Development of the U.K. Code of Corporate Governance - Essay Example

? Development of the U.K. of Corporate Governance Introduction Corporate governance explores the connections and responsibilities between the board, management, shareholders, and pertinent stakeholders within a legal and regulatory framework. Sir Adrian Cadbury highlighted the principle of corporate governance as the equilibrium between economic and social goals; between individual and communal objectives (Mallin 2011, p.3). The UK corporate system can be regarded as a three-party system (comprising of directors, shareholders, and the auditors) that is principle based rather than rule based. The paper reviews the development of corporate governance and the outcomes of the changes since 1990 to the culmination of a combined code in 2003, and the impact of the recent bank crisis on corporate governance structures (Lee 2006, p.36). The rise of Corporate Governance Since the 1980s, corporate governance issues have continued to attract immense interests. Issues such as corporate fraud, corporate failure, and corporate collapse, excess of executive remuneration, abuse of management power, and corporate social and environmental responsibility gained prominence, and have continued to attract attention in media reports, academic debates, public forums, regulatory agendas, and governmental policy. However, despite the earlier concerns and subsequent regulatory endeavors, corporate governance issues became even more prominent and exposed with the onset of the global financial crisis 2007-10. Subsequently, some academics, policy analysts, and corporate practitioners have associated the severity and increasingly circular nature of the financial and economic crisis to corporate governance failures, whether functional or technical (Sun, Stewart and Pollard 2011, p.16). In the 1980s, broader stakeholder concerns remained eclipsed by the market-driven, growth- oriented outlooks of Reaganite and Thatcher economics. The Director’s responsibility to enhance stakeholder value was reinforced with profit performance models gaining prominence and shaping the foundation for the privatization of state-run entities. The threat of predator takeover bids (for the market control) was touted as a critical incentive for strong board-level performance. In the UK, the Guinness case and consequently, the collapse of Robert Maxwell’s companies brought to the fore the need for checks and balances (especially for boards dominated by powerful executive directors), as well as in cases where the posts of chief executive and chairman of the board were merged, and the outside directors were weak (Boyd 1994, p.335). It was at this time that the concepts of corporate governance became the focus of attention; in fact, the phrase itself was son to emerge. How Corporate Failure Led to Growth of Corporate Governance The UK economy experienced a prolonged period of economic growth from 1981 to 1989; however, in the same period, there were a number of company failures arose with some manifesting spectacular collapses including Asil Nadir’s Polly Peck, Robert Maxwell’s MCC, plus the $8bn failure of the Bank of Credit and Commerce International (BCCI). These collapses shared a number of similarities: a recent clean bill of health from auditors, an ostentatious and powerful leader, an absence of action from non-executive directors and minimal participation with institutional investors (Smerdon 2010, p.5). These collapses stirred public concern, partly because of the massive involvement of numerous of deposit holders in the collapse of BCCI and thousand of pensioners in the collapse of the Maxwell Empire, and also because of the overriding perception that the UK industry was lagging behind economically compared to other countries with Europe. Hence, it can be argued that the evident failure or lack of accurate reporting in the majority of cases that would have otherwise allowed investors to spotlight the warning signs was the biggest motivation for the drive for corporate governance in the UK (Du Plessis, Hargovan, Bagaric, Bath, Jubb and Nottage 2011, p.317). Similarly, there were concerns regarding the potential liability faced by auditors who unknowingly signed off set accounts only for them to emerge to be a misrepresentation of the facts and also poor internal control apparent within the collapsed companies, especially Maxwell Communications Corporations (Aras and Crowther 2009, p.58). The fact that the set accounts of the collapsed companies had been approved by auditors is an indication that auditors were losing their self-regulatory role. In the interim report, the committee drummed support for self-regulation and emphasized the central role that non-executive directors should play. The underpinning factors included slackness of accounting standards; the absence of a concise framework that guarantees that directors kept under review, the controls in the business, and competitive pressures on both companies and on the auditors, which rendered it complicated for auditors to face up to the directors (Cadbury 1992, pp.5). The Code essentially represents a consolidation and refinement of several different reports and codes exploring opinions on good corporate governance. The first step towards the formulation of the Code was the publication of the Cadbury Report (1992). The report was developed in response to significant corporate scandals associated with governance failures within the UK. The committee was formed in the aftermath of the collapse of Polly Peck, a significant UK company that went insolvent after several years of falsifying financial reports. The committee was initially limited to mitigating financial fraud subsequent to BCCI and Robert Maxwell scandals; however, the committee was expanded to incorporate corporate governance. Thus, the report extended to cover financial, corporate governance, and auditing aspects. At the heart, of Cadbury Committee’s recommendations was a Code of Best Practice intended to promote the crucial high standards of corporate governance behavior (Cosh and Hughes 1997, p.104). The outlined recommendations were at the outset highly controversial, even though they mirrored the prevailing “best practice,” and stipulated that this practice be accommodated across listed companies. Simultaneously, the Cadbury committee made it known that the myth of “one size fits all” was no longer acceptable. Majority of the institutional investors, as well as a section of the media, had pointed out that the initial Cadbury report failed to address the issue of executive pay exhaustively (highlighting instead in disclosure and transparency) (Maassen 1999, p.124). In essence, the reporting of pay levels and the process of evaluating the pay levels was not discussed by the report. The Greenbury committee was incorporated as “a study group” exploring executive compensation and in a significant way was responding to growing public anger on the spiraling executive pay in public utilities that had been privatized. In response to the raised concerns, the committee recommended that: the aim of the committee was to highlight ethical practice in the evaluation of Director’s remuneration and institute a Code of such practice (Mallin 2007, p.22). The committee underlined the independence of remuneration committees and established significant reporting requirements. The third committee that was chaired by Sir Ronal Hampel suggested a combination of the principles of both Greenbury and Cadbury into a “combined Code” (Pass 2006, p.467) Several other reports were issued through the next decade including Higgs review that highlighted the role of non-executive directors and responded to the recent problems emanating from the collapse of Enron in the U.S. The combined Code together with its philosophy of “comply or explain” is being widely cited and followed outside the UK. The Code avails flexibility and smart discretion and accommodates the legitimate exception to the sound rule (Higgs 2003, p.3). The 21st century also presented new corporate governance problems manifested by the spectacular collapse of Enron, key U.S. companies, due to heavy, undisclosed indebtedness and dubious corporate governance attitudes among the executive directors. Apart from the U.S., corporate governance also featured in other places including the UK manifested in companies such as Marconi, British Rail, Independent Insurance, and Tomkins that were experiencing governance problems (Wearing 2006, p.17). In 2010, a fresh Code was introduced by the FRC simultaneously with a fresh approach to the UK Corporate Governance Code that implicitly separated issues from one another. Despite the massive corporate governance reforms undertaken in the UK, corporate governance failures have exposed a soft underbelly of institutional, systemic, and moral failures (Mallin 2011, p.3). Minor corporate governance compliance issues continue to surface within the UK. For instance, Alpha Airports was suspended from stock exchange in 2006 owing to corporate governance issues. An Analysis on the Efficacy of the Code in Protecting the Interests of Stakeholders The U.K. system, like that of the U.S., predominantly promotes the interests of shareholders above that of other constituents. However, the UK corporate governance manifests weak rights of stakeholders and an enhanced exposure to risks. The efforts invested in soft regulation have heralded massive changes in corporate governance practice and structure (Griffith1999, p.1). The present corporate governance protection measures for the interests of stakeholders can be regarded as weak, and there is a need to reform the present state of law so as to protect stakeholders’ interests, and maximize wealth creation for the society (Deakin 2005, p.11). UK Banking Crisis The banking crisis witnessed in the UK can be linked to insufficient implementation of corporate governance codes and principles. This is not to mean that the present corporate governance Code is faulty, but the evident weak areas such as executive remuneration, board practices, risk management, and exercise of shareholder rights. The principles of corporate governance can address these key governance concerns and the recorded failures appear to emanate from the lack of implementation of lack of implementation of those principles. Indeed, there were no substantial problems with corporate governance Codes prior to the financial crisis, and the core challenge remain with the implementation of the Codes (Great Britain 2009, p.7). Turner review or instance can be regarded as downplaying the role that remuneration, which was at the centre of the banking crisis. The banking crisis in the UK and the global financial crisis raise some critical corporate governance issues: where were the directors, especially the independent outside directors, in the failed financial institutions? Where were the banking regulators? Where were the auditors? Did they appreciate and guarantee reporting of exposure to risk? Government bailouts also raises a critical question of moral hazard-In shielding bankers from their past uncontrolled decisions, would others be predisposed to undertake excessive risks in the future?; and, did the disproportionate bonuses and share options persuade short-term and idealistic risk-taking with share-holder funds? Regardless of the fact that the crisis was unprecedented, the banking crisis is indicative of complacency on the part of banking regulators. In the UK, although the Financial Review Council failed to find evidence of severe failings in the governance of British businesses outside the banking sector, the council recommended changes to the UK Code to enhance governance in key corporations (Vasudev and Watson 2012, p.101). The proposed changes were fashioned at enhancing accountability to shareholders, to guarantee that boards are well balanced and outspoken, to enhance a board’s performance, and deepen awareness of its strengths and weaknesses, to reinforce risk management, and underline that performance-related pay ought to match the company’s long-term interests and risk policy. The underpinning problems inherent in corporate governance systems does not just dwell on some technical or implementation issues, but mainly about issues regarding paradigms, governing approaches, and the orientation of corporate governance systems that are profoundly embedded in Anglo-American financial capitalism. The debates on the corporate governance failures continue as critics point out that, the core problems with banks and the whole financial industry in developed countries that orchestrated the financial crisis remain largely unresolved. Based on this observation, Bank of England governor in 2011 advised that, devoid of reform of the banks, Britain risks suffering an extra financial crisis (Financial Services Authority 2009, p.11). The banking crisis exposed severe faults and shortcomings in remuneration practices within the banking sector and, especially within investment banking. The bonus-driven remuneration structures significantly encouraged reckless and excessive risk-taking. Furthermore, the design of bonus schemes was not allied with the interests of shareholders and the lasting sustainability of the banks (Financial Services Authority 2009, p.27). The banking crisis registered in the UK is indicative of clear failings in the remuneration committees within the banking sector. Conclusion Although, corporate governance reforms within the UK have delivered significant fruitful outcomes, the reforms do not seem to solve the fundamental problems in corporate governance practices. As demonstrated by the financial crisis, and at large the banking crisis, corporate governance system did not just fail to avert the financial crisis and corporate collapses, but availed incentives for corporations to manipulate the share price and exploit corporate accounting principles and practices so as to create and undertake excessive financial and business risks for short-term profit maximization. It is essential that a number of reforms to remuneration are undertaken within the banking sector. These reforms may encompass enhanced disclosure requirements on entities regarding their remuneration structures and concerning remuneration below board-level. Similarly, reforms may be necessary to remuneration committees to render them more open and transparent, and an establishment of a Code of Ethics for remuneration consultants. References List Aras, G., & Crowther, D. (2009). Global perspectives on corporate governance and CSR. Farnham, Gower. pp.58. Boyd, B. K., (1994). 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