Concept And Importance Of Corporate Governance

Published Date: 02 Nov 2017

This section identifies different definitions of corporate governance, lay downs its importance and surmises the main development of corporate governance model around the world.

3.2.1 Definition of Corporate governance

There is yet no generally accepted meaning of corporate governance (Du Plessis et al, (2005); Solomon, (2010)). Du Plessis et al, 2005, argue that it is "something whose nature we know yet words do not provide an accurate picture" (p.1). They further argued that, in so far as providing a general working definition is concerned, despite the attempts by several academic, no specific coherent definition could be found. It differ from one interested party to the other and this could leads to confusion.

Thus, various definitions have been provided to define the term ‘corporate governance’ where most of the definitions reflect different points of view. These various definitions depends upon the perspective of the regulators, practitioner, researcher or theorist (Solomon, 2010).

However, Solomon (2010) stated that the "It seems that existing definitions of corporate governance falls along a spectrum, with 'narrow' views at one and more inclusive, 'broad' views placed at other" (p.5).

In an earlier place, Cadbury Report (1992) gave a definition to the term corporate governance as the system by which companies are directed as controlled. This definitions is based from the narrow point of view and consider corporate governance as an internal task of a company.

Moreover, Keasy and Wright (1993), defined corporate governance from the success of a company which consider to be a narrow point of view. They define corporate governance as:

"The structures, process, cultures and systems that engender the successful operation of the organization" (p.2).

Parkinson's (1993) defined corporate governance as:

"The process of supervision and control intended to ensure that the company's management acts in accordance with the interest of shareholders " (p.159).

This narrow point of view of corporate governance focused on accountability to shareholders.

These narrow perspectives of corporate governance refers to the relationships between a company and its shareholders and only focusing to ensure that accountability of managers towards shareholders of company. This narrow perspective were criticized that it fails refer to the role of stakeholders in corporate governance and their responsibilities in helping to attain corporate governance objective or the accountability of a company to a wide range of stakeholders (Du Plessis et al., 2005)

Apart from the narrow definitions of corporate governance, there is a set of boarder definitions that provides a wider insight to the subject of corporate governance which extends to comprise all the relationships between a company and its stakeholders rather than only shareholders. For example, Tricker (1984) Define corporate governance as:

"the governance role is concerned with the running of the business of the company per se, but with giving overall direction to the enterprise, with overseeing and controlling the executive actions of management and with satisfying legitimate expectations for accountability and regulation by interests beyond the corporate boundaries" (p.6 and7).

Also, Organization for Economic Co-operation and Development (OECD, 2004) defined corporate governance to extend the relationships with other stakeholders by stating that:

"Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. Good corporate governance should provide proper incentives for the board and management to pursue objectives that are in the interests of the company and its shareholders and should facilitate effective monitoring" (p.11).

Similarly, Solomon (2010) defined corporate governance from a wider accountability perspective to all stakeholders as:

"the system of checks and balances, both internal and external to companies, which ensures that companies discharge their accountability to all their stakeholders and act in a socially responsible way in all areas of their business activity".

Based on the above definition, corporate governance is concerned of two aspects namely, factors that are internal to the company as well factors that are external to the company ensuring that it serves the interests of all the stakeholders rather than being limited to addressing the interests of shareholders only.

Therefore, there are a wide range of definitions that refer to corporate governance based upon various perspectives. However, accountability seems to be a key in all perceptions, but the difference among them relay to whom that accountability is discharge; Narrow definitions of corporate governance focus on corporate accountability to only shareholders, while broader definitions emphasis accountability to shareholders as well as other stakeholders (Elkelish, 2007).

Furthermore, Solomon, (2010) argued that although the narrow shareholders' approach is compatible with the theoretical framework of the stakeholder accountability approach, the interest of the shareholders' can only be fulfilled by taking account of the interest of stakeholder, and that corporations can be more profitable in the long run if they are accountable to all of their stakeholders. This indicates that corporations can maximize their value over the long term, by extending their accountability to includes all their stakeholders and by improving their corporate governance system.

The above reveals that there is no single universal definition of corporate governance(Du Plessis et al., 2005). Most of these definitions show the basic perspectives or paradigms within which view are formed, from the narrow perspectives representing the relationship of a company to its shareholders, and the wider point of view of a company's to all stakeholders groups. This thesis adopts the broader view of corporate governance using a stakeholders approach where corporations are accountable to a broad range of stakeholders.

3.2.2 Importance of Corporate Governance

The importance of corporate governance has gained a lot of attention in the recent year as a result of the sequence of corporate scandals and economic crisis in a number of countries. Monks and Minnow (2004) stated that after the financial collapse of a number of leading companies in the UK, the USA and elsewhere, the important of corporate of governance became understandable. By having good corporate governance this will lead to enhance investor confidence, promote competiveness and improve economic growth, especially in emerging countries. James Wolenson, stated that

In the same context, Aikleng (2004), pointed out, investors in Malaysia lost their confidence due to the weak corporate governance standards and to the lack of transparency in Malaysia’s financial systems. Therefore, restoring confidence in the Malaysian economy depends on the improvement of good corporate governance standards.

Moreover, the OECD stated that good corporate governance may enhance productivity and promote economic growth for individual companies and across economics as a whole. it noted that:

3.2.3 Developments of international corporate governance

3.2.3.1 The UK Corporate Governance Code (Combined Code)

UK has made a tremendous effort to develop corporate governance practices in the country where they have appointed several committees from time to time to investigate and provide recommendations. The combined that was published in 1998 was an amalgamation of best practices that were recommended by such committees in different instances. The salient feature of combined code published in 1998 was that it was not a mandatory requirement for companies to adhere; rather it encouraged voluntary revelations without any legal obligation. In this context, The Combined Code (1998) introduced a concept called "comply or explain" where it provided companies the opportunity comply with the standards or provide an explanation for non-compliance (explain) to the stated standards. In commenting about this concept, Higgs (2003) states that legal enforcement/rigidity is unable to build the trust or control the behavior of a company and therefore, companies are expected to understand the significance of trust and thereby adhere to Combined The Combined Code (1998) and make voluntary disclosures. Higgs (2003) emphasizes more on the importance of voluntary disclosures in developing supreme corporate governance, which needs to be understood by organizations and its board of directors. The Combined Code of (1998) makes it a must for companies to include a statement of compliance explaining the application of The Combined Code in company annual reports. Further, The Combined Code (1998) also aims to transfer the extreme power that is wrested in the company’s board of directors and subcommittees represented by the executive directors of the company to the non executive directors of the company, valuing the importance of presence of non executive directors. This gives rise to a different form of decision-making and governance in a company and The Combined Code (1998) placed a great weight on segregating between the role of CEO and the chairman in a business organization.

2.2.3.2 Developments in the US (Sarbanes Oxley Act 2002 provisions)

Ribstein (2005) identifies "sudden acute regulatory syndrome" which occurs after a crisis that has caused major damages to the financial market and he views Sarbanes Oxley Act (2002) also falling into the same category. The main objectives of Sarbanes and Oxley Act (2002) were stated as improving accountability among the employees, boosting the quality of disclosure practices, incorporating changes to role of audit committee and enhance the accountability in the instances of false actions. (Gray, 2005) Another salient feature of Sarbanes and Oxley Act (2002) is that it creates congruence between interests of shareholders and the board of directors/managers of the company where it is expected to reduce the inspection cost to the shareholders that occurs in safeguarding their interest. Even though the objective was to reduce the cost, there have been severe comments on the significance rise in cost of compliance in publicly listed entities that attempt to follow Sarbanes and Oxley Act (2002). As a result, there have been many researches conducted in this subject where studies such as Litvak (2007a) and Zhang (2007) reveals that benefits that are accrued by complying with Sarbanes and Oxley Act (2002) is lower than the cost that is incurred to comply which were quantified through wealth effects and market reaction. Nonetheless, Li, Pincus and Rego (2008) reveals that there is high abnormal stock returns connected to compliance with Sarbanes and Oxley Act (2002). However, there is also another study conducted by Zhang (2007) that reveals the cumulative abnormal returns generated in legal occasions of Sarbanes and Oxley Act (2002) were highly adverse and these findings were reinforced by the findings of Litvak (2007b). Further to these studies, Chhaochharia and Grinstein (2007) conducted an investigation to find out impact of SOX on the firm’s value and it was revealed that firms with low fulfillment of SOX requirements gained positive abnormal yields in the time of publicizing this regulation and they concluded that small firms experience cost issues in complying with SOX.

Considering the aspect of accountancy, Lobo and Zhou, (2006) could result in a situation of conservative accounting practices where yields of company might be stated low. Lobo and Zhou, (2006) demonstrates that it could have a significant impact on valuation and calculation of capital gains made by stockholders. Further, is it also highlighted that SOX has surged the auditing and reporting costs of the organization where the average auditing charge has improved by USD 2.3 million in the time of the introducing SOX. These sentiments have resulted in a reduction in companies obtaining cross listing and improvement in the number of companies gaining private status. (Engel, et al., 2007; Marsoi and Massoud, 2007; Zhu and Small, 2007)

The King Report on Corporate Governance for South Africa

As the importance of corporate governance was highlighted in South Africa, The King Committee established in 1992 in order to review corporate governance practices that are associated with the Southern African Institute of Directors (Rossouw et al., 2002, p.296). The Mervyn King headed this committee and they laid down the objective of the committee highlighting the primary objective of improving the quality of the corporate governance practices in South Africa. (King Report, 2002) The committee presented its findings on corporate governance practices in South Africa with appropriate recommendations and subsequently the report was named as King 1, which had more similar findings and recommendations made by Cadbury Committee in UK.

However, the findings of King 1 was examined in 2002 based on its weaknesses such as not empowering the non executive directors by making them independent of the executive management of the company, which could have resulted in a higher liberation of the board of directors. (Malherbe and Segal, 2003). Further, as a major downfall of the King 1, analysts identified that King 1 has not been able to align its recommendations to solve burning issues in South Africa such as empowering black community, equivalence in employment practices and environment issues that are considered vital issues in the eyes of stakeholders. (Rossouw et al., 2002, p.300; Malherbe and Segal, 2003, p.195)

As a result of above-mentioned criticisms, Southern African Institute of Directors again summoned the King Committee in 2000 and they published the King Committee on Corporate Governance – Two including findings and recommendations in 2002. The recommendations of King Report II is make extension to the basic recommendations made in King Repot I in aspects of accountability, equality, obligation and translucence. (King Report, 2002). Further, King Report II substitutes the concept of integrated corporate governance used in King Report I with Inclusive/instrumental corporate governance and this is considered to be incorporating a distinctive and amalgam approach to corporate governance in South Africa. (King Report, 2002; Andreasson, 2009)

Other important developments around the world (OECD Principles of Corporate Governance)

Apart from the national level initiatives, supra-national bodies such as OECD have made tremendous effort to bring about corporate governance in business organizations. In such effort, OECD announced Principles of Corporate Governance in 1999 in order to increase attentiveness to cooperate governance in a worldwide context. Further, OECD principles were revised in year 2004 based on the finding of a empirical study that was conducted in its member countries including contributions from scholars.

In commenting on the limitations of OECD principles, OECD (2004) itself identifies that principles might be practical in all the countries due differences in business, economic, political and socio-cultural environments. However, OECD (2004) emphasizes on the positive aspects of such principles including enhanced economic proficiency, which could lead to assurance in investor’s minds. In further highlighting the positives, OECD (2004) states that these principles construct the road map for a sustainable development considering interests of all the stakeholders. As secondary benefits of compliance, OECD (2004) stresses on benefits such as reduction in corruption rates and improved corporate ethics, which are a must for the functioning of a business.

Nevertheless, scholars have identified weaknesses associated with OECD (2004) principles where Solomon (2010) highlights the lack of legal background or enforcement mechanism and Kirkpatrick and Jesover (2005, p. 127) identify that primary focus is only on publicly listed entities ignoring private and non listed companies. However, OECD (2004) has gain considerable level of acceptability at a global level where supranational bodies such as World Bank and International Monetary Fund apply OECD principles to evaluate corporate governance practices in certain nations. (Kirkpatrick and Jesover, 2005)

3.2 Corporate Governance Aspects

This sections highlghts the different models of corpoarte governance. it also identifies the most common topics in the regulations and codes of corpoate governance such as: the board of directors, ....

3.2.3 Corporate Governance Models

Corporate governance models differ according to the nature of countries applying the concept of corporate governance, for each country is different in terms of economic, legislative, political, social, cultural, and nature conditions. The relationship between the firms and the various categories of stakeholders also differs. As the OECD pointed out, "There is no single model of corporate governance". According to the OECD principles, in order for organizations to be able to compete in the current serious competition, these organizations should create their own corporate governance code to be able to respond to the customers’ new demands and seize the available opportunities. Coleman & Biekpe’s (2006) study pointed out that corporate governance systems differ according to the following:

the degree of ownership and control

The identity of controlling shareholders. For example, there is a huge conflict between the managers’ interests and the shareholders’ in the United Kingdom and the United States and this is known as the vertical agency problem, while the conflict is between the controlling shareholders and minority shareholders in Germany and Japan and this is known as the horizontal agency problem (Lefort & Urzua,2007).

In addition, De Miguel et al., (2004) stated that there are five main characteristics to distinguish between the models and the different systems in applying the concept of corporate governance. These five characteristics are the following:

The legal protection of investors

The level of ownership concentration

Development of capital markets

The role of the market for corporate control

The effectiveness of boards of directors

Moreover, Weimer and Pape, (2000) identified the dimensions and characteristics that can be used to describe and identify the differences between the models of corporate governance. These dimensions are:

The view of the firm: the intent in this dimension is viewed as a mechanism used to maximize the wealth of the shareholders or it is a social unit that seeks to achieve the interests and wishes of a large number of stakeholders.

Stakeholders who have the ability to influence management decision-making processes

The board of director system: does this model depend on the existence of a one-tier system or two-tier systems?

The importance of the stock exchange in the national economy,

The presence or absence of an external market for corporate control,

The ownership structure,

The extent to which executive compensation is dependent on corporate performance,

The time horizon of economic relationship,

However, corporate governance models are categorized into two models: the outsider model and the insider model of corporate governance. Rosser (2003) and Solomon (2010) explained that the main characteristics of the outsider model is described as diversified ownership structure; more separation of ownership and control; large firms owned predominantly by outside shareholder; and a strong legal protection of shareholders which is used in Anglo-American countries (e.g. US, UK, Canada, Australia, New Zealand). The main characteristics of the insider model is described as concentrated ownership structure in small group of shareholders (family ownership or state ownership); weak legal protection of shareholders; and companies owned predominantly by insider shareholders who also control over management.

Table 3.1 Main Characteristics of Insider and Outsider Models of Corprate Goverance

Characteristic

Insider

Outsider

Owners

Insider shareholders

Outsider shareholders

Ownership structure

Concentrated

Dispersed

Separation of ownership and control

Little

Separated

Control over management

Bu Insider shareholders

By Managers

Agency Problem

Rare

Exist

Hostile takeover activity

Rare

Frequent

Legal Protection of investor

Weak

Strong

Role of other stakeholders

Less

Strong

Source: Solomon (2010, p.191)

Note: This Table summarizes the differences between insider and outsider models of corporate governance.

3.1. A. The Anglo-Saxon model:

This model is applied in many countries around the world such as Australia, Canada, South Africa and some of the commonwealth countries, in addition to the United Kingdom and the United States (Scott, 1996; Weimer and Pape, 2000).

This model is used assuming that corporate governance protects the shareholders’ interest whether they are individual or institutional investors. Therefore, the shareholders’ interest is the only interest that the company aims to achieve. Moreover, the shareholders are the only stakeholders that have the power to influence the management decisions. So, the managers in the view of this model are agents for the shareholders. The main function for the top managers is to maximize the wealth of the shareholders. Therefore, the measurement of the company’s success in this model is the amount of profits and the return on the investment (Scott, 1996; Al-ajlan, 2005).

This model relies on several strategies to encourage the managers to achieve the needs and the interests of the shareholders such as linking the rewards to performance (the managers receive rewards as long as their performance achieves the goal), transparent accounting standards and the development of effective boards of directors. In the Anglo-Saxon model the ownership of the firms is separated and distributed to a large number of shareholders (Roe, 2003; Weimer and Pape, 2000). Moreover, laws provide the protection for minority shareholders (Denise and McConnell, 2003). The board of director system in this model is one-tier and is responsible for operational decisions and carries out a monitoring role over the executive management. This board consists of executive and non-executive directors (Monks and Minow, 2002; Al-ajlan, 2005,).

3.2. Insider model of corporate governance:

This model is applied mainly in Germany and Japan and depends mainly on the participation of banks, institutional investors and other corporate firms in the corporate governance process where there is an increased percentage of ownership by the banks and institutional investors in the companies. These shareholders possess the capacity and capability to enable them to control management and control the performance.

3.2. A. The Germanic model:

The Germanic model is considered as an insider model of corporate governance. This model seeks to incorporate the goals and interests of different groups of stakeholders, including the shareholders’ interest. The board system in this model is two-tier (Weimer and Pape, 2000; Al-ajlan, 2005). The boards consist of a management board (Vorstand), which is responsible for the day-to-day running of the firms and a supervisory board (Aufsichtsrat), which is responsible for supervising the management board. The supervisory board in this model consists of a group of members representing the shareholders and employees (Al-ajlan, 2005). Weimer and Pape (2000) noted that it is not allowed for the same person to be a member of both the supervisory and the executive board. In the Germanic model the ownership structure of the firms is concentrated. In addition, the mechanism of rewards and compensation linked to the performance of managers is not commonly used (Monks and Minow, 2002).

3.2. B. The Japanese model:

This model adopts the social view of the institution as it is considered as a community or a nation which must care about the interests and needs of different groups of stakeholders as well as the shareholders. There is a system known as Kereitsu in the Japanese model. This system is based on the interaction in the relationships between the business organizations in Japan. Gilpin (2001) has pointed out that the Kereitsu system consists of the top 200 Japanese companies. The most important groups in the Japanese model are the shareholders, employees, banks and major customers. These groups are considered as the strongest influence on the management of Japanese companies. According to the Japanese companies’ ownership structure, it is a concentrated ownership, although the proportion of ownership in the Japanese model is less than in the German model. Moreover, the Japanese model relies on one-tier to manage the companies. This model does not believe in linking rewards to performance (Monks and Minow, 2002).

3.2. C. The Latin model of corporate governance:

The Latin model contains some of the characteristics of the Anglo-Saxon model and some of the Germanic/Japanese models. Some of the countries that apply this model are France, Spain, Italy and Belgium. Shareholders are the influencing group in the Latin model, but not with the same level of influence as in the Anglo-Saxon model. The shareholders have the power to influence the board of directors of the companies and restructure these boards if 50% of them agree (Weimer and Pape, 2000). Some of the companies that apply the Latin model rely on the one-tier system and some of them use the two-tier system. According to the French law, the companies have the ability to choose between these two systems, whether to have one-tier or two-tiers. Regarding the ownership structure in the Latin model, there is a kind of ownership concentration in the companies. Moreover, the linking of the reward to the performance scheme is used to some extent (Monks and Minow, 2002).

3.2.2 Board of Directors

The board of directors is considered one of the most significant mechanisms to promote good corporate governance practices (The Cadbury Report, 1992, Abdel-Shaid, 2001) ) the board of director is one of the various interrelated factors that contribute to the proper functioning of the corporate governance system. Cadbury (2002) defined the board of directors as:

"The bridge between those to whom the board is accountable and those who are accountable to the board" (p.31). in addition, Solomon (2010) stated that:

"For a company to be successful it must be well governed. A well-functioning and effective board of directors is the Holy Grail sought by every ambitious company." (P.78)

The following sub-sections discuss different aspects related to the board of directors such as types of board of directors, board composition, board sub-committees

3.5.2.1 Unitary and Two-Tier Boards of directors Structures

Mallin (2010) stated that one of the difference between corporate governance all around the world is the board structure, which may be falling into one of these two main categories: (i) a unitary board system and (ii) a two-tier board system. A unitary board of directors system is very common in Anglo-Saxon countries such as in the UK and the US. This system includes both executive and non-executive directors sitting in one single board elected by the shareholders at the company annual general meeting (Solomon 2010; Mallin 2010). The board of directors’ falls in this category is responsible for all the company’s activities (Mallin, 2010).

On the other hand, the two-tier board system, or the dual board, is common in countries such as Austria, Germany, Denmark, the Netherlands and Japan. The boards in this category consist of a management (executive) board and the supervisory board, the management board is responsible for the day-to-day running of the firms, elected by the supervisory board, which only includes the executive directors. The supervisory board, is responsible for supervising the management board, elected by the shareholders and the supervisory board in this model consists of a group of members representing the shareholders and employees, and only consists of non-executive directors (Solomon, 2010; Mallin, 2010).

There are some similarities between these two types of board structures for example; the unitary board and the supervisory board usually share the function of choosing the members of the managerial body. For example, the unitary choose the top managements to run the company in the day to day basis. Whereas, the management board in the dual system is delegated by supervisory board.

However, each type has its own advantage and disadvantage. The proponents of one-tier system stated that there is a closer relationship and better information flows between directors in this system (Mallin, 2010). However, Mallin 2010, stated that , there is a lack of a separation between the functions of monitoring and management on a unitary board.

On the other hand, the supporters of the two-tier system (dual board) agree that this system provides a great opportunity to the stakeholders to have representative to set in the board to protect their interest (Solomon, 2010). In the countries under investigation in this study, according to their code of corporate governance, the board structure is a unitary board comprising of both executive and non-executive directors.

Board composition

Chairman and CEO

Splitting the role of CEO and the Chairman:

The main responsibility of the chairman is to lead , run board meetings and oversee the procedure of hiring, firing, evaluating and compensating the CEO (Jensen, 1993). However, the chief executive officer’s (CEO) responsibility is running the company’s business (Eliskh, 2007). Good governance practices usually advice to separate the positions of the chairman and CEO position and should not be carried by one person so that this person won’t have the power to control the company decision-making process (Mallin 2010, Solomon 2010). The UK Corporate Governance code (2012), for example, recommended the separation of the roles of these two positions as stated below:

"There should be a clear division of responsibilities at the head of the company between the running of the board and the executive responsibility for the running of the company’s business. No one individual should have unfettered powers of decision."(p.6)

In addition, the OECD (2004) states that the chairman and the CEO should be separated to achieve an appropriate balance of power and enhance corporate accountability by stating that:

"Separation of the two posts may be regarded as good practice, as it can help to achieve an appropriate balance of power, increase accountability and improve the board’s capacity for decision making independent of management." (p.63).

There is quite difference between UK corporate governance and The USA. The UK recommends the separation of the roles of these two positions, but in the USA there are no regulations or recommendations related to this issue. So one can notice that the CEO in USA companies is also the company chairman (Solomon, 2010).

However, some studies disagreed with the significance of separating the role of a company's chairman and CEO. For instance, Denis and McConnell (2003) stated that there is a little evidence on whether such a separation of the two posts enhances corporate governance effectives or whether it has a n effect on company performance or better decision-making. By having two roles at the same time will make it easier for them to take advantage of organizational challenges and opportunities (Weir et al, 2002.) Moreover, the communication flow also becomes better with two roles. Decision-making is uninterrupted due to clear and unambiguous leadership being followed (Hanifa and Hudaib, 2006.). in addition, Brickly et al. (1997) concluded that the costs of separation are greater than its benefits for the US large companies under investigation.

Thus, although there are some studies which do not agree with the significant of separating the two posts, there is a widespread studies and regulatory bodies who believed that the splitting the two posts considered to be as good practice of corporate governance and that would help to increase the board independence and efficiency and reduced the potential conflicts of interest. The next section focuses on the role of non-executives directors.

Non-executive Directors

By having a proper combination of executive directors, non-executive director (NEDs), and independent non-executive directors (INEDs) sitting on the board will enhance the board to fulfill its roles effectively. Thus, in defining a proper compensation for the board, it is crucial to understand the responsibilities that executives, non-executives, and independent director play this section highlights the definition and role of NEDs.

NEDs are an outside board member who have some relationship with non-board members and not holding the executive position in the company. They are, for example: relatives of management, consultant to the firm; involved in other related party transactions and etc, which may impair their real and perceived independence (Beasley, 1996; Carcello and Neal, 2000). Therefore, it has been asserted that non-executive directors (NEDs) are one of the key tools to have an effective board (Mallin, 2010). A lot of awareness has been pied to the role and the effectiveness of NEDs in companies after the companies scandals. In the UK, for instance, the Higgs Committee was established to review and reassess the role and effectiveness of non-executive directors. The Higgs review (2003) stated several recommendations on the role of NEDs, which is included into the UK Corporate Governance Code (2012). The UK Corporate Governance Code (2012) identifies the important role to be played by the independent non-executive directors that suggested by the Higgs Report (2003) by stating that:

"Non-executive directors should constructively challenge and help develop proposals on strategy." In addition, "Non-executive directors should scrutinise the performance of management in meeting agreed goals and objectives and monitor the reporting of performance. They should satisfy themselves on the integrity of financial information and that financial controls and systems of risk management are robust and defensible. They are responsible for determining appropriate levels of remuneration of executive directors and have a prime role in appointing, and where necessary removing, executive directors, and in succession planning" (p.10).

The non-executive director’s role basically has two main dimensions. The First dimension is the control function which means that the non-executive directors sitting on the board would exercise the control function over the executive director and ensure that they do not have the power to influence the board decisions. The Second dimension is that the non executive directors sitting in the board would contribute to the development and strategic decision making of the company (Mallin, 2010).

However, it is essential for non-executive directors to exercise their monitoring function effectively in order to contribute to the board. Therefore, the Higgs review (2003) in the UK provided comprehensive recommendations to the board and dealt specifically with the role and effectiveness of non-executive directors by stating that:

"To be effective, non-executive directors need to be well-informed about the company and the external environment in which it operates, with a strong command of issues relevant to the business. A non-executive director should insist on a comprehensive, formal and tailored induction. An effective induction need not be restricted to the boardroom, so consideration should be given to visiting sites and meeting senior and middle management. Once in post, an effective non-executive director should seek continually to develop and refresh their knowledge and skills to ensure that their contribution to the board remains informed and relevant. "

However, previous studies shows mixed results about the impact of the presences of non-executives on board. For instance, Hemalin and Weisbach (2001) in their studies about the US found that more NEDs on the board did not affect corporate performance, but they make better decisions regarding to CEO replacement, executive compensation and acquisitions. In addition, Hossain et al. (2001) investigated the relationship between the presences of the NEDs and firm performance in New Zealand firms and they found that more proportion of NEDs enhanced the firm performance. In contrast, there are some studies found that the more non-executives directors the worse it is for the company (Yermack, 1996; Klein, 1998). In the same Vain, Lee et al.(1999) found that there were negative relationships between the stock market reaction with the announcement of new non-executive director appointment.

However, there are some difficulties that may restrict the NEDs to fulfill their roles effectively. For instance, Weir and Laing (2000) argued that NEDs often command less knowledge about the company and find it too difficult to understand the complexities of the company. This difficulty is worsen by the fact that NEDs are usually in part-time posts who normally also sit on other boards (Bozec, 2005; Jiraporn et al., 2009). in addition, they may not have access to the needed information for decision-making and thus, difficulties may impede their performance and may lead to inadequate performance (Bozec, 2005). in the same context Pay (2001) states that:

"Even where NEDs are encouraged to contribute to and interrogate executive actions and proposals, they do not have perfect access to information or even access to perfect information: hence even those who have no prior connection with a board (i. e. `truly independent') are still very much in the hands of the chairman and the CE in terms of how agendas are put together, meetings are framed, information shared and decisions made " (p. 191).

Therefore, commonly the corporate governance codes pointed out that NEDs should devote adequate time to accomplish their roles effectively.