The effectiveness of the various corporate governance policies and approaches in the USA and United Kingdom - Essay Example

? Contemporary Corporate Governance Assignment Model MMN313335-10-AB Faisal Bandar Alotaibi ID S1036487 Contents Introduction 3 Corporate Governance 3 Historical Development of Corporate Governance in UK 5 Corporate Governance of USA 9 Comparison of the Two Approaches 10 Conclusion 11 Reference 12 Introduction During the last two decades, the business world witnessed a number of corporate scandals like the bankruptcy of Allegheny, Enron, Tyco, Global Crossing, WorldCom, and others. The bankruptcy of Lehman Brothers fuelled up the global financial crisis of 2008-09. All these corporate scandals and bankruptcies have raised the importance of corporate governance. The ultimate victim of all these scandals and crisis are the stakeholders who lose a large sum of money invested in the companies involved in these scandals. The investors take their investment decisions based on the information disclosed by the companies. Therefore, any type of wrongdoing or incomplete disclosure can cost a lot to the investors. Thus with every financial crisis and corporate scandals the relevance of corporate has increased largely. Different regulatory bodies and other government agencies have laid down various policies from time to time in order to increase the effectiveness of corporate governance. This paper aims at evaluating and analysing the effectiveness of the various corporate governance policies and approaches in the USA and United Kingdom. The paper encompasses the historical background and development of corporate governance in United Kingdom. In order to assess the various theories and approaches of corporate governance adopted by various countries, the paper gives the meaning and importance of corporate governance. The paper also compares the various approaches of corporate governance adopted by United Kingdom and USA. Corporate Governance Governance refers to governing someone with the help of some specified system, policies and principles. Thus, corporate governance is the principles, specified processes, policies, and systems used to govern a company. The principles of corporate governance acts as the guidelines used to control the activities of the company so that it can it can achieve its objectives and at the same time add value to the organisation in such a way so that the stakeholders can be benefited in long run. Thus, corporate governance helps the management to operate in such a way so that not only the shareholders but also the other investors, employees, customer and the society as a whole benefit from the actions of the company (Centre for International Private Enterprise, 2002, p. 3-4). The basic premise behind the principles of corporate governance is to enable the organisation to conduct its activities with fairness, maintain transparency in its operations and transactions, disclose all the relevant information, comply with all the rules, regulations and laws, be responsible and accountable to all its stakeholders, and maintain the code of ethics while conducting its activities. Practice of ethical activities is an important part of the corporate governance. Good corporate governance enables the company to achieve investors’ confidence and achieve goodwill in the industry. Thus, corporate governance is not only important for the stakeholders but also for the company too (Thomson, 2009). The Organisation for Economic Co-operation and Development (OECD) describes corporate governance as a system through which companies and other business organisations can be controlled as well as directed. Corporate governance helps to setup a structure through specifying the responsibilities and the rights of the various members of the companies like the board of directors, employees, and shareholders. Corporate governance sets the rules, regulations and the processes of decision making regarding the activities of the company. The corporate governance helps the company in setting up the companies objectives and goals, as well as enabling the company assess its performance and helps in achieving them. Corporate governance not only aims at maintaining accuracy and fairness in the financial statements but also incorporating ethical standards in the activities of the business (The Economist Intelligence Unit Limited, 2002). The Sarbanes Oxley Act of USA was an extension of the purview of corporate governance. In fact, it has evolved the whole concept of corporate governance. The Sarbanes Oxley Act came into being in 2002 just after the US economy witnessed a number of corporate frauds and scandals. Sarbanes Oxley Act was a response to correct the various gaps in the practices of corporate governance. The report found that the interests’ conflict occurred due to the activities of the management. It also found that the financial reports were not accurate, unreliable and lacked transparency of information. On one hand, the market and other regulators did not have many tools to control the activities of the business organisation. On the other hand, the conflicting interests affected the transactions of the security markets. Thus, the Sarbanes Oxley Act laid down various rules and regulations in order to correct these actions and strengthen the corporate governance structure (Guerra, 2004). Historical Development of Corporate Governance in UK Corporate governance is the process through which a company ensures that the board of directors perform the responsibility assigned to them, the operations and the reports produced by them is transparent, and that the directors of the company uphold the rights and ethics of the shareholders (Plessis et al, 2010, p.10). From the decade of 1980s and 1990s when the reform took place in United Kingdom, the inter-organizational networks remained underdeveloped. The intra organizational control, that is, the management control and their work process, was not up to the mark. The British government tried to recognize the constraints and found the necessity to maintain a strong corporate governance policy in the company structure (Rhodes, 1996, p.660-662). A country’s economy mostly depends upon the efficiency of the companies. The companies are free to take any step so that they can move forward, but they should ensure that they do not engage in malpractices. In the year 1992, the Cadbury committee was set up to prepare a report on corporate governance’s financial aspects by the financial reporting council. The committee, headed by Sir Adrian Cadbury, recommended some strategies available to the companies for internal control of the company and for reducing the fraudulent practices. The committee also recommended broadening the areas of audit and stated clearly the responsibilities undertaken by the companies for enhancing the corporate governance (Cadbury, 1992, p.74-77). The next development of corporate governance in UK concerned on the payments to the executive. The Greenbury report of 1995 came with the main recommendation of the committee as being to set up a remuneration committee for determining the director’s remuneration and a new committee that will decide about the new appointments in the board (Greenbury, 1995, p.21-26). In the year 1998, the Hampel committee recommended that the company should improve the communication with its shareholders, and it should find its own way for applying the corporate governance in the company structure (Hampel, 1998, p.32-40). The Hampel report proposed publication of a report that would assist the companies in applying the combined code. The Turnbull report presented the company structure with a milestone achievement by making some recommendations for improving the corporate governance process. The report recommended that the boards should be responsible for the internal control and risk management. The report assists the company in operating their business effectively by recommending various ways. The treasury of UK has commissioned Paul Myners for reviewing the institutional investment in United Kingdom. The report proposed the ways for facing the problems while an institution is making the decision. A proposal resulting from the report stated that the pension fund trustees should adopt some principle based on comply or explain for making decision about investment. The report also proposed some change in tax rule and legislative change (Myner, p.21-25). After that the US Securities and Exchange Commission that implies the law that the top executives of the company that is the CEO and the CFO have to confirm that the financial decisions are fairly supported by the financial statements stated the Sarbanes-Oxley act (2002). As the British companies trade in the US stock exchange, they also have to maintain the rules. As a result, the corporate governance procedure changes a lot in UK. In the year 2002, another report produced stated the requirement that the directors of the listed companies have to make a report, which would disclose the remuneration of the directors. In addition, these remunerations should also be approved by the shareholders at the annual general meeting (UK Legislation, 2002, p.10-12). The Higgs report, published in the year 2002, recommended that the non executive directors should be half of the board of directors, they should be assessed annually, the relationship between the major shareholders and the non executive directors should be close, and that they should not be in the board for more than two three years. In 2003, the committee headed by Sir Robert Smith presented recommendations on the structure and role that should be played by the audit committee for make the corporate governance more effective (Smith, 2003, p.2-9). The combined code on corporate governance published in 2003 applied the approach of ‘comply or explain’ for encouraging best practices of corporate governance in UK. The code stipulates that listed companies have to report that they have maintained the principles in the code, or they have to provide an explanation for not maintaining any principles. In the year 2006, the government adopted the superseded combined code of corporate governance. The code specifies the area of responsibilities especially for the executives, the auditors and, the shareholders (Financial Reporting Council, 2006, p.23-24). After that, the Companies Act implementation in the year 2008 was born, stating the implications maintainable by the stakeholders of the company. These include the shareholders right to sue the directors for wrongdoing and offence against the auditors for misleading information (UK Legislation, 2006, p.16-40). In the Combined Code 2008 restriction was made for an individual that he / she can’t chair more than one FTSE 100 companies (Financial Reporting Council, 2008, p.5-12). The adoption of the Walker report recommendation in the UK banks was in the year 2009. These recommendations concern the board size and compensation, risk management and remuneration structure. The corporate governance code published in 2008 replaced the code of 2008. It included the new features about the chairperson and board’s extra responsibility (Financial reporting Council, 2010, p.9-17). The companies follow the adoption and publication of the corporate governance code for the unlisted companies in the year 2010 on a voluntary basis (Institute of Directors, p.7). Corporate Governance of USA Because of the failures of Enron, WorldCom and some other companies, the US Congress introduced the Sarbanes-Oxley act in the year 2002, which would protect the investors from the possibility of fraudulent acts done by the company. As per this act, the top management are bound to ensure that the financial decisions coincide with the financial reports produced by the company. As per the rule, no company can engage in fraudulent activities, and if they are not maintaining the rules, they are bound to provide the explanation to the government and the US Securities and Exchange Commission. They may face the legal activity from the SEC for not comply with the principles (US Securities and Exchange Commission, 2002). Though the US companies are criticized for not performing well in the 1990s, the research report showed that the firms were not performing so bad in the scenario exists then but certain acts were implemented at that time to ensure an improved corporate governance. Along with the SOX act, the NASDAQ and NYSE provide some proposals for improving the corporate governance. From the case like Enron, the companies should take knowledge and thereby make improvement of the existing corporate governance culture (Holmstrom and Kaplan, 2003, p. 23-27). As per the law of corporate governance, the US companies are bound to maintain efficiency through the antitrust laws, introduce the proxy voting mechanism, prevent the abuse of monopoly power, and increase the transparency of financial statements and the legal enforcement (Palacio and Johnson, 2006, p.23-26). Organization for Economic Cooperation and Development (OECD) has clearly stated the roles of the stakeholders in a company, which includes the equitable treatment of the shareholders, mentioning the role of the stakeholders, and a transparent disclosure by the company management (US department of state / bureau of international information program, 2005, p.42). Comparison of the Two Approaches There are certain differences between the US and UK corporate governance system. The ownership of the UK listed companies is by the institutional investors and the pension funds, whereas in US, ownership is only by the institutional investors. The dual leadership is rare in USA but in UK, the companies mostly do it. There is less dispersed ownership in the UK companies than in the US companies. In US, there are no legal requirements to disclose the Corporate Social Responsibility (CSR) activities by the companies, but in UK, it is the best practice, according to the Operating and Financial review. The pension act of 2000 requires that in the investment strategies, all the environmental, ethical, and social issues be taken care of (Aguilera et al, 2006, p.149). Prior to the Enron case, there were some major problems existing in the US corporate governance system, like less scrutiny by the independent boards, and less responsibility of the investors. After the Enron breakdown, the SOX act came into existence and the companies were then bound to follow a strong corporate governance process (Jackson, 2010, p.39- 47). The UK firms listed in the stock exchanges of US are also bound to maintain the laws. However, there are no such strict rules existing in the UK. They have to maintain it voluntarily, and so they have taken a ‘comply or explain’ approach. The research results show that in US, there is scope for reducing the cost associated with the corporate governance, as well as a scope of improving the robustness of the securities market without filing the lawsuits against the directors of the companies which are publicly traded (Armour et al, 2007, p.24-27). Conclusion Corporate governance is a process to be observed by the companies to protect the interest of the stakeholders. The US and the UK markets are the two big markets of the world. There were many reports from the Cadbury report in 1992 on the UK corporate governance code. Each report recommends some extra implications and additions to the code for improving the corporate governance. Some implications were legalized (The Companies Act, 2006, the directors’ remuneration report 2002), but maximum requirements were not legalized. The companies have to comply with the regulations; otherwise, they have to provide the explanations to the stock exchanges. The company not listed in the stock exchange also have to maintain certain principles voluntarily. In USA, the companies have to maintain the rules according to the SOX act or they would face legal proceedings. Design and implementation of some rules in the UK would enhance the corporate governance effectiveness of companies in the region. Though the corporate governance rules increase the costs of the companies of US, the corporate governance structure is more robust there than in the UK. Therefore, the UK government has to implement some laws to make the corporate governance more robust so that the chance of fraudulent acts reduces in the continuously changing scenario of the market of these days. Reference Aguilera, R. et al. (2006). Corporate Governance and Social Responsibility: A comparative Analysis of the UK. and the US. [Pdf]. Available at: http://www.51lunwen.org/UploadFile/org201005121539296317/otpin.pdf. [Accessed on: December 19, 2011]. Armour, J. et al. (2007). Private Enforcement of Corporate Law: An Empirical Comparison of the US and UK. [Pdf]. Available at: http://www.ecgi.org/competitions/rof/files/UK_US_corp_law_enforcement_draft_ECGI.pdf. [Accessed on: December 19, 2011]. Cadbury, A. (1992). The Financial Aspects of Corporate Governance. Available at: http://www.ecgi.org/codes/documents/cadbury.pdf. [Accessed on: December 17, 2011]. Centre for International Private Enterprise. (2002). Instituting Corporate Governance in Developing , Emerging and Transitional Economies. [Pdf]. Available at: http://www.cipe.org/programs/corp_gov/pdf/CGHANDBOOK.pdf. [Accessed on: December 19, 2011]. Financial Reporting Council. (2006). The Combined Code on Corporate Governance. [Pdf]. Available at: http://www.ecgi.org/codes/documents/frc_combined_code_june2006.pdf. [Accessed on: December 17, 2011]. Financial Reporting Council. (2008). The Combined Code on Corporate Governance. [Pdf]. Available at: http://www.frc.org.uk/documents/pagemanager/frc/Combined_Code_June_2008/Combined%20Code%20Web%20Optimized%20June%202008(2).pdf. [Accessed on: December 19, 2011]. Financial Reporting Council. (2010).The UK Corporate governance Code. [Pdf]. Available at: http://www.frc.org.uk/documents/pagemanager/Corporate_Governance/UK%20Corp%20Gov%20Code%20June%202010.pdf. [Accessed on: December 19, 2011]. Greenbury, R. (1995). Directors’ Remuneration. [Pdf]. Available at: http://www.ecgi.org/codes/documents/greenbury.pdf. [Accessed on: December 17, 2011]. Guerra, J. E. (2004). The Sarbanes-Oxley Act and Evolution of Corporate Governance. [Online]. Available at: http://www.nysscpa.org/cpajournal/2004/304/perspectives/nv5.htm. [Accessed on: December 17, 2011]. Hampel, R. (1998). Committee on Corporate Governance: Final Report. [Pdf]. Available at: http://www.ecgi.org/codes/documents/hampel.pdf. [Accessed on: December 17, 2011]. Holmstrom, B. and Kaplan, S. (2003). The State of US. Corporate Governance: What’s Right and What’s Wrong? [Pdf]. Available at: http://research.chicagobooth.edu/economy/research/articles/185.pdf. [Accessed on: December 19, 2011]. Institute of Directors. (2010). Corporate Governance Guidance and Principles for Unlisted Companies in the UK. [Pdf]. Available at: http://www.iod.com/MainWebsite/Resources/Document/corp_gov_guidance_and_principles_for_unlisted_companies_in_the_uk_final_1011.pdf. [Accessed on: December 19, 2011]. Jackson, G. (2010). Understanding Corporate Governance in the United States. [Pdf]. Available at: http://www.boeckler.de/pdf/p_arbp_223.pdf. [Accessed on: December 19, 2011]. Myner, P. (2001). Institutional Investment in the United Kingdom: A Review. Available at: http://www.hm-treasury.gov.uk/d/31.pdf. [Accessed on: December 17, 2011]. Palacio, F. and Johnson, C. (2006). Corporate Governance-A Global Perspective. [Pdf]. Available at: http://www.frbatlanta.org/news/CONFEREN/06LatAm/palacios.pdf. [Accessed on: December 19, 2011]. Plessis, J. et al. (2010). Principles of Contemporary Corporate Governance. 2nd ed. China: Cambridge University Press. Rhodes, R.A.W. (1996). The New Governance: Governing Without Government. [Pdf]. Available at: http://law.hku.hk/gl/rhodes.pdf. [Accessed on: December 17, 2011]. Smith, R. (2003). Audit Committees Combined Code Guidance. [Pdf]. Available at: http://www.ecgi.org/codes/documents/ac_report.pdf. [Accessed on: December 17, 2011]. The Economist Intelligence Unit Limited. (2002). Corporate governance the new strategic imperative. [Pdf]. Available at: http://us.kpmg.com/microsite/Attachments/corp_govern_newstrat.pdf. [Accessed on: December 17, 2011]. Thomson, L. M. (2009). What is corporate governance? [Online]. Available at: http://articles.economictimes.indiatimes.com/2009-01-18/news/28462497_1_corporate-governance-satyam-books-fraud-by-satyam-founder. [Accessed on: December 17, 2011]. US. department of state / bureau of international information program. (2005). Promoting Growth through Corporate Governance. [Pdf]. Available at: http://photos.state.gov/libraries/vietnam/8621/translations/ej022005.pdf. [Accessed on: December 19, 2011]. US. Securities and Exchange Commission. (2002). Sarbanes-Oxley Act of 2002. [Online]. Available at: http://uscode.house.gov/download/pls/15C98.txt. [Accessed on: December 19, 2011]. UK Legislation. (2002). Statutory Instruments. Available at: http://www.legislation.gov.uk/uksi/2002/1986/pdfs/uksi_20021986_en.pdf. [Accessed on: December 17, 2011]. UK Legislation. (2006). Companies Act 2006. [Pdf]. Available at: http://www.legislation.gov.uk/ukpga/2006/46/pdfs/ukpga_20060046_en.pdf. [Accessed on: December 19, 2011]. Read More