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The paper "Activities of the Corporate Control Market" shows us that there are certain factors limiting the operation of companies in the United Kingdom, such as for example, the fact that directors are expected to act in the best interests of the Company…
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Extract of sample "Activities of the Corporate Control Market"
Market for corporate control and corporate governance The market for corporate control, where a weak business faces the possibility of a take over, provides a strong incentive for good governance but this market has been weak in the U.K.1 Hirschleifer and Thakor have discussed the impact of a strong market for corporate control providing the effect of a sharp kick-in-the-pants to the governance of a company, in that the Board/owners of a company are more likely to be strict with the management and ensure performance where there is a danger of takeovers2. Corporate governance as defined by the Cadbury Committee report is the “system by which companies are directed and controlled.”3
There are certain factors limiting the operation of companies in the United Kingdom, such as for example, the fact that a Director of a company does not have to be a natural person4 and directors are expected to act in the best interests of the Company 5 and their decisions are to be conditioned by their own judgment of what they consider to be best at the time the decision is made.6 There is an insufficient degree of control exerted by shareholders on corporate governance, in spite of the fiduciary duty of directors, which has led to an increased focus on how directors can be made accountable to shareholders – an aspect that has been referred to as the quest for shareholder democracy.7
Under the Companies Act 1993, Directors do not owe any duties directly to the creditors of the Company, the established rule is that Directors do not owe any fiduciary duty towards creditors in the day to day operations of the Company.8 A creditor of a Company can therefore enforce Director duties only in the name of the Company, since the Directors owe their duties only to the Company and exercise their financial obligations accordingly. The Companies Act does not impose the duty of good faith or competence but only imputes a duty to the Company, as spelt out by Hoffman LJ:
“….if a director chooses to participate in the management of a Company and exercise
powers on its behalf, he owes a duty to act bona fide in the interests of the
Company.”9
It is only when a Company is under liquidation that the Companies Act spells out the provision that Directors must not cause or allow the business of the Company to be carried on in a manner that will create a serious risk or losses to the creditors of the Company10. Therefore, the extent of control exercised by both shareholders and creditors in the extent of the control of the Directors in the day to day running of the company is limited and the scope for regulation of director misconduct or ensure accountability is limited. The facility available under the Companies Act to show that a Company is being run in a manner prejudicial to the interests of the stakeholders11 is also an expensive and time consuming option.
The conventional norms for business administration in the U.K. are governed by the Companies Act of 1985, which has not provided a strong framework legal framework for preventing director misconduct and personal enrichment at the expense of the Company. While there is general agreement on the need to introduce a stronger role for shareholders and corporate investors in a company as opposed to the interests of the Directors who exert managerial controls over the organization, a more democratic framework has not evolved in the U.K., perhaps because as Gower suggests,
“Athenian style democracy is not particularly appropriate for public companies.”12
Government regulation has also been traditionally weak within the U.K, because the tendency has been towards encouraging self regulation of Companies. For example, although the London Stock Exchange has the power to de-list a public limited company, this has rarely occurred, since the LSE has functioned more in the capacity of providing financial transparency rather than exerting any control upon the functioning upon the actual manner of functioning of the Companies. Therefore, under this regulatory structure it is up to the shareholders to press for legal action against the directors of a company, in the case of irregularities. Cadbury highlighted the lack of “ consistent means” in the traditional system of informal corporate governance which prevails in the UK13, with Directors being endowed with a high level of discretion to act in a company’s best interest. His report specifically identifies certain weaknesses to be addressed, such as loose accounting standards, the absence of a clear legal framework which provides for review of Directors in the performance of their duties14.
This report has been further built upon with the recommendations of the Hempel Committee on corporate governance to increase internal controls to address issues such as “financial management, compliance with laws and regulations” which also includes “minimizing of fraud.”15
The creation of the Financial Services Authority and legislation under the Financial Services and markets Act (FSMA 2000) have created wider powers for investigation and action by FSA.16 An attempt has been made to introduce increased regulation of Director incomes through the Directors Remuneration Report Regulations 2002. While existing listing rules already call for the listing of Director remuneration, this has now been made a statutory requirement under the amended Section 234 B of the Companies Act, with a new Schedule 7A that sets out detailed information that is to be included in the Directors Remuneration report.17 In addition, a report has been published by Derek Higgs on the role and effectiveness of non executive directors in providing a system of internal controls, which is likely to enhance the accountability of UK companies and enable non executive directors to watch out for the interests of shareholders by playing a more demanding and influential role.18
These measures are geared towards enhancing accountability and introducing a system of increased internal controls within the organization, which would have a corresponding effect on director function and corporate governance. They are likely to reduce the degree of market control that may be exercised in hostile takeovers of UK Companies, through the mismanagement of Directors that causes heavy financial losses to companies. Since measures are being mooted to increasingly control the functioning of directors and the executive officers of the Company through increased internal controls and the mandatory disclosure of remuneration, it is likely that corporate governance may improve. It may however be noted that the traditional UK system of self regulation of companies still has precedence over Government regulation, and only time can tell how effective the new measures are likely to be in preventing hostile takeovers.
Bibliography
Articles and reports:
* Committee on the Financial Aspects of Corporate Governance, (1992), The Financial Aspects of Corporate Governance (The Cadbury Report), London : Gee and Co. Ltd, 1992
* Cadbury, A. The Future for Governance: the Rules of the Game, Journal of General Management, Vol. 24, No. 1, 1998, pp 7-8
* Garrod, N. Environmental Contingencies and Sustainable Modes of Corporate Governance, Paper presented, Faculty of Economics, University of Ljubljana, Sept. 1996.
* Hirshleifer, D. and A.V. Thakor. Corporate control through board dismissals and
takeovers, Journal of Economics and Management Strategy, 1998, Vol. 7, pp 489-520
* Freshfields, Brukhaus, Deringer, 2003. Higgs Report: A more important role for non executive directors [online] available at: http://www.freshfields.com/practice/corporate/publications/pdfs/5004.pdf
* Hempel Report of the Committee on the financial aspects of corporate governance, 1998, pp 53-54
* Financial Services Authority. The Transfer of the UK Listing Authority to the FSA, 1999, Consultation Paper 37.
* Shutkever, Carol and Smith, Martin. The Directors Remuneration report Regulations 2002. [online] available at: http://www.mondaq.co.uk/i_article.asp_Q_articleid_E_19791
Books:
* Goulding P. Cavendish Publishing Ltd, 2nd edition 1999
* Gower Modern Company Law 6th edition, Paul Davies. Sweet & Maxwell
Cases:
* Bishopsgate Investment Management Ltd v Maxwell (No 2) [1993] BCLC 1282 at P1286.
* Whyte’s case (1878) 9 Ch D 322 p 328.
Legislation:
* Companies Act 1985 and 1993
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