Corporate Governance in the United Kingdom - Essay Example

? Corporate Governance in the United Kingdom Part Rules-based vs. Principles-based Approaches to Corporate GovernanceThe UK Corporate Governance Code of June 2010 was formulated with the purpose of facilitating effective, prudent and entrepreneurial management practices that can be successful to an organization in the long run. (Tricker, 2004) This purpose was based on the need for a guide to the components that make up an effective board. The underlying principles that attribute to good governance include: transparency, accountability and being focused on the long term sustainability of success in an organization. The rules-based approach to corporate governance was largely influenced by the Sharbanes and Oxley Act in the USA, which enshrined that the management and the board of an organization are expressly accountable for the financial reports that are published by their organization. (Mallin, 2005) Penalties are put in place for any instances of transgression as wells as setting rules on corporate governance which are also applicable to a company’s subsidiaries. This approach issues liability to directors in case of mismanagement, improves the communication of important issues to an organisation’s shareholders, improves the confidence that investors and the public have in the company, improves the internal control measures that a company puts in place as well as improving an organisation’s overall governance structures. Therefore, this approach is essential in the establishment of the minimum standards of practice that all should abide by. The principles-based approach to corporate governance on the other hand, is a complete contrast to the rules-based approach. This is because instead of the use of hard and strict rules to reform corporate governance as is the case with rules-based approach, the principles-based approach influences a broad set of practices that meet the expectations of all stakeholders. Thus the organization adheres to the spirit rather than adhering to what the code stipulates. This approach is largely used in the UK and is a listing requirement by the stock exchange. (Tricker, 2004) Those that champion the use of this approach argue that by setting up rules that all should follow; the rules-based approach does not speculate the invention of imaginative ways to get around the rules by some organisations. Principles-based approach is the best approach to use for those organisations that do not only want to abide by the minimum standards that are put in place; the implementation of this approach impresses all stakeholders in an organization. Part 2 Role of Institutional Investors in a Business Institutional investors are basically organisations which invest money in securities, real property and any other investment assets held in their name or held in trust for others like investment funds and pension funds. Corporate governance codes and principles have over the years stressed the importance of institutional investors in corporate governance. Not only are institutional investors being significantly influential in their home countries, through their increased cross-border ventures, institutional investors are also becoming an integral element in other countries as well. The global financial crisis triggered corporate governance reforms which subsequently stressed on the crucial role that institutional investors play. (Tricker & Mallin, 2005) The Cadbury Report in 1992 accentuated on the role of institutional investors by stating that, ‘We look to the institutions in particular to use their influence as owners to ensure that the companies in which they have invested comply with the Code’. (Tricker & Mallin, 2005) It is the role of institutional investors to ensure that there is a mutual understanding with the company regarding the objectives of the firm. Institutional investors should also evaluate companies’ governance structures, laying particular emphasis on the board structure and composition. The third main role of institutional investors is to ascertain that they make the ultimate use of the voting powers they hold in these companies. It is therefore required of institutional investors that they behave responsibly and make adequately adept decisions. Institutional investors should take up a stewardship duty and ensure that as business owners, they are more in tune with company affairs as well as being tougher on company boards. The Institutional Shareholders’ Committee (ISC) in 2009 published the Code on the Responsibility of Institutional Investors, which was what the Stewardship Code was based on. The ISC emphasizes on the need for institutional investors to improve the quality of dialogue between them and the companies so as to better the returns to shareholders, decrease the risk that results from poor strategic decisions and improve the implementation of governance responsibilities. (Tricker & Mallin, 2005) The responsibilities of institutional investors to a company cannot be adequately carried out without them being able to exercise their rights. The most fundamental right to many institutional investors is the ability to change the directors of a company. Effective stewardship is only possible when institutional investors can exercise their rights since this gives them the capability to contribute to the topical issues of the company such as nominating and appointing directors or removing underperforming directors. In conclusion, efforts to reform corporate governance in the UK have seen a greater emphasis laid on the importance of institutional investors. Institutional investors in their role as business owners are being encouraged to adhere to the Code of Responsibility for Investors set by the ISC and engage more in their investee companies. How Corporate Governance addresses Conflict of Interest with Non-Executive Directors Non-executive directors have the responsibility to supervise and control the activities of the executive directors as well as the board of directors. All directors must always act in good faith and in the best interests of the organisation’s stakeholders. In case any conflict of interest arises between the interests of the company and those of the director, then it must be declared by the director in question and the way forward agreed on by the board or the shareholders in a general meeting. (Mallin, 2005) Conflict of interest could arise in various forms; a non-executive director could be serving an advisory role on the board of two rival companies. This is a total conflict of interest to both companies and the corporate governance code clearly stipulates that all directors should exercise their duties in the best interests of the company. Therefore, in such an instance, the non-executive director is in breach of both his/her statutory duties and the corporate governance code in their capacity as a non-executive director to both companies. Remuneration of directors by the remuneration committee is another source of potential conflict of interest. This is because in the case that the non-executive director is involved in advising the remuneration committee, then there is a possibility of conflict of interest. (Mallin, 2005) In this case, the corporate governance code states that the chairman of the board of directors should ensure that there is constant contact established between the company and its principal shareholders regarding the remuneration of directors; thereby reducing the chances of conflict of interest. Part 3 Ways to Improve Corporate Governance in the UK The corporate governance code in the UK has a number of limitations in various aspects. First and foremost, it does not stress enough on the crucial need to have more accountability and highly professional ethical behavior emphasized within the boardroom. The UK company law should be amended so that directors are made personally liable with any criminal activities in order to have a responsible corporate environment. Greater accountability and ethical behavior are specifically important as there has been a decline in the nature of corporate governance due to the financial crisis experienced in the world. The UK corporate governance code does not instill proper measures to curb the issue of excessive remuneration of directors, this is because there have been cases of directors issuing themselves excessive remuneration packages. This shows the weaknesses of the corporate governance structures as well as poor corporate performance. It is also of importance to note that the recent credit crunch experienced worldwide has showed the failure of corporate governance mechanisms especially in banks. Banks in the UK like HBOS have been forced to be rescued by banks from other countries. In this case, the Spanish Santander Group bailed out HBOS which begged the question of why the bank had to be rescued by a bank in a country whose corporate law has been accused of failure in their protection of shareholders (Franks & Mayer, 2002). The UK Companies Act 2006 states that indeed directors may act in the best interests of their stakeholders but this is expected of them only if the shareholders benefit from their actions. This is a great loophole for encouraging corruption of directors through numerous selfish acts, a complete contrast to the code of governance that is in place in Germany and Anglo-America. The Anglo-American legislation clearly upholds the principle that gives supremacy to shareholders. (Franks & Mayer, 2002) Corporate governance in the UK basically attributes for a principles-based approach. This means that it does not recommend the much stricter rules-based approach that is followed in the US. The principles-based approach contrasts to the rules-based approach in that, as the rules-based approach sets the minimum standards that organizations must abide by, the principles-based approach is of the view that the minimum set standards in the rules-based approach might be not be enough for an organization’s stakeholders. However, the principles-based approach is not as strict hence giving a lee way for exploitation by selfish individuals. The US upholds the rules-based approach since it has expressly put in place the guidelines to follow thereby disregarding the principles-based approach (Franks & Mayer, 2002). Role of Accountants in Organizational Corporate Governance Accounting is a crucial part of corporate governance policies and procedures. Good corporate governance practices lay emphasis on the importance of having sound financial elements. Corporate governance and accounting are mutually dependent elements of any organization. This means that the quality of an organization’s corporate governance has an effect on the effectiveness of the organization’s accounting function. It also works the other way round; accounting has an influence on the quality of an organization’s corporate governance since it is a source of direct and indirect input into the success of corporate governance operations. The provision of credible accounting information by an accountant to help in the application of different corporate governance mechanisms is a source of direct input. On the other hand, indirect input involves the influence of accounting on the culture of an organization through valuing fairness and truth while providing the required information to the organisation’s stakeholders. In particular an accountant’s duty to a company in external reporting, management accounting and auditing (both internal and external auditing) is essential to the company’s corporate governance (Athula, Perera & Perera, 2009). An accountant’s role in external reporting provides financial information as well as non-financial information to stakeholders of an organization. Financial information constitutes information on an organization’s financial statements. Published financial statements assist stakeholders to make decisions regarding their involvement with the organization, thereby stressing on the importance that this information be made accurate and reliable by the accountant. One of the fundamental aspects of corporate governance and external reporting is external auditing. This ensures that financial statements have been prepared well and that they contain the true and fair view of the organization’s financial state (Athula, Perera & Perera, 2009). External auditing gives an independent opinion on the accuracy of financial statements by making a fair judgment on the financial statements. An accountant’s management accounting role provides information on budgeting, performance management, transfer pricing as well as reward systems, all of which are crucial in the implementation of corporate governance mechanisms. This information is also used as a basis in determining the strategic direction that the organization should undertake as well as helping the Board of Directors (BOD) to monitor the performance of the organization’s management (Athula, Perera & Perera, 2009). Through internal auditing, an accountant helps in risk reduction of frauds and errors thereby improving the organization’s internal corporate governance mechanisms (Athula, Perera & Perera, 2009) Internal auditing provides a series of tests and procedures that focus on improving the reliability and accuracy of reports made during management accounting. Internal auditing also ensures that there are effective systems in the organization through regularly investigating on the controls and procedures. Analyzed Problems and their Solutions There is an acute problem of shortage of the required information by shareholders. Over the years, shareholders have demanded for more information from the management of companies so that they can evaluate how their investments are being utilized. The directors are accountable for ensuring that this information is availed to the shareholders and other stakeholders accurately and in a prompt manner (Tricker, 2004). Therefore it is essential to shareholders that they appoint qualified directors who have the capability to provide the demanded information. The solution to this is that shareholders have to form formidable voting groups which have the capacity to pass concrete resolutions while appointing directors during general meetings. By so doing, they can ascertain that the directors who are appointed are fit enough to carry out their activities in the best interest of the shareholders. Another problem is the amount of accounting information that is supplied. Accounting information is fundamental to the evaluation of the performance of directors. In order for shareholders to monitor the directors’ performance, adequate financial information has to be at their disposal. If there are imperfections in the reporting of financial statements then there is the risk that corporate governance will as well be imperfect. The importance of supplying accounting information can therefore not be ignored. The solution to this problem would be to ensure that the external auditing function of the company is implemented to the letter. External auditing ensures that adequate accounting information is reported and that the reported information reflects the true and fair view of the company’s financial status. Through external auditing, shareholders can be sure that information supplied to them by the directors is complete and accurate, thus giving them a good platform to make their required decisions. There can be a problem of high monitoring costs to a small shareholder. This means that a small shareholder may not have the capability of monitoring the performance of directors as well as large investors. This is because the cost of monitoring may be too high for such an investor such that they would be forced to free ride on what the large investors decide. This brings about the issue that the company’s large investors are more often than not the deciders during general meetings. Therefore, the voice of the small shareholder is at times ignored albeit their reasonable concerns at times. The solution to this can be answered by the efficient market hypothesis, which states that there is efficiency in financial markets. References Tricker, B. & Mallin, C. (2005), Institutional Investors and Corporate Governance Reform. Tricker, B. (2004), Corporate Governance: Principles, Policies and Practices, 2nd Edition. Mallin, C. (2005), Corporate Governance 4th Edition. Financial Reporting Council. 2010, ‘The UK Corporate Governance Code.’ Athula, E., Perera, H. & Perera, S. (2009), Towards a Framework to Analyze the Role of Accounting in Corporate Governance in the Banking Sector. Macquarie University. Franks, J. & Mayer, C. (2002), Corporate Governance in the UK – Contrasted With the US System. CESifo Forum. Read More