Corporate Governance Regulations in the UK and the US - Essay Example

?Corporate Accountability Table of Contents 0 Introduction 3 2.0 Dimensions of Corporate Governance Regulations in the UK and the US 3 2 UK’s Perspective 3 2.2 US’s Perspective 5 3.0 Effect of Corporate Governance on Corporate Interest Groups 6 4.0 Factors that Led to the Collapse of Corporate Entities in the UK and the US 7 4.1 Collapses in the UK Corporate Governance 7 4.2 Collapses in the US Corporate Governance 8 5.0 Corporate Governance in the UK 9 5.1 The UK Combined Code 9 5.2 Maxwell Saga 10 5.3 Barings Bank 11 5.4 Polly Peck 11 5.5 Bank of Credit and Commerce International (BCCI) 11 5.6 Cadbury Report Committee 11 5.7 Greenbury Committee 12 5.8 Hampel Committee 12 5.9 Turnbull Report 13 6.0 Corporate Governance in the US 13 6.1 Enron Corporate Collapse 13 6.2 The Sarbanes-Oxley Act (2002) 14 6.3 The Securities and Exchange Commission (SEC) 14 7.0 Conclusion 15 8.0 References 17 1.0 Introduction Corporate governance is an effective way of safeguarding the stakeholders’ faith in the business. This is because a well governed organisation is visualised to be effective by stakeholders and thus initiates greater investment from them in the business. Often a management structure is used by organisations for conducting their operations. The concept is used as a framework of policies with the objective of protecting outside stakeholders’ investment in the organisation. Corporate governance is used by large organisations for generating a system of balances and checks. It provides the assurance that overextending of company’s resources is not generated by any individuals or departments. In other words, corporate governance helps in preventing both frauds and abuse from employees (Vitez, 2010). In this research paper, the various dimensions of corporate governance policy frameworks will be discussed with reference to followed principles in the UK and the US. Various theories and approaches were followed by these two countries for responding to major corporate collapse during the period of 1990-2002. Those approaches with practical evidences will be taken up for discussion in this research paper. 2.0 Dimensions of Corporate Governance Regulations in the UK and the US 2.1 UK’s Perspective The regulations of corporate governance follow a market-based approach that provides flexibility to the companies in organising and exercising their responsibilities, while simultaneously ensuring their shareholders proper accountability. The accountability is maintained in the UK through “Combined Code on Corporate Governance” that works on the basis of ‘comply or explain’. This approach makes the judgments easy that is to be presented case after case. This form is supported by investors, companies and regulators in the UK and has been adopted in other financial markets as a model. The approaches in the UK towards corporate governance provide high standards combined with relatively lower costs of association. The board of the UK corporate governance presents assessment of position of the company and provides accountability for maintaining sound internal control system. The board is responsible for maintaining shareholders’ contact for understanding their concerns and opinions (Financial Reporting Council, 2006). The code of the UK corporate governance consists of five main sections, namely, leadership, effectiveness, accountability, remuneration and relations with shareholders. With respect to leadership, companies are initiated to be lead by an effective board consisting of both executive as well as non-executive directors. In complying with the code ‘effectiveness’, companies should have an exact balance of experience, knowledge and skills. For pertaining to accountability, there should be proper assessment of the prospects and position of the companies. In case of remuneration, the payments of directors should be sufficient enough for attracting qualified candidates and lastly, the companies should bear a dialogue with shareholders on the basis of mutual understanding about its objectives (Wilberg, 2011). 2.2 US’s Perspective From the perspectives of the US, under the guidelines of corporate governance, the companies are required to adopt the guidelines addressing the subjects required. The codes of corporate governance are required to be posted on the website of companies for maintaining transparency. The companies should strive for disclosing the fact as to whether they have adopted the code of ethics. It is although not mandatory for a company to adopt the code of ethics, but it needs to disclose the reason of not adopting. The code of ethics that is adopted by the company has to be applicable to all the employees, directors and officers (Locke Liddell & Sapp LLP, 2003). Regarding the issues related to issuing of personal loans, it is not lawful for a company to either arrange for or provide personal loans to its executive officers and directors. The companies must disclose their “non-GAAP financial measures” in the form of reconciliation presenting the most directly comparable measures. The inclusion of those measures in any of the financial statements of the company that is required to be disclosed by the Article 11 of Regulation S-X is forbidden (Alexander, 2004). It is argued that due to the efficient legal protection to shareholders in the UK and the US, the shareholders are encouraged to become minority shareholders through ‘dispersed share ownership’. A research study on the validation of corporate governance in the countries of the UNECE region suggested that there are two types of corporations that are publicly traded, the “manager dominated model” and the “controlling shareholder-dominated model” (Salacuse & Braker, 2002). 3.0 Effect of Corporate Governance on Corporate Interest Groups This is essential to notify the probable effects of corporate governance on potential stakeholders in corporations. The effects can be best understood with reference to agency and stakeholder theory. The agency theory helps in identifying issues of conflicts among various groups which have interest over the company. The reason of conflict is different objectives of different groups namely stockholders, managers and creditors. Shareholders’ objective is to maximise profit, while banks objective is to reduce risks. Managers find themselves at a riskier position with the objective of maximising profit because their careers are dependent on their ability of earning profit and present to the board for appraisal. The agency theory looks at the firms as units of conflict rather than a unitary object. Following the agency theory in corporate governance, conflicts are considered not abnormal but as a part of the corporations’ structures (Ghoshal, 2005). The stakeholder theory of corporate governance is considered as a highly participatory and democratic concept. In this model, rather than considering a firm as a machine that produces profit, it is visualised as a social institution. The stakeholder theory suggests that firms are made for taking care of more than just the shareholders. The firms following stakeholder theory operates with the belief that a large proportion of the population is dependent on their efficient operation and expected performance level (Freeman & Et. Al., 2004). 4.0 Factors that Led to the Collapse of Corporate Entities in the UK and the US 4.1 Collapses in the UK Corporate Governance The principle-based approach of corporate governance is enforced by the UK combined code that bounds the companies for strictly following those principles. After its collapse in 1990, the number of codes has increased. This ensures that the government is keen on addressing the issues of collapse and make modifications in their principle based approaches. The following section reflects the necessary modifications through discussing the factors that led to the collapse (ACCA, 2008). The approach lacks caution towards introduction of statutory requirements in corporate governance for directors. This resulted in hampering the extent for a unitary board towards strategy formulation (Lipton, 2003). The ‘comply or explain’ concept puts pressure on the companies to “play safe” and “comply”. This ‘box-ticking approach’ weakens the concept which is aimed towards retention of flexibility in the companies’ behaviour of corporate governance. There is flaw in the code that non-compliance is treated as poor governance (Tricker & Mallin, 2009). The UK combined code does not focus on the training of the board, whereas the board is a distinct entity and requires adequate knowledge and skills. An important role needs to be played by the professional development programs and needs to be ideally mentioned in the framework for combined code (Barker, 2008). 4.2 Collapses in the US Corporate Governance In the United States, rule-based approaches are followed for efficiently handling corporate governance issues. The first reason that has been encountered for collapse in corporate governance is misalignment of the interests of the shareholders and managers. The agency theory can be best utilised for solving this issue. The mechanisms of internal corporate governance in the US failed to resolve the issues of fraud and misinformation that resulted in managerial misconduct and provide them the chance of deceiving shareholders and investors (Broshko & Li, 2006). There was flaw on the part of the external gatekeepers, credit rating agencies, auditors and securities analysts because they did not uncover the frauds financially and manipulations in the earnings. Thus, the investors and shareholders were not informed about the problems and discrepancies (Financial Standards Foundation, 2010). There were flaws on the part of the shareholders themselves as they did not show vigilance for protecting their own interests. The corporate boards had to be more alert towards the behaviour of managers that resulted in corporate scandals (Edwards, 2003). 5.0 Corporate Governance in the UK 5.1 The UK Combined Code UK corporate governance code was formerly known as combined code. The code had been proposed to illuminate the position to both foreign investors and foreign companies listed in the UK. The UK governance code restructured and developed new principle and provision, and few key changes than the old combined code. The changes are formed to provide bigger prominence to the principles and support a successful leadership, effectiveness, communication and accountability (FRC, 2006). Leadership: The new principal can increase the leadership, effectiveness as well as the responsibilities of chairman of the board. It underlines the duty of non–executive directors with senior independent director by offering constructive challenge (Yelder, 2009). Effectiveness: The new principle emphasises on the requirement for appropriate level of commitment from all directors. The board should have appropriate balance of skills, proficiency, experience, and knowledge of the company to perform their respective responsibility and duty efficiently (FRC, 2006). Accountability: The board is responsible for deciding the nature and extent of the risk to take successful strategy. The board must apply the principles of corporate reporting, risk management as well as internal control principal transparently and maintain proper association with company’s auditor (FRC, 2006). Remuneration: A proper remuneration must be provided to attract, retain and encourage the quality director which is essential to operate an organisation effectively. A formal as well as transparent procedure should apply for making remuneration packages and creating policy (FRC, 2006). Relation with shareholders: The board has responsibility for undertaking a reasonable dialogue between shareholders and directors. The dialogue must be based on mutual understanding of the company’s objectives (FRC, 2006). 5.2 Maxwell Saga Corporate governance seeks to provide incentives for the management and board to accomplish the objective of the company and interest of shareholders. Recent scandals of corporate governance show the failure of combine code. Maxwell Corporation which was a large publicly quoted company comprised of two companies Maxwell Communication Corporation and Mirror Group. The presumed suicide of Robert Maxwell (chairman and chief executive) reveals the financial scandals of the company. It has been found that the company has debt about GBP of 4 billion and GBP of 441 million in the pension fund. It was the greatest fraud of 20th century (Maier, 2005). 5.3 Barings Bank In the year 1995, Barings Bank of the UK asserted bankrupt. The collapse of Barings Bank contributes to the demand of better governance (Carroll, 2009). 5.4 Polly Peck Polly Peck which is a textile company of the UK was collapsed in the year 1990 because of the Chief Executive of the company, Asil Nadir. In the year 1988, almost ?58m of Polly Peck’s money had been transferred to the private account of Chief Executive (Scribd, 2011). 5.5 Bank of Credit and Commerce International (BCCI) In the year 1991, BCCI faced losses of almost 10 billion USD to 17 billion USD which was one of the biggest bank frauds of that time. Systematic fraud over many of years was the reason for financial collapse of BCCI (Sungard, 2011). There is a need for independent and unified regulation and wide corporate governance structure to prevent fraud and collapse of organisation. 5.6 Cadbury Report Committee UK Combined Code is a consolidation of a number of different report regarding different views on better corporate governance. The first movement of UK combined code was the issue of Cadbury Report. The report of Cadbury Committee is a model which describes the management of corporate governance investigation. The overall quality of Cadbury Committee Report lies in the fact that it is recognised internationally and has been decisive in the development of corporate governance in the UK (Yelder, 2009). With regards to scandals of Maxwell Corporation the Cadbury Committee Report had suggested a ‘Code of Best Practice’. The suggestion provides a series of governance practices as well as formation and composition of board committee. The report also underlines the significance of non–executive directors (Maier, 2005). 5.7 Greenbury Committee Greenbury Report incorporate UK combine Code on remuneration of director which was major concern for investor and public at large during 1990. In privatised industry the remuneration was increasing and the packages of remuneration was unable to offer required incentives for directors to improve performance. It was recognised that corporate governance problem concerning the remuneration of director must be addressed in a thorough way. This led to the establishment of Greenbury Committee (Manifest, n.d.). 5.8 Hampel Committee The Hampel Committee was founded in the year of 1996. The aim of this committee was assessment of combined code of Cadbury Committee and Greenbury Committee. The Hampel Committee’s objective was to re-evaluate whether the combined code’s real purpose was being fulfilled or not. The Hampel Committee report focused on avoiding the misuse of unrestricted authority assigned to the management. The report favoured greater participation of shareholders in company affair (Manifest, n.d.). 5.9 Turnbull Report Turnbull report was first issued in the year 1999. The objective of this report was to provide guidance for directors on the combined code for sound business practice. This report helps to pursue business objectives even in evolving business environment. The report evaluates the way a company has implemented combined code that is related to internal control (Lam, 2010). 6.0 Corporate Governance in the US 6.1 Enron Corporate Collapse The collapse of Enron in the USA during December 2001 had been resulted due to the “accounting drama”, the investigation into which had dug out three issues related to the collapse. First issue had been that there was a corporate culture that provided encouragement to the staffs for influencing the policy makers (public) for privatising and deregulating the US energy sector. Secondly, the company provided instructions and led the accounting system into ‘dubious’ financial transactions and this resulted in the ultimate collapse of the company. The third issue was the most significant that forced the financial markets of the US into chaos (Goliath, 2002). 6.2 The Sarbanes-Oxley Act (2002) For handling the collapse related issues that occurred in the US during the period 1990-2002, Sarbanes-Oxley Act (2002) was passed. The aim of this act was to regulate and register all the public accounting firms by performing activities related to inspections, disciplinary proceedings and investigations and thus enforce compliance with the standards of professionalism. The act outlines the following responsibilities under the sections: Section 204: Auditors are required to report all the critical policies as well as practices of accounting to the audit committee of the firm. Section 203: The reviewing partners along with the lead audit should rotate the audit once in every five years. Section 201: The public accounting firms are prohibited from providing any non-audit service during the firm’s auditing (Ohio Cooperative Development Centre, 2001). 6.3 The Securities and Exchange Commission (SEC) For handling collapse issue and ensuring that these issues do not arise in the future, the SEC took responsibilities for protecting the investors along with maintaining orderly, fair, and efficient markets and thus facilitates formation of capital. The SEC’s mission is growing more and more compelling with the growing first-time investors for helping them secure their respective futures (US Securities and Exchange Commission, 2011). 6.4 The Public Company Accounting Oversight Board (PCAOB) PCAOB is a non–profit as well as private sector organisation which was established by Sarbanes–Oxley Act of the year 2002. This organisation aims to supervise accounting experts who provide autonomous audit report for organisations that are publicly traded. PCAOB has various responsibilities which are: Registration of public accounting organisations Setting up inspection, quality control, principles and ethics, and other rules and regulations which are related to company audit Conducting assessment, analysis, and corrective schedules and proceeding of registered accounting organisations Implementing joint compliance with Sarbanes–Oxley Act (US Securities and Exchange Commission, 2011) 7.0 Conclusion It is evident from the research that corporate governance failure has led to taking up various measures both by the UK as well as the US authorities for safeguarding the stakeholders’ rights. Factors have been identified throughout the paper that actually had led to the collapse of the corporate governance during the period 1990-2002. It has been revealed from the research that both the developed countries of the world have become much concerned about the collapse issues of corporate governance and accordingly have initiated various resolving measures aimed at avoiding such collapse in the future. 8.0 References ACCA, 2008. Corporate Governance Codes. Students. [Online] Available at: http://www.accaglobal.com/pubs/students/publications/student_accountant/archive/sa_apr08_campbell.pdf [Accessed April 02, 2011]. Alexander, K., 2004. Corporate Governance and Banking Regulations. Working Paper 17. [Online] Available at: http://www-cfap.jbs.cam.ac.uk/publications/downloads/wp17.pdf [Accessed April 02, 2011]. Barker, 2008. The UK Model of Corporate Governance: An Assessment from the Midst of a Financial Crisis. Corporate Governance Briefing. 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