The development of corporate governance code in UK since 1992 - Essay Example

?Corporate governance Contents Corporate governance Contents 2 Introduction 3 Corporate Governance Development 4 Corporate Governance Practices 8 Application of Corporate Governance Codes in Burberry and BP 9 Recommendation and Conclusion 11 Reference 12 Introduction This project aims to evaluate the development of corporate governance code in UK since 1992. The motive behind the study of corporate governance stems from the fact that corporate governance has become an essential part of management of shareholders’ interests, both in UK and US. Corporate failures such Maxwell Publishing Group, BCCI, Poly Peck and Coloroll in 1980s and early 1990s in UK brought the issue of corporate governance practices by publicly listed organizations (OECD, 2004, p.19). There is no set definition of corporate governance and mostly depends upon the specific country’s view and oversight of the issue. Generally, it is known as a system of rules and principles as to how an organization should be governed and controlled. The roots of corporate governance lie in ‘Agency Theory’, which explains the problem of principal-agent. The managers or agents are bestowed with the responsibility of managing the company on behalf of the company’s owners or principals. While these agents have informational advantage, the principals have to rely on the board appointed by them to oversee the agents’ management. Therefore, agency theory has had a deep influence in shaping the characteristics and reforms of corporate governance (Lehman, 2005, p.250). A proper governance mechanism in organization was required in order to facilitate a prudent and effective entrepreneurial management to deliver the long-term success of the organization underlying assumption of corporate governance is that the board of directors is responsible for the management of business and control of risks faced by it (Calder, 2008, p.2). While the framework of an effective corporate governance is still is in development stage in most of the developed economies, the recent economic downturn has raised the doubt over the effectiveness of corporate governance can ever be achieved. UK introduced the Code on Corporate Governance in 2010 and Stewardship Code in response to the recession (H.M. Treasury, 2010, p.39). These two Codes are based on the Walker Review Committee being set up to review the corporate governance practices in banking sector. U.S. has addressed the issue of corporate governance and auditor’s independence through Sarbanes Oxley Act in 2002 in response to Enron collapse and other corporate scandals, and Dodd-Frank Wall Street Reforms along with Consumer Protection Act in 2010 (Copeland, 2010, p.1). These reforms and developments indicate that the importance of having an effective corporate governance framework in order to protect not just the shareholders’ interests but also the other stakeholders’ interests. Considering this, the development of corporate governance framework in UK and practices of the Code through the analysis of two UK-based firms Burberry and BP have been provided. Burberry is a manufacturer of luxury fashion clothing, fragrance and accessories in UK and was established in 1856 (Burberry, n.d.).Burberry is listed on London Stock Exchange. BP was established in 1908 through a discovery of oil well in Persia. The company is listed on London Stock Exchange and NYSE (BP, 2012). Both the firms follow the provisions of corporate governance practices in the new Code on Corporate Governance 2010 and the Company Act 2006. Corporate Governance Development The process by which the stakeholders of a company get assured that the board of directors of the company is performing their duties efficiently, which assigned to them. The board members of the company should design the process, so that the interest of the stakeholders maintained properly by the operations done by the company management. The company management should also look after that whether the company properly maintains the ethics, corporate social responsibility or not. In the decade of 1980s the inter-organizational and the intra organizational networks of the companies of the United Kingdom were under developed. The stakeholders’ interest was not maintained properly in the companies. The government of the United Kingdom tried to solve the problem and make a scenario where the stakeholders of the companies like the investors, the common people, the banks and the government stay secure from the performance of the company (Rhodes, 1996, p.660-662). For this purpose, some guidelines needed to be preparing by the government, which the companies can follow for effective corporate governance. The economy of the country depends on the performance of the companies mostly, so the government should implement some guidelines for ensuring the transparency of the companies. In the year 1992, the financial reporting council has set up Cadbury Committee for looking after the financial aspects of the corporate governance structure of a company. Sir Adrian Cadbury headed the committee. The one-person committee has recommended to make broad the areas of financial auditing, the practices which will reduce the fraudulent practices inside the company. The directors should take tough steps to control the internal activities of the company, they should maintain adequate accounting records for assuring the transparency in the company. There were some recommendations about the going concern of the company that the companies should follow the corporate governance code as per the companies’ act 1985 (Cadbury, 1992, p.74-77). In the United Kingdom, the next development of corporate governance was in the area of payments to the executive. A committee headed by Sir Richard Greenbury published the report in July, 1995. The board has recommended that every company should set up a committee, which would determine the remuneration of the directors, and it would decide about the new appointments in the board (Greenbury, 1995, p.21-26). The next development of corporate governance was in the year 1998. The Hampel committee has produced the Hampel report in the year 1998, which recommended creation of combined code by consolidating the two previous reports Cadbury and Greenbury reports. The committee has recommended that a company should make an effective framework so that the communication between the shareholders and the company management can be improved (Hampel, 1998, p.32-40). In the year 1999, the committee led by Niger Turnbull published the next report on corporate governance. This report was about the financial and operational control frameworks of a company. The report has recommended that the board of a company should produce an annual statement for ensuring an effective internal control mechanism. The board should also be responsible for the risk management of the company. The internal control of the board also includes their responsibility of financial control. The committee recommended that the companies should not develop their own mechanism of corporate governance also; it has recommended that the responsibility of the external auditors should not increase in the area of internal controls. Thereafter the next development on corporate governance was in the year 2001, which was done through the Myners report. The report found the problems faced by the company management from making an effective decision. The committee has made some proposals to tackle the problems. The proposal was that the pension fund trustees should adopt a ‘comply or explain’ framework voluntarily so that they can take the decision about the investment decision. There was some proposal of changes in the tax rules of the United Kingdom (Myner, p.21-25). At the end of the year, 2001 Enron got bankrupted due to the accounting malpractices and lack of transparency in the auditing. Their policies of accounting were different, as they recognize the revenues when they made a deal, not the time when they have received the payment. Such accounting practices leads to the bankruptcy of the company. The auditing firm of Enron Arthur Andersen also dissolved due to the case. Therefore, in the United States the federal government felt the need of change in the laws regarding the corporate governance of the companies. The Securities and Exchange Commission of the United States brought a law named Sarbanes Oxley act, which requires that the companies listed in the bourses of the United States needs to follow the rule strictly. The law requires that the CFO and the CEO needs to confirm that the financial statements support the financial decisions taken by them suitably. The companies based in the United Kingdom also have to started to practice as per the Sarbanes Oxley act as they are also listed in the stock exchanges of United States (Holmstrom and Kaplan, 2003, p. 23-27). At the end of the year 2002, the UK government made regulation that the companies should produce the annual remuneration report of the directors, which make the corporate governance more transparent. The regulation also says that the report is requiring the approval of the shareholders of the company at the time of the annual general meeting. In January, 2003 the Higgs report on corporate governance has been published which has recommended about the role of the non-executive directors of the company. The report recommends that the non-executive directors of the company should comprise of half of the board. The non-executive directors of the company should not serve more than three years in a company. The non-executive directors should comprise the audit committee members of a company and at least one of them should have relevant financial experience as per the recommendation of the Smith committee, chaired by Sir Robin Smith (Smith, 2003, p.2-9). In July 2003, the financial reporting council (FRC) issued the revised code of corporate governance, based on the recommendations made by the report of Smith committee and Higgs committee. As per the code, the companies have to comply with the principles of the code or they should provide explanation for not abiding by the guidelines. In the year 2005, the financial reporting council (FRC) has updated the guidance of corporate governance for the companies, which took effect from the financial year started on or after 1st January 2006. The guidance included that the companies should provide meaningful financial information as an addendum of the financial statements. The directors of the company should take enough care to the internal controls of the company as they used to carrying their general duties. As per the regulations of 2005, the companies had to publish the operating and financial review report as a part of the annual review. However, in November 2005 the United Kingdom government has announced that the companies did not have to produce an operating and financial review report (OFR) rather they have to add a business review as part of their annual report, which would be more flexible than the OFR. In the year 2007, the financial reporting council has reviewed the combined code further. In the year 2009 the corporate governance policies of the companies has undergone some important changes. As per the companies act, 2006 which was in force from the year 2009, the companies had to abide by some rules. As per the new law, the shareholders could not sue the directors of the company for their wrongdoing; rather the company can sue the directors for their negligence. The new duty of the directors includes promoting the success of the company by considering the factors like interest of the employees, the long-term effect of a certain decision etc (The National Archives, 2006, pp.29-30). The financial reporting council reviewed the combined code of corporate governance in the year 2007 and based on the review some changes incorporated in the year 2008. The companies used to provide the explanations of poor quality, as they did not have to follow the rules legally. As per the combined code of corporate governance of 2008 an individual can be in the board of directors in more than one company for the FTSE 100 companies and for the companies which are outside of the FTSE 350 companies, the company chairman can be in the audit committee if he or she is independent. In November 2009, the Walker report was published which recommended the changes in the area of board size of the companies and the composition of the board. The remuneration structure and the risk governance structure became more stringent as per the recommendation of the report. Based on the Walker report the financial reporting council made changes in the combined code and the new name of the code became “the UK corporate governance code”. The UK corporate governance code of 2010 recommended about the role of the chairman, which became more responsible role to ensuring the transparency of the company, the role of the non-executive directors etc (Financial Reporting Council, 2010, pp.12-26). In June 2010 the UK stewardship code has published and the aim of that was to ensuring more transparency in the company and also it ensures that the shareholders’ interest are maintained. The companies have to follow the guidelines otherwise; they have to explain the reason of not following the rules. The company management has to monitor the performance of the company, there would be voting rights of the shareholders, as well as they have to prepare reports for the public as well as for the clients (Financial Reporting Council, 2010). Corporate Governance Practices From a study conducting on the listed firms in the United Kingdom it has been found that the changes in the board structure has not been affected by the problem regarding agency cost in the post Cadbury time period. The study conducted to found out the impacts of the changing corporate governance structures and the agency costs. The increase in the board ownership has decreased the costs when the agency costs have been increased because of the introduction of the nomination committee (McKnight and Weir, 2009, pp.139-155). There are two codes introduced by the financial reporting council, practiced by the companies at present. The codes are the UK corporate governance code, revised at 2010 and the other code is the UK stewardship code, which implemented in the year 2010. The companies have to comply with the codes or they have to explain the reason of not following the guidelines. In an annual survey conducted on the FTSE 100 firms it has revealed that 50% of the firms abide by the guidelines fully when 40% of the firms left only one or two guidelines. The financial reporting council has concluded that the companies are taking effective steps for managing risks. They have concluded so after the discussion with the directors of the company, the shareholders of the company and the risk officers, auditors etc. The data suggests that the companies have not changed the structure and composition of the board of directors since 2009, which suggests that there are minimum three directors in the board. The report suggest that the only a small number of companies has breached the rules which means the corporate governance structure existed in the United Kingdom is flexible enough (FRC, 2011, p.11-15). As a result, the companies are not finding it difficult to comply with the codes and there is economic stability in the country. When the contemporary economical condition of the world taken in consideration by the researcher, then it can be said, the economic condition of the United Kingdom is good enough with respect to the global scenario. In the era of globalization for maintaining the economic stability in a country, the companies play a big role. When there is an effective corporate governance structure in the companies, they can fulfil the interest the stakeholders and in United Kingdom, the companies are able to do that. As a result, the economic condition of the country remained good in the financial turmoil also. Application of Corporate Governance Codes in Burberry and BP The two organisations that are to be discussed are British Petroleum and Burberry. Both the organisation has developed a strong corporate governance code and has been practising for over the years. British Petroleum has implemented an effective and system of comprehensive corporate governance which was mainly designed in order to safeguard organisations interest of the shareholders, to promote timely and effective decision and most important to provide transparent information. The framework of the BP includes the principles, which guide the management team and the board and system of control, which defines the working culture of BP. The Board of BP works within the framework as described in the governance principles. The principles usually describe the relationship of the board with the shareholders and the executive management. The board is directly responsible for the overall direction of BP on behalf of it shareholders and is accountable to the shareholders for all the activities of BP’s business. Thus the board focus its activities on the development of the strategy and monitoring the risk and performance of the business. The board committee consists of five permanent committees which are safety, environment and ethics assurance committee which aims to monitor the management of non financial risk. The board along with its committees receives information from the external sources as and when required. One of the major activities of the board in 2010 was with regards to the incident of Deepwater Horizon in the Gulf of Mexico. The board appointed an addition of four non executive directors who together would bring an experience in the oil and gas industry, accounting and audit and also in global strategy. The members of BP need to meet with certain aspect which should be relevant to the team (BP, 2012). The board governance principles allocate the task of monitoring the executive actions and assessed the performance of certain committees. The audit committee of BP, after the incident in Gulf of Mexico, have put on additional focus on the matters which were of concern. The committee mainly concentrated on the effects of financial consequences with respect to the event. The audit committee spent a considerable amount of time and effort in order to review the challenge that was likely to review the cost of immediate and a longer financial responsibility along with the adequacy of disclosure of both the financial consequences and all the other related contingents, which were not reported at each of the prescribed reporting date. The audit committee has also with accordance to the corporate governance has reviewed the aspect which has surrounded the deployment of the financial resources of BP in response to the incident (BP-a, 2012). This shows the responsibility of the committee towards the incident and to take care of the financial consequences and all this actions took place because of the effective corporate governance that British Petroleum practices. The board has developed the principles so to fulfil the responsibilities of the organisation towards the shareholders and other who are associated with the organisation. The next organisation is Burberry whose corporate governance would be discussed in the following lines. Burberry is among the leading British luxury brand with global presence. The brand also practises corporate governance and the board remains committed in maintaining a high standard of governance which the company believes is essential in maintaining the effectiveness of the business and to build in the confidence of the investors. In 2003, protest of the shareholders in UK which was led out by the National Association of Pension Funds against financial agreement which was agreed by the company, Burberry. The arrangement that was made was about to pay the management of Burberry an excess of 13million pound on the dismissal. The NAPF did not have any issues with regards to the remuneration of Bravo but they were concerned only with the lack of performance incentives. The chairman of Burberry did not want to lose an asset like Bravo so he announced that corporate governance would be introduced to draw a balance between the incentives and performance and in attracting and retaining the best possible person (BBC News, 2003). Michael Mahony, the Senior Vice President of Commercial Affairs and General Council has put in charge of the corporate responsibility on behalf of the company and the board. The board of Burberry compiles with the provision of the UK corporate governance code of 2010. Burberry has been practising corporate governance and for over the years and focuses primarily on five areas, which include a healthy business, partnership and it revolves on shared values and ethical standard. It has been seen that organisation with high standard of ethics has been the most profitable and thus it has become mandatory for organisation to practice corporate governance to increase the loyalty and investors and at the same time reduce the risk. Burberry focuses on delivering excellent products and services along with quality services; Environmental excellence by operating efficiently with minimum amount of waste and maximum control; providing excellence in people management by attracting and retaining the right talent and aims to contribute to the society by investing the communities where the organisation operates. In the financial year 2009-10, the Burberry group had strengthened the corporate responsibility team and added 13 members. The team of CR has been located globally such as in London, Hong Kong, New York and also Tokyo and leads the supply chain of Burberry, along with labour, environmental and investment initiatives in partnership along with its stakeholders. Thus, the group is proud of history of exploration, which focuses on innovation and the desire to excel and improve the work. The group continues to push in order to achieve the highest standard of quality in their corporate responsibility in improving the conditions of the organisation at all the different levels of supply chain, environmental sustainability and invest in the global communities (Burberry, n.d). Therefore, Burberry practises corporate governance, which has added to its success, and bring about a financial growth in the group along with the other factors. Recommendation and Conclusion In the report, the researcher has discussed about the development of the UK corporate governance code from 1992 to present. For ensuring a good corporate governance structure in the companies, the government has set many committees for suggesting the changes those are required in the companies. The committees suggested changes in the various areas of the company. Combining all the recommendations made by the committees, the government has made the corporate governance code. At present the companies, listed in the stock exchanges of the United Kingdom has to follow to codes of corporate governance. The codes are the corporate governance code, which revised in the year 2010, and the other is the UK stewardship code, implemented in the year 2010. The companies have to comply with the rules or they have to explain the reasons for not following the guidelines. The whole world has to face financial recession due to the failure of some big banks or financial organizations. Despite of that the financial condition of the United Kingdom was not so bad. From this, it is derived that that the financial base of the country is strong. The financial condition of a country largely depends on the performance and the financial condition of the companies. As the performance and the financial condition of the companies of the United Kingdom was good throughout the years so the country had not to face the problems during recession so much. It can conclude that the corporate governance structure of the country is good and the companies follow it well. The companies like BP and Burberry that discussed in the report also get success by following a good corporate governance structure. In the time of Gulf oil spill incident, BP has managed the situation well due to their effective corporate governance structure and their financial condition has been stable. The corporate governance structure in Burberry is also good, they have also performed well during the last decade, and they are a leading player in their industry. The researcher recommends it from the present scenario that the United Kingdom government can implement the law of corporate governance instead of the ‘comply or explain’ structure. It is found from the research that the companies are used to follow the rule, excluding only a small number of companies. Therefore, if the government make the corporate governance code legal then the companies also have to follow the rules, which did not follow it. However, there may be some scenario that the companies can leave one or two guidelines, but in those cases they have to explain the reasons of not maintain the guidelines. Implementing a law like the Sarbanes Oxley act in the United States would make the corporate governance structure of the United States stronger. Reference BBC News, 2003, ?12m Burberry fat cat revolt. [Online]. Available at: < http://news.bbc.co.uk/2/hi/business/3066955.stm> [Accessed 2 March 2012]. BP, 2012, Corporate Governance. [Online]. Available at: < http://www.bp.com/sectiongenericarticle800.do?categoryId=9036184&contentId=7066896> [Accessed 2 March 2012]. BP-a, 2012, Audit Committee Report. [Online]. 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