Corporate Governance in the UK - Essay Example

Corporate Governance in UK Lecturer Introduction In the last two decades, corporate governance has gradually developed due to the perceived changes and perception of the nature and role of corporate governance in firms. From the Cadbury Committee Report, an early definition of the term; corporate governance is primarily the system through which different companies are directed and controlled. In this, Board of Directors takes responsibility for governance in the companies. On the other hand the shareholders also have a role in the governance as they appoint not only the directors but also the auditors; as such having a satisfaction that the right governance structure is stable. Higgs Report, ten years after the Cadbury Committee Report, stated that corporate governance offers a framework of accountability; that is, the processes and structures in a bid to make sure that corporations are managed as per the expectations and interest of the owners. Still, on the definition, the OECD Report asserted that corporate governance primarily understands the structure of corresponding responsibilities and relationship among a major or central group that consists of the shareholders, managers and board members who are essentially designed to foster the needed competitive performance in order to achieve the primarily objectives of the corporations. In addition, the structures spell out distribution of responsibilities and rights among various participants in the company including the stakeholders, shareholders, managers and the board (Cadbury, 2000). Essentially, governance of practice is perceived as an excellent mean to create a system of control between the administration and the panel as well as enhance accountability to the shareholders from the board. Notably, this system of accountability and control obviously facilitates and maintains long term economic growth by facilitating an alignment of incentive between the owner and the manager of a given company. Notably, corporate governance is considered as a development of the conception of a government; that has been in existence from the days of social organization and as such has continued to evolve and finally become a constitution of different nations. Indeed, its importance is partly due to its classical notion of meeting the expectations of the shareholders especially in areas related to finance. Initially, the good corporate governance was not practiced in most companies including in the United Kingdom despite the fact that it is a significant tool in minimizing agency cost, reduce cases or risks of frauds, and protecting the wealth and resources of the shareholders through an increase in auditing and improving meritocracy in the boardrooms. As such various inquiry committees came up to address such issues; therefore, capturing the aforementioned gains. Such committees included the Cadbury Committee in 1992, the Rutterman Report in 1994, the Greenbury Report in 1995, the Turnbull Report in 1999, the Hampel Report in 1998, the Higgs Report and the Smith Report in 2003. Many papers and information have been documented after the Cadbury Report and it is also expected that much will continue to be examined in relation to the governance structure, remuneration of the top management and corporate performance. With the above, the paper seeks to analyse corporate governance in the United Kingdom and effectiveness of this system in the country. Indeed, by analysing the above it is somehow interesting, given the fact that UK is the home of various reports related to corporate governance including Cadbury Committee Report, becoming a wellspring of other current reforms related to corporate governance. Corporate Governance Notably, the corporate world in UK witnessed a great upheaval due to the way companies were governed. With the introduction of committees to investigate the issues, starting with the Cadbury Committee, many companies have perceived change on issues pertaining auditing, the board structure, and appointment of the companies’ directors. This report was sort of a response to the perception that the country was lagging behind in issues relating to corporate governance. Furthermore, it was widely accepted that UK did not have the best practice and as such various companies had collapsed as a result of this (Cadbury, 2000 p.7). This included the Maxwell Communications Corporation, BCCI, and the Asil Nadir’s Polly Peck. The Cadbury Report was later followed by three other important reports; that is, the Greenbury, Hampel, and Turnbull in 1995, 1998 and 1999 respectively. The Cadbury Committee Report responded to various issues including the relationship between the chief executive and the chairman, position of the company, role of the non executive directors, and reports on internal control (Cadbury, 2000 p.7; Geoffrey & Kirchmaier, 2006 p. 74). Recommendations from this report together with a separate report were combined to form what was initially branded the “Combined Code”, the “UK corporate Governance Code”. However, the Code was later updated in 2003 in order to accommodate other recommendation reports on the role and responsibilities of non-directors and the audit committee The Greenbury Report primarily addressed issues concerning with rising of the executive pay mainly in privatised utilities (Greebury, 1995, p. 34). On the other hand, the Hampel Report did a review on the progress of various companies which were responding to the previous two reports (Corporate of Governance, 1998 p. 8). From the review, various recommendations were given (HM Treasury, 2001 p.6). Turnbill Report responded to the significant issues of how to establish and implement excellent practice systems of controlling the corporations’ internally. In the late 2001, the Labour government completed a wide range of review of Company Law which primarily addressed the different aspects of corporate governance in regard to the Companies Act. In 2003, the UK government passed to Financial Reporting Council the responsibility of not only publishing but also maintaining the Code. Notably, in 2006 and 2008 few changes were made to the Code by FRC (Geoffrey & Kirchmaier, 2006 p. 78; New Combined Code on corporate governance, 2003). As a result of these activities, corporate governance in the United Kingdom is alleged to be the most transparent and open in the industrialised countries. In fact it is currently ahead of the United States in regard to the quality of the environment created for the investors to enjoy; that is, in terms of financial regulations (Turnbull, 1997 p. 205). The system has also established a strong working relationship between auditors; that is, the internal and external. It has been noted that the role of internal auditors greatly improved when the corporate governance was first published in 1992. Indeed, the Turnbull Report on auditing addressed significant role played by internal audit in making sure that internal control are in place (Turnbull, 1997 p. 207). As a consequence of this, an increase in value status and profile of various companies was noted. Additionally, given that in this system, audit is involved in ensuring that management and monitoring procedures have been considered in firms, risks are therefore, likely to be identified. Under this, it will be certain that risk management responsibility has been included in the organization. This is followed by a report that allows the reporting and tracking of appropriate risk management issues. The key features of the UK system as predicted by the company law, Listing Rules and the Combined Code include; remuneration of the executive to be significantly be linked to their performance; the type of remuneration to be carried out should be transparent, a regular review to be done on the board and committee, transparent and formal ways of appointing the directors as wished by the shareholders, a balance to be created between the independent non-executive and executive directors, clear division of power at the top management and the board to be united and every member to carry out their roles and responsibilities for the wellbeing of the company. In regard to the above feature, most of the principles are not entirely defined by the company law but primarily are seen in the Combined Code. As such, they are majorly ‘soft law’; that is, a code which is non-binding and can monitored and conducted at the same time enforced by the shareholders of the company (Dedman, 2003 p. 45). With this, one may argue that not all features of corporate governance may be defined by stiff requirements of legislation. In addition, it acknowledges the fact that there exists a common interest between the shareholders and the company which should be encouraged. As (Coombes & Wong, 2004 p. 47) argues, this kind of soft law model allows individual corporations to choose corporate governance procedures to a certain degree. As a result, the shareholders may adjust codes of conduct if they find it justifiable to do so. This kind of flexibility is perceived to bring in a positive impact on the performance of the company since governance requirements do differ from one corporation to another depending on several factors including ownership structure, nature of personal business activities and size of the company. Despite this, however, for this kind of soft law to work in the company, the shareholders are expected to have relevant and correct information. This is quite important because the shareholders must make decisions and judgements when they are well informed. Notably, this may be a major challenge to most companies given the fact that disclosure requirements for some information may not be guaranteed especially in cases where it is likely to affect the running and credibility of the firm. As such, informed judgement may be clouded due to lack of appropriate and relevant information of issues pertaining the running of the company. Nevertheless, the system primarily emphasises on voluntary corporate governance, representing a light regulatory control which is somehow underpinned by careful targeted regulation and law. The system has also allowed the shareholders to, in extreme situations; underpin their rights if negotiations with the board are not fruitful. Unlike the US system, in UK, the shareholders have extensive voting rights that include dismissing and appointing new directors and calling for extraordinary general meetings. However, despite the fact that the shareholders have their right since they own the company, some rights may dearly affect the running and the reputation of the company. This is so due to the fact that some decisions may be made from a misinformed judgement creating instability in the board. In relation to the above, the UK system pushes for constructive dialogue between shareholders and the companies especially in regard to financial issues. This is primarily reflected in the Combined Code, section 1. Under this, the board is expected to ensure that constructive dialogue takes place with the shareholders. Initially, some critiques argued that investors lacked satisfactory engagement with the shareholders; however, the issue was deeply addressed in some reports including the Higg’s (Higgs, 2003 p.23). In response to this, most investors responded by increasing the ownership capabilities. Nevertheless, it is said that there is room for improvement in regard to the relationship. It is noted that one of the major obstacle to proper dialogue is due to the level that corporate governance specialist are accorded in the companies. This results to a decrease in interaction with the top management; which further decreases their role as effective negotiation partners for the company’s board. One efficient but sensitive solution to this problem is that the investor may nominate their non-executive members on board; nevertheless, this option may negatively impact their flexibility in selling and buying shares in the company. Therefore, it is fairly apparent that there is a need for the code of responsibilities related to the investor to be parallel with that of Combined Code (Wilson, 2000 p. 155) The effectiveness of the system may also be analysed from its strengths in various areas. Notably, the system has gained the ability to provide high and acceptable standards of corporate governance at low costs. Measures as spelt out by the Combined Code, though voluntary, have successfully, driven important changes in corporate governance behaviour. For instance, as noted before 1990, limited companies differentiated or separated the role and responsibility of the CEO and chairman. However, at present division of roles is perceived in most companies. It has also contributed to the growth in number of board committees and non-executive directors influencing the overall governing of the company. With this, UK has indeed outperformed the United States and other industrialized countries and therefore, set the corporate governance standards high. In addition to the above, the compliance costs are somehow lower compared to other countries. As a result of this, various companies and investors have opted for London instead of New York especially since the beginning of Sarbanes-Oxley Act (Coombes & Wong, 2004 p. 44). A unitary board has been considered as core paradox of UK system of corporate governance. This approach sort of tries to bring together monitoring function, business advisory and strategic setting role within on institutional structure. As such, the board find itself in confusion since it is not clearly spelt out whether it should consider itself a step up the management or a step down or even as shareholders. Arguably, however, with the changes taking place in the system, the board is clearly playing the role of a supervisory body. This has been improved by the existence of board committees which primarily serves to split the board function and composition. Notably, the non-executive directors are significant part of the UK system (Geoffrey & Kirchmaier, 2006 p.77). This is especially so in corporations that shareholders engagement is less substantial. However, it is argued that non-executive directors’ role is still wanting. This is largely accredited to the reality that they have less time and specific knowledge about the company which is paramount in challenging the executive management. In addition, it is generally believed that there is some difficulty experienced while recruiting individual for this positions. Indeed, this concern was raided by investors and chairmen of companies in one of the FRC reports. The rewards awarded to the members is small compared to the risks that there are entitled to given that law does not put a distinction between them and the executive directors. Despite noting this gap and calling for training and attractive packages for the non-executive directors, the system has recorded few responses to this call (Wilson, 2000 p. 158). Conclusion It is quite obvious that the corporate governance in UK expresses transparency and openness especially in matters related to finance. This is attributed to the fact that audit; an important component of corporate governance has played a major role by allowing the stakeholders and shareholder to work effectively in companies. As an outcome of this, it is taken to be one of the best systems among the industrialized countries. In the current economic times, good governance is said to be a delicate issue considering the fact that there is a need to act on too much and too little. Corresponding to the above, it is noted that with its increased safe laws in regulating companies and low associated costs, the system need not be become complacent. Various areas need to be reviewed so as to maintain its good shape. Such areas as discussed in the paper include working on a strong dialogue situation between the shareholders and the board, extreme care while introducing more regulatory requirements for all the directors, push for effectiveness in working with non-directors, and encourage the participation of the shareholders; if otherwise, a legislative approach may be encouraged discouraging potential investors. References Cadbury, A. (2000). The corporate governance agenda. Corporate Governance , 8 (1); 7-15. Coombes, P., & Wong, S. (2004). Why codes of governance work. McKinse Quarterly , 2: 48-53. Dedman, E. (2003). Executive turnover in UK firms: the impact of Cadbury. Accounting and Business Research , 33 (1); 33-50. Geoffrey, O., & Kirchmaier, T. (2006). 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