obligatory nature and ramifications of not being able to meet the payroll and not being in a position to pay a dividend on common stock. Not being able to meet the payroll, or pay suppliers, or pay a finance charge can lead to the creditors taking action against a company that can force it into bankruptcy (Owens and Wilson, 1996). A poor return on the company’s investments means that there is little money left after paying employees, suppliers, and bankers to pass on to shareholders in the company in the form of a dividend payment on the common stock. The inability to pay a dividend does not force a company into bankruptcy. Dividends on common stock are not obligatory and shareholders have no legal basis for pursuing the payment of dividends in court. Monies due to employees, suppliers, and bankers are obligatory in nature and these parties do have access to the judicial system to protect their rights. A low return means a meager or nonexistent dividend. A shortage of cash and the exhaustion of borrowing capacity means impending insolvency and possible liquidation of the company. Since bankruptcy is not associated with poor returns as such, but with insufficient liquidity, then risk should be measured in terms of insolvency and its impact on corporate survival, and not solely in terms of an undesirable return (Blanchard and Johnson, 1983).

This hurdle rate varies from one company to another depending on the respective roles of equity and debt in its capital structure and the cost of capital associated with equity and debt. The hurdle rate can be calculated on a before or after tax basis, which is not as simple as it may seem because a dividend on a common share of stock is paid with after tax dollars while interest on debt is paid with before tax dollars (Peters, 1992). This is a consequence of interest on debt being a tax deductible expense whereas dividends are not. If gross margin is less than fixed costs and depreciation, the before tax income will have a negative value. A negative taxable income is not considered a tax credit (Frame, 2002). Any negative taxable income is accumulated as a tax loss carry forward to shield future tax liabilities. Once the tax loss carryforward is exhausted, any further tax liabilities are paid as a current expense. Some rounding errors are present as all figures are expressed to the nearest thousand of dollars (Borg & Gall 1989).

The conventional view has no allowance for risk. Everything is on a most likely schedule. There is no appreciation for risk other than attempting a few “What If” scenarios to examine cases where production is something other than the most likely case. Even here, one wonders what to do about the results of “What If” scenario analysis besides noting each one individually and finding out that all may not go well with this project if the scenario deviates somewhat from the most likely course (Petroski, 1985). The second alternative is simulating the range of possibilities as provided from management assessments with a payout of all positive cash proceeds to the equity owners (zero maximum balance in the escrow account). Presumably this money is to be invested in other long-term projects bearing the same rate of return. Under these circumstances, the risk of insolvency of some degree is virtually certain, with an 80 percent probability of insolvency being in excess of $1 million, the demarcation line for a real possibility of bankruptcy (Laudon & Laudon 2005). This, in effect, increased the capital investment and lowered the rate of return. In addition, positive cash flows were used to repay the accumulated deficits in the escrow account before being passed on to the equity owners (Saaty, 1999). Upfront funding of the escrow account reduces the risk of bankruptcy to something on the order of one chance in a hundred. With upfront funding of the escrow account, deficits generated in the early years of the project’s life can be funded. This significantly diminishes the risk of insolvency, but the cost is an increase from 40 to 60 percent in the probability that the minimum hurdle rate of the company will not be satisfied (Solomon, 1998). At this point, non-executive directors have a tool for measuring risk that can be easily adapted to evaluate alternatives such as various sized escrow accounts and ways of funding such accounts. Non-executive directors have the results of such simulations and ways to evaluate the results. However, management has something even more valuable. Through the use of the escrow account, management can control the degree of risk. Adding to the escrow account reduces both the degree of risk and reward (Senge, 1990). Suppose that management is considering two projects and there are capital funds for only one project. Both can be evaluated for risk and reward, but they cannot be compared to reach a decision on which to select because the nature of the risk is different for each project. By adjusting the initial funding of an escrow account, however, the risk of bankruptcy can be equated with some corporate objective. The corporate objective should not be 0 percent because the risk of bankruptcy can never be totally eliminated. Once the risk of both projects have been equated with some corporate objective, such as 1 percent, then the reward of the two can be compared to see which is higher. All other things being equal, the project with the higher expected reward should be selected as the one to be funded since the risk of both projects is the same (Montgomery, 1998).

The ranking of projects is usually in terms of reward with little regard to risk. The use of simulation and the adjustment of the escrow account permit projects to be ranked by reward for a given level of risk. This should place managers in a better position to select those projects that should be funded and those that should be shelved. A general purpose simulation program could be written containing the principles described here 9Schermerhorn, 2007). Management would enter assessments of the most likely values, and the limits on the range of values, for the key variables along with a maximum negative balance in the escrow account to separate insolvency from bankruptcy. The program would determine an initially funded escrow account that satisfies the corporate objective on risk. The funding of the escrow account becomes part of the capital commitment of the project (Solomon, 1998).

Conclusion

Intelligent advice provided by non-executive directors is a skill that will facilitate a strategic management philosophy. It provides a way to review the options, set prioritized agendas, and effectively use organizational resources. Intelligent advice is a process that defines goals and then provides the strategies to achieve them. It is a systematic method to anticipate and adapt to expected change. Crafting an organizational purpose is the most important task in the entire strategic-planning process. If purpose is wrong, then all that follows is wrong. At best, resources will be misdirected; at worst, human resources will be wasted toward an unworthy cause. Whether the purpose of the organization is to make and sell goods, heal the sick, teach, or provide a service, the statement must convey the heart and soul of an organization. It is the organization’s central theme; it must convey its essence and its lasting value. Purpose also governs the behavior of the entire organization and is the indispensable focus.

Bibliography

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