EXECUTIVE SUMMARY:
Corporate Governance relates to the way in which companies are directed and controlled. Directors are responsible for corporate governance, in some cases a conflict of interest may exist between directors and shareholders. Therefore, guidance is provided on corporate governance which aims to ensure that directors manage their business in the best interests of the shareholders.
Businesses around the world today need to be able to attract funding from investors in order to function, expand and grow. Before investors put their money into the business they need to be sure that the business is sound and financially viable, they also need assurance that it will operate in the same way for the foreseeable future. Investors therefore need to have confidence that the business is being well managed and will continue to be profitable.
Corporate Governance encompasses a vast number of topics which aim at harmonizing the relationship between the directors and the shareholders. It gives special focus on the fact that companies need to be run in an open and transparent way and director need to play a critical part in the success of the company as their main objective is to maximize shareholder wealth.
Reports and studies have been published which gives an insight into how a company can be run effectively and how important and essential are the roles of directors in relation to shareholders and the operations of a public limited company.
INTRODUCTION:
This report will present how the studies into corporate governance begin and how the collapse of big businesses affected investor confidence all over the globe. It will also give an over view of how directors attitudes needed to change in order to gain back investor confidence. It will also discuss how pivotal are the roles played by company directors and how it can effect the success or the failure of a company.
Furthermore we will also discuss the UK model with regards to corporate governance and compare it with other models in the European Union and The United States of America. Essentially what we aim at doing is to present to the reader a summary of how directors play a part in the success of the company and how their role into bringing into practice corporate governance rules and regulations brings about a positive outcome with regards to the functioning of a company.
In the end what we hope at achieving is that the reader will appreciate the importance of both the director's role and also the UK Corporate Governance model.
BACKGORUND:
A proper study into the corporate governance model began around 1991 in the United Kingdom. This was done or we could say this was needed because the investing and financial community realized that many large companies were run by directors who weren't trustworthy.
The original committee was called - "The Cadbury Committee". This was headed by Sir Adrian Cadbury. The basic aim was to try and produce a code of good behavior for directors of listed companies.
Moving forward what we see today are companies acting not only financially responsible but also providing a service to the society. In many ways directors of listed companies have played a critical role in bringing about this change. Even thought the corporate governance model in the United Kingdom is principles based directors have played an important part in effectively implementing the codes of best practice.
UK CORPORATE GOVERNANCE MODEL:
The UK follows a principles-based model of corporate governance this means that in The United Kingdom:
THE COMBINED CODE (2006):
The Cadbury Code of best practice is said to have influenced the development of corporate governance codes in many countries. The combined Code (2006) has listed rules by which companies listed on the London Stock Exchange must abide by.
The Combined Code contains broad principles and also specific provisions. Companies are required to report on how they apply the main principles of the Code, and if that haven't complied with it they need to give an explanation.
The Code requires that every company should be headed by an effective board, which is collectively responsible for the success of the company. It goes further by saying that there should be a clear division between the roles of the Chairman and CEO. This is essential for god governance and also for a balanced board.
The Code also gives emphasis to the fact that there should be a balance of executive and non-executive directors in the board. It also gives us a summary of how there should be a transparent procedure for the appointment of new directors to the board.
DIRECTORS AND BOARD SRUCTURE:
A major corporate governance difference between countries is the board structure, which maybe unitary or dual. As in the UK and in the majority of EU member states the unitary board structure is predominant.
UNITARY BOARD:
The United Kingdom follows a unitary board structure. The unitary board is responsible for all aspects of the company's activities and all the directors are working to meet the same end. The shareholders of the company elect the directors in the AGM (Annual General Meeting).
There should be a balance in the board for this purpose the board comprises of both executive and non-executive directors. This is set out in a way that half of the board members are Executive Directors and half are Non-Executive Directors. The Chairman is independent of any business functions and is the most senior person in a non-executive function. The CEO (Chief Executive Officer) is the most senior person in executive function.
Therefore the combined code recommends that there should be separation in the roles of the Chairman and CEO. The chairman is responsible for running the board whilst the CEO is responsible for running the company.
ROLE OF THE BOARD:
The board is responsible in performing functions with the main objective of maximizing shareholder wealth. According to the agency theory directors are agents of the company appointed by the principal who are the shareholders. The principal engages the agent into doing work.
It is important that the roles, duties and responsibilities of the directors are clearly defined. The Combined Code (2006) states that:
'The board's role is to provide entrepreneurial leadership of the company within a framework of prudent and effective controls which enables risk to be assessed and managed'.
Directors are expected to make decisions keeping in mind the company's best interest and should be objective and practical in making those decisions.
The board should meet regularly and should have a constructive agenda to discuss. The Chairman should ensure that the directors are kept informed and also meetings are conducted with an agenda which is to be followed. As mentioned earlier the duties of the CEO and Chairman should be clearly defined and there should be a balance in the board, which is important for independence and transparency.
The Chairman:
As mentioned earlier the chairman is responsible for running the board and also for ensuring that the board meets regularly. He is also given the task of making sure that the directors are kept well informed in order to make an informed and constructive contribution to all board meetings. The directors need to contribute in a way that they express their views at board meetings.
The Chairman also acts as the face of the company in ensuring that there is constructive dialogue with the shareholders and that they are kept informed of the workings of the board, as observed by many companies information is passed on through hierarchy's on a strictly need to know basis. The shareholders should be only concerned with the working of the board to an extent which satisfies and ensure them that it is working on their behalf and in their best interest.
The Chairman also heads the nominations committee where he is expected to give an input the appointment of directors. According to a theory on call hegemony, the company's management is a club and they act so in every manner. This implies that they would only let those people in who can adjust to their thinking and compliment them. An independent chairman would give a constructive input in a way that he would ensure that talent is brought into the company.
The Chief Executive Officer (C.E.O):
The CEO is the most senior person in executive management; he is responsible for taking care of the company's business. On the other hand the chairman is responsible for running the board. It is recommended that there should be a clear and precise segregation between these two roles. They should not be held by one person because it would give that person too much power, therefore destroying the principle of independence.
This fact is often argued upon, in the United Kingdom we have M&S which was headed by a single person who acted in the capacity of Chairman and CEO. Sir Stuart Rose was given the post of managing M&S in the capacity of both the CEO and Chairman. As mentioned earlier the UK is principles based, and following the principle of 'COMPLY OR EXPLAIN' - M&S issued in their corporate reports that since he was not found to be abusing his powers and had exceptional experience together combined with high principles it was therefore without and prejudice that he should be allowed to act in both capacities. This is not very common and is quite rare.
It has further been argued that whether a CEO after retirement should act as the Chairman. This is generally discouraged as the chairman should be independent.
The Combined Code (2006) in this regard states:
'A chief executive should not go on to be the chairman of the same company. If exceptionally a board decides that a chief executive should become chairman, the board should consult major shareholders in advance and should set out its reasons to shareholders at the time of the appointment and in the next annual report'.
As well as a lack of independence it is generally viewed that it would cause a problem for the incoming CEO if the retired CEO is still present in the capacity of The Chairman. In this scenario it is argued that the chairman who is responsible for running the board might get involved in running the company, therefore there would be a clash.
Executive Directors:
The executive directors are involved in the daily functions of the business. They have a responsibility of running what is assigned to them. For the board to be balanced half of the board needs to consist of Executive Directors who are responsible for running the business. They are given an executive function which means they have decision making powers. They are evaluated based on their performance this is way a large part of an executive directors pay is performance based.
The Hampel Committee Final Report (1998) suggests that the board introduce formal procedures to assess both their own collective performance and that of individual directors also.
Non-Executive Directors:
They are a mainstay for good governance. The Non - Executive Directors role has mainly two dimensions. One dimension is normally a control or counter weight to executive directors as to ensure that the presence of non-executive directors does not enable an individual to unduly influence the board's decisions.
The second dimension is that the contribution on non-executive directors can make the overall leadership and development of the company more effective and transparent. The Cadbury report recommends that Non-Executive Directors should be ideally selected through a formal process and their appointment should be considered by the board as a whole.
Although there is a legal duty on all directors to act in the best interests of the company, this alone does not guarantee that the directors will act objectively. To ensure that there is objectivity in decisions that the board makes various codes have again and again emphasized that there should be a balance of independent non-executive directors.
THE BOARD COMMITTES:
The board may appoint various sub-committees who are responsible for reporting back to them with regards to various functions they are responsible for. The major board sub-committees are:
It is important for good governance that these committees function objectively and the members follow principles of best practice. This would as a result harmonize corporate government practices. Various reports such as the Cadbury report and the Higgs review have emphasized that the existence of various board committees are essential for good corporate governance.
COMPARISON:
If we compare the United Kingdom with other countries in the European Union we will find that some countries such as The Netherlands, Germany and Slovakia operate on the basis of a dual board system as opposed to a unitary board.
The Dual Board system comprise of two tiers. There is a top tier which is sometimes called the supervisory board. A feature of this is that it will contain non-executive directors and at least one member would represent employee interests.
The lower tier is commonly called the executive board and will comprise of executive directors. The plans and policies of the executive board cannot be implemented with out authorization from the top tier.
In this sort of board system the duties of the two tiers are legally defined. For instance there is no migration between the two tiers. Therefore there is amore autocratic style of governance where as in the UK it is more relaxed and democratic.
If we compare the UK with the USA, we will find that in The United States there is a rules-based attitude towards corporate governance. This implies that corporate governance principles are defined by the law of the land and compliance is compulsory.
The United States also follow the Sarbanes Oxley Act while referring to corporate reporting and following good governance.
We therefore argue that over here on The United Kingdom we are much more relaxed and open. For example if a code is breached it is expected that a full report of the breach should be provided for in the corporate reports. This is not the case in the United States where of a code is breached than the officer of the company may face imprisonment.
CONCLUSION:
We have discussed the board structure followed in the UK and have also seen that through out the rest of Europe there is predominantly a unitary board system that is followed with exception to a few countries. The roles of the officers of the company i.e. The Chairman, The CEO and other executive and non-executive directors and specifically defined by the combined code.
It is expected of them to follow the code in order to bring about and effective and good corporate governance model. There have been many reports and reviews issued to ensure that company's and specifically listed companies act in the best interest of the shareholder. The basic aim is to harmonize corporate governance practices and also develop a healthy business.
In conclusion companies need to obtain a form of license from societies and communities in which they operate. They need to make a form of social contract. It is pivotal therefore that the director who are agents and stewards of the company play a pivotal role in a way to bring about an effective model of corporate governance.
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