The idea of corporate governance in the broad concept of company law is of particular importance as it is essential for the companies to be controlled in a good manner. “Corporate governance is about promoting corporate fairness, transparency and accountability. The corporate governance structure refers to the allocation of rights and responsibilities of the board, managers, shareholders and other stakeholders, and points out the rules and procedures necessary for the decisions taken in relation to corporate issues. It also incorporates the organization’s strategic response to risk”  . The objective of Corporate Governance is the correct management of the company by the board in order to achieve the objectives for the interests and the best of the company. As a result, a Code was composed in order for the company to be guarded and particularly to control the directors, the Corporate Governance Code. In our essay we will be discussing whether the UK Corporate Governance Code and legislative framework deal effectively with the problems shown by the recent corporate scandals.
Scandals of corporate governance
The scandals and recession in the last two decades resulted to a loss of investor confidence and a fall in market value which led to a reform of the corporate governance for all listed companies in the UK. Many companies which appeared to work properly, such as BCCI, Polly Peck and the Maxwell Group, collapsed and this raised questions about the accountability processes in the UK. In general the public was suspicious towards actions by the large corporations. Maxwell due to bad management was led to debt and it resulted being one of the largest scandals and worst bankruptcies of last century. Large companies such as Enron, Tyco, HealthSouth and Worldcom fell into the recent accounting scandals and resulted to investors’ loss of confidence. Many of them collapsed and were required to ask bankruptcy protection from creditors. Enron was one of the top ten companies in the United States but it collapsed since it was declared insolvent and was involved in the collapse of Anderson which was one of the “big five” global accounting firms. Enron is the biggest bankruptcy in the US history. Similarly, a large Italian public company, Parmalat, declared bankruptcy.
“Against the backdrop of corporate scandals and fraudulent accounting practices, governments and regulators have sought to introduce stronger legislation and regulation to guard against similar collapses in the future and restore investor confidence in financial markets”  . Some countries had legislation and codes for corporate governance for many years other have developed them in the last few years. The sudden collapse of a number of high-profile companies in the early 1990s was the reason of the reforms. Especially for public listed, further initiatives have been needed to improve the functioning of the boards of companies within the existing legal structures. “Under the UK Companies Act 1985, directors are required to prepare financial statements that give a “true and fair view” and for those financial statements to be independently audited. External auditors will need to obtain a sufficient understanding of a company’s control environment and activities to be able to assess the risks of material misstatement in those financial statements”  .
Reforms and the Committees
Firstly, we have the Cadbury Committee report which was issued in 1992 by the Financial Reporting Council, headed by Sir Adrian Cadbury, and recommended a Code of Best Practice. It paid attention to the performance and remuneration of boards and resulted in greater transparency and accountability in directors’ meetings. Some of the major recommendations of the report were the appointment of non-executive directors and an audit committee in order to control the financial aspects of the company and to distinguish the role of the chair and chief executive.
After the Cadbury we have the Greenbury report which was set up in 1995 by Sir Richard Greenbury who was the head of a study group. According to this report, the section in the Cadbury, relating to the executive pay, was modified. The most important recommendations were to compose a remuneration committee which would decide the remuneration of the directors and a nominations committee to watch over the new appointments to the board. Despite the fact that Greenbury Committee was helpful to identify the problems for remuneration the solutions proposed with the use of non-executive directors were not successful.
The Greenbury report was taken forward by the Hampel report in 1998 which was established by the Hampel Committee. The recommendations of the two previous reports were combined by this report. The main recommendations of the Hampel report were the creation of a ‘Combined Code’ and to gain better communication with the shareholders and create a balanced situation between monitoring the company and permit them to apply the corporate governance principles as they wanted to.
“One of the key features of the Combined Code 1998 is the use of non-executive directors as custodians of the government process. However concerns about non executive directors’ inability to monitor the board and management led to the publication of two reports under the chairmanship respectively of Derek Higgs and Sir Robert Smith in 2003”  . “The Higgs Report sets out guidance for non-executive directors and chairmen and made proposals for the Combined Code to require a greater proposition of independent, better informed individuals on the board ,greater transparency and accountability in the boardroom, formal performance appraisals , and closer relationship between non executive directors and shareholders”  . The Smith Report refers to the basic issues of the audit committee which is responsible for the support of the independence of the auditors and also to keep the decency of the financial issues of the company. It was also given direction for providing non-audit services by the auditor of the company, it improved transparency and the incomes for the committee.
Corporate Governance Code 2010
As a result of the above Committees we have the Combined Code on Corporate Governance which was set up to prevent the creation of other scandals. It is necessary because it sets out standards for good practice of the company and particularly about the board leadership, remuneration, accountability and relations with the shareholders. Additional modifications were made in 2006 and 2008 by the Financial Reporting Council, which controls the function of the Code and is responsible for what is included in it. The most recent version of the Combined Code is that of 2010. It applies only to public listed companies and is not binding but if the companies do not comply with the Code, they must give an explanation of non-compliance. This is the ‘comply or explain’ approach.
Firstly, in relation to the board of directors the main principle set out in the Code is that in every company there should be an efficient and helpful board which will have the responsibility for company’s success  . The board shall be properly distributed so that everyone in the company to undertake the tasks allocated according to the office, without interfering in each other’s work beyond his duties. All the decisions taken by the directors must be taken impartially for the welfare of the company. Also, non-executive directors should be effective in helping to develop the company’s strategy and monitor its operation and management and oversee the reporting of performance. Moreover, according to the main principle of section A.2 of the Code “there should be a clear division of responsibilities at the head of the company between the running of the board and the executive responsibility for the running of the company’s business. No one individual should have unfettered powers of decision”  . Previously, the positions of chairman and chief executive were for the same person and that person did whatever he wanted and as a result there could be abuse of powers. For that reason, the Combined Code provides separation of the powers between these two positions. In the Polly Peck scandal the director misused his powers and as a result he was transferring large sums into secret private accounts and he was providing the company with wrong reports.
In addition, based on the section D.1 of the Code relates to remuneration, is stated that “levels of remuneration should be sufficient to attract, retain and motivate directors of the quality required to run the company successfully, but a company should avoid paying more than is necessary for this purpose. A significant proportion of executive directors’ remuneration should be structured so as to link rewards to corporate and individual performance”  . Directors should not decide on their own remuneration but the non- executive directors should be involved in order for each director to receive an appropriate remuneration. In the Tyco scandal the chief executive officer and the chief financial officer of the company took large sums as “loans” for their own remuneration, but the shareholders had no idea about that.
Moving on, another thing mentioned in the Code is the accountability and audit. Section C.1 is related to the financial reporting and states that “the board should present a balanced and understandable assessment of the company’s position and prospects”  . Also, an audit committee is required for all companies as to avoid any type of fraud in the company. That committee should be consisted from at least three directors of the company, particularly non-executive directors and the chairman of the board. According to the Enron scandal, there was fraud since it lied about its profits and was indicted for concealing debts in order not to be shown in the accounts of the company. If the audit committee had controlled the directors’ audits then the scandal would be avoided.
Accordingly, the code illustrated the importance of institutional investors and shareholders in general. The Code specifically in the section E.1 of the Code mentions that “there should be a dialogue with shareholders based on the mutual understanding of objectives. The board as a whole has responsibility for ensuring that a satisfactory dialogue with shareholders takes place”  . The Companies Acts mention that the two important members of a company are the directors and the shareholders. However, it does not mention how power should be divided between them and this is done through the company’s constitution. Often the constitution leaves too much power to the directors and the shareholders disregard any rights are given to them for control. The Corporate Governance Code reinforced this idea that shareholders should monitor and control the actions of the directors in any given opportunity they have.
Another aspect was whether non-executive directors are the most suitable to ensure that problems which led to the scandals would not re-appear. “Non- executive directors are directors without executive management responsibilities but who are concerned with general management policy and strategy and monitoring of the executive directors although their precise role is the subject of the debate. They commonly have letters of appointment setting out their role and responsibilities”  . There is no legal definition in the Companies Act 2006 for non-executive directors but it is provided in the Code. In any case they should be able to control the decisions of the management and monitor its goals and objectives. They should be able to satisfy themselves that any financial information is not biased and that reports are the exact reflection of the company’s position. One of their most important roles is the application of the remuneration rules for the executives which must be created with integrity. The code mentions that non-executives should be independent in order to carry out their function properly. However, it is yet unknown if this can actually happen. Non-executive directors can sometimes have close relationships with the executives since all information they have are provided by them. So even if they find that something is wrong they may still find it difficult to present it.
Is the Code really effective?
From the above analysis it seems that the Corporate Governance Code 2010 is effective in solving the problems created by the scandals regarding the governance of corporation. This is in contrast with the Companies Act 2006 which does not include such analysis of this area. As it was mentioned above the code works on a ‘comply or explain’ basis which gives a certain flexibility to companies and their directors to take risks and decisions in a free market. However, non-compliance must be explained with a rational way because shareholders have the ability to monitor any refusal to comply and can oppose any misconduct. All problems created may not have been solved in general but still the Code is an improvement to previous rules provided for control of the company. Yet, contrary to this type of ‘soft’ law which exists in the UK there are those who support a more strict application of the law such as the Sarbanes-Oxley Act 2002 which was the response of the US for the scandals.
As seen from the above, we come to the conclusion that the UK Corporate Governance Code is efficient, as the problems resulted from the scandals have decreased. It is a Code which aims to the good governance of the corporation and in general it has achieved with its recommendations a better control and management of the company. “The problems are most acute in and most attention has focused on listed public companies with widely dispersed shareholdings, but corporate governance is an issue for all public companies and even large private companies”  . The original problems regarding excessive power of the directors, remuneration problem, monitoring and audit function were tried to be solved. Although this has been achieved up to a point, the use of non-executive directors as the main solution to the problems creates some doubts whether they are the best way to avoid future scandals. This is why it is very important for corporate governance to continue to evolve.