Changes to Corporate Governance in the UK - Example

Part Introduction Firms mainly adapt to weaker environment by adopting voluntary corporate governance measures. A study on a number of firms within the U.S. indicated that the more firms adopt voluntary corporate governance mechanisms, the higher their valuation (including profitability and sales growth) and the lower their cost of capital. The function of a code of corporate governance is to enhance the general quality of corporate governance practice and assist effective, entrepreneurial and prudent management that can yield the long-term success of a company. Changes to Corporate Governance in the UK since the Cadbury Report The original Cadbury Report of1992 was followed by several reports and a succession of voluntary codes that reflected prevailing issues and debates. The reports on corporate governance entail the Cadbury Report (1992) (attached to best practice), Greenbury Report (1995) (made recommendations on Code of Best Practice and executive pay) Hampel Report (1998) (Combined Code on corporate governance), Turnbull Report (internal control), and Higgs Report, to mention but four, plus intervening specialist reviews such as Myners Review (DTI, 1996, HMT, 2001. A significant change has been witnessed in the UK since the Cadbury Report, notably a new Companies Act 2006. The Financial Reporting Council has heralded changes to the UK Corporate Governance Code to aid company boards become more and more effective, and accountable to their shareholders. The changes carried out to the code entail clearer statement of the board’s responsibilities in relation to risk, an enhanced emphasis on the significance of getting the appropriate combination of expertises on the board (Hegazy and Partner 2010, p.32). UK Corporate Governance Code (2010) Principles The “comply or explain” approach represents the trademark of corporate governance within the UK. This approach has been critical in operation since the Code’s beginning and forms the basis of the Code’s flexibility (Adams 2003, p.723). The main principles of the code entail: first, leadership touching on the separation of responsibilities directed by an effective board. Second, effectiveness whereby the board and its committees ought to manifest the appropriate balance of skills, independence, experience, knowledge of the company to enable them discharge their respective duties and responsibilities effectively (Clarke and Branson 2012, p.265). The third principle involves accountability whereby the board is expected to present a fair and understandable appraisal of the company’s position. Fourth, remuneration touching on the level and components of remuneration and procedure whereby the levels of remuneration should be adequate to attract, motivate, and retain directors. Finally, the fifth principle explores dialogue with shareholders and constructive use of the AGM based on the mutual understanding of objectives. Rules-based and Principles-based Approaches to Corporate Governance Many countries, inclusive of the UK have adopted what has come to be referred to as a “principles-based approach to the enforcement of the various provisions of the corporate governance code. Notably, the publicly-traded companies have to recognize the significance of corporate governance provision. By featuring the requirement to fulfil the codes within the listing rule companies are able to adopt a more flexible approach to code provision, compared to instances in which the compliance if underlined by law (Arjoon 2006, p.53). It is essential to note that compliance in a principles-based jurisdiction is not voluntary in any material sense. In rules base approach, compliance is essentially a matter of law rather than a rule of listing. For instance, U.S. companies must comply with SOX provisions. This has led to the rise of compliance consultancy among both management consultants and accountants. One of the criticisms levelled against this approach is that it adopts a “one size fits all” approach to corporate governance whereby similar detailed provisions are demanded of small and medium-sized entities (Arjoon 2006, p.54). If an approach is rules-based or regulator-led (monitoring and enforcement of corporate governance), then it must be a “one-size-fits-all approach that constraints innovation and adaptability. Part 2 The Role of Institutional Investors and their Relationship with this Business Company overview GlaxoSmithKline (GSK) operates in three key areas of business, namely: pharmaceuticals that entail prescription pharmaceuticals; vaccines; and, consumer healthcare that encompasses oral health, wellness, nutrition, and skin health consumer health products. GSK has instituted a sustainable long-term approach to enhancing access to medicine (ATM). GSK has board-level responsibility for ATM activities and has instituted a sustainable approach to deliver access initiatives within Index Countries. GSK engages with multiple external stakeholders on ATM linked issues. During the Index period, GSK engages with diverse stakeholders such as NGOs, government representatives, investors, academics, and industry organizations on issues such as access to healthcare and disease prevention, intellectual property, pricing, and competitiveness. Reporting to Shareholders GSK reports formally to stakeholders twice each year during release of half-year and full-year result in face-to-face presentations with institutional investors, analysts, and the media. To guarantee that the non-executive directors are aware and comprehend the views of substantial shareholders, GSK’s board has instituted briefing process managed by the chairman highlighting sector-specific issues and overall shareholder preferences. It is no doubt that institutional investors have played a central function in enhancing the corporate governance within corporations, as well as impacting positively on the efficiency and stability of financial systems (Sun, Stewart and Pollard 2011, p.23). In the UK, the level of ownership by individuals has overall decreased over the years, whereas ownership by institutional investors has increased. Institutional investors represent financial institutional that accepts funds from third parties for investment under their own name, but on such parties’ behalf and entail pension funds, mutual funds, and insurance companies. Corporate governance codes and guidelines have overtime recognized the critical role played by institutional investors (OECD 2011, p.2). Recent corporate governance reforms undertaken in response to the global financial meltdown have placed significant emphasis on the function of institutional investors. The UK Stewardship Code outlines that: institutional investors ought to publicly divulge their policy regarding how they intend to discharge their stewardship responsibilities; should feature a vigorous policy on overseeing conflicts of interest; monitoring their investee companies; establishing concise guidelines dwelling on when, and how to enhance their activities as a mode of safeguarding and enhancing shareholder value; ought to be keen to act jointly with other investors where appropriate; should manifest a succinct policy on voting; and, should account intermittently on their supervisory and voting activities (Ferreira and Matos 2008, p.500). The UK corporate governance code embraces the underpinning assumption that shareholders can best safeguard their own interests, provided that they manifest adequate rights and access to information. The Cadbury Report appreciated the function played by institutional investors. The combined code (2008) (sec E) highlights three core principles. First, it outlines that institutional shareholder should enter into a dialogue with companies grounded in the mutual understanding of objectives. Second, it outlines that in evaluating an entity’s governance arrangements, especially centring on the board structure and composition, institutional shareholders should award due weight to all pertinent factors drawn to their attention (Du plessis et al. 2011, p.317). Third, institutional shareholders have a responsibility to make use of their votes. The Role of Institutional Investors in GlaxoSmithKline (GSK) Institutional investors mainly have a strong preference for firms that manifest good governance and that are cross-listed. Such firms mainly tend to have higher firm valuations, better operating performance, and lower capital expenditures. As a result, institutional investors have become a prominent force among GSK’s stakeholders. Given the size of their shareholding, the power of institutional investors cannot be underestimated. The Cadbury Committee appreciated that institutional investors have a distinctive role to ensure that its recommendations were adopted by corporations (OECD 2011, p.3). As such, institutional investors in GSK have utilized their power and influence to guarantee the implementation of best practice outlined in the Code. The institutional investor’s capability to exert significant influence over GSK has concise implications for corporate governance, especially with regard to standards of corporate governance and issues relating to enforcement (Mullerat and Brennan 2011, p.51). In GSK, institutional investors have been able to: dialogue with the company based on the mutual understanding of goals; appraise the company’s governance arrangements, especially those touching on board structure and composition; and, bear a responsibility to make considered utilization of their votes. As such, institutional investors should manifest a concise statement of their policy on activism and how they intend to undertake their responsibilities; should closely monitor the performance of GSK; should intervene where necessary on issues such as company’s strategy, GSK’s operational performance, GSK’s acquisition/disposal strategy, independent directors falling short of holding executive management to account, internal control failing, insufficient succession planning, an indefensible failure to comply the Combined Code, unsuitable remuneration packages, and GSK’s approach to corporate social responsibility (OECD 2011, p.3). Issues Arising from Growth in Importance of Institutional Investors The growth in significance of institutional investors has brought to the forefront critical issues such as the application of shareholding rights. Institutional shareholders are subject to broadly varying levels of regulation and in some cases exercise fiduciary responsibility in voting their client’s securities (Ferreira and Matos 2008, p.499). Institutional investors acting in a fiduciary capacity are expected to divulge their general corporate governance and voting strategy, practices, and handling of material conflicts of interest. The Major Potential Conflicts of Interest that Affect Non-executive Directors Executive directors mainly possess a direct responsibility for business operations, while the non-executive directors possess a responsibility of bringing autonomous, objective judgement to abide on Board decisions. In key areas of the business, executive directors straightforwardly manifest conflict of interest in such areas such as remuneration of directors and supervision of the audit of the entity’s accounts. Other areas that may cause conflict of interest include defending one’s own turf, not inviting criticisms of one’s consequent proposals, and takeovers and management buyouts (Mallin 2007, p.22). The core role of non-executive directors is to avail independence, oversight, and constructive challenge to the board. This governance function differs with the role of the executive team that is to manage the business. To evade potential conflicts of interests, non-executive directors are expected to consult with the Chairman prior to taking up any additional external appointments. Non-executive directors should ensure that they make all decisions objectively in the interest of the company. Hence, non-executive directors should ensure that they are not sufficiently dependent on the income generated from their non-executive appointment to the level that it impacts on their independent judgement (Wearing 2006, p.18). Conflicts of interest may arise when a decision has to be made regarding the reappointment of a director. The UK Corporate governance Code outlines that all fees/compensation for non-executive directors ought to be fixed by the Board of Directors, and demand previous approval of shareholders within general meeting. A non-executive director represents one from outside the company. Role Non-executive Directors in GlaxoSmithKline (GSK) Non-executive directors in GlaxoSmithKline have been pivotal in the overall success of the company, especially for the creation of long-term shareholder value. The key roles played by the non-executives centres on bringing an independent judgement to bear on management’s proposals and performance (Wearing 2006, p.17). In all of these roles, independent non-executive directors manifest fewer conflicts of interests compared to executive directors. The independent non-executive directors have contributed numerous qualities to the board; nevertheless, they should not be viewed as heralding the expertise in a certain area to the company. This success has arisen from constructive engagement with, and challenging management, aiding in the structuring of the company’s strategy, satisfying themselves on the sufficiency of the reporting and management information standards, and re-examining the effectiveness of the executive management (Zhao 2011, p.57). Overall, the non-executive directors have acted in a manner that they perceive to be in good faith, exercise reasonable care, skill, and diligence and evade conflict of interest. Part 3 Lessons from other Countries: Comparison with U.S. Regulator-led Corporate Governance The regulation of corporate governance within the UK derives from diverse rules, regulations, and recommendations, notably: common law rules (director’s fiduciary duty), statute (Companies Act), listing rules, company’s constitutional documents, the combined code on corporate governance, non-legal guidelines released by bodies that embody institutional investors, and financial services. The U.S. approach to corporate governance can be typified as a regulator-led system largely enforced via SEC regulation, stock exchange listing rules and state law. Corporate governance in the U.S. is determined largely by legislation in the shape of the Sarbanes-Oxley Act (2002), plus detailed regulations that SOX demanded that entities such as the Securities Exchange Commission (SEC), NASDAQ, and NYSE are expected to formulate and implement. The UK approach differs significantly from the general approach adopted by SOX. Although, SOX-related regulations employ the “comply or explain” principle in a number of instances such as determining whether a company manifest a “code of ethics,” in the majority of cases, U.S. regulation tends to depend on the legislation and fines (and/or imprisonment penalties) for the contravention of the requirements of SOX (Adams 2003, p.724). The U.S. approach to the supervision of corporate governance at a state level is minimally dependent on shareholder engagement compared to the UK, in which shareholders are empowered via voting rights as provided by the company law (Solomon 2010, p.346). Furthermore, there is generally more deference to board decision-making within the U.S., compared to the UK. Publicly listed companies registered with the SEC are supposed to stick to strict disclosure requirements. Frequently, the amount of supervision, regulation, and reporting required in the U.S. is cited as being more than what is necessary. Ways in which Corporate Governance in the UK could be improved The UK Corporate Governance approach features non-binding, principles based approach that highlights the need to adapt implementation to differing legal, economic, and cultural practices. Whereas the code is proportionate and capable of dealing with a broad variety of circumstances, there is a relatively absence of prescription as to the manner in a company’s board organizes itself and carries out responsibilities. The key linkage is between the company and its shareholders, rather than between the company and the securities regulator. Contrary to legislatively-based approach of the U.S., UK corporate governance highlights board engagement with shareholders. This facilitates high standards of corporate governance behaviour devoid of stifling wealth creation. Indeed, the UK approach is perceived as less costly and more flexible compared to the U.S. model. Efforts to enhance corporate governance should hinge on strengthening the conversation between boards and shareholders, the efficiency of non-executives, and a more consequential implementation of the “comply or explain” principle (Hegazy and Partner 2010, p.32). It is also essential that the distinctive needs of smaller entities are addresses. The UK corporate governance approach, grounded on the assumption of critical dialogue between boards and UK institutional investors, ought to adapt to the challenge of a transformation within the ownership structure of listed companies. Similarly, the regulatory burden enforced on boards should be vigilantly monitored. A disproportionate focus on compliance, instead of issues of strategy and value-creation, weakens the viability of the UK’s unitary board concept (Solomon 2010, p.345). Conclusion Good Corporate Governance underlies market confidence, efficiency, and integrity, and subsequently facilitates economic growth and financial stability. The UK approach to corporate governance combines high standards of corporate governance with comparatively low associated costs. The UK corporate governance code can derive insights from the financial crisis. First, there is a need for reform efforts focussed on: strengthening board supervision of management; highlighting risk management as an essential board responsibility; and, facilitating remuneration custom that balances risk with long-term firm performance criteria. Policy makers can seize the momentum generated by the financial crisis to address the weaknesses exposed in corporate governance regime. References List Adams, E. S. (2003). Corporate Governance after Enron and Global Crossing: Comparative Lessons for Cross-National Improvement, Indiana Law Journal 78 (2), pp.723-781. Arjoon, S. (2006). Striking a balance between rules and principles-based approaches for effective governance: A risk-based approach, Journal of Business Ethics 68 (1), pp.53-82. Clarke, T., & Branson, D. (2012). The SAGE handbook of corporate governance, London, SAGE. pp.265. Du plessis, J. J. et al. (2011). Principles of contemporary corporate governance, Cambridge, UK, Cambridge University Press. pp.317. Ferreira, M. A. & Matos, P. (2008). The colours of investors’ money: The role of institutional investors around the world, Journal of Financial Economics 88 (1), pp.499-533. Hegazy, M. & Partner, K. (2010). Corporate governance in the UK: Audit committees and disclosure arrangements-A web-based analysis, Journal of Business Studies Quarterly 1 (2), pp.32-55. Mallin, C. A. (2007). Corporate governance, Oxford, Oxford University Press. pp.22. Mullerat, R., & Brennan, D. (2011). Corporate social responsibility: the corporate governance of the 21st century, Alphen aan den Rijn, Kluwer Law International. pp.51-53. OECD (2011). The Role of Institutional Investors in Promoting Good Corporate Governance, Corporate Governance, OECD Publishing. pp.2-4. Solomon, J. (2010). Corporate governance and accountability, Chichester, West Sussex, U.K., Wiley. pp.345. Sun, W., Stewart, J., & Pollard, D. (2011). Corporate governance and the global financial crisis: international perspectives, Cambridge, Cambridge University Press. pp.23-35. Wearing, R. (2006). Cases in corporate governance, London, Sage. pp.17-18. Zhao, Y. (2011). Corporate governance and directors independence, Austin, Kluwer Law International. pp.57. Read More