UK Corporate Governance Code - Essay Example

?Contents Contents Introduction 2 UK Corporate Governance 2 UK Combined on Corporate Governance 4 Discussion 7 Conclusion 8 Bibliography 9 Introduction There has been a gradual evolution of business dynamics from government and state sponsored businesses and industries to individual powerhouses dominating the field till the later part of the 20th century. However, the business system that has been dominant for the last 40 years or so has been that of the shareholder – centric approach. As a result, the board of directors of a company, which is the ultimate decision making authority of a company, has been forced to become more accountable to the shareholders. However, the present Combined Code on Corporate Governance has been more of a reaction to worldwide business scandals rather than being a pro-active measure that ensures business legitimacy (Porter, 2009). Notwithstanding this fact, there has been a considerable amount of progress made in the direction of ensuring accountability and transparency, especially in Britain. It started with the formation of the Corporate Governance Code in the early 1990s. Hence, in the below sections we study the Code and the legislative framework in its present form and determine its effectiveness in the face of modern scandals and financial debacles. UK Corporate Governance Code Since the 1970s, there has been an increased amount of focus on corporate governance. This may largely be attributed to the development of big multi-national companies; however, the process is still in motion. As a consequence, some of the board of directors of listed companies, who form the most powerful body in the company, of the US and UK are required to be non-executive. The CEO is no longer the sole head of the company and shares responsibilities with the non-executive directors. The idea of creating an independent atmosphere where all perspectives can be included has been extended through a number of measures as a "force for good" in the economy. The "comply or explain" principle which is one of the main features of the Code has its roots in the Cadbury Committee or the Committee on the Financial Aspects of Corporate Governance report of 1992. Originally setup to come up with recommendations for financial auditing and other financial matters due to the scandals involving the Polly Peck and Robert Maxwell companies, the Cadbury Committee headed by Sir Adrian Cadbury made four important recommendations. These were with respect to the board of directors, non - executive directors, executive directors and reporting and control mechanisms. However, these were not mandatory and the companies were free to follow their own course since it was determined that a legalistic approach would result in compliance only to a minimum basic level that negated the main aims of the Code. It was also felt that a "one size fits all" formula must not be adopted and that companies must be allowed the option to choose their own course that satisfies their unique requirements. Subsequently there was the Greenbury Report of 1998 that dealt with the remuneration of directors issue (Barker, 2008). The Code underwent a significant review in 1998 when Sir Ronnie Hampel was charged with the duty of validating the effectiveness of the existent Code. It was recommended that there was no need for radical or revolutionary changes, instead the principles needed to be extended to detailed measures for the listed companies to implement. This was called the Combined Code on Corporate Governance which contained two levels of prescriptive practices, one of which was a set of detailed provisions and the other was a set of open - ended principles. The companies were similarly required to present a two level declaration of the compliance of the above measures in their annual report. The Code underwent another review in 2003 following the Higgs and Smith report which added another layer of compliance norms to the existing Code. It was made up of high – level main principles, mid – level supporting principles and low – level provisions (Moore, 2009). UK Combined Code on Corporate Governance However, in an attempt to make the code flexible and informal, the principle of “comply or explain” was adopted. UK listed companies were either free to adopt the rules of the code or to opt out of one or more provisions in which case they needed to explain how the adoption of the code was unsuitable or detrimental to the company. This was to be detailed in the annual director's report at the end of each fiscal year (Apostolides, 2008). While the same principle has remained through recent revisions of the code, it has become multi – layered and contains certain prescriptive measures and certain open ended guidelines (Moore, 2009). Another important aspect that the code deals with is regard to director's remuneration. In particular the issues in this regard are: the size of the basic pay increases, the huge gains from share options and the compensation payments to directors on loss of office. Therefore, there was a need to identify good practices to regulate direct remuneration and incorporate this into the Code (Hicks & Goo, 2008). The Greenbury Committee identified the following practices: the establishment of remuneration committees, the determinants of remuneration policy for executive directors and other senior executives, the disclosure and approval of the details of the remuneration policy and the length of service contracts and the determination of compensation when these are terminated. These recommendations were incorporated in the Combined Code on Corporate Governance in 1998 (Hughes, 1996). An equally important provision of the Combined Code on Corporate Governance is the power given to non-executive directors of the company. The division of roles of CEO and chairman is one of the well known measures. In addition, the Code also states that the chairman should be an independent non-executive director, that at least half the Board, should consist of non-executive directors, that the Nominations Committee should consist of a majority of independent non-executive directors and that the Remuneration and Audit Committees should comprise at least three members all of whom should be independent non-executive directors. These seemingly complex set of measures have been setup to meet a complex set of requirements. The scandals of the 1990s demonstrated that no matter how large a company, when power is concentrated in the hands of a few people who are associated with the company for a long time and have complete control over it, there is a possibility that illegal procedures may be carried out especially with regard to financial practices. Therefore, the provisions dealing with non-executive directors are meant to bring in independent ideas. Sharing of power has been an important step to achieve these aims (Pass, 2006). Although the refined corporate governance code has been received well within both the investor and directorial communities in the UK, let us look at the practical effectiveness of the code. It implies that the recent Combined Code on Corporate Governance, as it is called, needs to achieve a balance between best corporate governance practices that prevent scandals such as Enron, etc and not only permit diverse institutional practices but also encourage them at the same time. The Code has a number of detailed provisions to help a company develop a healthy governance system; however there is widespread belief that the Code is very prescriptive which was proved in the case of the Marks & Spencer plc. The plc promoted its CEO to the dual role of executive chairman, a move which was met with a lot of hostility from the investors of the company. The "comply or explain" principle of the code has also come under criticism because it is believed that it allows boards to get away with unconvincing explanations of non – compliance with the norms of the Code. Therefore, in an attempt to achieve flexibility and organization, there is a danger that the Code might not have achieved either (Moore, 2009). One of the defining philosophies of the Code regardless of the provisions is that the Board of a company is answerable to its shareholders; therefore all of the provisions of the Code will be effective only when there is an increased amount of communication between the shareholders and the Board. While the division of the board into monitoring and managerial functions prevents concentration of power, it also leads to an ambiguity of purpose. Some of the issues that might arise under such a circumstance are excessive size of the board, poor information flow within the board and a lack of cohesion within the members of the board, all of which ultimately lead to its ineffectiveness. There has also been a call for better implementation of the "comply or explain" principle. Only 10% of the FTSE 350 companies fully comply with all of the aspects and provisions of the Combined Code. The Financial Reporting Council (FRC) has also argued that those companies who are required to provide explanations at times of non-compliance often do so with basic and unsatisfactory information (Barker, 2008). Although power sharing within the board has been achieved through the inclusion of non – executive members, their effectiveness is yet to materialize. One of the reasons for this is due to their lack of knowledge of the specifics of the company. Another limitation of the Code has been with regard to the needs of the SMEs (small medium enterprises). Most of the measures of the Code are meant for large corporations and the “comply or explain” principle of the Code is believed to force companies to adopt the provisions of the Code even though it might not be most suitable to the SMEs. Discussion In allowing companies a choice to follow the norms of the Corporate Governance Code, it may seem that it has taken a soft approach. However, the board of a company still needs to answer to its shareholders. By strengthening this process of accountability towards shareholders, the Code has made the board both the governing and monitoring agency. However, if the shareholders are to review the actions of the board, it is important that they receive appropriate and relevant information. The disclosure requirements in annual and other periodic reports are mandatory and are governed by law ensuring that shareholders are able to find out the required information. Therefore the "comply or explain" principle of the Code is successful in promoting healthy corporate governance measures and thus helps avoid scandals. Having looked at the general guidelines of the Code, let us consider the effectiveness of the Code with respect to specific criteria. The governance code is effective and cost efficient at the same time, especially in comparison to other systems. Although the nature of the Code is voluntary, it was found that post 1992 when the governance measures were introduced 94% of the 350 FTSE companies had a division in the roles of chairman and CEO. The FTSE ISS Corporate Governance Index and the Governance Metric International both rated UK as the country that had the best score. The voluntary principle also cuts down on costs. When compared to a mandatory system such as that in the US, it is estimated that cumulative implementation costs could be around $1.4 trillion (Barker, 2008). At the same time, only 10% of the 350 FTSE companies have adopted all of the provisions of the Combined Code. Even in the face of measures that are based on preventing the "one size fits all" model, there is still some work that needs to be done with regard to SMEs. The costs of implementing the provisions of the Code are much higher for SMEs and therefore there is a risk of them adopting the "box-ticking" approach (Barker, 2008). Conclusion Although the Corporate Governance Code of the UK has been reactive to external changes, it has proved to be effective in promoting healthy governance procedures overall (Dignam, 2006; Barker, 2008). In a testimony to its success, 26 out of the 27 member states of the European Union have adopted the UK style of governance. The theoretical framework has been laid and emphasis will now need to be given on effective and widespread practical implementation. Further research regarding the effectiveness of the various provisions of the Code will help make small changes to the existing framework. Despite the criticism on the Code over certain provisions, it is clear that there is a need for governmental intervention in corporate governance similar to any other managerial process such as equality rights, safety practices, etc. This will help satisfy the needs of all of the stakeholders concerned while allowing profit-making institutions to flourish (Alpaslan et al. 2009). Bibliography Alpaslan, C. M.; Green, S. E. & Mitroff, I. I. 2009. Corporate Governance in the Context of Crises: Towards a Stakeholder Theory of Crisis Management. Journal of Contingencies & Crisis Management, Vol. 17 Issue 1, p38-49. Apostolides, N. 2008. Exercising corporate governance at the annual general meeting. Corporate Governance. 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