BSc Finance and Accounting - Essay Example

? BSc Finance and Accounting Professional Accountant Assignment Part There have been several trends and changes in corporate governance in the UK since the Cadbury Report was released in 1992. This has been influenced by many reports including the Hampel Report, and the Greenbury report which sought to create a combined code for the directing and control of businesses in the UK. These codes have evolved to what is known today as the UK Corporate Governance Code, the latest of which was released in 2010. The UK Corporate Governance Code 2010 sets principles out the principles of ideal and best practices in corporate governance. The UK Corporate Governance Code of 2010 is required by the Financial Services Authority listing rules to get all listed companies on the Stock Exchange to use the UK Corporate Governance Code. This is based on the Financial Services Markets Act of 2000. The Corporate Governance Code of 2010 is overseen by the Financial Reporting Council. Thus, public listed companies must comply with the UK Corporate Governance Code 2010. Those who fail to comply with the corporate governance Code have to explain why they departed from it. Private companies are encouraged to use the UK Corporate Governance Code of 2010. The fact that public listed companies are required to comply or explain makes the UK Code a principles based code. This is in contrast with the rules based code which is connected to the Sarbeans-Oxley Act of the United States. There are three elements of reporting that are meant to prevent fraud and wrongful reporting by people charged with corporate governance: opportunity, incentive and rationalization (Strohm, 2006). In a rules-based system of corporate governance like the United States, preventing inaccurate reporting is done by limiting opportunities (Jeffrey, 2011). This is done by precision and setting strict standards for reporting. Failure to comply with the precise and strict standard leads to legal sanctions. The principle-based corporate governance system of corporate governance is a comply-or-explain system where the rationalisation of actions are documented. This is a communication based system meant to strengthen moral incentives by clarifying morally responsible methods of reporting. The UK Corporate Governance Code of 2010 is a rules-based system and it focuses on five main systems and structures: 1. The Board of Directors: Every company is to have a board of directors which would be tasked with the long-term leadership of the company. The board is tasked with the running of the company. No one on the board is required to have unfettered powers. There are checks and balances on all members including the chairman who has responsibility for maintaining the effectiveness of the board. On unitary boards, there must be a balance between executive and non-executive directors to promote checks and balances on the single board. 2. Effectiveness: The board must be ran through various committees like the remuneration, audit and risk committees. The committees need to use skill, experience and independence to discharge their obligations. The committees must have formal opportunities. To ensure effectiveness, the members of the board must be open for periodic nomination by the shareholders and this must be done at least once every three years. 3. Accountability: The board must use balanced and understandable methods for assessing the company's position from time to time. The assessment must include important areas like risk management, strategic management and internal controls. These assessments must be disclosed through formal arrangements on corporate reporting, risk management and internal control to disclose information. 4. Remuneration: There must be formal and transparent methods of fixing remuneration. This system must be enough to encourage appropriately skilled persons to join the board and they should not be too much. 5. Shareholders: The board needs to have constant contact with members of the board of directors. This should be done through annual general meetings amongst other things. Part 2 Assessment of Elements of Corporate Governance in Tesco, UK In the normal sense, a company is formed by various shareholders coming together to pool their resources to establish a corporate entity. Companies have limited liability and due to that, the shareholders have a separate existence from the companies they form. A shareholder's worth in a company is judged by the number of shares that the entity owns. Shareholders control affairs of companies. Thus, the more shares an entity owns in a company, the more say that entity can have. This is because there is voting rights that come with the number of shares an individual or entity owns in a company. Currently, in the UK, most companies raise capital by the sale of shares to individuals and powerful entities that can afford to buy large stocks in a company. According to Mallin (2009) in 2004, individuals owned 14% of shares in companies. Insurance companies owned 17% of shares and pension funds controlled 16%. Unit Trusts had 2% of shares in the companies whilst overseas investors also controlled 32% of shares corporate entities in the UK. Tesco PLC is a company incorporated in the UK in 1932 by Jack Cohen. The company grew in the decades afterwards and went public in the 1980s. Tesco is funded by the investment of various shareholders who own shares in the company. Tesco now has a global presence in the grocery and retail industry. With a strong and entrenched position in the UK, Tesco has expanded into the United States, Asia, the European Union and South America. The floating of shares in Tesco made it a different entity. Legally, the shareholders from various backgrounds could acquire shares in the company. And this gave them voting rights which could allow them to wield influence. This include the election of directors and auditors to control and recheck things respectively in the company. According to the 2011 financial reports of Tesco PLC, the company has 200,000 shareholders. The report states that Tesco has a large number of pension funds who own shares in the company. Blackrock Inc owns 5.48% of shares in the company whilst Legal and General Investment Management Limited owns 3.99% of shares in the company. The third largest group of shareholders are Berkshire Hathaway Inc which owns 3.02% of shares in the company. These three groups of dominant shareholders are investing more in the company than others. Due to that, they would expect to be given some degree of respect and regard in several affairs. This is because if the people charged with corporate governance in Tesco make mistakes, it is their capital that is likely to go down the drain. Thus, they would have some power and some right in Tesco and this must be respected and honoured. According to Mallin, the power of dominant stakeholders like Blackrock Inc, Legal and Global Investment Management Limited and Berkshire Hathaway Incorporated would have power that revolves around the 'exit and voice' framework (2009). Dissatisfactions on the part of these large shareholders can lead to various levels of concern which they can raise before the management and directors of Tesco. This is because they have each invested in several tens of thousands of shareholders in Tesco. And due to that, they are likely to be more particular about monitoring things in the company and helping to promote their interest. If Tesco is not meeting their interest in the right manner, these large shareholders can release their shares and take their money from the company. This would mean there would be a change in the shareholding and capital structure of the company and this would involve the reduction in the capital base of the company. Shareholders are a group of stakeholders in every entity. There are various approaches and systems used by the persons charged with corporate governance in dealing with the demands and requirements of these stakeholders. The Mendelow Matrix provides guidelines on how the people charged with corporate governance can deal with the requirements and expectations of various stakeholders. The matrix balances the interest of stakeholders and their power in the company. Those with high power and low interest need to be kept satisfied. Those who have low interest in the company and low power need to be monitored and minimal effort must be exerted on them. Stakeholders with high interest but low power must be kept informed. However, stakeholders with high interest and high power need to be engaged closely and actively. Figure 1: Mendelow Matrix Institutional investors are stakeholders with high power. These people have power because they can change managers and also exit the company by releasing their shares in the company. Obviously, institutional investors have high interest in the company because they have invested a lot of money by buying shares in the company. Thus, in the case of Tesco, these three companies with the highest shares are the highest institutional investors and they hold a lot of influence. Thus, it is apparent that they keep the investors satisfied and engage with them actively. In Tesco's Annual Report of 2011, the company stated that the Non-executive Directors have a direct responsibility in engaging with institutional investors. The institutional investors would be interested in undertaking dialogue with Tesco and also evaluating the governance disclosures of Tesco. This is because each year, they can involve in voting to change directors and also change trends and systems. Non-executive Directors of Tesco involve in stakeholder engagement with these dominant shareholders. This is done through reference to group strategy, meetings and presentations as well as private meetings with them. Conflict of Interest that Affect Non-Executive Directors The main obligations of Tesco's directors is defined in terms of what the directors are expected to do according to the corporate code. Tesco's directors need to: 1. Define the framework for strategic and operational affairs 2. Monitor the fair running of the company. 3. Ensure that there is no dominant party with unfettered powers 4. Set their own salaries 5. Nominate the members of various sensitive positions. These five issues potentially creates conflicts of interest. This is because the board have power and capabilities. These members of the board have to use the power in their best interest and not do things in a way and manner that would create problems and issues with the company. They have to avoid the agency problem and ensure that they get the best of results. In order to ensure that the board works well, Tesco maintains a unitary board structure. However, the board has seven executive directors and seven non-executive directors as well as one senior independent director. The seven executive directors are CEOs drawn from the strategic business units and the various regional units of the company. These CEOs play a dual role of being part of the board and also see to the routine running of their respective functional unit of the company. There are also non-executive directors who are independent. They work by setting and supervising various committees on the board that are meant to help in running the company. The committees that operate in Tesco are the: 1. Remuneration Committee 2. Nominations Committee and 3. Audit and Risk Committee The remuneration committee sets the remuneration for the various directors. The committee operates in a way and manner that the various elements and aspects relevant to setting a salary are weighed up. Through this, they find logical ways of setting salaries to prevent a situation where the directors will set their own salaries on the basis of their own expectations. In the normal sense, human beings have unlimited wants and desires. Thus, if directors set their own salaries, they are likely to define a huge salary that would go against the company and be tantamount to a fraud against the company. The nominations committee ensures that the right procedures are used to nominate top level managers. This is to prevent favouritism and the use of inappropriate standards for the appointment of top level managers of the company. Audit and Risk Committees are meant to monitor the activities of the company. This ensures that there is a constant monitoring of activities in Tesco and the rightful recommendations are made and brought before the non-executive directors as and when the time comes. Part 3 Ways of Improving Corporate Governance in the UK and Lessons from Other Countries There are several things that can be done to improve the UK's corporate governance system and structures. Most of these things revolve around: 1. Compliance framework. 2. Legal scope of work. 3. The board structure and systems. Yong identifies that the position of the comply-or-explain system creates room for a lot of manipulation and a possibility for illegalities (2009). According to Yong, in spite of the numerous corporate governance rules that came to force around 2007, there were major problems with firms in the corporate sector because most of the compliance requirements were not robust enough. This is particularly serious in the principle-based jurisdiction where directors and managers had to either comply or explain their departures. Some of the departures were deliberately done to further the rights, causes and expectations of directors. Unlike the United States where tough measures were used in the compliance framework, the UK has a green area that can be exploited. To bridge most of these loopholes, there might be the need to experiment in some elements and aspects of the rules based system in the UK as well. This would force managers to comply and not use the departure opportunities to their advantage. As these corporate governance codes continue to become pervasive and accepted in the UK, it might be necessary to integrate them into the Companies Act. This would help the UK to move from a strictly principles based system to a rules based system where the force of law would compel more entities in the UK to use these codes and systems. The standards for some activities must also be improved. This is because the definition of terms like 'independent' in describing the non-executive directors is unclear (Keassey et al, 2011). This is because there is an apparent contradiction in describing Non-Executive Directors as independent and also demanding them to play a dual role in the company. Such contradictions should be re-examined and improved so that the framework becomes more consistent. Perhaps one of the suggestions for the attainment of this end is to create a two-tier board system to promote exact independence and enhance the dual role in a more objective manner. As the UK attempts to move from a comply or explain system to a system of formal rules and regulations for optimal results, there is the need for the main stakeholders to seek continuous improvement. There should be more dialogue and discussions on how to improve the existing systems. This would help the country to build a robust system that can be generally accepted before integrating it into the legal framework and systems. References Jeffrey, C. (2011) Research on Professional Responsibility and Ethics in Accounting London: Emerald Group Publishing Keassey, K., Thompson, S. and Wright, M. (2011) Corporate Governance: Accountability, Enterprise and International Comparison Hoboken, NJ: John Wiley & Sons Publishing. Mallin, C. A. (2009)Corporate Governance Oxford: Oxford University Press. Strohm, C. (2006) United States and European Union Auditor Independence Regulation London: Springer. Yong, L. P. K. (2009) Lessons in Corporate Governance from the Global Financial Crises Sydney: CCH Australia. Read More