The UK Corporate Governance Code - Coursework Example

?CORPORATE GOVERNANCE The UK Corporate Governance which was previously known as the Combined on Corporate Governance or The is the foremost set of principles that are applicable to all the UK listed companies. The responsibility to oversee the Code, its terms, effectiveness and implications belongs to the Financial Reporting Council (FRC). The concept of Corporate Governance is still most effectively defined by the classic description gave in the Cadbury Report. It states: “Corporate governance is the system by which companies are directed and controlled. Boards of directors are responsible for the governance of their companies. The shareholders’ role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place. T h e responsibilities of the board include setting the company’s strategic aims, providing the leadership to put them into effect, supervising the management of the business and reporting to shareholders on their stewardship. The board’s actions are subject to laws, regulations and the shareholders in general meeting (Cadbury Committee. 1992, Para 2.5).” The Code guides the board towards more effective practice. Its underlying principles are all those of good governance, they include accountability, transparency, probity and focus on the steady success of an entity over long term. The code is continuously changing to incorporate the alterations in the socio-economic environment. It has been reviewed in 2005, 2007 and 2010 in the recent past. The new code applies to the accounting periods beginning on or after 29 June 2010 and is applied to all the companies whether they are incorporated in UK or not (FRC, 2010). The approach that is followed since the beginning of the Code is to comply with it or explain why it is not being followed. It is referred to as “Comply or Explain”. According to this approach, all the listed companies are supposed to follow the Code, to ensure better governance, but incase the companies think that there is an alternative way to ensure that as compared to the one stated by The Code, they can employ that but they have to properly explain the reasons and circumstances that led to that change to the shareholders, whose rights might have been influenced as a result of that change. According to the latest report on UK Corporate Governance Code by the FRC, the main principles for The Code are: Leadership. The board should be led by an effectively. The responsibility of heading the board by the Non-executive directors and the responsibility of heading the company’s operations by the executive directors should be equally divided. The Chairman is the head of the board as a whole whereas the executive directors are also led by the Chief Executive Officer (CEO) of the Company. The Chairman is responsible for the effective functionality of the board. He is responsible for ensuring the clear and efficient flow of information between the shareholders and the board. As per new reforms passed in 2011, female directors will also be introduced into the board structure (FRC, Consultation Document 2011). The board of directors has the power to hire fire and compensate senior management. Their purpose is to resolve the issues, specially relating to conflicts of interests, between the decision makers and the risk bearers. Their control resolves the issue of high agency costs and facilitates the existence of an open corporation. Recent economic theory implies that the balanced structure of the board of directors is a crucial part of good governance (Baysinger, Butler, 1985). According to agency theory, shareholders interests are better protected if there is segregation between the duties of CEO and the Chairman. Where as, stewardship theory argues that the shareholders interests are maximized if both the roles are entitled to the same person. According to the author, a few test results show that stewardship theory is supported more than the agent theory (Donaldson, Davis 1991). According to The UK Stewardship Code, it’s mandatory that the duties are segregated between a Chairman and a CEO, as it can be troublesome for all the non-executive directors to have a hold over a very influential CEO if there was no higher office to it. Effectiveness. The board and the committees should have a balanced set of skills. The directors should be appointed formally and transparently. The directors should be submitted to re-elections at regular intervals of time. And the board should review its performance meticulously and that of its committees and directors on individual basis. A key aspect of the effectiveness of a board’s performance is its composition. To make sure that the firm’s processes are working properly it is advised that their performance is governed by the non-executive directors. To overlook the other aspects of the board, committees are formed. The more pronounced of whom are the audit committee, nomination committee, risk committee and the remuneration committee. The remuneration committee decides the compensation packages of the directors where as audit committee governs the reporting of the financial performance of the organization to the shareholders. As far as the nomination committee is concerned, it is encouraged to be comprised of majority of non-executive directors. It’s the responsibility of the nomination committee to appoint directors. According to the new Code, it is encouraged that the directors are re-elected at the first annual general meeting after their first appointment and then re-elected afterwards at intervals of not more than three years. As far as the non-executive directors are concerned, they are re-elected if they are the part of the board for more than nine years. Accountability. The board is accountable for the company’s overall performance. It should ensure the proper communication regarding its strategies and how it is planning to achieve its goals. It should establish proper procedures for effective corporate reporting, risk management and internal controls. To ensure transparency in its reporting it should maintain fair relations with the company’s auditors. The board is accountable for the shareholders investments. It has to ensure that the money that the shareholders have invested in their firm is utilized efficiently so that it could benefit both the company and the shareholders. Sometimes there are conflicts between the people running the business and those who are providing the investment for the business. As defined by the principal-agent theory, a principal (shareholders) hires a manager (agent) to run his or her firm for him. The firm’s performance is then represented by the gross profit that is proportional to the manager’s effort and the degree of positive chances that a market can provide that can be maneuvered for the best interests of the organization. So they are compensated accordingly as well. In case of no principal-agent relationship, all the managers are accountable for their own targets, either its maximization of profit, or reduction of costs. Their efforts are reimbursed directly, and there is no need for corporate governance as there are no conflicts of interests between the principal and the agent. Such a structure is defined by the neoclassical theory as the “black box”. In this situation focus is not on the plan but simply on the inputs and outcomes (Hart, 1995). According to The Code, an audit committee is mandatory to be established that governs the financial reporting to the shareholders. Study has shown that more effective results are achieved when the audit committee is comprised of outside directors, meaning the directors that do not take part in the day to day business of the organization. It has also been established that a board that works independently of the CEO is more effective in its performance (Klein A, 2002). Remuneration. Remunerations should be set in a way that they are attractive enough to retain and motivate the directors of the company but it should be compatible with the performance of the directors. Meaning the directors should not be getting paid for more than is required. The remuneration packages should be set by a remuneration committee, so that the directors are not involved in the decision of establishing their own remunerations. The remuneration committee should be comprised of the majority of non-executive directors. Study has shown that director’s compensation is directly proportional to shareholder’s return. Also, it has been seen that companies which adopt governance regulations show lower growth rates in the director’s remuneration as compared to the ones that have no governance regulations. It has also been seen that separating the roles between CEO and Chairman has no influence on director’s remuneration (Conyon, M.J. 1998). Relations with Shareholders. The whole board is responsible for keeping an efficient relationship with the shareholders. The whole point of establishing the Code is to ensure that a healthy relation is maintained with its shareholders. Effective communication should be established so that the shareholder’s could be ensured that whatever the risks are being taken, they are expected to benefit both the company and the shareholders. The company’s business model should be explained to them ensuring that the board is taking full responsibility for its actions. The shareholders should be encouraged to participate in the annual general meetings (AGM), so that they are kept updated of the company’s future plans and their opinion is also accounted for. MATRIX: For the purpose of this course work the two UK listed Companies that will be analyzed are Carillion Plc and Deutsche Bank. Article Theme Explanation and Examples Corporate Governance and The Board of Directors: Performance Effects Of Changes in the Board Composition. (Baysinger, Butler 1985) Balanced board structure is crucial for good governance. This article emphasizes on the fact that the board structure should be balanced between executive and non-executive directors, so that none have a deeper influence in the decision making process. Board of directors at Deutsche Bank comprises of two kinds. One is the management board, having six personals along with a Group executive committee. The other is the supervisory board that comprises of twenty personals. The board of Directors at Carillion Plc comprises of eight people in total. There are different Chairman and CEO. Out of the total board structure, four are non-executive directors where as the rest are the executive directors. Stewardship Theory or Agency Theory: CEO Governance and Shareholder Returns.  (Donaldson, Davis 1991) Comparison between Agency Theory and Stewardship theory. Agency theory implies that there should be segregation between the responsibilities of CEO and the chairman where as the Stewardship theory implied that one can be liable for both the responsibilities. According to the author, through some empirical tests it was established that stewardship theory was preferred. According to the Code Of Corporate Governance these duties should be segregated. As we can see in both the cases of Carillion Plc and Deutsche Bank, they have different personals for the responsibilities of Chairman and CEO. It is more effective this way as no one side of the board can deeply influence the other. Audit committee, board of director characteristics, and earnings management.  (Klein A, 2002) Composition of Audit Committee. Effective performance if the committee was functional independently from CEO. Audit committee is responsible for the accurate and efficient reporting of the financial performance of the company. It is also responsible for governing effective risk management, internal controls and internal audit. It is established by the author that the audit committee should be comprised of non-executive directors so that it should be able to perform independently of any kind of influence from the CEO. In Deutsche Bank, the audit committee comprises of six non-executive directors and it is governed by the Chairman of the Company. In Carillion Plc, it is comprised of total four people, all of whom are non-executive directors and it is governed by the Chairman of the Company too. Corporate Governance: Some Theory and Implications (Hart O., 1995) Managers are accountable for company’s overall performance to the shareholders. In this article the author established that the managers of the company are accountable for the performance of the company resources. As a part of its Board Policy, Carillion Plc, takes full responsibility of the Company’s assets as well as of the goodwill, property and business related information. This policy is specially governed by their integrity committee. Where as Deutsche Bank has established the Code of Business Conduct and Ethics, which is governed by the Sarbanes-Oxley Act of 2002. Every member of the board is bound by it and follows it. Corporate Governance and Executive Compensation (Conyon, 1997) Directors’ compensation is directly proportional to the return earned for the shareholders. According to the author a director’s remuneration is directly proportional to the return he earns for the shareholders of the company. However the article also mentions that the companies that are governed by the Code show less growth in their remuneration plans. In Carillion Plc, the fees for executive directors are decided by the remuneration committee which consists of non-executive directors only, whereas for the non-executive directors it is decided by the board as a whole, but external opinion is also taken into account to see if the remuneration packages that are decided are compatible with the general practices in the market. At Deutsche Bank, the compensation packages are devised by the remuneration committee. These packages are compatible with their performance. Bibliography COMMITTEE ON THE FINANCIAL ASPECTS OF CORPORATE GOVERNANCE (LONDON, ENGLAND), & CADBURY, A. (1992), Report of the Committee on the Financial Aspects of Corporate Governance. London. Committee and Gee. FINANCIAL REPORTING COUNCIL, June 2010, The UK Corporate Governance Code. Available at: [Accessed at: 19-Dec-2011] FINANCIAL REPORTING COUNCIL, 2011, Consultation Document: Gender Diversity On Board, Available at: http://www.frc.org.uk/images/uploaded/documents/FRC%20Consultation%20Document%20-%20Gender%20Diversity%20on%20Boards3.pdf [Accessed at: 20-Dec-11] BARRY D. BAYSINGER & HENRY N.BUTLER 1985, Corporate Governance and the Board of Directors: Performance Effects of Changes in Board Composition, Journal of Law, Economics, & Organization, Vol. 1, No. 1 (Spring, 1985), pp. 101-124  (article consists of 24 pages), Published by: Oxford University Press, Stable URL: http://www.jstor.org/stable/764908 KLEIN, A. (2002). Audit committee, board of director characteristics, and earnings management. JOURNAL OF ACCOUNTING AND ECONOMICS. 33, 375-400. OLIVER HART 1995, Corporate Governance: Some Theory and Implications, The Economic Journal, Vol. 105, No. 430 (May, 1995), pp. 678-689, (article consists of 12 pages), published by: Blackwell Publishing for the Royal Economic Society, Stable URL: http://www.jstor.org/stable/2235027 DONALDSON, L., & DAVIS, J. H (1991), Stewardship Theory or Agency Theory: CEO Governance and Shareholder Returns. Australian Journal of Management.16, 49-64. FINANCIAL REPORTING COUNCIL, UK Stewardship Code 2010, Available at: < http://www.frc.org.uk/images/uploaded/documents/UK%20Stewardship%20Code%20July%2020103.pdf> [Accessed at: 20-Dec-2011] MARTIN, J. CONYON, 1997, Corporate Governance and Executive Compensation, International Journal of Industrial Organization, Vol 15, Issue 4, pp. 493-509, Carilion Plc, Available at: < http://www.carillionplc.com/ifrs/investors_corporate.asp> [Accessed at: 20-Dec-11] Deutsche Bank, Available at: < http://www.db.com/ir/en/download/Corporate_Governance_Statement_Corporate_Governance_Report_2010.pdf?dbiquery=null%3Acorporate+governance> [Accessed: 20-Dec-11] Read More