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The focus of this essay is to trace the development of corporate governance in the context of the UK over the past years. I will also be looking at the impacts of corporate failure in Maxwell communication. Finally, conclusion will be given.
Background of Maxwell Communication
Robert Maxwell was born British on 10 June 1923 and died on 5 November 1991, and was member of media proprietor and former member of parliament, (MP) who rose from poverty to build an extensive publishing empire, which collapsed after his death due to the fraudulent transactions Maxwell had committed to support his business empire, including illegal use of pension funds.
Corporate governance is the process of supervision and control intended to ensure that the company's management act in accordance with the interests of shareholders. (Parkinson, 1994) Corporate governance is concerned with issues such as effectiveness and efficiency of operations, reliability of financial reporting, compliance with the law and regulations, and safeguarding of assets.
Corporate governance committees
The Cadbury report 1992
As a result of the Maxwell affair in 1991 which saw Maxwell abuse his power and take money out of a pension fund to invest in his business activities, the Cadbury report in 1992 was formed covering three areas board of directors, auditing and shareholders. "The Cadbury report focused attention on the board of directors as being the most important corporate governance mechanism, requiring constant monitoring and assessment. However, the accounting and auditing function were also to play an essential role in good corporate governance, emphasizing the importance of corporate transparency and communication with shareholders and other stakeholders". (Jill and Airs Solomon)
The Greenbury report 1995
As a result of public and shareholders concerns about director's remuneration a second committee was formed which produced the Greenbury code of best practice in 1995. The new code focused on four major areas, The role of a Remuneration Committee in setting the remuneration packages for the CEO and other directors; The required level of disclosure needed by shareholders regarding details of directors' remuneration and whether there is the need to obtain shareholder approval; Specific guidelines for determining a remuneration policy for directors; and finally Service contracts and provisions binding the Company to pay compensation to a director, particularly in the event of dismissal for unsatisfactory performance.
The Greenbury Code recommended the establishment of a remuneration Committee, comprising entirely of non-executive directors, to determine the remuneration of the executive directors. However, in terms of service contracts, Greenbury recommended a maximum notice period of 12 months rather than three years as suggested by Cadbury. It was not widely accepted as many believed that the recommendations made did not sufficiently deal with the issue of linking directors pay to the Company's performance in the interests of shareholders. (Jill and Airs Solomon)
Hampel report 1998
The Hampel Committee was established in 1996 to review and revise the earlier recommendations of the Cadbury and Greenbury Committees. The Final report emphasized principles of good governance rather than explicit rules in order to reduce the regulatory burden on companies and avoid 'box-ticking' so as to be flexible enough to be applicable to all companies. It was recognized that good corporate governance will largely depend on the particular situation of each company. This emphasis on principles would survive into the Combined Code.
Hampel viewed governance from a strict principal/agent perspective regarding corporate governance as an opportunity to enhance long term shareholder value, which was asserted as the primary objective of the company. This was a new development from the Cadbury and Greenbury Codes which had primarily focused on preventing the abuse of the discretionary authority entrusted to management. In particular, the report favoured greater shareholder involvement in company affairs. For example, while the report recommended that unrelated proposals should not be bundled under one resolution shareholders, particularly institutional shareholders, were expected to adopt a, 'considered policy' on voting. Another key advance was in the area of accountability and audit. The Board was identified as having responsibility to maintain a sound system of internal control, thereby safeguarding shareholders' investments.
Further, the Board was to be held accountable for all aspects of risk management, as opposed to just the financial controls as recommended by Cadbury. Hampel did not advance the debate on director's remuneration, choosing only to reiterate principles inherent in Greenbury. In particular Hampel did not believe that directors' remuneration should be a matter for shareholder approval in general meeting. This would not become a requirement until the introduction of The Directors' Remuneration Report Regulations in 2002. (Jill and Airs Solomon)
Combined Code 1998
The Combined Code consolidated the principles and recommendations of the Cadbury, Greenbury and Hampel reports. It was formulated in 1998 and revised in 2003 following the publication of the Higgs report. The Code is divided into two sections. The first outlines principles of best practice and their supporting provisions for companies, while the second does the same for shareholders. While compliance with the Code is not mandatory, the Code was appended to the listing rules and listing rule 12:43A requires a statement by companies to provide shareholders with sufficient information to be able to assess the extent of compliance with section one of the Code.
Instances of non-compliance should be justified to shareholders.16 November, 2004 Milestones in UK Corporate Governance Section 1 of the Code is comprehensive covering topics such as the composition and operations of the Board, directors' remuneration, relationships with shareholders, the supply of information, and accountability and audit. The fact that the Code has provided both principles and provisions has resulted in a Code that is powerful enough to effect specific recommendations and flexible enough to be applicable to most companies.
Section 2 of the Code is much shorter, covering shareholder voting, dialogue with companies and the evaluation of governance disclosures. As institutional investors invest on behalf of the shareholders they represent they have a responsibility to hold the companies in which they invest to account. In particular, the Code recognized that the responsibility for maintaining good dialogue and mutual understanding belongs to both companies and its institutional investors. Finally when evaluating the quality of governance disclosure by companies, institutional investors are to give due weight to all relevant factors. This is rather vague and the area has been recognized as a shortcoming of the Code, leading to membership associations of institutional investors having to produce guidance to its members on this area. (Jill and Airs Solomon)
The Turnbull report 1999
The turnbull committee was established specifically to address the issues of internal control and respond to the provisions in the combined code. The report provided an overview of the systems of internal control in existence in the UK companies and made clear recommendations for improvements, without taking a prescriptive approach. (Jill and Airs Solomon)
Higgs Report 2003
A report was published in 2003 following Derek Higgs' report into the role of non executive directors. The report recommended a number of changes to the Combined Code and a revision of the Code in July 2003 incorporated most of the Higgs recommendations. The Report examined the role, independence and recruitment of non-executive directors. Higgs viewed the non-executive director's role as: Making contributions to corporate strategy; monitoring the performance of executive management; satisfying them selves regarding the effectiveness of internal control; Setting the remuneration of executive directors; and being involved in the nomination, removal and succession planning of senior management.
The Combined Code recommended that Boards should comprise of at least one-third non executive directors, a majority of whom should be independent. However, the Code did not detail how to assess independence. Therefore Higgs outlined a series of tests of independence such as length of service, associations to executive management, financial interest or significant shareholding. In particular cross-directorships were identified as compromising independence, the simplest case being where two directors act as executive directors and non executive directors alternatively at two companies.
However, in practice there may be a complicated network of inter-relationships such that it remains difficult to externally determine a directors' independence. With regard to recruitment, Higgs recommended stronger provisions governing nomination committees. Higgs called for all listed companies to establish a nomination committee, chaired by an independent non executive director (not the Chairman) and comprising a majority of independent non-executive directors. However, it was recognized that the recommendations regarding non-executive directors would be harder for smaller companies to adopt. (Jill and Airs Solomon)
The smith report 2003
As an accompaniment to the Higgs report another review was commissioned by the UK government in response to the Enron scandal, with the aim of examining the role of the audit committee in the UK corporate governance. The report dealt with the relationship between the external auditors and the companies they audit, as well as the role and responsibilities of companies audit committees. (Jill and Airs Solomon)
Revised Combined Code 2003
The revised Combined Code, published in July 2003 was a direct result of the recommendations of the Higgs report outlined above and also the Smith review concerning Audit Committees. As with the 1998 Combined Code, companies are required to report on their compliance against the Code and should explain areas of non-compliance. The revised Combined Code is effective for Companies with financial years starting on or after 1 November 2003. The new Code amounts to a significant revision of the 1998 Code. In particular the Code calls for, a separation of the roles of the Chairman and Chief Executive.
The Chairman should satisfy the criteria for independence on appointment, but should not, thereafter, be considered independent when assessing the balance of board membership; A Board of at least half independent non executive directors. The Code defines independence as recommended by the Higgs Report; Candidates for Board selection to be drawn from a wider pool; the Board, its committees and directors to be subject to an annual performance review; at least one member of the audit committee to have recent and relevant financial experience; and In contrast to the Higgs Report, the revised Code permits the Chairman to chair the nominations committee, except where the committee is considering the appointment of the chairman's successor. (Jill and Airs Solomon)
The impacts of corporate failure in Maxwell communication
Fraud-proofing pension schemes is almost impossible, but in response to Robert Maxwell's theft of more than four hundred and fifty million pounds from his employees' pension funds the government set up the Pension Compensation Board. This board ensures that money that is not returned to the pension fund by the employer is compensated, up to a maximum of ninety percent of the total losses. The idea is that employees should never be so severely disadvantaged by pension fund fraud again. The fund managers, under the direction of Robert Maxwell, used the collateral from these loans to prop up the share price of the ailing group and further increased the fund's exposure to self-investments.
As the group collapsed, a large percentage of the pension fund assets were lost. Following this scandal, a self-investment limit of 5% was introduced and trustees were given the obligation to ensure such limits were adhered to. The 1995 Pensions Act also introduced fines for rule breaches by trustees, and eventual disqualification and emphasised the need for adequate governance standards and basic prudential investment management principles. In particular, it introduced a requirement for independent custodians, less leverage by the employer over the trustees (more employee trustees), and better independent actuarial information for trustees.
Furthermore, legislations also differ in the extent to which there are direct or indirect qualitative controls on the role of pension funds in corporate affairs. These include for example, rules on participation in shareholder meetings, on voting alliances between different pension funds, and on the election of boards of private corporations. Pension funds in the UK for example, have no legal duty to vote, while those in the US do. On the other hand, UK pension funds that hold a "block of shares" are not subject to any filing requirements, wile those in the US must file the 13(d) Form with the Securities Exchange Commission. US pension funds can in fact be sued for breaching any duty of disclosure to their plan participants. This applies to investors who, individually or jointly, hold 5% or more of a firm's equity. Hence, while individual action by a pension fund is not required in the UK, UK funds face fewer disclosure obstacles to act jointly than their US counterparts when voting in the election of boards of companies.
In concluding good corporate governance is not just a matter of prescribing to particular corporate structures and complying with a number of hard fast rules. There is an underlying need for broad principles that extend beyond immediate effects to social consequences.
The ways in which a company gives effect to these principles might lead to the corporate failure, and this differs according to its size, complexity and whether its shares are made publicly available.
As Maxwell communication collapsed, a large percentage of the pension fund assets were lost. Following this scandal, a self-investment limit of 5% was introduced and trustees were given the obligation to ensure such limits were adhered to