Preying On The Fear Factor (Paying For Perceived Non-Executive Risks)

Risk is about perceptions, not facts. Our perceived views of severity and likelihood are more important than historic figures of actual severity and likelihood. If you want a good example of the importance of perception over reality – the fourth annual Ernst & Young Corporate Governance survey amongst board members of the UK’s leading 500 companies suggests that, although a quarter of those surveyed were more likely to consider becoming non-executives than 12 months ago, over 40% had become more sceptical of such a move. Is this change in appetite due to new facts or new perceptions?

So have risks risen? It’s brutal, but we can try and find out about prosecutions of directors for errors, omissions or malfeasance, but sadly there is no equivalent for aspiring non-executive directors of the exemplary Health & Safety Executive database – see http://www.hse-databases.co.uk/prosecutions/ - for an example of how information about prosecutions gives you a real feel for the size, scale, sector and likelihood of prosecution - 982 cases prosecuted in 2003/2004, an average fine of £13,947, 89% of prosecutions leading to conviction, 17 directors and managers prosecuted with 11 convictions. If we had more information about other director risks, e.g. DTI censures or manslaughter cases or even payouts in court, perhaps I could be scathing about these shy non-executives misunderstanding of the facts.

But I can’t be scathing, because these retiring folk have little information. All they have as indicators of risk are insurance premia rises. Given that even charities have seen insurance rises well in excess of 30% during the past few years – for your information, according to insurers charity risks appear to be intensively correlated with airplane/skyscraper terrorist events – insurance premia are poor indicators.

Every risk has its price. With the government, the media and the insurers all ‘pumping up perception’, it’s no wonder that I have personally seen superb, independent non-executives stating that they would now expect £35,000 to £40,000 per year for the typical 12 to 24 days per annum when the same individuals would have taken £12,000 to £24,000 less than two years ago. If the risk of being a non-executive director has historically been mis-priced, I am the first person to welcome a more accurate assessment. However, this just doesn’t feel right. Risks have not risen that much – or we’ve been very inaccurate for a very long time.

When perception rather than facts or market demand leads to a “non-executive bubble”, albeit a pale imitation of the internet bullet also driven by misperception, who suffers? Well, this particular misperception costs companies in higher non-executive compensation and higher directors’ errors & omissions insurance; exacerbates the gap of moving from an unlisted company to a listed company; and most of all means that small companies are starved of influential outside connections and advice, precisely why we encourage them to engage non-executive directors. Moreover, there is a move towards qualifications over added value.

Increasing corporate governance pressures favour non-executive directors with the right qualifications – and many accounting readers will now feel rather smug here, including this author. However, most small companies do not have governance problems – they typically have problems with distribution channels, access to finance, marketing, key account management, technical issues or contracting. The non-executive who can help with these issues may not have the right string of letters after their name to get appointed. Who cares if you’re a talented street trader with a gift for marketing, you don’t have the MBA or CIM qualification to be a non-executive director.

Further, if the entire non-executive idea is discredited: they’re over-qualified; don’t really understand business; expensive and only needed when you go for a listing - then there are going to be fewer places all around, even for the qualified. And that’s going to hurt the UK economy, whether our perceptions concur with it or not.

Michael Mainelli, PhD FCCA FCMC MBCS CITP MSI, originally did aerospace and computing research followed by seven years as a partner in a large international accountancy practice before a spell as Corporate Development Director of Europe’s largest R&D organisation, the UK’s Defence Evaluation and Research Agency, and becoming a director of Z/Yen (Michael_Mainelli@zyen.com). Michael also achieved the first ISO 9001 certification in the City of London financial markets for the accountancy practice in 1990 and went on to help clients, such as one of the largest commodity traders, achieve ISO 9001 certification.

Michael’s humorous risk/reward management novel, “Clean Business Cuisine: Now and Z/Yen”, written with Ian Harris, was published in 2000; it was a Sunday Times Book of the Week; Accountancy Age described it as “surprisingly funny considering it is written by a couple of accountants”.

Z/Yen Limited is a risk/reward management firm helping organisations make better choices. Z/Yen undertakes strategy, finance, systems, marketing and intelligence projects in a wide variety of fields (www.zyen.com), such as developing an award-winning risk/reward prediction engine, helping a global charity win a good governance award or benchmarking transaction costs across global investment banks.

[An edited version of this article appeared as “Preying on the Fear Factor (paying for perceived non-executive risks)", Accountancy Age, VNU Business Publications (17 February 2005) page 26.]