The UK Approach to Corporate Governance - Essay Example

The UK Approach to Corporate Governance: A Critical Comparison By Introduction In the current highly competitive businessenvironment, companies pay great attention to concerns over unethical corporate practices. This trend has increased particularly after the collapse of corporate giants like Enron, WorldCom, and Tyco over the last decade as a result of accounting fraud and misrepresentation of financial and non-financial information. Today each country has its own set of corporate governance policies and principles so as to improve firms’ operational transparency and overall organisational performance. This paper will discuss the UK approach to corporate governance and critically compare this approach to that of other nations, namely USA, Canada, and France. The paper will also address the limitations of financial reporting. Corporate governance The concept of corporate governance has evolved from olden days and undergone considerable changes from time to time. According to Solms and Solms (2008), corporate governance can be defined as “the set of processes, customs, policies, laws, and institutions affecting the way a corporation (or company) is directed, administered or controlled” (p.2). Organisational managements are always eager to update their corporate governance policies in accordance with the needs of the current business environment, because corporate governance principles influence the relationship between different stakeholder groups and the objectives of the organisation (OECD, 2004). Firms mainly focus on their corporate governance strategies to enhance economic efficiency, operational transparency, and shareholder values. As a series of corporate failures and bank collapses over the last decade were attributed to accounting fraud and poor internal check systems, today business enterprises give particular emphasis to improving their corporate governance policies. In addition to stating the roles and responsibilities of the board of directors, corporate governance strategies give emphasis to the rights and privileges of stockholders. History of UK Corporate Governance As per the ICA document A history of corporate governance in the United Kingdom (2009), corporate governance developments began in UK in late 1980s and early 1990s as a result of the corporate scandals such as Polly Peck and Maxwell. Those scandals were resulted from financial reporting irregularities, and hence the government established the ‘Financial Aspects of Corporate Governance Committee’ chaired by Sir Adrian Cadbury. The Cadbury Report published in 1992 recommended a number of measures for increasing the transparency of financial reporting. In 1995, the Greenbury Report recommended extensive disclosure of directors’ remuneration in annual reports and also suggested the establishment of a remuneration committee comprising of non-executive directors (Ibid). The Hampel Committee, which was established to review the extent to which the Cadbury and Greenbury Reports had been adopted, published the Hampel Report that led to the formation of the Combined Code of Corporate Governance (1998). The 1998 Combined Code was applicable to all listed companies from 31st December 1998 until fiscal years starting on or after 1st November 2003, and it was replaced by the revised Code in 2003. The 1998 and 2003 Combined Codes required companies to provide in their annual reports a statement on how they have abided by the Code Principles and Code Provisions related to internal control. However, companies were in need of proper guidance on how this should be approached. This situation led to the establishment of Turnbull Committee in 1998, and subsequently the Turnbull Guidance was published in September 1999. The Directors’ Remuneration Report Regulations were published in 2002 to enhance the powers of shareholders with respect to directors’ pay (Ibid). In 2003, the Higgs Report addressed the role and effectiveness of non-executive directors. Around the same time, another report called Smith Report was published to provide guidance on audit committees. The suggestions from the Higgs and Smith Reports resulted in some notable changes in the Combined Code of Corporate Governance, leading to the formation of 2003 Combined Code. The Financial Reporting Council (FRC) announced a review of the Combined Code in 2009 to make number of amendments to the Code. The revised Code is known as the UK Corporate Governance Code, which applied to reporting periods beginning on or after 29th June 2010 (ICA, 2009). This Code was recently revised in September 2014. UK approach to corporate governance UK corporate governance laws precisely define the rights, powers, and duties of managers, directors, and auditors, and the position of other key stakeholder groups such as employees and the community. Since the board of directors is at the helm of affairs of any company, the UK corporate governance policies give emphasis to the accountability of the operations of board of directors. The UK’s corporate governance approach is ‘shareholder friendly’, and it promotes shareholders’ sole voting rights in the general meeting (Fairley, 2010). If the voting mechanism seems inefficient to protect the interests of shareholders, directors’ conduct may be questioned in a court of law. The corporate governance law also describes the rights of directors such as issue of resolutions and removal of board members. In addition, the directors are to perform a set of duties and responsibilities with utmost competence, in good faith, and strong loyalty to the organisation. The balance of power between the board of directors and the general meeting reflects a UK company’s corporate governance. The term ‘governance’ is commonly used to represent the principles mentioned in the UK Corporate Governance Code. The UK Corporate Governance Code 2014 is a set of corporate governance principles that are aimed at the performance enhancement of the listed companies on the London Stock Exchange. The Listing Rules of the Financial Service Authority require the public listed companies to disclose how they have complied with this Code and to explain where and why they have ignored the Code (Sealy 2012). Although this is not mandatory, private companies are also encouraged to abide by the corporate governance guidelines proposed in the Code. The UK Corporate Governance Code adopts a principles-based approach as well as a rules-based approach; and the former provides a pathway to best practices whereas the latter rigidly defines the exact practices that public companies need to comply with. The UK Corporate Governance Code 2014 describes the proposed corporate governance principles under five sections and they include leadership (Section A), effectiveness (Section B), accountability (Section C), remuneration (Section D), and relations with shareholders (Section E) (Financial Reporting Council, 2014). The Section A of the Code states that every company should be led by an effective board of directors which is collectively responsible for achieving the success of the company in the long term. This Section describes the role of the board, division of responsibilities, chairman, and non-executive directors. The Section B addresses the composition of the board, appointments to the board, commitment, development, information and support, evaluation, and re-election while the Section C deals with financial and business reporting, risk management and internal control, and audit committee and auditors. The Section D details the level and components of remuneration and procedure. Finally, the Section E includes subtopics such as dialogue with shareholders and constructive use of general meetings (Ibid). It is interesting to see that the Code (Schedule A) suggests performance-related remuneration for executive directors in order to avoid the situation of unfair executive compensation and to eliminate the misappropriation of powers. Similarly, the Schedule B of the Code necessitates the disclosure of corporate governance arrangements so as to improve the transparency of company operations (Financial Reporting Council, 2014). The Code’s accountability and audit sections are constructed in the light of the recent corporate scandals, and therefore the Code mandatorily requires the formation of an audit committee comprising of independent non-executive directors only. Considering the provisions of this Code, current corporate strategies in UK are competitive enough to keep in touch with shareholders and to keep them informed of key organisational affairs. Finally, the revised Code puts forward improved practices for effectively treating institutional shareholders who represent an great part of the UK financial market structure. Corporate Governance of US, Canada, and France Like the United Kingdom, the United States also gives importance to corporate governance practices in the country mainly after the collapse of corporate giants like Enron, WorldCom, and Tyco. However, it is important to note that corporate governance practices in US are not regulated by any particular statute but are influenced by the governing instruments. More clearly, such practices in the country are affected by the corporate law and the court decisions of each issuer’s state of incorporation whereas the US federal security laws and requirements of the national security market regulate those practices in the case of publicly-owned issuers. As stated in an online document, “matters governed by state law include the voting rights accorded to shareholders, the functions of the board, and the ability of board members and executives to enter into transactions with the company” (United States, nd.). State corporation laws are non-identical in all the 50 states in US. As many corporate enterprises choose to incorporate in Delaware, Delaware law is considered to be a potential reference point for state corporate governance practices. “U.S. federal securities laws also affect corporate governance practices, primarily in the areas of disclosure and financial reporting, proxy voting, and the submission of shareholder proposals for consideration at shareholders’ meetings” (United States). In addition, the national securities markets are also able to influence corporate governance practices through their requirements that are applicable to issuers of securities traded on their markets. The US corporate governance system is based on the principles of shareholders’ wealth maximisation. The governing bodies or influencing statues of corporate governance system in USA include Securities and Exchange Commission (SEC), the Sarbanes-Oxley Act of 2002, and regulations of the stock exchanges like NASDAQ and NYSE (Value Walk Staff, 2013). The Canadian corporate governance system is derived from the British common law model, and it was significantly influenced by developments in the US. However, compared to a US corporation, a Canadian corporation is more likely to have a chair who is not the CEO, and it would commonly maintain fewer executives on the board than a UK corporation. Canadian corporate governance policies are structured by legal rules and institutional shareholder groups, the media, and professional director associations like the Institute of Corporate Directors play a notable role in promoting the best practices. According to MacDougall and Yalden (2012), in Canada, the sources of legal rules for corporations include the common law, provincial corporate statutes, securities laws and rules, stock exchange requirements, and a wide variety of other regulations and policies. Interestingly, Canada maintains a national institutional investor organisation to enhance better corporate governance practices in the country. The Canadian Coalition for Good Governance (the CCGG) comprises 48 members, many of whom are the nation’s largest institutional investors (Ibid). Considering the sensitivity of recently emerged troubles in the global corporate sector, France has also revised it corporate governance code. The revised code is able to guarantee enhanced transparency and more efficient and self-regulation, and it includes stricter recommendations on executive remuneration, which is major area of concern for corporate regulators. The revised code promotes shareholder ‘say on pay’ and other improved compliance measures (Allen & Overy, 2013). Critical Comparison Although corporate scandals of US companies like Enron and WorldCom have significantly influenced the UK Corporate Governance Code, there are many notable differences between the US and UK in terms of their corporate governance system. According to Charan and Neff (2010), the major difference in corporate governance between US and UK is that the CEO serves as the chairman of the board in the US whereas the CEO does not generally hold the chairmanship of the board in UK. The UK corporate governance policies are affected by a number of rules and regulations including common law rules, company’s constitutional documents, the Listing Rules, and the UK Corporate Governance Code. As Uzun (2007) points out, corporate governance practices in US are influenced by the Sarbanes-Oxley Act of 2002 (SOX), SEC, and stock exchanges like NASDAQ and NYSE. The UK corporate governance system relies on a ‘comply or explain’ approach whereas the US regulation tends to implement legislation and fines and imprisonment penalties for violating the corporate code of conduct or SOX (Wright & Siegel et al, 2013, p.36). However, in response to the alarmingly severe scandals in Europe, the UK is tending to introduce mandatory and punitive measures, imitating the US model. In the words of Franks and Mayer (2002), a major point of contrast between UK and US corporate governance models is the powers of the board of directors. In UK, the boards do not play a significant role in corporate governance, and non-executive directors commonly do not perform a disciplinary function. In contrast to this, boards of directors in the US play a crucial role in disciplining management, and non-executive directors have an important role in this process. In UK, hostile takeovers and markets in share blocks are not associated with the disciplining of the management of poorly performing companies (holdings held by industrial companies is an exception) (Franks & Mayer, 2002). On the other hand, both disciplinary takeovers and the market in the US share blocks are associated with poorly performing firms. Regulatory differences between the UK and US are obvious in the areas of fiduciary responsibilities of directors and protection of minorities, particularly in relation to takeovers and new equity issues. The authors tell that fiduciary responsibilities of directors are considerably weaker and protection of minorities is significantly stronger in the UK than in the US (Ibid). I do not believe that UK corporate governance system is more effective or efficient than the US system, because the UK system relies on a liberal ‘comply or explain’ approach which may not necessarily ensure enhanced operational transparency. Limitations of Financial Reporting Financial reporting in UK is subject to many limitations, and therefore financial statements are not capable of meeting all the information needs of users. The current financial reports in UK simply focus on the financial effects of transactions and other events but not on important extent on their non-financial effects. In addition, the current financial reporting policies fail to reflect future events or transactions that would enhance or impair the firm’s competitiveness. Experts suggest that current reporting practices simply reflect a conventionalised representation of transactions, and hence they are not effective in meeting the information needs of modern investors. UK’s financial reporting practices are highly aggregate and information on various transactions and balances are combined into a few figures in the account. As a result, investors often find it difficult to evaluate the components of the business properly. Many of the financial reporting limitations identified with UK corporations are common in the case of US companies too. Generally, the scope of financial reporting practices in the US is limited by the omission of non-financial information. US financial reports pay less attention to narrative description of the major operations and discussion of business risks and opportunities (The Institute of Chartered Accountants, n.d.). In addition, US financial reporting is not competitive enough to provide users with a detailed understanding of how the business is governed and controlled. Conclusion From the above discussion, it is clear that the UK Corporate Governance Code revised in 2014 forms the basis of all corporate governance practices in the United Kingdom. The history of this combined Code can be dated back to the publication of Cadbury Report in 1992. UK’s corporate governance approach is shareholder friendly, and it specifically defines the rights and powers of the shareholders and the board of directors. After a series of corporate failures in the last decade, a number of provisions such as performance based pay for directors and the disclosure of corporate governance arrangements were added to the Code to enhance the operational transparency of UK public companies. Similarly, countries like US, Canada, and France also improved their corporate governance policies recently in order to address the issue of corporate fraud and to gain investor loyalty. The UK corporate governance system is not more effective and efficient than the US system as UK adopts a more liberal approach to corporate governance, which tends to compromise operational transparency. References Allen & Overy (2013) Revised code of corporate governance published in France. 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