Structured Corporate Governance Principles in Case of Corporate Failures - Essay Example

How effective is the UK Revised Combined likely to be in improving the Governance of Listed PLC's Introduction: The UK revised combinedcode was published in 2003 following considerable debate on its effectiveness in implementing changes in Corporate Governance (McNeil and Rimmington, 2004). Corporate governance guidelines were developed for listed companies and represent the best practice blueprint for big and small companies alike. Structured Corporate Governance principles are necessary for listed companies and are especially useful in case of corporate failures where standards and effectiveness of the board and control systems could be flawed1. The Cadbury report laid the foundation for corporate governance in listed companies published in 1992 and other standards and guidance have appeared in recent years (Cadbury Report, 1992; Dedman, 2002). Following the Enron report, two review committees were commissioned by the UK Financial Reporting Council (FRC) to review UK corporate governance2. The two independent review reports - the Higgs Report on Non-Executive Directors and the Smith Report on Audit Committees, were published in January 2003 and form the bases for the revised Code [also see Higgs review (2003) and Smith review (2003)]. In this analysis the features of the revised combined code will be discussed along with studies to show and suggest whether the implementation of this code is likely to improve the effectiveness of corporate governance for listed companies. The Revised Combined Code - The revised code contains 14 principles for companies supported by 48 code provisions. Many aspects of the revised code have remained unchanged from the original code although there have been many important changes. The code suggests that the board should comprise of independent non-executive directors along with executive directors and the code contains guidance on the meaning of independent directors emphasizing on independence as an important measure (Long et al, 2005). It also lays down the rule that the role of chairman and chief executive should not be a position taken by the same person (in Combined Code, 2003). The chairman should be independent and only in certain exceptional cases, the chairman can also be a former chief executive. It has also been suggested that the position of a senior independent non-executive director should be included. This new position of senior independent non-executive director shows that the director must be identified in the annual report and also be given specific responsibilities (Long et al, 2005). The other specifications of the revised code show that all listed companies should have an audit committee, a nomination committee and a remuneration committee. The audit and remuneration committees should have at least three members and all the members should be independent non executive directors3. The majority of the members are expected to be independent non executive directors and the committee is also headed by the chairman who is an independent non executive director (Long et al, 2005; Chambers 2005)4. The code also specifies that at least one member of the audit committee must be a financial expert or a person with the relevant financial experience and having membership with a professional accountancy body. The code highlights on performance evaluation and regular monitoring and emphasises on the performance evaluation of board members and the committees and executive directors (Combined Code, 2003; Directors' Remuneration Report, 2002). The annual report should include a disclosure on the performance evaluation process. The external auditors are important as well and the audit committee is given the primary responsibility of making a recommendation on the appointment, reappointment and removal of external auditors. The audit committee is given the responsibility to develop and implement policy on engagement or taking services of the external auditor to supply non-audit services. The Audit Committee states in its report that the revised Combined Code, issued by the Financial Reporting Council on 23 July, is derived from Derek Higgs' review that examines the role and effectiveness of non-executive directors and Sir Robert Smith's guidance for audit committees5. The revised Combined code serves as a blueprint for listed companies, big and small, and provides specific guidance on implementation of these provisions that listed companies and other organisations should seek to adopt (Solomon 2004; McNeil and Rimmington, 2004). The principles of best action and best practice of corporate governance are guided by the provisions of combined code and provides a guideline for companies who can then carefully consider the course of action that they need to take. The revised code contains main and supporting principles and provisions. The listing rules are given in the combined code and companies are required to confirm the extent of their compliance with 48 detailed code provisions and explain the rationale for non-compliance if any. The revised combined code is expected to replace the 1998 code which is annexed to listing rules and after its introduction in July 2003, are applied since November 2003 (Chambers 2005). The Financial Services Authority consults on necessary rule changes that can be implemented on the companies but not on the Code itself. In the next section we highlight the main features of the Revised Code. The 14 main principles of the revised code are given here: 1. Every company should be headed by an effective board which is collectively responsible for the success of the company. The importance of the board is highlighted in the revised code on corporate governance and the code seeks to redefine the structure of corporate organisation by suggesting that the board is ultimately responsible for all decision making processes and success of the company 2. 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. The code specifies that no single person should be given the power of decision making on important matters and there should be a division of responsibilities among board members and directors with the sole joint responsibility of helping to run company' business 3. The board should include a balance of executive and non-executive directors (and in particular independent non-executive directors) such that no individual or small group of individuals can dominate the board's decision taking. A balance of executive and non-executive directors6 is needed so that no single individual or a small group of individuals can dominate or strongly influence the board's decision making. Decision making at the board level should be done with a democratic approach of taking suggestions from embers at all levels 4. There should be a formal, rigorous and transparent procedure for the appointment of new directors to the board. It is suggested that the selection of new members to the board, has to be a formal, rigorous and transparent procedure so that there is no bias and only the right members are selected. 5. The board should be supplied in a timely manner with information in a form and of a quality appropriate to enable it to discharge its duties. All directors should receive induction on joining the board and should regularly update and refresh their skills and knowledge. All directors are required to go through a phase of formal induction after joining the board in which they are updated on company progress and are able to refresh and revaluate their skills and knowledge. The board members should have the requisite information to discharge their duties in an appropriate manner. New directors should receive a full, formal and tailored induction and training when they join the board. 6. The board should undertake a formal and rigorous annual evaluation of its own performance and that of its committees and individual directors. Constant evaluation of the performance of board members and individual directors has also been suggested to ensure maximum effectiveness and high performance of board members. The company should ensure that skills and capabilities of directors are maintained and updated regularly. 7. All directors should be submitted for re-election at regular intervals, subject to continued satisfactory performance. The board should ensure planned and progressive refreshing of the board. Board members and directors are given opportunities to serve at the board again by the method of re-election. The board should however also be refreshed with new members to represent the dynamism of a progressive company 8. Levels of remuneration should be sufficient to attract, retain and motivate the directors of the quality required to run the company successfully, but a company should avoid paying more than is necessary for this purpose. A significant proportion of executive directors' remuneration should be structured so as to link rewards to corporate and individual performance. Remuneration should be in accordance with corporate and individual performance. Board members should be paid attractive remuneration so that they are motivated to give their best to the company and help it run successfully. Yet the remuneration should not be too high or disproportionate (Combined Code, 2003; Directors' Remuneration Report, 2002). 9. There should be a formal and transparent procedure for developing policy on executive remuneration and for fixing the remuneration packages of individual directors. A formal transparent procedure has been recommended by the Code so that remuneration could be fixed on members' consensus and a joint board decision and a strict company policy for remuneration should be in place to avoid any malpractice on unjustified remuneration7 10. No director should be involved in deciding his or her own remuneration. The board should present a balanced and understandable assessment of the company's position and prospects. For deciding a director's or executive member's remuneration, the board members should be jointly involved and present a balanced assessment of the company's position and prospects. The directors are themselves not allowed to decide on their own remuneration 11. The board should maintain a sound system of internal control to safeguard shareholders' investment and the company's assets. Shareholders interests are taken into primary consideration and all decision are taken with a view to safeguard shareholder investments and company's assets. A method of internal control has been suggested to maintain adequate and consistent company performance. Major shareholders are offered to meet with new directors as part of the process. 12. The board should establish formal and transparent arrangements for considering how they should apply the financial reporting and internal control principles and for maintaining an appropriate relationship with the company's auditors. The code emphasise that financial reporting methods should be characterised by transparency and formalised arrangements. The board should apply sound internal control and financial reporting to maintain an adequate relationship with the company auditors8. Regular or necessary interactions between board members and company auditors have been emphasised to ensure financial auditing transparency of the company 13. There should be a dialogue with major shareholders based on the mutual understanding of objectives. The board as a whole has responsibility for ensuring that a satisfactory dialogue with shareholders takes place. There should be a mutual understanding and recognition of objectives for the company and a dialogue between shareholders and company managers and executives could be facilitated as required by the Code to ensure that shareholders are apprised of company objectives and company directors are also aware of shareholder needs and expectations. 14. The Board should use the AGM to communicate with investors and encourage their participation. The annual general meeting should form the platform for communication between board members, company executives and shareholders and also investors. The board is expected to encourage participation of the investors and shareholders in the annual meeting to get their feedback and views on company performance and clarify on doubts or issues on investment in the company9 . Webb et al (2003) argue that there have been major governance breakdowns in public limited companies in recent years that have led to the introduction of governance codes that limited companies are obligated to follow. One of the main focuses of these introduced codes seems to be an increased participation of investors in governance issues. However Webb et al argue that if institutional investors choose to increase participation then there may be anomalies in the operations of capital markets and can increase costs with institutional investors as delegated monitors, thus questioning the viability of investor participation in corporate governance. The code requires that companies provide a disclosure statement. This disclosure statement should have two parts and listed companies are required to make the statement and report how the main and supporting code principles have been applied and also provide a confirmation of compliance with the code's provisions to show that the company has been complying with the code laid out. This extends to the 14 main and 21 supporting code principles. If the company does not comply with the provisions, the board or executive members of the company are expected to provide an explanation. It is expected that listed companies will comply with the Code's provisions most of the time although some departure from the provisions of the Code may be justified in certain circumstances and each company is expected to review the provisions carefully and provide their explanation as to why they departed from or did not follow code provisions. Some smaller listed companies can consider certain provisions of the Code as disproportionate or not relevant. Some provisions may be more relevant for smaller companies than for bigger companies whereas some others are only relevant for bigger companies and provisions may be relaxed for smaller companies. A smaller company has been defined as a company that is below FTSE350 throughout the year and immediately prior to reporting year10. Yet despite the company being big or small, all companies are encouraged to use and apply the provisions of the Code in full. Conclusion: The revised combined code has been generally effective and is being implemented in all PLCs within the UK following breakdown in corporate governance in limited companies in recent years. Although the implementation of the combined code has been successful there may be still many issues that have to be addressed and according to McNeil and Rimmington (2004), many companies seem to have questioned the value of such a code. Yet, considering the fact that the code emphasises on structure and control at an organisational level as well as investor participation and shareholder interests at a consumer or investor level; issues of transparency, accountability and business performance are features that seem to have been rightly highlighted within the code. The impact and influence of the code is likely to be successful only if companies value its effectiveness in corporate governance. Bibliography THE COMBINED CODE ON CORPORATE GOVERNANCE July 2003 http://www.fsa.gov.uk/pubs/ukla/lr_comcode2003.pdf Combined Code (revised July 2003) Audit Committee Institute http://www.kpmg.co.uk/aci/docs/aci_rev_comb_code.pdf The Higgs Review (2003), Review and related information: http://www.dti.gov.uk/cld/non_exec_review The Cadbury Report (1992), Greenbury Report (1995) and Hampel Report (1998): http://www.ecgi.org/codes/country_pages/codes_uk.htm The Smith Report (2003): http://www.frc.org.uk/publications/content/ACReport.pdf The Company Law Review (2001) and the Company Law White Paper (2002): http://www.dti.gov.uk/cld/ The Directors' Remuneration Report Regulations 2002: http://www.hmso.gov.uk/si/si2002/20021986.htm Griffin, Stephen "Corporate Collapse and the Reform of Boardroom structures - Lessons from America" (2003) 6 Insolvency Law 2003 pp.214-225 - Westlaw Solomon, Aris and J.F. Solomon (2004) "Assessing the Potential Impact of the Revised Combined Code on Corporate Governance" (2004) 15 International Company and Commercial Law Review pp 99-104 Hannigan, B. 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