Key Principles, Importance, and Development of Corporate Governance in the United Kingdom - Term Paper Example

Corporate Governance in the UK Contents Contents 2 0 Introduction 3 2.0 Key Principles of Corporate Governance 3 2 Leadership3 2.2 Culture 4 2.3 External Focus 4 3.0 Importance of Corporate Governance 5 4.0 The development of corporate governance in the UK 6 5.0 Analysis of Corporate Governance in the UK 7 5.1 Essential Elements 7 5.2 UK Governance Approach Rationale 9 6.0 Effectiveness Analysis 10 7.0 Advantages of the UK Governance System 11 8.0 Conclusion 12 Bibliography 13 1.0 Introduction Excellent corporate governance is crucial to efficient operations of a free market. Therefore, it facilitates creation of wealth, as well as, elimination of poverty. However, in the UK, there is no proper legal definition of corporate governance. Nevertheless, a general definition of corporate governance is the set accountability framework to stakeholders, users, as well as, the entire community, where organizations make decisions, control and lead their functions, in order to achieve their goals. In UK, the existing definition of corporate governance is based on Cadbury Committee which was formulated in 1992. The committee defined corporate governance as a system that companies are controlled and directed. Further, another great scholar in the UK known as Professor Parkinson defined corporate governance as the procedure of controlling and supervising that is intended to make sure that management takes the shareholders interests into consideration. 2.0 Key Principles of Corporate Governance According to Davies and Aston (2011, pp. 59), Corporate governance is an aspect that combines a variety of robust structures and processes with more crucial characteristics of efficient leadership, as well as, high behaviour standards. This is attributable to the fact that, it incorporates strong internal distinctiveness and the capability to scan the external environment more effectively. The common major principals of corporate governance that have been adopted in the UK are discussed herein. 2.1 Leadership Leadership is one of the principal that has been adopted by organizations in the UK. Leadership establishes an organization’s vision and helps in generating clarity on objectives, strategies, responsibilities and roles of the workers by fostering professional interaction (Davies and Aston, 2011, p. 61). 2.2 Culture Organizational culture forms huge bases of honesty and openness in which behaviours and decisions are challenged in order to enhance accountability. This is supported by processes and systems that have been set in an organization. Some factors that ensure accountability in an organization are risk, financial, and performance management. These elements must be considered in order to have reliable information that will enhance decision making (Davies and Aston, 2011, p. 61). 2.3 External Focus External factors, form efficient strategic regulatory regime that promote improved corporate governance. This is attributable to the fact that, it enhances flexibility with suitable based on complete information on capacity and performance. Therefore, balancing the internal and external elements in a business is imperative. This is because, excellent governance usually support efficient decision making. However, poor corporate governance leads to poor decisions (Cadbury, 1992, pp. 5-9). Decision making involves risk assessment and reducing that risk by operating an organization through open culture. However, there are challenges that are faced by organizations when using the open culture methods of enhancing corporate governance. This means that openness is supposed to be underpinned via robust financial, performance, as well as, information management structures. Efficient use risk management and accountability frameworks based on clear understanding and communication across the organization’s roles and responsibilities also support corporate governance (Keenan, 2004, p.175). According to Higgs (2003, pp. 45-49), the imperativeness of efficient leadership is making sure that good corporate governance is maintained in all UK organizations. Ultimately, organizational leaders are accountable for their achievement especially when they maintain the right balance of the principles discussed, then they will be able to have excellent corporate governance. Corporate governance is increasingly being used in UK organizations both in the private and public organizations. By utilization of the above discussed approaches, it is possible ensure that contracts and partnerships are efficient especially when using these elements to enhance corporate governance. The effect of an organization’s corporate governance reflects on the outcomes and quality of the work being done in an organization (Dedman, 2002, pp. 338-343). 3.0 Importance of Corporate Governance Organizations that maintain excellent corporate governance have the capability to uphold high-quality services as well as delivering improvement. However, poor corporate governance contributes to severe financial and service failures. The developing debate on corporate social governance is the issue of stark perspective. This is because, quality governance affects trust levels in numerous organizations and how they offer their services: Loss of trust damages the organizations and discredits their services. This is widely affected by the kind of services offered in any organization. Research done by Dahya et al. ( 2002, pp. 467-469), depicts that corporate governance is the backbone of any organization in spite of their size. Additionally, the leadership of the company determines a lot the way an organization is going to be in the future. This is because leadership is enhanced by good communication which leads to excellent corporate governance. 4.0 The development of corporate governance in the UK The progress of corporate governance in the UK can be explained by some series of corporate scandals and collapses which took place in the early 1980s as well as in the 1990s. This is when the UK entrepreneurs recognized the essence of proper management and control in organizations. Therefore, a committee that was led by Sir Adrian Cadbury was established and came up with a report that was tabled in 1992. This committee was responsible for addressing issue pertaining to the relationships the CEO and the chairman as well as highlighting on the role played nonexecutive directors in addition to reporting internal controls and the organization’s position. The committee therefore came up with a set of rule that would be followed by organizations. Therefore, a requirement to impose that added several rules for the London stock exchange. The rule stated that organizations are supposed to report whether they did follow the recommendations or not. If not, they were supposed to explain why; they did not comply with the set rules (Dedman, 2003, pp. 37-41). These recommendations are still being added up to today, but in 1995 another report was established and it set recommendations on remuneration. In 1998 the two reports got combined into a single code which was known in the UK as the Corporate Governance Code. However, in 1999 another, separate rule was issued in order to direct leaders on development of risk management as well as internal control structures. Today, the rule has been updated to fit the current business world. Risk management in any organization is extremely imperative. This is a good way to enhance corporate governance by ensuring that the organization and the people working there are protected. Additionally, the management should be able to formulate risk mitigation factors that are not only important for the organization at large, but also for the individuals ensuring that the set codes are followed. This is why in 2003 there was an update on the Code in order to incorporate recommendations from all the reports that described the role of exempt directors as well as, establishment of the audit committee responsibilities. This is when the UK Government decided to give the Financial Reporting Council (FRC); independent controller responsibility in enhancing corporate governance. Additionally, the FRC was given the responsibility of maintaining and publishing the Code. The most recent update made the FRC was in 2010, reflecting the issues that were learnt from the UK financial service section (Coombes and Wong, 2004, pp. 50-51). However, despite that there have been massive changes on the code; the approach that was set in 1992 by the Cadbury Report has been preserved. Another update was done four years ago by the UK Stewardship Code. This update under established that institutional investors should make formal reports regarding their policies for engaging and monitoring the organizations they invest. The update has been able to improve corporate governance extensively in many UK organizations. This has not only enabled the companies to make better profit margins, but it has also enabled them to maintain high standards in offering their services. it is imperative for the UK government to make sure that all these codes are followed. That way; organizations will be able to offer suitable and satisfactory to the shareholders (Owen and Grant, 2005, p. 63). 5.0 Analysis of Corporate Governance in the UK 5.1 Essential Elements The UK corporate governance approach has several essential attributes, as can be discerned from the preceding overview. One of these primary features emphasized by the governance system is the need for an effective board, capable of providing effectual leadership (FRC, 2003, p.15). The board members are expected to be collectively accountable for a company’s success in the long-run. The board is also supposed to have proper balance of autonomy, skill and experience. For higher efficacy, the board should have official and guileless process for recruiting directors, while shareholders should have the mandate to ratify all appointments. The UK governance system also advocates for regular appraisal of the board, in order to ensure that all its directors and committees (Parkinson and Kelly, 2004, p. 110). The other significant aspect of the UK corporate governance system is its emphasis for accountability. Under this stipulation, a company’s board is supposed to present an unprejudiced evaluation of its fiscal position. Respective boards are also entrusted with the responsibility of determining the nature and degree of the risks their companies are willing to take. This is supposed to lay the foundation for sound internal control and risk management systems. The system even proposes official procedures for executing these risk management duties, including creation of audit committees comprising of experienced and autonomous directors (Davies, 1997, p. 48). According to Davies (2003, p. 14) remuneration is yet another key factor provided for under the UK corporate governance system. The governance code requires companies to have effectual and transparent processes for setting compensation for executive personnel. This could involve creation of a remuneration board of autonomous directors, which would further be ratified or disapproved by shareholders through voting. An imperative provision of the governance system under this section is the requirement for a company, to link a percentage of the remuneration to performance considerations contrived to foster long-term company success (Smith, 2003, p.61). The final principal governance aspect that cannot be overlooked constitutes a company’s relations with its shareholders. This feature takes into account a company’s constant contact with its shareholders, in order to address their concerns and keenly consider their opinions in decision making. The UK governance system is also emphatic on the need for a company to propose valid resolutions for material shareholder concerns during general meetings (Berglof and Claessens, 2004, p.32). 5.2 UK Governance Approach Rationale The 2006 Companies Act in the UK requires company directors to focus their attention toward progressive shareowner value. This explains why the governance system is emphatic on company boards’ commitment to business sustainability, with special regard to the basic business model and formulated strategies. The regulatory framework is also founded upon the basic idea that, exemplary governance can enhance a board’s ability to effectively manage a company and deliver success in the long-run, while remaining accountable to investors (Jones and Pollitt, 2004. pp. 163-165). As emphasized in the original Cadbury Report, the efficacy depicted by company boards when they execute their duties, largely influences Britain’s position as a competing investment destination. Therefore, even though boards should have the freedom to propel their organizations forward, they should exercise it within the limits of responsibility. Such assertions clearly show that accountability is the foundation of the UK corporate governance system. The British government also acknowledges the fact that a regulatory system, which seeks to enhance efficacy of corporate governance and manage risks, has a high likelihood of succeeding if it supports instead of constraining company leadership (Becht, Bolton and Roell, 2003, pp. 65-67). 6.0 Effectiveness Analysis Based on survey findings by Arcot and Bruno (2005, pp. 41-43), approximately 49% of UK companies reported non-compliance with the revised governance code. However, the researcher is keen to note that, this proportion of companies is typically non-compliant with only one or two aspects of the code. Therefore, when these are combined with companies that fully comply, the FTSE 350 adheres to 97% of stipulated code provisions. This implies that by 2012, slightly more than half of all FTSE organizations, that is 51%, showed compliance with the UK Corporate Governance Code. With more than half of the UK companies complying with 97% of the code’s provisions, it is apparent that the UK is progressively adopting positive corporate governance (Davies and Aston, 2011, p. 70). Monks and Minow (2011, pp. 25-27) note that a relatively large percentage of companies complied with the code provision regarding the first corporate governance system feature of board balance and effectiveness. This is because out of the 55 FTSE 350 companies that did not have adequate independent board members, about 18, who make up a third of the examined organizations, were compliant. Further, in regard to diversity of the board, companies are increasingly including women and relatively young people in their governing committees. However, the gender diversity provision is not widely accepted, since only 47 companies of assessed FTSE 350 companies adopted the mayor’s 25% female composition criteria (Tirole, 2001, p. 37). Taking into consideration the code provision on accountability, companies are increasingly embracing the idea of holding audit meetings. This is evident from the fact that approximately 80% of assessed companied held from one to five audit meetings. If this figure is representative of the UK company population, then it is fair to state that the accountability culture is growing steadily, albeit slowly. The same applies to the condition providing for setting of remuneration. Myners, (2001, pp1-9) further, reports that there is continued improvement in company engagement with shareholders. This is shown by the fact that about three quarters or 75% companies currently report to actively converse with shareholders, especially in critical decision making. This is perhaps attributable to the rising desire of investors to get involved in company matters, in an effort to ensure that they get maximum returns on investment and avoid being exploited by malicious boards. The code provisions are clearly steering corporations toward equitable distribution of job opportunities, rational remuneration, responsibility to shareholders, and elevated involvement of shareowners in critical decision making. It is also evident that UK companies are increasingly embracing the code of governance, which shows that they link the regulatory framework to accountability and potential success (FRC, 2008, pp. 20-21). It is noteworthy to mention that compliance with the UK code of governance is not without its unique challenges. For instance, some companies, especially the relatively small ones argue that accountability recommendations like external audits are not suitable since they have limited resources and such measures would be financially unfeasible. Other companies cite insufficient autonomous directors as justification for not complying with provisions on balance of board committees. These are valid arguments, which the mayor’s office should evaluate even as it makes efforts to foster full compliance with the code of governance (Mallin, 2007, pp. 47-50). 7.0 Advantages of the UK Governance System The corporate governance system in the UK is clearly designed to address a wide array of issues. This ensures that it covers most of the governance concerns companies are likely to engage. The governance code also identifies potentially productive principles, but the organizations have the luxury to choose the ones they consider to be best suited to their situations and business models. Ultimately, the UK governance code shows that the principal association between a company and its investors is paramount to that, which exists between it and the stock exchange or securities comptroller (Tricker, 2009, pp. 50-53). 8.0 Conclusion The UK corporate governance system has evolved and attained significant milestones since the advent of the Cadbury Report. It is an irrefutable fact that the Cadbury committee raised a platform for the contemporary, largely efficient, framework of UK corporate governance, by providing directive principles for many succeeding codes. The country’s system clearly shows that quality of business governance is frequently shown by the quality of decision making processes and eventual decisions. Consequently, public sector companies should combine valid information acquired from formal processes like external audits, with relatively informal issues of integrity and receptivity, to make informed decisions. This is because; the more candid and receptive companies are regarding their performance, the more likely they are to inspire trust and continued dealings with members of the public, services recipients, shareholders, and other stakeholders. Such honesty and transparency, creates a strong foundation for problem resolution and improved overall performance in the long-term. 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