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The UK Corporate Governance Code

Info: 2846 words (11 pages) Essay
Published: 18th Jul 2019

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Jurisdiction / Tag(s): UK Law

Corporate governance refers to the way by which a corporation or company should be operated, regulated and controlled. The corporate governance code is a group of policies, customs and laws that sets out the framework as to how this is achieved. The requirement for such codes stems from the potential misuse of power by the board of directors, who ultimately manage the corporation in limited companies. In limited companies, “the shareholders role in governance is to appoint the directors and to satisfy themselves that an appropriate governance structure is in place.” [1] Directors are bestowed with broad powers that allow them to deal with the company’s’ aims and objectives and with all powers, unless there is a ‘check’ on those powers, they may be subject to abuse. The UK Corporate Governance Code serves as this check on the directors’ powers. Sir Adrian Cadbury advises that the aim of corporate governances is to balance economic and social goals and to align the interests of individuals, corporations and society. [2]

As a consequence of the corporate scandals revealed in the late 80’s, [3] a committee was set up to explore the system of corporate governance in at attempt to improve and raise the standards of corporate governance and to restore investor confidence. This committee headed by Sir Adrian Cadbury, known as the Cadbury Committee, created in 1991 consisted of the Stock exchange, Financial Reporting Council and the accountancy profession produced the ‘Report of the Committee on the Financial Aspects of Corporate Governance’ in 1992. [4] This report listed a number of recommendations concerning the practices of Directors, Non-executive Directors, Executive Directors and those on Reporting and Control with the core recommendation being that the boards of all listed companies should comply with the code. [5]

The Cadbury report was followed by Greenbury report in 1995 which concerned directors’ remuneration and this was subsequently followed by the Hampel Committee in 1998 which drew up the Combined Code on Corporate Governance. [6] This was revamped in 2003 by the Higgs Report on the role of effectiveness of Non-Directors. [7]

The reason for these committees has been the fact that major scandals and large corporate collapses had to be addressed. An example of one of these collapses can be seen in the Enron case. In Enron, the directors were found to have been concealing debt and inflating profits in order to increase their company’s value. Executives were found guilty of fraud after they sold off their shares in the company in excess of $1 billion. They were also charged with money laundering and conspiracy. The investigations that took place into Enron’s accounting revealed that they failed to disclose the debts and losses that company suffered in their accounts and financial statements. After being accused of fraudulent behaviour, the share prices plummeted causing the company to file bankruptcy.

Another example is the Italian dairy corporation Parmalat SpA. The Parmalat scandal has been named as Europe’s largest ever financial fraud, and parallels the collapse of Enron. After Parmalat had trouble making bond payments, questions arose as to the financial situation of Parmalat. Although the bank sheets showed a positive of just under €4bn, the Bank of America released a paper displaying Parmalat’s accounts as forgery. After investigations began, it was found out that Parmalat’s true debt was in excess of €14bn.

A couple of major scandals prior to these include the Maxwell scandal and the Polly Peck scandal. After the death of Robert Maxwell, his media companies stopped trading on the stock exchange. It was found that he had been supporting his business through the illegal use of pension funds. He took £400m from the company’s pension fund scheme in order to pay off his corporate debts. At the time of the collapse the company’s debts were approximately at £3bn. A similar situation occurred with the stealing of company funds in the Polly Peck scandal. An investigation by the Accountants’ Joint disciplinary found that Chief Executive Asil Nadir had been transferring funds into offshore companies. Chief Executive Asil Nadir was able to conceal his actions and was able to pay out £141m in 64 different deals. The firm then collapsed in 1990 with debt amounting to £1.3bn. [8]

These cases reveal an alarming lack of transparency in the conduct of global companies. Through these cases we can highlight numerous problems that surrounded corporate governance which allowed for directorial malpractice. A lack of transparency in financial disclosure can lead to a decline in investor and consumer confidence. It also dented confidence in the accountability processes spurning a sense of a general distrust of large companies. [9] The Cadbury committee laid down some recommendations in order to improve governance mechanism, increase shareholder power and enhance disclosure. The approach that surfaced in the early 90s was that on moral grounds it was right to include shareholders in the decision making process. This approach could be justified through economical benefit, by empowering shareholders, there is a greater sense of trust between investors, employees are at ease with their job security ultimately leading to benefit. [10] The original concern was that companies applied minimal standards and the reason for the Code was to engage companies in applying the letter of the law as well as the spirit of the rules.

Over the last couple of decades the UK has continue to develop a distinctive structure of corporate governance law. In a review of the combined code, a shareholder representative body (Pension and Investments Research Consultants Ltd) produced a report that only 33 % of listed companies complied with the provisions in the Combined Code. [11]

In 2010 the Financial Reporting Council published a new UK Corporate Governance Code 2010, which now gives the listing rules statutory authority requiring PLCs to disclose how they have complied with the Code, creating for a more transparent accounting system addressing previous issues. The combined code was voluntary so it was up to a company to choose whether to adhere to it , however, the fact still remains that there has been no change to the ‘comply or explain’ requirements. Therefore a company must produce an annual report as to how it has complied withy the Code and if it as not complied with all the Code’s relevant provisions then providing reasons for non compliance of the identified provisions. The fact that the comply or explain approach is seen as being less costly and flexible, than the alternative approach that the United States has adopted in the Sarbanes-Oxley Act [12] which makes failure to comply with the Governance Code a criminal offence. [13]

The new code produced in 2010 has created new provisions such as [14] :

  • Leadership :- Chairman is responsible for the board and ensuring its effectiveness
  • Remuneration:- Levels of remuneration should be sufficient to attract, retain and motivate directors of the quality required to run the company successfully
  • Relations with Shareholders: – There should be a dialogue with shareholders based on the mutual understanding of objectives.
  • Board effectiveness:- Requires the board to have diversity in skills, independence and knowledge
  • Board Composition:- Nominations should be based on merit against objective criteria
  • Accountability: – The annual report should explain company’s objectives.

The scandals that have been mentioned above such as Enron and Parmalat show an increase in managerial discretion which led the Cadbury Committee to introduce the notions of non-executive directors (NEDs). [15] There is no definition for a NED ‘but as the name suggests they are directors without any additional managerial positions in the company’. [16] The reason for NED is that they stand to defend the interest of shareholders and ensure corporate governance through them being independent of the company. Alongside the introduction of the NED was the committee structure. This notion was set to address the main the problems which were identified through the major corporate scandals over the last couple of decades. The issues were remuneration, appointment of directors and the auditing of companies. The aim was to have at least one NED on the appointment, remuneration and auditing committee in order to ensure transparency and to improve the accountability of directors. [17] “Although they cannot guarantee against corporate malpractices, NEDs can play a significant role where they are effective”. [18] Due to the fact of their independence they cannot benefit from the decisions they make and therefore only benefit the stakeholders. However, there is also a strong case against the use of NEDs. The vital aspect of NEDs is that they are independent yet the appointment of NEDs raises doubts as to their independence. Although they are appointed by executives with the consent of shareholders, the nominations made for the NEDs from fellow executives, and the nominations are made from the same social circle and backgrounds compromising their independence from the start. Instead of safeguarding stakeholder interest, they may just comply with the business procedures of those people that nominated them. Dingham uses the metaphor to describe this as “an invitation to design, build and run a new international asylum, which is even more to their liking.” [19]

In addition to corporate governance, the courts have been developing the aspect of directors’ liabilities. The directors’ duties are now codified within the Companies Act 2006 allowing for more clarity on the issue. The duties listed within the act are listed below [20] :

  • Duty to Act within their Powers
  • Duty to promote the success of the company
  • Duty to exercise independent judgment
  • Duty to exercise reasonable skill, care and diligence
  • Duty to avoid conflicts of interest
  • Duty not to accept benefits from third parties
  • Duty to declare interest in proposed transaction or arrangement with the company

The law also provides remedies if directors fail to comply with these duties. Developed from the common law principle, [21] it has now been entrench into the Companies Act. [22] Aside from this, the introduction of a statutory derivative claim allow for shareholders to sue on behalf of the company to get a remedy for the company. [23] The introduction of this legislation not only strengthens shareholder power but also provides a sense of security. The case of Burland v Earle [24] explains that a minority may bring such an action, but the action is confined to acts that are fraudulent or ultra vires. The derivative claim is also limited to actions that cannot be remedied by a majority.

Over recent times there has been widespread dissatisfaction over the levels of remuneration especially after the banking collapses. The government addressed this problem by making it mandatory to disclose the levels of remuneration offered to directors. [25] It has since been incorporated into S. 420 CA 2006, which provides that directors of a quoted company must produce a director’s remuneration report every financial year. [26]

In general the new UK Governance Code 2010 has come along way from the times of the scandals such as Polly Peck and Maxwell. It has introduced new policies to ensure that shareholder concerns are answered by placing the duty upon the chairman to raise them. [27] Although the Code is not binding upon companies, the retention of the “comply and explain” procedure does solve some of the problems that used to exist. Other legislative framework such as the codification of the directors’ duties within the Companies Act has seen the accountability of directors issue been put to rest as well as increasing shareholder power to remedy any wrongs committed by directors through a derivative claim procedure. The introduction of NEDs has seen created a check on the board to ensure that directors act in the best interest of the corporation. The new Governance Code sees that at least half the members of the board are NEDs in larger companies to ensure that the objectives are constrained to the interests of the company and not any private agendas. I do believe that UK legislation and framework have both evolved in order to respond to the governance issues. Although the new legislation and framework may not provide all the solutions to the problems once posed I judge it will do a great job in ensuring that companies are more efficient, enhancing disclosure to provide more transparent accounts and ensuring directors, as well as the entire board, act solely for the interests of the company and therefore look after the interests of shareholders who were once robbed of their investments. It is no surprise that large publicly-quoted firms are increasingly conforming to international standards of corporate governance best practice. [28] I believe UK has developed a great model of corporate governance which has managed to keep the managerial costs low whilst doing so. It now reflects the issue of accountability to shareholders promoting company efficiency.

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