UK Corporate Governance Code and the Legislative Framework

Company Law

Introduction

The Financial Reporting Council has recently promulgated its revised UK Corporate Governance Code (by way of amendment of the Combined Code). The Code is the primary set of corporate governance principles applicable to listed companies with a premium listing on the London Stock Exchange notwithstanding the place where the company is incorporated.

Corporate Governance

Governance is a word that scarcely existed 30 years ago. Corporate governance is commonly regarded as “the entire framework within which companies operate” [1] .

It is also considered as “concerned with holding the balance between economic and social aims. The governance framework is there to promote the effective use of resources and equally to require responsibility and the stewardship of those resources. The goal is to align as nearly as possible the benefits of individuals, corporations and society” [2] .

However, the UK Corporate Governance Code, being one of the most important instruments regulating this field of law, is still not a kind of legislation. And its predecessor, the Combined Code has never been. It was not passed by the Parliament either but came from the committees representing business and financial interests and it is invoked only to the companies, listed above, and only within the boundaries of the principle of “comply or explain”.

Historical review

Nevertheless, history of the Code and Scandals that led to its introducement were rather celebrated.

The ‘overturn’ began in the early 1990s with the innovative report from Sir Adrian Cadbury considering the financial aspects of the corporate governance. Aimed at listed companies and accounting especially on standards of corporate conduct and ethics, the “Cadbury Code” was gradually accepted by the City and the Stock Exchange and, in 1998, after further reports, it developed into the Combined Code on Corporate Governance.

The Cadbury Committee [3] consisted of the Stock Exchange, the Financial Reporting Council and the accountancy profession. This Commission appeared mostly as a result of the Maxwell scandal [4] , where the director, Mr. Maxwell had been found unsuited for the position of a director. Regrettably, but in 1971 this characteristics was actually assigned to him, and there was no legislative act that could have dismissed him from the position of a director. Consequently, 550 million pounds went missing due to inappropriate management.

In the Greenbury Report and the Hampel Report, the issue of remuneration raised and a revision of the previous recommendations of the Committees took place resulting in having principles of good governance rather than explicit regulations. The Combined Code of 1998 encompassed the principles and recommendations of the Cadbury, Greenbury and Hampel reports altogether.

Thus, by 2003, sections had been added on payments, risk control, internal management and audit committees.

Nearly at the same time the Company Act was passed and has now become a law. This act permits companies more flexibility in choosing the ways they operate. For example, written directives signed by the shareholders are an alternative to calling general meetings, and is regarded as making it much simpler to use them. Written directives will no longer need to be approved by each of the shareholders. Besides, companies can use electronic methods of record-keeping. Directives and resolutions may be circulated by electronic mail or by websites, but with the shareholder’s consent. This amendment is undoubtedly speed up the decision making process overall.

Walker Report

In 2008, the banking crisis and the efficient nationalisation of some UK banks caused that the government to ask Sir David Walker to look in separate at corporate governance in UK banks and other significant financial institutions [5] . That caused more fundamental revision of the Code by the FRC. A new wording duly came out, this time with a new title – the UK Corporate Governance Code.

More concrete, Walker strove to look at:

– how to perfect risk control at the board level;

– whether incentive and bonus programmes promote risk undertaking;

– the proper balance of abilities, experience and independence on a board of directors;

– the position of institutional shareholders in relations with and monitoring boards of directors.

All in all, the 2009 Walker Report created 39 useful recommendations for better corporate governance. It’s important to point out that they were mostly aimed at banks, huge insurance institutions and other financial establishments. Some of them were commonly appropriate for companies of other sectors and therefore feature in the FRC’s UK Corporate Governance Code of June 2010; others will operate as simple examples of best practice in particular cases.

That was another attempt to improve the already existing system of control over the benefits of the participants involved in a company and it is an integration of all the previous attempts. It dealt with different aspects of the board structure, the internal management and a number of the best feasible manners to perfect corporate governance for listed PLC’s.

In accordance with the Code the positions of the Chairman and the managing director were to be held by different individuals, with clearly different roles between them so that there can be a better control over their deeds. Of course these two positions could be held by the same person but the grounds on this had to be explained, because it was evidently much easier to abuse the power when these two important positions were held by the same individual, as in the event of Polly Peck, where Asid Nadir had all the power in his hands. The result of this was the fact that no one could control him and he easily abused it, creating the so-called “Polly Peck scandal” [6] .

In this scandal, the product of the electronics multinational company established by Nadir, collapsed with £1 billion of formerly undeclared debts. Asid Nadir, the Chief Director of the company, was accused of theft amounting to £34 million.These scandals encouraged the Cadbury Committee to introduce at least three non – executive directors’ positions and to fix that the positions of Chairman of the Board and Chief Executive Officer of these companies are to be held by two different persons [7] .

In the Code the issue of remuneration was also touched. Under this document, there had to be a transparent and formal course for the remuneration of the directors and there had to be a remuneration committee composed of non–executive directors as well that will set up the remuneration level for each individual director separately. Moreover, this remuneration course had to be included into the annual report on the company. The issue of remuneration is known to have been set up in the Code as a result of the next “scandal” in the field of corporate governance, called “Tyco Scandal” [8] . Reportedly, once the Chairman of the company appeared to be involved in using the company’s assets to buy homes and rare artworks for the executives. Mr. Kozlowski, the chief director of the company has habitually abused his position and caused Tyco to expend lots of money for his personal benefit.

The Issue of Non-executives

The use of non- executive directors was merely one of possible manners of perfecting the internal administration by providing new ideas and giving more efficient proposals, making sure that the suitable procedures are kept and that the executives are appropriately trained, as they will have independent board members who will criticise their actions and attempts and skills for running the company successfully.  The board had to be with at least two non- executives, if it isn’t a big company and up to half the board of directors for the large companies. Those amendments were rather appropriate, since in the Wyevale Company unsuitable director and two non- executive directors were actually dismissed by the non- executive directors.

It should be noted, that non-executive directors are directors without additional administrative positions in the company. They were first considered as a solution to the corporate management problems and to the continuous scandals of the “Cadbury Committee” and they still are one of the most famous solutions of the Code.

The non- executives surely should be independent, but there is and always will be a big question whether they can be independent altogether. The non-executives are usually appointed by the executives and the shareholders from the range of non-executive directors being recommended by other fellow executive directors; they are commonly of the same educational, social and business environment as the executives, and moreover, they once a while have been the executive directors previously by themselves. That will evidently make it burdensome for them to check up the decisions of the executives and cancel them, as they already have an amicable relationship with the executives. Moreover, the non- executives are dependent on the information that they are supplied with by the executives, and with not challenging or asking questions (because of their relationship) it will be difficult if not impossible to spread a scandal that may take place. Even if they want to check up the information in details as the non- executives, that happens in many companies, and are able to examine the affairs of a company, they’ll need lots of time and persistence to check the course of the company every day. That factually makes them inefficient, being inappropriate and deprived of the necessary information and time to deal with each company; therefore, they are commonly unable to have an adequate control over the company’s affairs.

There is another matter with the responsibility of the non-executive directors. The thing is, under the Code, their responsibility sharply differs from their workload, the time and the information they usually have access to. That makes the non–executives more lenient towards their duties taking into account the amount of remuneration they get. Because it’s obvious, that their payment is not at the same level with that of the executives. Besides, they have relatively little responsibility towards the shareholders.

It appears that the code has a broadly beneficial impact regarding the companies and investors. It acknowledged better standards of governance generally, and the “comply or explain” approach is working actually well, as the activity of the companies can be evaluated by the quality level of the explanations they give. Moreover, it is obligatory to proceed to control over the accuracy of the “comply or explain” practice, which appears to be of great significance. Besides, there is undoubtedly positive change in the quality of disclosure by the companies, even if there is still large place for improvement as is stated by investors and observers. All in all, the Code has been very successfully introduced.

Notwithstanding the fact that the Code was frequently argued to be too detailed and not enough flexible for being effective in the corporate governance, this seems to be irrelevant for these companies for the present days. On the other hand, even if the Code is too much detailed, it still does not cover several significant parts that interest the investors. In fact, the Code being not a kind of legislation, and being not legally binding, cannot be so easily enforced if the company does not want to comply with.

The UK Corporate Governance Code of 2010

Not being fundamentally re-written, the UK Corporate Governance Code of 2010, however, has undergone several significant changes. Among them:

(a) new principles, for example, the position of non-executive directors in challenging and developing the strategy;

(b) amendments to extant principles, for example, boards must take into consideration the benefits of gender and other distinctions while making appointments;

(c) amendments to Code provisions, the most notable of which is surely a new proposal of the yearly re-election of all directors;

(d) each company with a Premium Listing on the London Stock Exchange should either “comply” or “explain” with the new Code as regards the financial years beginning after June 2010.

However, it’s probably worth noting that a new section considering this principle in comparison with the previous reading of the Code. Thus, a new Code recognizes that “non-compliance” can be justified in case if proper corporate governance may be reached in other manners. Herewith, the company must “clearly and carefully” explain the grounds for such non-compliance to shareholders and must aim to represent how its practice is consistent with the corresponding principle and promote right management. Simultaneously, it has to be mentioned that the Code accomodates also rather sensible response to the financial crisis, namely, it has increased emphasis on the position of the chairman, the necessity of constructive challenge from non-executive directors, and the central position of the board in risk control. However, the Code incorporated also some provision, not very pleased by the scientists.

First of all, it goes about a new requirement for the yearly election of the entire board. Under the former legislation, the most directors were actually re-elected only every third year. This very provision is supposed to intensify a short-termist mentality amongst directors, and contradicts the other Code principles (and company law) promoting the board to concentrate on “the long-term success of the company.”

Now a new Code has different point considering the remuneration. Thus, the performance-related parts of the executives’ remuneration are to be formed in such a way to promote the long-term development, and being stretching. At the same time, the Code of 2010 discourages all possible forms of performance-related payments for the non-executive directors, not only the options [9] . In addition, now the chairman has to ensure that all directors are aware of their shareholders’ problems and interests, while previously, the chairman and other “directors as appropriate” were demanded just to maintain contact with the shareholders.

Conclusions

To conclude, the revised Code has finally been improved significantly but still there are some uncovered issues that are to be regulated and existing problems in the sphere of the corporate governance to solve. Even if it is not legally binding it still is followed by most of the companies and with the help of the London Stock Exchange it is not easy to break the principles set up in the UK Corporate Governance Code. That surely means that the Code is rather effective in practice nowadays. Of course the “comply or explain” rule gives the possibility to the companies to evade the Code, however they are judged by investors and the official bodies taking into account their explanations. And if the explanations are not precise enough, the company won’t be able attract investors and would be under the permanent control of the London Stock Exchange and all the other state bodies involved in business.