UK Corporate Governance

10th April 2013

What is corporate governance?
The legal framework
The self-regulatory framework
UK Corporate Governance Code
Key issues

What is corporate governance? 

There is no single, accepted definition of what the expression 'corporate governance' means. The majority of the definitions employed by corporate practitioners relate corporate governance to “control” of the company.

"Corporate governance is the system by which businesses are directed and controlled." (Cadbury Report, UK)

Another related theme common to definitions of corporate governance focuses upon the  "supervision" of the company or of management. In addition, a number of definitions relate corporate governance to a legal framework, rules and procedures and private sector conduct. Finally, some practitioners talk of governance as encompassing relationships between shareholders, boards and managers.

Perhaps the most comprehensive definition of corporate governance is set out by the Organisation for Economic Co-operation and Development (OECD):

"Corporate governance is one key element in improving economic efficiency and growth as well as enhancing investor confidence.Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. Good corporate governance should provide proper incentives for the board and management to pursue objectives that are in the interests of the company and its shareholders and should facilitate effective monitoring." (OECD Principles, 2004, Preamble)

In other words, corporate governance means rigorous supervision of the management of a company; it means ensuring that business is done competently, with integrity and with due regard for the interests of all stakeholders. Good governance is, therefore, a mixture of legislation, non-legislative codes, self-regulation and best practice, structure, culture, and board competency.

The board and the individuals comprising it are at the heart of the company. They are the link between those who provide the capital and to whom they are accountable, and those, who carry out the policies and decisions they make and who are therefore accountable to the board. Corporate governance exists to provide a framework within which these regulations can operate effectively and the board can fulfil its key purpose.

The legal framework 

The starting point for tracing governance in the UK is the system of company law. This is a statute-based law, further developed by the courts through precedent.

At its heart are the relevant provisions of the Companies Act 2006, which replaced, revised and sought to modernise previous companies legislation. The Companies Act 2006 was brought into effect over several years, the final provisions coming into force in October 2009. The Act sets out, for the first time, the principal duties owed by directors to their companies. These duties apply to all companies, public and private, holding and subsidiary, and are a statutory benchmark of best practice for all. They are not, however, comprehensive. Other general duties are contained in the Insolvency Act 1986, as well as specific requirements and liabilities under a host of other legislation relating to health and safety, competition, tax etc. Some reference to case law precedents is also likely to be needed.

The self-regulatory framework 

Much of governance goes beyond the legal framework. Company law deals at length with the individual and collective responsibilities of directors, but hardly mentions processes, quality standards or outcomes. Hence the development of the self-regulatory governance framework in the UK through various reports, which were driven and backed by those to whom the board is accountable. These reports concentrated on issues concerning the mechanics of controlling the boards of companies and their directors, preventing fraud, improving information about companies, and making boards of directors more accountable to shareholders.

The start of a formalised approach to the governance of UK companies was the report of the Committee on the Financial Aspects of Corporate Governance, or the Cadbury Report, 1992, to which was attached a Code of Best Practice. This was further developed through a series of reworkings including those of the Greenbury Committee, culminating in the Directors’ Remuneration – Report of a Study Group chaired by Sir Richard Greenbury, or the Greenbury Report, 1995 with its recommendations on executive pay and a Code of Best Practice.

It was then decided that previous governance recommendations should be reviewed and brought together in a single code. The work was carried out under the chairmanship of Sir Ronald Hampel and the ensuing Final Report: Committee on Corporate Governance, or the Hampel Report, 1998, with its Combined Code on Corporate Governance, which had a number of provisions relating to internal control. However it gave little guidance on internal controls’ scope and extent. Consequently the Institute of Chartered Accountants in England and Wales, backed by the Stock Exchange formed a working party to study the matter of internal control, which resulted in the Turnbull Report, 1999.

In 2002, the Department of Trade and Industry (DTI) asked Derek Higgs to look at the role and effectiveness of non-executive directors. The ensuing report, known as Higgs Review, 2003, also suggested amendments to the Combined Code. At the same time as Higgs was reporting, the Financial Reporting Council (FRC) had asked a group chaired by Sir Robert Smith to issue Combined Code guidance for audit committees. In July 2003 the revised Combined Code, taking account of both the Higgs Review and the guidance for audit committees was published, and took effect for reporting periods beginning on or after 1 November 2003. The 2003 Code has been updated at regular intervals since then and is now called the UK Corporate Governance Code.

UK Corporate Governance Code 

All the UK reports and codes, including the latest Code, have taken the ‘comply or explain’ approach. Although only quoted companies (UK and overseas) with a premium listing on the London Stock Exchange are obliged to report how they apply the Code principles and whether they comply with the Code provisions and, where they do not, explain their departures from them, the Code has had a noticeable wider impact on governance. This is true not just of non-quoted companies, but also of organisations outside the commercial corporate sector where parallel codes of governance are emerging. For a quoted company reporting on its application of the Code is one of its continuing obligations under the Listing Rules published by the UK Listing Authority (UKLA). If quoted companies ignore the Code, then there will be penalties under the Listing Rules.

Key issues 

The key corporate governance issues were the reasons why the reports came into being. They include:

  • Board structure and membership
  • Board management
  • Directors’ remuneration
  • Financial controls
  • Accountability and audit
  • Relations with shareholders

In all these issues, what has emerged is a corporate governance framework to enable companies to create prosperity within margins that are recognised and understood by their shareholders.

Companies are complex, wealth-producing machines. Shareholders own claims on the company. They have great powers – they can appoint and dismiss directors, they can wind up the company and they can change the nature of its business. All stakeholders have the potential to influence – for better or worse – the survival and prosperity of the company.

It is up to the board to manage the company’s relations with shareholders and other stakeholders, to balance stakeholder interests and the company’s interests, in the light of market forces, the law and regulation.

At the most basic level, it is about complying with the law and applying structural requirements that are underpinned by a business reason. Beyond that the policies, procedures and culture of the company inform its governance. In the end in developing the governance of the company, one has to come back to the purpose of the board: to provide the leadership to create prosperity.

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