Combined Code And Corporate Governance Scandals Accounting Essay

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Corporate Governance specifies the distribution of rights and responsibilities in a company, such as the board, the shareholders, the managers and the stakeholders and provides the procedures in deciding corporate affairs. "It is the system by which companies are directed and controlled" and its main purpose is to ensure that the company is being run n an objective way. In the UK, the key elements of the corporate governance framework are derived by the Companies Act 2006, the UK Listing Rules, the Combined Code on Corporate Governance and by guidelines created by the institutional investor organizations. The collapse of Enron and a number of other companies in the US had a striking impact upon the process of corporate law reform, not only in the US but worldwide. In our essay we will be discussing the impact of those scandals in the UK and whether the UK Corporate Governance Code and the UK's legislative framework related to listed public companies, effectively address the problems revealed by those corporate scandals.

Corporate scandals are political and business scandals that often arise with the exposure of misbehavior by the executives of large public companies. In the UK, a great amount of companies collapsed without notice in the 1980's and the 1990's. These included Maxwell Group, Polly Peck International, the Bank of Credit and Commerce International, Barings Bank, British and Commonwealth and the Mirror Group News International.

Whenever something goes wrong, the finger of blame points in different directions. The directors, have much greater access to the information system of their company and are more aware of the company's financial position. They are also able to maneuver that information that is released to the shareholders. In addition, the directors may be tempted to take decisions aimed at boosting the company's performance in a short-period of time, creating the so-called "Icarus effect scandals", while the shareholders are more worried about the long-term endurance of the company. In the case of the Barings Bank, the collapse occurred due to inadequate control of the company and because investors were not fully informed about what was really happening in the company. External auditors were accused of not noticing the warning signs and much of the blame was put on the improper action on behalf of the chief executives of the company. Similarly, in the case of Polly Peck, insolvency happened after years of faking financial reports.

Events in other countries, such as the collapse of Enron and WorldCom in the US, have influenced thinking in the UK. Especially Enron, made the UK government embrace governance issues such as the role of the non-executive directors and supervisory bodies, management remuneration and the responsibility of management for financial statements. If Enron confirms the old adage that there is nothing like a good scandal to produce company law reform, it is novel, perhaps unique, in being a foreign scandal producing law reform in Europe. [2] 

Combined Code's creation

The UK Corporate Governance Code is a set of principles concerning good corporate governance aimed at public companies that are listed on the London Stock Exchange. Its importance derives from the Financial Services Authority's Listing Rules [3] and it requires that public listed companies act in accordance with a "comply or explain" system; firstly, the company must report how it applies the principles in the Combined Code and secondly, the company has to either verify that it complies with all the Code provisions or give grounds for non-compliance.

The first step to the initial formation of the Combined Code on Corporate Governance was the publication of the Cadbury Report, by a committee by Sir Adrian Cadbury, in 1992. The Report was a response to Polly Peck's insolvency in 1991. It was initially restricted to prevent financial fraud but when BCCI and Robert Maxwell scandals took place, Cadburys remit was extended to corporate governance in general. On the proposals of Cadbury Committee, another committee was created to review the progress on corporate governance in public listed companies. The committee issued the Greenbury Report in 1995, which was mainly focused on directors' remuneration. In 1998, the Hampel Committee on Corporate Governance was set up to review the recommendations of the Cadbury and Greenbury Committees and its report, combined with the other two reports created the Combined Code. In 1999 the Turnbull Report was produced to provide guidance for company towards relating to their risk management responsibilities. Due to concerns over the role of non-executive directors and the role of the audit committee, in January 2003 the Higgs Report on non- executive directors and the Smith Report on audit committee were created. Finally, the Financial Committee combined the above Reports in a revised Combined Code in 2003.

Combined Code

While legislation facilitates trading and regulates companies, it is perhaps not the most effective means of promoting good management practice in public companies. The Combined Code 2010, even though it is voluntary, is the most recent effort of improving good corporate governance performance in the UK.

Directors' performance

The role of directors is vague and they derived from the Companies Act 2006, common law and the Combined Code. The first principle in the Combined Code 2006, states: "Every company should be headed by an effective board, which is collectively responsible for the success of the company." The company's directors have to undertake the necessary training, according to the company's requirements. In the Higgs review it is recommended that the board should have a proportionate size and at least half of them should be independent non-executive directors (NEDs), amongst with an executive representation on the board. NEDs, as members of the unitary board, should monitor the management's performance and scrutinise its actions in meeting the agreed goals. They are responsible for determining executive directors' remuneration levels and they have a crucial role in appointing and removing executive directors. There is no statutory definition of NEDs but they have mainly been looked upon as defenders of shareholder interests. As it was revealed in the Maxwell Scandal, if the director was released due to his lack of ability to run the company, as in the Wyevale Company, the company would not have reached its resolution.

Separation of the Chairman and the CEO

In relation to the Combined Code, when the same person holds both the position of the Chairman of the board and Chief Executive Officer (CEO), there is a possibility that he becomes a domineering influence in the decision-making of the company and run the company for his personal benefit, as it was shown in the Polly Peck scandal. The Chairman is accountable for the leadership of the board and for ensuring that all directors receive accurate information. It is now acknowledged that the role of Chairman and CEO should be held by two individuals that would check on each other, providing better balance. [4] If these two places are being held by the same person, then the company should provide sufficient explanation for doing so.

Remuneration

The issue of remuneration is also dealt with inside the Combined Code. With the use of the semi-fiction that the articles constitute an agreement between the shareholders and the company, it became possible for this issue to be shifted back to the board of directors, with the likely exploitation of payment systems. The levels of remuneration should be adequate to motivate the directors to run the company in a successful way but the company should avoid paying extreme amounts for this purpose. In addition, no executive directors or senior management should be involved in his remuneration; only the remuneration committee should be dealt with this matter. This committee should only be consisted of NEDs, although it is allowed for the Chairman of the board of directors to sit in. As it was shown in the "Tyco Scandal", the company's chairman, Mr Korlowski, was found to use company's capital for his personal benefit, for at least five years.

Audit Reports

The Combined Code requires that each public listed company should have an audit committee consisted fully from NEDs of whom at least one should have the relevant financial experience to examine the director's actions and his auditors' objectivity. The committee will have to 'pit its judgment… perhaps on technically complex issues' against both senior management and auditors and for that reason its members should be tough, knowledgeable and independent-minded. [5] 

While the Companies (Audit, Investigation, and Community Enterprise) Act 2004 has put the necessary legal changes in reforming auditing, the Combined Code has put the matters in a "comply or explain" basis. To take the Enron case, the auditors had benefit in not investigating the company's financial arrangements so closely, in order to maintain their precious non -audit cooperation with the company. Similarly, in the WorldCom scandal, many of the board members and auditors were found to be creating fraudulent audit reports.

Shareholders democracy

The centre of many of the problems relating to corporate governance is the relationship between shareholders and directors in a company. In large companies, even though most decisions about the company will be taken by the board of directors, shareholders still have a central role to play in the company's governance. While the definition of corporate governance in some countries, like Germany, states that directors should treat alike the interests of the shareholders and the stakeholders, the UK legislation is strongly based on the principle of shareholders' supremacy. Although the Companies Act 2006 now states that directors may consider the interests of their shareholders, they are expected to do so when there is benefit towards their shareholders. In the Combined Code it is stated that the board should have a satisfactory dialogue with shareholder to ensure mutual understanding and avoid conflicts, since the shareholders, when involved in scandals are one of the main victims.

Non-Executive directors' effectiveness

According to the Financial Times, "The role of the board is under more scrutiny than ever before and the value of good non-executives has been cast into sharp relief. In it imperative that the non-executives appointed to any board have the correct experience, expertise and personal qualities to enable them to carry out their roles effectively." NEDs have to ensure that there is balance of power on the board and that they are able to dominate fellow-executive directors. Their role is, however ignored when companies perform well. It is mostly when companies perform badly that they come into the spotlight, as it has been demonstrated in the previous corporate governance scandals. Despite the limited nature of the reforms in Mr. Higgs report, the reaction on behalf of the PLCs Companies was at first one of opposition due to the parallel changes which government had been promoting leaving shareholders as holders of governance rights within companies. [6] But, compliance to the Code is made due to fear of the government deciding to take the Combined System relating to NEDs out of the Listing Rules and placing it in the Companies Act, just as it had done with the regulation of director's remuneration.

There are conflicted views about the effectiveness of the NEDs. While it is acknowledged that they bring the expertise to the board of directors, it is noticed that they lack the prerequisite insider-knowledge about the company and they have to rely on the integrity of information given to them by the executive directors and the management. This puts a restriction upon their effort to make a substantial contribution to the company. [7] In addition to this, some hold too many NEDs positions resulting to not being able to give sufficient time to any of the companies involved. From the recent scandals, it is verified that legislation in itself cannot automatically improve corporate governance but it can at least compel non-executive directors in taking their role seriously.

General Review of the Combined Code

It has been a general view that the Combined Code has succeeded in meeting its objectives by concentrating its attention of boards and directors on the importance of maintaining internal balance. Many respondents noted that the Code promotes a thorough awareness of risk and control within listed public companies and an increase in the quality of risk management. In 2007, Pensions & Investment Research Consultants Ltd reported that only 33% of public listed companies were fully obedient to the Code but this is not essentially a bad response since it has been noticed that compliance rates have been rising. One of the respondents said that "it represents the most effective piece of corporate governance guidance to have appeared in the UK over the last 10 years or so".

There was criticism though about the levels of disclosure coming from the Guidance and the responsibility of the board in implementation. It was felt that the Guidance's approach had been unsuccessful since companies were following its recommendations only to meet regulatory requirements rather than incorporating the procedure into their businesses. It has also been found that boards delegate compliance with the Code to subcommittees and have distanced themselves from the whole process. This is exactly the opposite of what the Code intended, since dialogue on risk and internal management was what the Code was aiming for.

The main question about the Code's approach is between the desire to maintain flexibility and consistency at the same time. Should there be a "one size fits all" solutions, which may not be appropriate for everyone? If a company finds that no- compliance is ideal for them, there should not be criticism by the investors. We may discover that companies departing from government practice codes due to exceptional circumstances surpass all others and cannot be viewed as badly-governed.

Conclusion

Concluding my essay, even though the Combined Code has brought significant changes to UK's corporate governance system, there are still significant changes to be made. The "one size fits all" approach does not provide the companies with the flexibility they need since companies are not homogenous entities. Also, there is no way of enforcing NEDs' duties and the Code has little to say on the accountability of NEDs to shareholders. In addition, the "comply or explain" system gives the Companies the opportunity to companies to avoid the Code but with the risk of the investors being pushed away. The fact that no corporate governance system is flawless is a valuable lesson to be learned and even though the Code has not extinguished the possibilities of scandals, it has definitely minimized them.

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