Comparative Corporate Law: The United States and the UK - Case Study Example

COMPARATIVE CORPORATE LAW CASE STUDY Introduction On many corporate governance issues the United s and the UK follow an Anglo-American system quite distinct from Europe and Japan. Such a system is characterised by a "shareholder" form of capitalism, which emphasises the corporation’s purpose of maximising shareholder wealth. In addition, the Anglo-American regime exhibits a pattern of dispersed share ownership and well-developed stock markets in which institutional investors play a leading role. Notwithstanding these structural similarities, the mechanism of shareholder capitalism in the United States and the UK are different, and nowhere is this more exemplified than by the respective responses by these two Government following major incidents of corporate fraud. This Case review compares some of the differences between the corporate environments operating in each of these jurisdictions, and explains how they may have contributed to such divergent responses. One can characterise these responses as legislative and/or regulatory. Legislative responses refer to legal changes that are made, which force businesses to change their practice if they are to remain compliant. In this instance, legislation is an externally enforced means of changing corporate behaviour. Regulations on the other hand can be externally or internally generated, and can promote a desired change of behaviour through legislature or through Codes of practice developed by industry bodies such as the group representing licensed auditors. Whether the regulations are internally or externally generated, one important aspect in which they differ from legislative regimes is the higher degree of importance placed on monitoring of entities within regulatory regimes. Legislative regimes primarily depend on the sanctions to foster compliance. Immediately, following the corporate governance crisis that occurred in the United States in 2002, the federal government implemented far reaching legislature, to protect investors from such levels of corporate fraud. On the other hand, when the U.K experienced a similar crisis in its corporate governance system in 1991, the response was much different. What followed was over a decade of Commission reviews which each provided best Codes of Practices for agents within the corporate governance regime. Eventually legislature on corporate fraud was only enacted in the Fraud Act of 2006. The analysis in this review points to some of the reasons that these government undertook such different responses. Firstly, prior to the crises, there was significant corporate governance legislature present in the US but separated by State boundaries. As shall be shown shortly, the competing legislature in different jurisdictions led to a belief that what was needed was overarching federal legislature. Secondly, the institutional investors in the UK readily adopted longer-term pay-off outlooks in line with Corporations’ own longer-term outlook and thus a dialogue between stakeholders and managers was more readily developed in the UK than in the US. Thirdly, the greater dispersal of corporate control within the UK business model meant that regulatory changes were easier to develop in the UK than in the US in which business practice concentrated power in the CEO. This case review starts with an analysis of the US corporate environment that led to implementation of the Sarbanes-Oxley 2002 Act. The next section analyses the UK corporate environment that prompted the commissioning of a number of reports on corporate governance throughout the 1990s. This review then ends with a conclusion that highlights the differences between these two jurisdictions. U.S Corporate Governance An important influence on the corporate governance structure in the U.S. is the federalist system of government. Each state has “sovereign power with reference to the enactment and administration of all laws covering offences within its boundaries, which are not distinctly allocated to the province of the federal government” (Ramage, 46). The result of this being the governance structure of U.S. corporations is largely determined by the law of the state in which a company is incorporated. This availability of corporate regulation is good it has been argued because it creates competition among jurisdictions within the United States leading to the creation and implementation of efficient corporate law (Ribstein 3). Good Corporate governance in the United States depended on this competition in market of jurisdictions. The fraud cases starting with Enron in 2001 and including WorldCom, Global Crossing and Qwest among others show, highlighted failures in this market of jurisdictions to not only properly monitor the activities of corporations, but also prices did not reflect the true value of these companies because agents within corporations were able to conceal information or provide inaccurate information on corporations despite laws that stated otherwise. The Sarbanes-Oxley Act of 2002 was a quickly implemented legislative reaction to this market failure that mandated a number of reforms to enhance corporate responsibility, enhance financial disclosures, and combat corporate accounting frauds. It created the Public Company Accounting Oversight Board (PCAOB) to oversee the activities of the US auditing profession (Coates, 92). At its core, the Sarbanes–Oxley legislation was designed to fix auditing of U.S. public companies, as indicated by its official name The Public Company Accounting Reform and Investor Protection Act of 2002. Up until that time, the federal regime had left corporate mandates to the jurisdiction of the States and had only enacted disclosure requirements. One notable feature about the Sarbanes-Oxley Act was that while it did increase the resources of the Securities and Exchange Commission, the SEC was not given any power to enforce criminal laws. This still lay within the power of the Department of Justice and the federal states. The post Enron era ushered in reforms that arguably sough to improve the rights of and protect shareholders. The preamble to the Sarbanes-Oxley Act makes clear, the goal of the Act is protection of shareholder interests1. However, at the other end of the spectrum is this competing belief that US Corporations need to be protected from its shareholders (Hill, 829). As such, U.S. Corporate Law does not encourage a close relationship between the Company managers and shareholders as will be seen in the case of the UK. The US the relationship between institutional investors and portfolio companies is characterised less by collaborative pursuit of the long-term health of the company and more by scripted communications between analysts and corporate investor relations departments as company managers stretch to meet securities analysts’ quarterly financial projections (Jensen, 2005). Consequently, institutional investors in the US do not play the strategic consulting role that is becoming more common in the UK” (151).An emerging competing goal in American academic literature is that of protecting the corporation from shareholders (Hill,829). How are investors in the U.S. different to those in the U.K. that corporations in the U.S. would need protection from them? That the U.S. emphasis on corporate governance has always been legislative rather than regulatory is evidenced by the fact that before Sarbanes–Oxley, total U.S. spending on securities regulation (SEC spending together with spending by other public or quasi-public regulatory bodies) per dollar of market capitalization was less than 80 percent of spending in the United Kingdom. Even after Sarbanes–Oxley, U.S. spending on securities regulation remains below that of the United Kingdom (Coates 95). However one argument is that overselling regulation as a panacea for good corporate governance, might mislead investors back into the same complacency that contributed to the recent frauds (Ribstein, 53). U.K. Corporate Governance The corporate scandals that led to the UK government’s reflection on the domestic Corporate law, the collapse of Robert Maxwell’s financial empire and the Polly Peck crises, occurred in 1991, nearly 10 years prior to that in the U.S. The UK government’s response to the corporate governance challenges it faced then was more deliberated that that of the U.S, and over the next decade, five major committees were established to evaluate various aspects of corporate governance, making recommendations about accounting practices, executive compensation, board composition, and expanded nonfinancial disclosure, before legislature was culminated in the Fraud Act of 2006, and The Company Act 2006. One argument that could be made to support this more considered UK approach was the less emphasis on the role of the market in the creation of the UK Corporate Legal regime. As such, one can argue, it was harder for the government to identify the causes of these corporation failures in the way the U.S. government was able to, given the prior dependence on market theory. The first of these Commission was the Commission on the Financial Aspects of Corporate Governance, Report of the Committee on Financial Aspects of Corporate Governance (1992)2. While its "remit" was to study the finance and audit functions at Maxwell Communications and Polly Peck, the Cadbury Committee went further in its recommendations, and issued recommendations that were incorporated into a Code of Best Practice for preserving auditor independence and enhancing the supervisory role of the nonexecutive members of the board of directors (William and Conley:512). Following this, “The Confederation of British Industry” reported on Directors Remuneration: (hereafter Greenbury Report)3 producing its own code of practice aimed at improving accountability in executive pay. The code stressed the role of nonexecutive directors in setting executive compensation, disapproving of American-style Executive pay practices, and emphasized the importance of shareholder participation in the remuneration function and a "philosophy of full transparency," including detailed disclosure of directors remuneration in annual reports” (Williams and Conley: 512). The Hampel Committee was established to undertake a review of impact of the Codes of Practice established in the Cadbury and Greenbury. The 1998 report4, resulted in a "Combined Code," which structured corporate governance in listed companies until 2003, at which time a revised Combined Code was issued, based on the 2003 Review of the Role and Effectiveness of Non-Executive Directors5 (hereafter Higgs report). This Review synthesised the corporate governance recommendations of Cadbury, Greenbury, and Hampel. The Higgs report introduced a range of techniques that were explicitly designed to foster active dialogue between independent directors and institutional investors, and to treat independent directors as a conduit between institutional investors and management (Williams and Conley: 514). Such reforms continued in the U.K. Companies Act of 2006 which sought to enfranchise indirect investors holding shares through a nominee6 (Hill, 826). The emphasis which the Cadbury Committee had placed on the importance of shareholder voting power to improve corporate governance was emphasised and reiterated in The Hampel Committees Report, which encouraged pension funds and other institutional investors to become more engaged in corporate governance. The 2001 report of the Company Law Review Steering Group7 recognized that the primary purpose of the corporation is to create profits for shareholders, but concluded that the time frame for assessing profit creation must be long-term, not short-term. Conclusion This comparative Case Review of Corporate Governance in the UK and the US has sought to analyse the different responses that these respective governments had to serious instances of corporate fraud. Despite both these countries having what has been described as a similar Anglo-American corporate governance regime that could be distinctly compared to that in the Europe or Japan, they have in the last decade, adopted different means of conducting their corporate governance regimes. A number of reasons for these differences have been highlighted in this case study. Firstly, the federalist structure of U.S. corporate law meant that different States were implementing different governance regimes. The presumption of the merit of this was based on the theory that competing jurisdictions would create a market outcome of efficient corporate governance. A number of high profile incidents of corporate fraud, beginning in 2001, led to a reassessment of the ability of the market to limit the behaviour of corporate actors and protect the interests of shareholders. As such, soon after the corporate scandals broke, the Sarbanes-Oxley Act was implemented as a market correcting measure. Improved legislation, which promoted more federal oversight in corporate governance, was the solution. Secondly, despite the Act’s emphasis on shareholder rights, no overt attempts were made to improve the dialogue between shareholders and Corporations. It can be argued that this is the result of a belief that corporations have to be protected from shareholders. Given the high proportion of investment funds that constitute institutional investors in the U.S., protecting Corporations that must necessarily take a long-term business view from these types of investors which are focused on the short-term gain, is prudent. By contrast, a different number of Codes of Practice developed since the corporate scandals of the early 1990s in the UK, emphasised the development of constructive dialogue between the managers and shareholders, centered on a more long-term company outlook. Given the higher proportion of pension funds and insurance companies institutional investors in the UK, this is arguable easier to accomplish than in the U.S. model. Finally, the leadership structure of UK and U.S. corporations differ significantly. While the Cadbury and Higgs reports had emphasised splitting the leadership job between a CEO and a Chairman of the Board of directors, for achieving good corporate governance, in the U.S., the leadership power is still concentrated in the CEO. One can argue that the U.S. model of the company makes it more difficult for a company to undertake an internal review of its governance regime, to develop a Best Practice Code, not only for itself but for its industry. In such a situation where corporation power is so heavily concentrated, effective systems of control are more likely to be developed externally. In the UK, the greater dispersion of power and oversight within the Corporation arguable makes it easier for the corporation and industry to develop best practice guidelines on its own. References Aguilera, Ruth V., et al 2006. Corporate Governance and Social Responsibility: a comparative analysis. Corporate Governance and Social Responsibility 14(3): 147-158 Coates, John C. IV (2007) The Goals and Promise of the Sarbanes–Oxley Act. Journal of Economic Perspectives 21(1):91-116. Combined Code on Corporate Governance (2003) Available at http://www.fsa.gov.uk/pubs/ukla/lr_comcode2003.pdf (accessed November 2nd, 2010). Companies Act 2006. Fraud Act 2006. Hill, Jennifer, G. (2008) Regulatory Show and Tell: Lessons from International Statutory Regimes Delaware Journal of Corporate Law 33:819-843. Ramage, Sally (2007). A Comparative Analysis of Corporate Fraud MPhil thesis Available at http://wlv.openrepository.com/wlv/handle/2436/14408 viewed November 3rd 2010. Report of the Committee on Financial Aspects of Corporate Governance [Cadbury Report] (1992). Ribstein, Larry E. (2002-2003). Market vs. Regulatory Responses to Corporate Fraud: A Critique of the Sarbanes-Oxley Act of 2002. J. Corp. L. 28:1-67. Sarbanes-Oxley Act of 2002. Williams, Cynthia A. and Conley, John M.(2005) An Emerging Third Way? The Erosion of the Anglo-American Shareholder Value Construct. Cornell Intl L.J. 38:493-551. Read More