Development of the UK Code of Corporate Governance - Literature review Example

DEVELOPMENT OF THE UK 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 is mainly 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 background to these changes and the outcomes of the changes since 1990 to the culmination of a combined code in 2003, especially its impact for governance structures. Finally, the paper explores whether the implemented changes have benefited stakeholders. The frustrating outcomes for acquiring company shareholders in most of the corporate acquisitions in the early 1990s coupled with growing public discontent regarding some pay deals for top executives, as well as a series of high profile corporate scandals, are some of the factors that inspired early calls for governance reform. Since then, scrutiny on corporate governance in UK companies has deepened, especially after the publication of the Cadbury Report in 1992. The report heralded calls for adjustments in the size, composition, as the role of boards of directors, changes in the role of institutional shareholders, changes in the remuneration and selection of executives, and alterations in legal and accounting regulations (Boyd 1994, p.336). The evidence accessible at the time of the Cadbury Report in 1992 and subsequently thereafter detailed that the selection instrument within the market for corporate control was vastly imperfect and that most takeovers were not yielding performance gains either with regard to profitability, or for their shareholders (Dickerson, Gibson and Tsakalotos 1997, p.346). The failure of owners to monitor and control managers so as to guarantee that value maximizing decisions are taken heralded reliance on the market for corporate control to discipline management (Agrawal and Knoeber 1996, p.378). The concerns revolving around the evident failure of corporate acquisitions to convey the promised returns to shareholders were intensified by high profile cases detailing high incentives to top management not linked to outstanding corporate performance (Beiner, Drobetz, Schmid, and Zimmermann 2006, p.249). These events were underlined by a series of corporate collapses and scandals that rocked UK and abroad, in the 1980s and 1990s. The core concerns at the time dwelt on the effectiveness of the board of directors as custodians of the shareholders’ interests and sponsors of transparency of company accounts and reports (Bhagat and Black 2002, pp.232). The formation of the Cadbury Committee (set up in May, 1991) by the Financial Reporting Council was the first step towards tackling the financial aspects of corporate governance. The sponsors of the committee were inspired by the identified low level of confidence both within the arena of financial reporting, and in the capability of auditors to avail safeguards that the users of company reports sought and expected (Cadbury, 1992). The underpinning factors were viewed as 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). The Cadbury Committee laid down the standards that have over the years been refined and expanded in the intervening years. The governing principles details transparency in reporting and a code of practice that is grounded in “comply of explain” instead of legislation. The report concerned the successful function of the board of directors, the delineation of the functions of chief executive and chairman, the function of nonexecutives, board committees and the audit process (Smerdon 2010, p.6). At the heart of Cadbury Committee’s recommendations was a Code of Best Practice intended to promote the crucial high standards of corporate governance behaviour. The London Stock Exchange demanded that all listed companies registered within UK, as an abiding obligation of listing in order to affirm whether they were complying with the set Code and furnish reasons for any areas of noncompliance (Omoyele 2006, p.194). The continued concerns regarding top executive remuneration led to the formation of the Greenbury Committee. The aim of the committee was to highlight ethical practice in the evaluation of Director’s remuneration and institute a Code of such practice. The committee underlined the independence of remuneration committees and established significant reporting requirements. These guidelines have subsequently been supported by reports advanced by the Association of British Insurers (2006), plus others. The Financial Reporting Council sequentially instituted the Hampel Committee mandated to review the findings and conclusions from the Cadbury and Greenbury Reports. This yielded a Combined Code on Corporate Governance published in 1998 (Cosh and Hughes 1997, p.124). In a reaction to this code, the Institute of Chartered Accountants in England and Wales commissioned the Turnbull Report that sought to examine internal control competence and mechanisms. The directions that emerged were afterwards revised in 2005 (Turnbull 1997, p.25). Subsequent to Enron and WorldCom scandals, the Higgs Report (2003) led to the revision of the Combine Code. All along, Soft Regulation and shareholder performance were at the heart of the instituted reforms. 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 Higgs report notes that the topical cases of corporate underperformance in the UK, especially the function of the board and nonexecutive directors, has reasonably been contested (Higgs 2003, p.16). Summary of Corporate Governance in UK Cadbury Report (1992) The Report on “Financial Aspects of Corporate Governance” established proposals on the composition of company boards and accounting systems in order to mitigate corporate governance risks and failures. The report explored ethics and corporate governance informed by the series of sensational business scandals that had rocked the UK. In order to minimize the power of executive directors, the committee proposed an enhanced role for nonexecutive directors, adjustments in the board procedures, and a dynamic role for auditors (Cadbury, 1992). Rutteman Report 1994 The publication of the Rutteman Report in 1994 on Internal Control and Financial Reporting was based on the United States’ COSO report titled “Internal Control-Integrated Framework” and stressed that the internal control statement should be an essential part of the corporate governance statement. This statement should detail an affirmation from the directors of a listed company that they are accountable for the company’s system of internal control. Secondly, a depiction of the internal controls procedures that have been instituted by the directors, and an appraisal of their effectiveness (Deakin and Hughes 1997, p.3). The statement should concisely inform that such a system can avail only reasonable, but not an absolute assurance against misstatement or loss. Greenbury Report (1995) The Greenbury Report released in 1995 dealt with the growing concern on the level of director remuneration. The committee advised that pay structures should be fashioned to match the interests of directors and shareholder. Hampel Report (1998) The Hampel Report was proposed to be a revision of corporate governance systems in the UK. The mandate of the committee revolved around reviewing the Code established by the Cadbury Report. The report examined whether the Code’s original aim was being met. The committee concluded that there was no requirement for restructuring of the UK corporate governance system. The Report sought to merge, synchronize, and clarify the Cadbury and Greenbury recommendations. The Combined Code (June 1998) The preceding reports inspired the compilation of the Combined Code of Corporate Governance (1998) centring on the composition and operations of the board, directors’ compensation, accountability and audit, interactions with institutional shareholders, and the roles of institutional shareholders. Turnbull Report (1999) The Turnbull Report was released by the Internal Control working party of the Institute of Chartered Accountants in England and Wales. The Report laid down guidelines on how directors’ of listed companies conform with the UK’s Combined Code requirements with respect to internal controls, inclusive of aspects such as financial, operational, and risk management (Turnbull 1997, p.18). The Higgs Review (2003) Derek Higgs led a short independent review on the role and effectiveness of nonexecutive directors and the audit committee. The review directed at enhancing and strengthening the present Combined Code. Higgs published his report titled “Review of the Role and Effectiveness of Non-Executive Directors” in January 2003. Higgs powerfully supported the model of non-prescriptive approach -comply or explain. He also advocated for extra provisions with enhanced criteria for the board composition and assessment of independent directors (Higgs 2003, p.18). Smith Report (2003) The Smith Report centred on corporate governance presented to the UK government in 2003. The report explored the independence of auditors in the face of the collapse of Arthur Andersen. The report recommendations now shape part of the Combined Code on corporate governance pertinent via the Listing Rules for the Exchange. One of the outstanding observations is that auditors should explore whether a company’s corporate governance structure avails safeguards to preserve their own independence (Salacuse 2004, p.70). An Analysis on the Efficacy of the Code in Protecting the Interests of Stakeholders in Public Limited Companies Listed UK companies are expected to abide by the Combined Code on corporate governance. The most topical is a combination of Cadbury and Greenbury versions on corporate governance, as well as Turnbull Guidance, Smith guidance, and the Higgs Report (Pass 2006, p.167). The debate centring on the implementation of either a shareholder oriented model or stakeholder oriented model of corporate governance is rife within the UK (Griffith 1999, p.3). The U.K. system, like that of the U.S., predominantly promotes the interests of shareholders above that of other constituents. However, with the onset of new corporate scandals (in the case of Enron and WorldCom), the UK has executed several modifications such as enactment of Companies Act 2006 to ensure that the system is more stakeholder inclusive (Deakin 2005, p.12). The protection provided to stakeholders through the Companies Act 2006, Insolvency Act 1986 (protection for creditors), and Voluntary Codes of Corporate Governance can be perceived to be inadequate. Despite the protections availed by the corporate governance Codes against dysfunctional managerial decisions, contractual protection do not fully safeguard stakeholders (Deakin 2005, p.13). The Corporate Governance Code is inadequate in its present format for sheltering the interests of stakeholders in public limited companies. UK’s Enlightened Shareholder Value (ESV) approach maintains profit maximization as the central function of an organization. The ESV approach continues to emphasize on the importance of decision making that yields a firm’s long term value creation by giving precedence to the interests of the organization’s stakeholders (Vinten 2001, p.36). Section 172: the Companies Act 2006 imposes a duty to directors to promote the success of the company whereby director are expected to carry out their mandate in a way that they consider, in good faith, probable to promote the success of the company (Verlag Goyang Media 2006, p.2). This requires promotion of the interests of the company’s employees, relationships with suppliers, client, the environment, and the community. Although compliance to the established corporate governance Code will highly likely yield enhanced performance of the company at large, the codes fail to impose the management to look after the interests of stakeholders (Letza, Sun, and Kirkbride 2004, p.243). The UK corporate governance manifests weak rights of stakeholders and an enhanced exposure to risks. The UK System does not avail adequate power to stakeholders to voice their rights, especially guaranteeing that stakeholders will be protected against wealth transfers. Although, one cannot contest the significance of stakeholders in propelling the operations of a firm, the existing channels for safeguarding the interests of stakeholders under UK corporate governance system remain weak and sometimes ineffectual (Kiarie 2006, p.329). This deprives stakeholders’ confidence and propagates uncertainty on the arena of fashioning a long-term and close connection with the company (Davies 2010, p.8). This can be remedied, in part, through reinforcement of Self Governance and enhancing the role of institutional shareholder in safeguarding the interests of stakeholders in the UK. Conclusion The efforts invested in soft regulation have heralded massive changes in corporate governance practice and structure. 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. The prominent shareholder value approach, among other benefits, has been central in promoting efficiency and creation of a successful accountability mechanism. References List Agrawal, A. & Knoeber, C.R. (1996). Firm performance and mechanisms to control agency problems between managers and shareholders. Journal of Financial and Quantitative Analysis vol.31, pp.377-397. Beiner, S., Drobetz, W., Schmid, M. M., & Zimmermann, H. 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