Corporate Governance Is The System By Which Companies Are Directed And Controlled Accounting Essay
The first version of the UK Code on Corporate Governance was produced in 1992 by the Cadbury Committee. The classic definition of Corporate Governance in the context of the Code:
'Corporate governance is the system by which companies are directed and controlled. Boards of directors are responsible for the governance of their companies. The shareholders' role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place. The responsibilities of the board include setting the company's strategic aims, providing the leadership to put them into effect, supervising the management of the business and reporting to shareholders on their stewardship. The board's actions are subject to laws, regulations and the shareholders in general meeting.'
The board of directors leads and controls a company and hence an effective board is the fundamental to the success of the company. The Department of Trade and Industry (2004) agreed that effective boards are as much concerned with performance as with conformance in meeting the requirements of company law and applying the principles and provisions of the Combined Code. However, the UK Corporate Governance Code (2008) concluded a similar criterion as Combined Code (2004) on board effectiveness.
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'Firstly, there should be a formal, rigorous and transparent procedure for the appointment of new directors to the board. Secondly, all directors should be able to allocate sufficient time to the company to discharge their responsibilities effectively. Thirdly, all directors should receive induction on joining the board and should regularly update and refresh their skills and knowledge. The board should be supplied in a timely manner with information in a form and of a quality appropriate to enable it to discharge its duties. Fourthly, the board should undertake a formal and rigorous annual evaluation of its own performance and that of its committees and individual directors. Lastly, all directors should be submitted for re-election at regular intervals, subject to continued satisfactory performance. '
The UK Code on Corporate Governance (2010) also stated that the purpose of corporate governance is to facilitate effective, entrepreneurial and prudent management that can deliver the long-term success of the company. Good Governance has always association with success companies and would help companies attract investment capital. The understanding of corporate governance that the work of Cadbury Committee insisted: 'The country's economy depends on the drive and efficiency of its companies. Thus the effectiveness with which boards discharge their responsibilities determines Britain's competitive position.'(Cadbury, 1992) Moreover, the Cadbury Committee emphasized the freedom driven within a framework of effective accountability, which is the essence of any system of good corporate governance (Cadbury, 1992). There is an increasing realization the higher standards of corporate governance are not only necessary to ensure accountability, but also to positively improve corporate performance (Clarke, 2007). More sophisticated methodologies are now being applied with more promising results, with 'an increasing body of finance literature suggesting companies with superior governance offer better relative investment performance or lower investment risk' (Clarke, 2007).
Clarke (2007) found that the board of directors is the fulcrum of corporate governance: the critical nexus in which the fortunes of the company are decided. Stiles and Taylor indicated the same viewpoint in 2001: 'The board is the link between the shareholders of the firm to-day operations of the organization'.
The effectiveness of non-executive directors
Corporate governance has become a heated-discussed topic in developed economies recently as a result of widespread failures of the global financial system (Shleifer and Vishny, 1997). There is little doubt about the primacy of this condition as it is commonly accepted that a 'lack of monitoring by independent, disinterested non-executive directors has been a major cause for the various corporate scandals that we have witnessed' (High level Group of Company Law Experts, 2002). Kakabadse et al. (2010) observed that 'the conflict of interest that occurs by having a board consisting almost entirely of insider executive directors means that independent evaluation of company decisions is seriously compromised'. In the point of view, legally, the outsider non-executive directors, who are expected to discharge the duties of loyalty, care and good business judgment, are equally responsible for the management of the corporation (Lorsch and Maclver, 1989). On the other hand, practically, Weimer and Pape (1999) suggest that the non-executive directors advise the inside executive directors on a major policy decisions while bearing the interests of shareholders. In the aspect of Agency theory, it assumes that the presence of independent non-executive directors on the company boards should help to monitor management on behalf of shareholders by introducing an independent voice in the boardroom (Solomon, 2010). It would reduce the notorious conflicts of interest between shareholders and management. So, an independent board needed to be created both competent and free from bias. According to Firth et al's research findings in 2007, boards with a large proportion of non-executive directors are more likely to implement performance-related pay schemes. They conclude that the independent non-executive directors help to align the interests of shareholders and the CEO via the compensation of CEO.
However, the non-executive directors have not escaped criticism during the global financial crisis. Burgess(2009) observed that 'the quality of former non-executive directors in RBS has been questioned as many of them had limited banking experience and could hardly be regarded as independent, particularly when the bank had a very powerful CEO making it difficult for the non-executive directors to stand up to him'. In the recent research findings, Lawler and Finegold (2005) revealed that there are no significant relationships between board effectiveness and the practice of having a non-executive chair or that of having an independent person serving as a leader. It indicates that a well functioning corporate governance system is more than just putting a structure in place. Although the law setting the rules of board duties, it still have a large part of the actual governance and control of corporations occurs that not written into laws. It would be useful to have an adequate understanding of agent or management motivation and behaviour within a corporate setting (Marnet, 2007).
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It is reported in the 6th International Conference on Corporate Governance and Board Leadership (2003) that on the basis of in-depth interviews with 60 board members of Belgian listed companies, the directors were asked to sum up what they believe are elements of a good board of directors. The quality of the board meetings and board compositions are two most crucial elements of a good board of directors. A good director must prepare the information well including the data and format before the meeting. Also directors must show interest in what the company and its business units are doing. Moreover, the quality of discussions or debates is crucial for an effective board meeting. Each director should have an opportunity to speak up freely and contribute in the meeting. Berghe and Levrau (2005) said that the board of directors must be critical but to preserve a comfortable and constructive climate during the board meeting. The report also emphasizes the decisions made by board of directors may not be dominated by management or shareholders. It should be considered well and might appear on the board agenda more than once. On the other hand, the role of board of directors is, as one director explained, "We need to be able to see the present, whilst keeping an eye on the future". An effective board of directors must have the courage to take risks. Furthermore, monitoring and control is a second role of boards. They should strictly monitor the evolution of the outcomes, and confront these with the financial plans.
Most of the recent codes strengthen the independence of board. On the one hand, they adopt an increase in the proportion of independent directors on the board. On the other hand, they advocate a more extensive and restrictive definition of independence. That is to say, most of businesses express a strong belief of independence that has potential to prevent future scandals. However, director's independence is not enough. In-depth analysis of the corporate scandals at Enron, WorldCom and others has revealed that the occurrence of conflicts of interest throughout the chain of monitoring was one of the key issues in those collapses. 'Not only at board or corporate level, but also at the level of the external monitors conflicts of interest seemed to have flourished, leading to situations wherein the personal interests of the parties involved prevailed over corporate and social interests' (Van den Berghe and Baelden, 2003). The scandals have demonstrated that good governance will not come by writing codes of best practice and monitoring the formal application of these recommendations. Some of these companies complied with all the necessary regulations, but yet, it went wrong. In fact, there are a lot of corporate governance advocates who state the opinion that an independent director should not only find himself formally in the right position, but needs also ''something more'' than the characteristics determined in the corporate governance codes and recommendations (Berghe and Baelden, 2005).
The Tyson Report on the Recruitment and Development of non-executive Directors in 2003 states that as non-executive directors' responsibilities and liabilities increase, companies should invest more in training. Companies that score high marks on surveys of good corporate governance usually devote considerable time to training their non-executive directors. The Combined Code (2008) considered the information and professional development as an essential prerequisite for directors. The main principle observed that 'all directors should receive induction on joining the board and should regularly update and refresh their skills and knowledge'. It is suggested in the Combined Code (2008) that 'the directors should continually update their skills the knowledge and familiarity with the company required to fulfil their role both on the board and on board committees'. On the other hand, the company should provide the necessary resources for developing and updating the director's knowledge and capabilities. In the Code Provisions, it is suggested that the chairman should provide the new directors a 'full formal and tailored' induction when they join the board. The company still needs to offer an opportunity for major shareholders to meet the new non-executive director.
The Institute of Directors (2009) discovered that the effectiveness of newly appointed non-executive directors should be improved by quickly building their knowledge of the organization. The organization should provide an induction for those non-executive directors help them know where they can use the skills and experience they have gained elsewhere for the benefit of the company. In the Review of the Role and Responsibilities of Non-Executive Directors, Derek Higgs (2003) recommends that a comprehensive, formal and tailored induction should always be provided to new non-executive directors to ensure an early contribution to the board. Essentially, non-executive directors will already have relevant skills, knowledge, experience and abilities. Nonetheless, extending and refreshing their knowledge and skills will add to their credibility and effectiveness in the boardroom (IoD, 2009).
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The David Walker's second report with financial recommendation in December 2009 recognized the importance of learning lesÂsons from the collapse of the banks, while at the same time acknowledging the lack of evidence currently available as to the overall effectiveness of non-executive directors on boards. The report is much made of the need for behavioural change with an emphasis on the culture within the boardroom and the importance of constructive challenge of the manageÂment. One of the important proposals concerned with the induction, training and the development of non-executive directors. However, the role of a director particularly that independent non-executive director is fundamenÂtally different to that of a senior operational manager from whose ranks most non-executives are recruited. The role requires a holistic view of the organization, not just one specific functional area. Edward Walker-Arnott (2010) observed 'non-executives require an explicit appreciation of their distinctive role as governance actors, including their duty to rigorously challenge and assess the competence of the executive team on behalf of shareholders'. This perspective may not come naturally to many directors as they make the transition from executive to non-executive roles.
Walker-Arnott (2010) also implied that independent non-executive directors as a distinct professional grouping could benÂefit from defining themselves. The particular group of directors would incorporate approÂpriate director-level training. It would also promote values of independence, challenge, and public service amongst its practitioners. It is possible to have an external induction process that non-execÂutive directors were fully acknowledged of their governance responsibilities, including their legal duties and the expectations of shareholders and other stakeholders.
For new arrivals, the quality of the induction process is critical. It needs to give directors an 'early feel' for the business and an understanding of the issues they are likely to be dealing with whilst, in the meantime, giving them an early opportunity to make a positive contribution and add value to the board (DTI, 2004). A high quality executive team will not tolerate the directors for a long time in terms of board dynamics thus it is significant for new non-executives to catch up the step as quickly as possible. ICI's approach gives us an example of the successful application on induction process. Peter Ellwood, Chairman of ICI, believes that a proper induction process for new directors makes sound commercial sense: 'The Board is collectively responsible for the success of the Company. The relentless search for world class performance must start within the Boardroom. To work optimally, non-executive directors need to really understand not only the business but also their personal and corporate responsibilities. They have to have a feel for the company, not just turn up to meetings. We are looking for them to have an understanding of what drives the business and how they personally can make an effective contribution'. In practice, at ICI, the process of induction is designed to fit for both individual and the specific gaps in their knowledge or experience. For example, the induction arranges new directors to meet as many people in the company as they can, across the departments such HR, Finance as well as out in the field. They are advised to have a travel to acknowledge to the business and will continue to do this throughout their time on the board. The ICI thought it is important for new directors whether they are keeping up to speed. 'Each new director has a formal induction session led by the Company Secretary, augmented by the Assistant Secretary and someone at a senior level with a good deal of company experience, explaining the issues for ICI' (DTI, 2004). The sessions mainly covered such as Risk, Regulation and Practice, including fiduciary duties, duties of care and diligence, how the board is managed, what makes an effective board, the Combined Code and other regulations. New directors become more effective as contributors more quickly. The experience is valuable for new directors. Peter Ellwood is undoubted of the benefits to the business: 'It's bottom line common sense to give new directors a thorough induction. It's not rocket science but good practice, because it means that the people joining the board will be more effective.' He still emphasized the induction will add new director's value and make them effective much more quickly and utilize their talent for benefit of the business and its shareholders at the outset. The Boardroom recently carried out a survey of leading institutional shareholders in order to inform the development of its personalized development programmes for directors and senior executives (DTI, 2004). The responses from the shareholders perspective highlight one of the importance is that an effective induction process with strong support for making induction training compulsory for new directors.
Director's Skills and Qualifications
Generally speaking, business experience is important for a non-executive director. However, an effective board is necessary formed by a variety of backgrounds. The Higgs Report assumed that 'the interplay of varied and complementary perspectives amongst different members of the board can significantly benefit board performance'. According to the assumption, non-executive directors would be chosen by different genders, nationality, expertise and experience. The responses from research and consultation indicate the evidence that there is a shortage of good people to take on non-executive roles. In some circumstances, the board seems to have sufficient supply of talent however the problem is not being well dealt with. It has been suggested that candidates for non-executive directors is narrow. It is clearly that the company is interested in recruiting the best people for this position. However, it is difficult for board to distinguish the merits of them without bias and subjective judgment. The Higgs research shows that 'Non-executive directors are typically white males nearing retirement age with previous public limited company director experience. There are less than 20 non-executive directors on FTSE 100 boards under the age of 45. In the telephone survey for the Review, seven per cent of non-executive directors were not British, and one per cent was from black and ethnic minority groups'.
The report still mentioned the proportion of genders in non-executive directors: 'The very low number of female non-executive directors is striking in comparison with other professions and with the population of managers in UK companies overall. The labour force survey investigates that across the corporate sector as a whole, around 30 per cent of managers overall are female. Only six per cent of non-executive posts are held by women, and there are only two female chairmen in the FTSE 350.
However, the diversity and mix of experience and gender would beneficial for the board in playing an advisory role in decision making and setting strategy plan. With the similar backgrounds non-executive often tend to think in a similar but narrow aspect. In addition, it is reported that in some areas women directors tend to be more strongly represented in roles such as human resources, change management and customer care which are not regarded as traditional routes to the board.
The recruitment or replacement of the non-executive directors is not only considering the basic skills and qualification of individual but also the diversity and mix background to make board effectiveness.
On other hand, as the Higgs Review observed, 'Currently, few executive directors or talented individuals just below board level sit as non-executive directors in other companies. Of more than 5,000 executive directors in UK listed companies, currently 282 hold a non-executive director post in a UK listed company. There are many benefits of doing so. The company that employs the individual on a full-time basis will benefit from the individual gaining a broader perspective and developing skills and attributes relevant to any future role as a director. Conversely, the board of the company receiving the individual benefits from executive experience elsewhere. This encourages the sharing and dissemination of best practice.' (Higgs, 2003)
In the Tyson Report (2003), it is said that chief executives of large companies appointed qualified managers to actively nurture non-executive directors' talent from their "marzipan" management ranks to serve on their divisional, regional or subsidiary boards. The report also states that chief executives also are willing to encourage such individuals to accept non-executive directors' positions on the boards of non-competitor companies. Nevertheless, as the responsibilities and liabilities required on non-executive directors increase, the commitment time of non-executive directors' positions augments. Thus, the chief executives are therefore likely to become more reluctant to allow their most promising managers to assume them (Tyson, 2003).
In the past, the managers' talent has not been traditional source of non-executive director candidates, whilst the companies regularly claim that people are their valuable asset. It is also agreed by Higgs (2003) that the issues dealt with in such areas are important ones for the board and that management roles in such areas encourage skills and attribute that is highly relevant to the boardroom. It is reported that only 20 of the FTSE 250 currently have the human resource function on the board. Afterwards, when the Higgs Review was published, Geoff Armstrong, Director General of the Chartered Institute for Personnel & Development (CIPD) said: 'There is a vast pool of talent within the human resource profession. Such individuals would bring a new dimension to the non-executive role and ensure that an organization's key driver of value - namely its people - is taken seriously at board level. They would bring a fresh and much-needed perspective to the decision-making process.' The CIPD believes that human resources professionals could also bring critical expertise to the remuneration committee.
The Armstrong Institutes observed that 'Pay and reward is their stock-in-trade - it would make a lot of sense. Equally, selection, induction, training and performance management are areas of expertise which could be applied with value to both executive and non-executive directors'. The Tyson report (2003) discovered that 'lawyers and consultants working in advisory roles to business are another source of non-executive director's talents as are those who have retired from accountancy firms and are no longer restricted from holding non-executive directors positions'. It should be encouraged by professional service firms to let their senior people accept non-executive appointments. The investigation indicates that currently only fourteen percent of FTSE 100 non-executive directors have accountancy qualifications and less than three percent have law qualifications. Moreover, since women are better represented in professional services than in top management positions in the corporate sector, an increase in non-executive directors' appointments from such firms is likely to mean an increase in women serving in non-executive directors positions. In a word, the skills and experience of non-executive directors is a valuable asset on companies, which could not only become more effectiveness through training and induction but also take a professional advisory role in another companies.
The thesis is what makes board effective. After the scandals at Enron Corp., Tyco International Ltd, Adelphia Communications Corp., and WorldCom Inc. earlier this decade (Solomon, 2007), there is a growing interest in the corporate governance systems of developing and transitional economies. The Combined Code (2008) emphasized that 'all directors should receive induction on joining the board and should regularly update and refresh their skills and knowledge' which represent one of most significant parts of the board effectiveness. However, many studies focus on non-executive directors' independence and pay schemes but not on the induction programme and skills and qualification update. Although much of the literature ignores the existence of director induction programme there is evidence to suggest corporate should take more attention on it. In the Higgs report about review of the role and effectiveness of non-executive directors (2003), there is an induction checklist which provides a guidance of induction. As a criterion, the research will check the induction programme presenting in the corporate governance of the annual report. Therefore, the thesis will bridge the gap in the literature by following the Combined Code and other report to examine whether each company have an eligible induction programme according to the criteria and been disclosed appropriately in the annual report.
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