International Corporate Law and Governance - Case Study Example

International Corporate Law & Governance

Introduction

Corporate governance is an important aspect of organizational management and needs to be regulated. Different countries have set some guidelines which must be complied with to ensure sanity and utmost ethical adherence in corporate management. An example of such corporate governance principles is the Cadbury Report of 1992. The importance of these corporate governance codes is to create synergy and cohesiveness among the corporate stakeholders. This paper aims at analyzing paragraph 2.5 of the Cadbury Report in the context of the UK and international company and governance law.

Analysis of the Cadbury Report

The Cadbury report on corporate governance paid much interest on the financial aspect and tried to reduce the influence of shareholders in governance, once the share holders appointed a board and the auditor, the role of running the governing the corporate is to be assumed by the board and the auditors. This is a method of leadership that separates the management from the ownership and treats a public owned company as a separate entity from the shareholders i. e. the shareholders. Since it was the first initiative by the private sector to develop corporate governance principles, the report helped to streamline the best practices in corporate management in the UK. The Cadbury report aimed at creating flexibility in companies to respond to situations in accordance with the individual situations as opposed to a written letter of code.

The report has created a lot of sanity in the corporate world as it has been able to stipulate and define different roles of the corporate stake holders and at the same time given the investors the ultimate strength to influence how their investments are managed. A good corporate governance principle does not only prescribe the corporate structure but also spells fast and hard rules that should be complied with. It emphasizes the importance of flexibility and informed decisions depending on the prevailing circumstances in a company. Companies should be willing and able to review their governance codes of conduct and explain the special circumstances that require the departure from the best company codes.

On the other hand, the shareholders should be able to demonstrate flexibility in the interpretation of the company’s code of ethics and judge directors on the bases of their merit in such circumstances. In the Cadbury’s report, the shareholder has bestowed the power and authority of running the company to the board of directors who should run the company on behalf of the shareholders. This shows that the shareholders are still the overall key stake holder as they determine who manages the company. However, by playing the passive role of just electing the board and the auditor, the shareholders lose the control.

In reference to the incomplete contracting theory and the economics of agency theory, this form of corporate leadership is subject to problem of information asymmetry in the separation of corporate ownership between the shareholders and the management. As such, in the modern corporate environment, the shareholder lacks the financial management skills and the managers require the funds from the financier. This creates a conflict of interest in the governance of corporate as the shareholder faces a risk of losing his funds if the manager decides to expropriate it. This is the major problem with the Cadbury report as according to agency theory, the board of directors and the auditor are expected to meet their demands at the expense of the shareholders and to opportunistically act at the expense of their interests.

The Cadbury report provided a framework of an effective audit committee that could safe guard the interests of shareholders from the opportunistic trends of the agency theory. This was by stipulating the duties of the audit committee, the size as well as creating communication links between the shareholders and the board. However, the Cadbury report did not create flexibility in the constitution of the committee as companies are not identical in size. Other companies are also too small to require such committees.

In any effective corporate governance, the main requirements are accountability, transparency, and equity. Efficient governance ensures that there is motivation, coordination, and transparent allocation of resources while equity ensures that there is protection of the interests of the stakeholders and that management is monitored.

Various corporate governance devices have been drafted with an objective of controlling the modern corporations. In the USA for instance, such devices have increased the ownership of shares by the management, created audit committees, and institutional investors. There has also been a change in the constitution of independent non-executive directors (INEDs) on the board and the separation of duties of chief executive officer and the chairman. This has been a very significance step as it has cemented on the independence of the NEDs on the board of directors which is very effective for corporate governance.

The effectiveness of corporate governance is however, a multi-faceted issue that is affected by other factors like the legal system which affects and influence of the application and the efficiency of the corporate codes.

Legal system

In corporate governance are rules which define how the corporate environment is managed. As such a legal infrastructure is necessary to provide the laws and enforcements of the rules with the aim of achieving the standards for investor’s protection. In the absence of an effective legal system, managers would maximize their interests at the expense of the investors. These rules are enforced under an individual country’s Company Law for all incorporated companies.

The United Kingdom

In UK the legal system was indigenously developed and was based on the judicial law (common law) which was based on the Companies Act of 1985. Over the years, the laws have been amended to create a modern complex legal system. In 1998, UK established a Company Law Review Steering Group whose deliberations led to the creation of the Department of Trade and Industry which drafted the country’s company law. Under the company’s Act, they reviewed a wide range of company law based on investigations and prosecutions and insolvency procedure. The steering group drafted a number of recommendations into the country’s corporate governance principles with regard to the directors and the shareholders’ role as well as the corporate governance reporting. The steering group also recommended the “comply approach” of the codes as opposed to making them compulsory requirements for every company. The UK codes of corporate governance have avoided a prescriptive approach as the one adopted by the USA. However, there are a few rules which the UK companies have to comply with. All the reports compiled in the last decade such as the Cadbury and the Greenbury report were later combined into a single report called the Combined Code of 1998. The report was primarily based on the Hampel recommendations.

This report which to date acts as the supreme code of corporate governance in the UK dictates that corporate governance is a responsibility that rest squarely on the board of directors. The directors are controlled by the principles of trust and the duties given to them under the law. The Combined Code has two parts, one defining the principles of governance in relation to the company and with the shareholders. The second part requires all the UK listed companies to disclose their statements. Within the principles of good governance, the specific duties of the chairman, CEO, and the board of directors are given. In the common law, the board of directors is expected to always act in the best interest of the corporation. It also emphasizes on the importance of board’s accountability, the role of audit committee, and the necessity of internal controls in assisting the board.

In the European Union (EU), there is a governance framework on which corporate governance codes and, recommendations are listed and they relate to all arms of a firm. Through corporate governance, listed companies are required to comply with the codes stipulated each at the national level of a respective country. United Kingdom (UK) as a member of the EU is expected to conduct samples interviews form participants from different sectors and capitalization level s to determine the shareholding structure. This will assist to identify whether laid rules on shareholding have been complied with:

• Shareholder engagement

In reference to the Green Paper, an abiding law among the member states of EU, shareholders have an interest of the financial institutions. This is mainly because they are used in determining the risk management of a firm. The adoption of the Green Paper in 2010 addresses companies are subject to the following; directors, shareholders, governance framework. In reference to shareholders, the framework outlines the responsibilities of the shareholders as that of oversight. They are accountants of performance and the management, most are passive and as such, they are concerned about short-term revenue.

• Short-termism

Therefore, there is need to reevaluate these roles as a long-term envision of profits could encourage interest in sustainable performance and long-term returns. Moreover, they should be encouraged to have an active role on corporate issues. The shareholding structure for different firms evaluate their minority protection is expanded to suit the day-day running of the firms. In reference to UK companies, corporate governance is enacted to firms that issue share to a regulated market. The distinction is not on the type or size of the company, therefore, the abiding corporate codes could be similar to a small size and medium sized firm. In such a case, the shareholder is no different form a manager which might be confusing depending on the complexity of the tasks undertaken. Therefore, corporate codes are meant to bring sanity to such cases by providing tailored solutions depending on the size of the business. In adopting a different approach of corporate governance in relation to company’s size and type, the difficulty of shareholding will be resolved.

• Shareholding Relationship between types of companies

Corporate laws account for governance issues that are found in an unlisted company. Moreover, the existence of shareholders in such a firm is vital as they are responsible for managing the company. As opposed to a listed company where the shareholders are passive, the unlisted companies tend to involve them more and thereby more attractive than the listed entities. The Green Paper 2010 indicated that shareholders in financial institutions are limited or lacking, and this contributed to accountability problems in the management side. Moreover, the associated risks with financial institutions could be reason why shareholders fund it hard to make decisive decision on making losses. It is argued that shareholders in a financial institution always win as the event of a loss is passed onto the creditors.

The attitude of shareholders of taking excessive risk in financial institutions is a complex concept that may cost the operations of such a firm. In light of this, it is advisable to look into the interest of minority shareholders by protecting them as proposed in the Green Paper. Furthermore, in dispersed ownership companies, there is need to liberate the minority shareholders and to ensure that their needs are adequately addressed.

• Relationship with investors and managers

Among the key responsibilities of the shareholders is the usage of their right during voting and cooperating with other shareholders. As such, they get to evaluate the company an dialogue with the board as part of their engagement mandate. In the event that there is a long-term investment into the company, the shareholders will chip in and engage with the investee firm and ensure governance is upheld. Surprisingly, shareholders are more beneficial to short-term engagement as opposed to long-term negotiations. In reference to the Green Paper, shareholders have difficulty in evaluating engagement costs of and valuing the returns of an investment and thus acted as puppets.

In a bid to caution shareholders, the commission on Green Paper studied the views of the public on the roles of investors and many were opposed to the decision of publishing records and voting rights before transacting with corporate. This was aimed to create awareness and ensure that investors’ decision on public disclosure was sufficient. In the case of a family owned business, majority shareholders are the likely to expropriate funds without the knowledge of the minority. As such, corporate codes and governance practices in the world over requires engagement of all concerned parties without discrimination.

In the Hong Kong, minority expropriation has risen due to family domination and ownership concentration to the majority shareholders. In relation to the Green Paper on the EU, shareholders are responsible for the inability to invest in long-term investments as they are not conscious of the pricing strategy in the market due to their laid back attitude. Moreover, in the US corporate governance on shareholding is a combination of state and federal laws. In relation to the Enron Scandal, US laws on corporate apply to all firms regardless of their listings and status. It is the requirement of all firms to submit their yearly reports and to account for their expenditure. This is the responsibility of the auditors, who are held to account by shareholders.

An annual report shows the internal operations and is presented to the shareholders through Annual General Meetings (AGMs). At such forums, in the US for instance, shareholders question the auditors on the reports and in the event of speculative figures, they clarify to the shareholders. In reference to the Sarbanes-Oxley Act of 2002, external auditors are expected to hold independent status and standards. Furthermore, the boards and auditors operate on standards approved by shareholders. This act was incorporated into the stock market of New York as a governance practice in 2003 and 2004. Shareholding of non-US firms has caused the enlisting from NY stock exchange due to the adoption of these practices.

Distinction of Shareholders Globally

There is not much difference between corporate law in the US and UK, however, in France civil law is the basic system of corporate governance. The basic company laws have been modified to suit the economic regulations of 2001 and the modernization of the economy of 2005. The supplemented law on economic regulation passed in 2001 is evidence of the country’s commitment to corporate governance. Generally, large shareholders are a basis of concern in large firms and they are active in corporate governance.

United States (US)

The corporation law is established under individual state jurisdiction and theses laws are different depending on the state. As such, incorporating in one state may give rights to shareholders that are not present to other states. Moreover, the status of a company in terms of size determines the jurisdiction of operation in the specific state, and it requires that both directors and act in the common interest of shareholders. Shareholders on the other hand are mandated with the role of reviewing the board’s performance and ought to reflect on the needs of the public. In the case of Delaware, an incorporation that have jurisdiction in several states boasts of multi-state corporations that are listed in the New York Securities Exchange (NYSE).

The company came up with corporate governance laws to facilitate its wide base and is referred to as Delaware General Corporation Law (DGCL) It regulates the governance of the multi-state empire and supervises its management while giving room for flexibility. The DGCL equips the directors with the responsibility of foreseeing the daily operations. The board may delegate its responsibilities to appointed committees in the remuneration, auditing and nomination sectors to look into its managerial duties. Moreover, the large volume of law cases assists it to predict the outcome of several suits to its favor and as such it able to keep the reputation of its business. In the event of a court case, the directors are protected by its articles of incorporation and bear no personal liability to the problems of the business.

Therefore, USA corporate governance on securities is non-prescriptive in approach and it relies on disclosure as opposed to stipulations of laws and regulations in behavior control. Investors are thus able to judge companies on their disclosure merits as opposed to complex and costly laws that protect an investor and hinder swift business deals. The Securities Exchange Commission (SEC) (Mallin, 2006) is a federal body that oversights the trading of US companies and promotes disclosure of vital information while protecting investors and enforcing laws. Therefore, as stated, the environment of corporate governance in the US depends on disclosure and the rules made are a reflection of this fact. Other than the audit committees, the rest of the company departments are supposed to come up with rules to be followed by all employees of a company.

Australia

Corporate governance in Australia has been influenced by globalization and presence of institutional investors. This has created a high standard of governance under principles stipulated in the Australian Stock Exchange (Mallin, 2006). The ASX principles are enforceable under the Australian Listing Rules and the Corporation Act. The principles assume a non-prescriptive approach of corporate governance but insist on company compliance to certain rules. It acknowledges that no single approach would be suitable for all companies at all times. Under the ASX listing rules, a listed company should provide a statement of it governance principles during the reporting time. The ASX principles also provide a list of issues that should guide the formulation of corporate governance codes in a company.

Conclusion

The role of corporate in a country’s economy cannot be overlooked. However, they need regulations to create sanity and synergy in the management. Since the stake holders in the corporate world have varying interests and roles, governance codes are important in streamlining the aspects of corporate management and to protect the interest of the stakeholders. Thus, different countries have formulated company laws and corporate governance principles to foster a conducive environment for companies.

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