Chapter 4

Governance Context

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Corporate Governance

• ‘Way businesses structured and controlled’• CG varies across national boundaries:

• cultural reasons• social contexts• historical reasons• commercial focus

• CG regime impacts nature of accounting• strong shareholding culture will require strong

reporting culture

• Importance reasserted by recent frauds etc.

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Corporate Governance in UK

• Anglo/American CG model common to English-speaking world

• Characterised by:• gulf between directors and owners

• board of directors

• stock exchange as major source of finance

• Financial accounts seen as one means of bridging gulf between directors and owners

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Best Practice

• Frauds have led to model being questioned• Flaws:

• too rigid• open to abuse• too focused on rights of investors

• Accounting bodies, government have been proactive• Various reports address different aspects• Best Practice reports and codes

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Cadbury Report

• Commissioned by FRC, Stock Exchange etc.

• Chaired by Sir Adrian Cadbury

• Reviewed CG with specific reference to:

• responsibilities of directors

• nature of accounting information required

• audit committees

• relationship between owners, boards and auditors,

etc.

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Cadbury recommendations

• Board:

• importance of efficient board emphasised

• separate CEO and Chairman

• Executive Directors

• service contracts to be limited to 3 years

• disclosure of remuneration

• Non-Executive Directors

• greater role

• independence important

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Cadbury recommendations ctd.

• Reporting and Controls:• responsibility of board in relation to accounts• importance of supplementary narrative info.

• Audit Committee• critical role in liaising with auditor• should comprise of 3 non-executive directors• has emerged as critical element of CG regime

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Greenbury Report

• CBI formed group to produce code in relation to directors’ remuneration

• Chaired by Sir Richard Greenbury• Recommendations in respect of:

• remuneration committee• disclosure provisions• remuneration policy• service contracts and compensation

• Directors’ remuneration still source of controversy

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Hampel Report

• Group formed to continue work of Cadbury• Chaired by Sir Ronald Hampel• Reiterated much of Cadbury & Greenbury• Important in maintaining momentum• Recommendations:

• different individuals as Chairman and CEO• directors contracts not to exceed 1 year• non-executives on remuneration committee• training of directors

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Turnbull Report

• ICAEW set up group to pursue Cadbury ideas on internal control & risk

• Chaired by Sir Nigel Turnbull• Assigns a strategic importance to these areas in

context of CG• Shows directors how these areas are to be

integrated into CG model

• In future may be seen as seminal report

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Turnbull Report (Continued).

• Focus on principles rather than rules• Emphasis on:

• successful risk management as means of adding value

• internal control only possible if embedded in internal processes

• role of board in reviewing and implementing• key risks to be identified and managed

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Higgs

• Focus on Non-Executive Directors (NEDs)

• Reflects increasingly important role:

• Independent

• Strategy, control and governance roles

• Higgs Report (2003) recommended:

• NEDs to comprise at least 50% of board

• Separation of CEO and Chairman roles

• Ideally NEDs might serve two three-year terms

• Commended for avoiding perceived excesses of SOX

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Smith

• Reflected increased importance of Audit Committee

• Now seen as vital element of CG architecture

• Recommended that Audit Committee:

• Be comprised of at least 3 independent NEDs

• One member to have financial experience

• Monitor and review integrity of financial statements, controls, etc.

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Combined Code

• Cadbury, Greenbury and Hampel formed basis of original Combined Code adopted by SE

• Supplemented by Turnbull, Higgs and Smith• Code based on “Comply or Explain” approach

• Different to US• Essentially ‘principles-based’

• Significantly impacts company disclosure, e.g. in Annual Report

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Stakeholder theory

• Looks beyond investors and their needs• Recognises a broader constituency, e.g.:

• employees• environmentalists• others

• Challenges primacy of financial markets• Champions greater transparency and

accountability• Potential for radical reform of CG model

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Summary

• CG a critical influence on nature, content and focus of the accounting process

• CG regime in UK part of Anglo-American scheme

• Characterised by investor emphasis• Frauds, scandals were catalysts for change• Cadbury, Greenbury, Hampel, Turnbull, Higgs

& Smith• “Comply or Explain”• UK now world-leader in ‘best practice’