Recent corporate scandals in international circles have increased the awareness of corporate governance codes in global investment. The executives of firms who are supposed to manage these companies engage in corrupt practises that adversely affects their organisations. The board of directors of companies as well as auditors and other regulators are also seen as not active in performing their monitoring and auditing roles respectively thus shareholders confidence dwindled. Because of increasing international trade and cross border links, there is significant pressure for the development of internationally comparable practices and standards. Accounting and financial reporting is one area in which this has occurred. Increasing international investment and integration of international capital markets has also led to pressure for standardization of governance guidelines, as international investors seek reassurance about the way their investments are being managed and the risks involved.
This paper will examine the corporate governance codes put forward by all stakeholders and it will also show how good corporate governance practises can positively affect firms' performance globally. Every organisations aim is to maximise shareholders wealth. When owners of a firm lose confidence in their businesses the value of that organisation will reduce and new capital will not be invested (Kim and Nofsinger, 2004).
According to the Cadbury report (1992), corporate governance is the system by which organisations are directed and controlled. It is the process by which company objectives are established, achieved and monitored. OECD also defined corporate governance as set of relationships that exist between a company's directors, its shareholders and other stakeholders. It also provides the structure through which the objectives of the company are set, and the means of achieving those objectives and monitoring performance are determined (OECD).
Corporate governance is concerned with the relationships and responsibilities between the board, management, shareholders and other relevant stakeholders within a legal and regulatory framework. Governance applies to all corporate bodies, commercial and not for profit, including public sector and non governmental organisations.
Corporate governance elements include the management, awareness, evaluation and mitigation of risk which is fundamental in all definitions of good governance. This includes the operation of an adequate and appropriate system of control. Also the notion that overall performance is enhanced by good supervision and management within set best practice guidelines underpins most definitions.
Good governance provides a framework for an organisation to pursue its strategy in an ethical and effective way and offers safeguards against misuse of resources, human, financial, physical or intellectual. Good governance is not just about externally established codes, it also requires a willingness to apply the spirit as well as the letter of the law. Again good corporate governance can attract new investment into companies, particularly in developing nations.
Accountability is generally a major theme in all governance frameworks, including accountability not just to shareholders but also other stakeholders. Corporate governance underpins capital market confidence in companies and in the government/regulators/tax authorities that administer them.
Governance focuses on ownership, because ownership and therefore financing results in businesses being formed and expanding. Different systems of governance are seen as best practice in different countries but the debate on governance has been on the Anglo-Saxon model where ownership and management are separate, and companies can obtain a listing on a stock exchange where their shares are bought and sold.
Corporate governance codes
The Cadbury report
The Cadbury committee in the UK was set up because of the lack of confidence perceived in financial reporting and in the ability of auditors to provide the assurances required by the users of financial statements. The main difficulties were considered to be in the relationship between auditors and boards of directors. In particular, the commercial pressures on both directors and auditors caused pressure to be brought to bear on auditors by the board and the auditors often capitulated. Problems were also perceived in the ability of the board of directors to control their organisations.
Responsibilities
The directors for instance are responsible for the corporate governance of the company, whilst the auditors provide the shareholders with an external objective check on the directors' financial statements. Also shareholders are linked to the directors via the financial reporting system. And other concerned users, particularly employees are indirectly addressed by the financial statements.
The Code of Best Practice included in the Cadbury report and subsequently amended by later reports was aimed at the directors of all UK public companies, but the directors of all companies were encouraged to use the Code.
Under provisions the board of directors are to meet on regular basis, retain full control over the company and monitor executive management. Certain matters such as major acquisitions or disposals of assets should be referred automatically to the board. There should be a clear division of responsibilities at the head of a company, with no one person having complete power. Generally this would mean the posts of chairman and chief executive being held by different people.
This Cadbury report sees non executive directors as important figures because of the independent judgement they bring to bear on important issues. There should be at least three non executive directors on the board, a majority of whom should be independent of management.
Again the report contains provisions about the length of directors' service contracts and disclosure of remuneration that are developed further in the Greenbury and Hampel reports.
In addition the audit committee was seen by the Cadbury committee as a key board committee. The audit committee should liaise with internal and external auditors and provide a forum for both to express their concerns. The committee should also review half yearly and annual statements. Another provision is that the annual report should present a balanced and understandable assessment of the company's position. The directors should explain their responsibilities for preparing accounts. Statements should also be made about the company's ability to continue as a going concern and the effectiveness of its internal controls.
The Greenbury code
The Greenbury committee in 1995 published a code which established principles for the determination of directors' pay and detailing disclosures to be given in the annual reports and accounts. The Greenbury code went beyond the Cadbury code. The Greenbury code recommends that the remuneration committee should determine executive directors' remuneration and that this committee should be comprised solely of non executive directors. Directors' service contracts should be limited to one year.
The Hampel report
The Hampel committee followed up in 1998 matters raised in the Cadbury and Greenbury reports, as we have seen aiming to restrict the regulatory burden on companies and substituting principles for detail whenever possible. Under Hampel, the accounts should contain a statement of how the company applies the corporate governance principles.
Secondly the accounts should explain their policies, including any circumstances justifying departure from best practice.
Combined Code
The London Stock Exchange subsequently issued a combined corporate governance code, which was derived from the recommendations of the Cadbury, Greenbury and Hampel reports. Since the publication of the Combined Code a number of reports in the UK have been published about specific aspects of corporate governance.
The Turnbull report (1999, revised 2005) focused on risk management and internal control whilst the Smith report (2003) discussed the role of audit committees. Lastly we have the Higgs report (2003) which focused on the role of the non executive director.
King report
South Africa's major contribution to the corporate governance debate has been the King report, first published in 1994 and updated in 2002 to take account of developments in South Africa and elsewhere in the world.
The King report differs in emphasis from other guidance by advocating an integrated approach to corporate governance in the interest of a wide range of stakeholders, embracing the social, environmental and economic aspects of a company's activities. The report encourages active engagement by companies, shareholders, business and the financial press and relies heavily on disclosures as a regulatory measure.
Singapore Code
The Singapore code takes a similar approach to the UK's Combined Code with the emphasis being on companies giving a detailed description of their governance practices and explaining any deviation from the Code. Some guidelines, particularly on directors' remuneration, go beyond what is in UK guidance. Revisions to the Code in 2005 reflected recent concerns which included expanding the role of the audit committee, requiring companies to have procedures in place for whistle blowing and the separation of substantive motions in general meetings.
Effects of corporate governance reports
The OECD report emphasises that codes may leave shareholders and other stakeholders with uncertainty concerning their status. Market credibility therefore requires that their status in terms of coverage, implementation, compliance and sanctions should be clearly specified.
As far as the UK Codes are concerned, a survey of institutional investors carried out in 2000, two years after the Combined Code was first issued, suggested that provisions of the Codes had had varying impacts. There had been effective implementation of proposals relating to board structure, non executive directors and board committees. However the reports had had only a limited effect on director remuneration levels, though there had been greater compliance with guidance relating to length of directors' service contracts and severance arrangements.
The Organisation for Economic Co-operation and Development (OECD) has carried out an extensive consultation with member countries and developed a set of principles of corporate governance that countries and companies should work towards achieving. The OECD has stated that its interest in corporate governance arises from its concern for global investment. Corporate governance arrangements should be understood across national borders. Having a common set of accepted principles is a step towards achieving this aim.
The OECD developed its principles of Corporate Governance in 1998 and issued a revised version in April 2004. They are non binding principles, intended to assist governments in their efforts to evaluate and improve the legal, institutional and regulatory framework for corporate governance in their countries.
They are also intended to provide guidance to stock exchanges, investors and companies. The focus is on stock exchange listed companies, but many of the principles can also apply to private companies and state owned organisations.
The OECD principles deal mainly with governance problems that result from the separation of ownership and management of a company. Issues of ethical concern and environmental issues are also relevant, although not central to the problems of governance.
The OECD principles
To begin, shareholders should have the right to participate and vote in general meetings of the company, elect and remove members of the board and obtain relevant and material information on a timely basis. Capital markets for corporate control should function in an efficient and timely manner.
Secondly all shareholders of the same class of shares should be treated equally, including minority shareholders and overseas shareholders. Impediments to cross border shareholdings should be eliminated.
And thirdly rights of stakeholders should be protected. All stakeholders should have access to relevant information on a regular and timely basis. Performance enhancing mechanisms for employee participation should be permitted to develop. Stakeholders, including employees, should be able to freely communicate their concerns about illegal or unethical relationships to the board.
Timely and accurate disclosure must be made of all materials regarding the company, including the financial situation, foreseeable risk factors, issues regarding employees and other stakeholders and governance structures and policies. The company's approach to disclosure should promote the provision of analysis or advice that is relevant to decisions by investors.
And lastly the board is responsible for the strategic guidance of the company and for the effective monitoring of management. Board members should act on fully informed basis, in good faith, with due diligence and care and in the best interests of the company and its shareholders. They should treat all shareholders fairly. The board should be able to exercise independent judgement; this includes assigning independent non executive directors to appropriate tasks.
ICGN report
The International Corporate Governance Network (ICGN) published a report in 2005 aiming to enhance the guidance produced by the OECD. The purpose is to provide practical guidance for boards to meet expectations so that they can operate efficiently and compete for scarce capital effectively. The ICGN believes that if investors and companies establish productive communication on governance issues, the prospects for economic prosperity will be enhanced.
The ICGN guidance emphasised that the structure of boards will depend on national models. Boards should be responsible for guiding corporate strategy, monitoring performance and the effectiveness of corporate governance arrangements, dealing with succession issues, aligning remuneration with the company's interests, ensuring the integrity of systems and overseeing disclosure.
Also directors should have appropriate skills, knowledge and experience, demonstrate independent judgement and fulfil their fiduciary duties to shareholders and the company. They should be re-elected at least once every three years. And the board's chair should not be the current or former Chief Executive Officer. Corporations should establish audit, compensation and nomination/governance committees. Also there should be a formal process for evaluating the work of the board and individual directors.
And with shareholders it (ICGN) says, companies should act to protect shareholders' rights to vote: divergence from shareholders having one vote for each share they own should be justified. Shareholders should be able to vote on removing individual directors and auditors. Shareholders should have the right to put resolutions that are advisory or binding on a board of directors.
Major changes affecting the equity, economic interests or share ownership rights of existing shareholders should not be made without prior shareholder approval. And institutional shareholders should be able to discharge their fiduciary duties to vote. They should be able to consult with management.
The company should also aim to excel in the financial returns it achieves compared with a bench mark based on the performance of its sector peer group. There should be full disclosure of ownership, voting rights, shareholder agreements and significant relationships. The audit committee should oversee the company's relationship with the external auditor.
Under ethics and stakeholders, the ICGN states that Corporations should implement a code of ethics and conduct their activities in an economically, socially and environmentally responsible manner. The board is responsible for determining, implementing and maintaining a culture of integrity. In addition companies should have procedures for monitoring related party transactions and conflicts of interest. The board should be responsible for managing successful and productive relationships with the corporation's stakeholders. There should be disclosure of policies involving stakeholders. In particular there should be measures aligning employee interests with stakeholder and other interests, such as employee share ownership or other profit-sharing programs.
Significance of international codes
Codes such as the OECD code have been developed from best practice in a number of jurisdictions. As such, they can be seen as representing an international consensus. They stress global issues that are important to companies operating in a number of jurisdictions. The OECD code for example emphasises the importance of eliminating impediments to cross border shareholdings and treating overseas shareholders fairly.
Although the OECD code is non binding, its principles have been incorporated into national guidance by a number of companies including Greece and China. The OECD principles have also been used by organisations such as the World Bank as a basis for assessing the corporate governance frameworks and practices in individual countries. These assessments are used to determine the level of policy dialogue with and technical assistance given to these countries.
The fact that the local codes of different countries are based on the same international code means that compliance costs for companies who are operating in many jurisdictions will be reduced. It also gives investors some confidence about the application of governance rules.
The development of international codes should also be seen in the context of the development of robust financial reporting rules, since investors' concerns with unreliable accounting information has meant that they have questioned corporate governance arrangements. Developments in international accounting standards aim to promote greater international harmony in accounting practice and international convergence on governance is consistent with this.
Limitations of international codes
A number of problems have been identified with international codes
International principles represent a lowest common denominator of general, fairly bland, principles. Also any attempt to strengthen the principles will be extremely difficult because of global differences in legal structures, financial systems, structures of corporate ownership, culture and economic factors. As international guidance has to be based on best practice in a number of regimes, development will always lag behind changes in the most advanced regimes. Besides the codes have no legislative power and the costs of following a very structured international regime like one based on Sarbanes Oxley may be burdensome for companies based in less developed countries, who are not operating worldwide.
Contribution of corporate governance codes
The reports have highlighted the contributions good corporate governance can make to companies. Furthermore the codes have emphasised certain dangers that have contributed to corporate governance failure, for example individuals having too great an influence. Again the provisions have provided benchmarks that can be used to judge the effectiveness of internal controls and risk management systems. The guidelines have promoted specific good practice in a number of areas, for example non executive directors, performance related pay and disclosure.
Lastly the recommendations have highlighted the importance of basic concepts and highlighted how these can be put into practice, for example accountability through recommendations about organisation stakeholder relationships and transparency by specifying disclosure requirements.
