Plunging financial markets may finally compel boards to do what critics of "fat cat bonuses" never could - get tough with lavish executive rewards.

The financial crisis - which has triggered massive balance sheet writedowns at investment banks, big job losses and a global credit squeeze - has persuaded top executives of some of the world's largest banks - Goldman Sachs, UBS, Deutsche Bank and Barclays - to forgo bonuses.

It is not the first time this has happened, as Peter Hahn, a fellow at Cass Business School, remembered in the FT last week.

He recounted how, as a young banker at Kidder Peabody in New York during the early 1990s, he overheard executives, who had been earning more than £1m a year, discussing shopping at discount stores.

This time it is not just overweight pay packets and conspicuous consumption of top executives that is worrying shareholders.

Critics are also questioning the role and performance of directors whose job it was to oversee the senior managers running the business.

Michael Schrage, an MIT Sloan School research associate and former director of Ticketmaster, who has advised businesses as diverse as Accenture, Johnson & Johnson, MasterCard, BP, Mars and Fujitsu, recently wrote in the FT: "The banks' managements ruinously failed to assess the real risks their companies took in pursuit of profit. But the boards of directors - the fiduciaries responsible for representing shareholder interests - also failed in their duties.

"The global financial melt-down reflects, in no small part, the failure of meaningful boardroom scrutiny.

Honesty and any serious hope for the future of corporate governance compel that this be acknowledged."

Mr Schrage argues that risk management should be the "explicit duty of the board", but experience had shown that "companies trading hundreds of billions of dollars' worth of credit instruments had inadequate risk management systems that were neither understood, challenged nor improved by boardroom review."

So should regulatory regimes be tightened? And should it be up to ministers to determine pay levels if taxpayers are footing the bill?

If so, there is a risk of emasculating managers to the extent they would fear to take any risk, stifling investment and undermining potential for growth.

It might be more effective if non-executive directors and institutional shareholders simply became more assertive in holding companies to account, as Paul Myners, minister for the City, recently attested.

Speaking at a conference for non-executive directors organised by Independent Audit, the corporate governance consultancy, Lord Myners called on investor groups, such as the Association of British Insurers and the National Association of Pension Funds, to provide better training and guidance for non-execs.

But ultimately, it must be up to institutional shareholders to find their voice.

On the one hand, they must not become back-seat drivers and prevent management taking acceptable investment risks. However, recent events suggest they do need to monitor much more closely the operations of the businesses they invest in.

Greater disclosure would help. Non-executive directors have been criticised for failing to question reward schemes that encouraged excessive risk-taking.

The pay levels of top board directors, for example, are published in annual accounts but not the salaries and bonuses paid to senior management.

"Compensation committees have lost sight of internal relativities and have failed to consider the relationship of top executive pay to the rest of the workforce," says Lord Myners. He did not expect non-executives to determine lower-level pay, but asserted it was "a key role of the board to design a reward structure that leads to the right behaviour".

Companies, particularly banks, should be pressed by investors to publish details of top earners, not just board members, he said.

A similar theme was taken up in a report last week by an all-party parliamentary committee, established "to develop and enhance the understanding of corporate governance".

It highlights a "surprising lack of board level contact between senior managers and directors".

It says: "Over the past 10 years, the proportion of the board which is composed of hands-on, executive directors has declined to the point where they now account for less than a third of all board members in the FTSE 350. Over the same time period, many of these companies have witnessed a significant increase in the size and complexity of their businesses."

Both these factors have led to a rise in the responsibilities of the senior managers who are just below board level. Indeed, one could argue that, in many important respects, the senior executives who slip below the governance radar are now the people who really run UK plc, conclude the MPs.

In a typical FTSE 100 company, nearly half the executive committee is not represented on the main board. HR directors, likely to become increasingly important figures as businesses seek to cut costs by shedding staff, are present in only 6 per cent of FTSE 350 board rooms.

Philip Dunne, the Tory MP who chairs the all-party group, says: "Present economic conditions show more than ever, the need for non-execs to get beneath the skin of the board and to provide shareholders with more confidence in the capabilities and skills of key executives below board level."

The separation of different, often highly technical, management functions had created "organisational silos" in less well run companies, according to a report by the Senior Supervisors Group which represents supervisory agencies of major financial groups in France, Germany, Switzerland, the UK and the US.

Businesses with the best understanding of and control over balance sheet growth and liquidity needs were those that: "demonstrated a comprehensive approach to viewing firm-wide exposures and risk, sharing quantitative and qualitative information more effectively across the firm and engaging in more effective dialogue," it said.

Poorly run companies, on the other hand, often "lacked an effective forum in which senior business managers and risk managers could meet to discuss emerging issues frequently; some lacked even the commitment to open such dialogue."

It is this disconnect between senior managers running the business and the directors whose job it is oversee them that needs to be addressed.

Copyright: The Financial Times Limited 2008