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Due to several financial scandals in the 1980s and 1990s such as Robert Maxwell and Enron and their 'mastery of malfeasance'(Clarke,1993) occurring without auditor warning, there was a need to restore public confidence through alterations and new reforms in order to answer questions on the quality and reliability of audited information (Cadbury 1992: Humphrey et al 1993). It has been said that 'Corporate Governance is the system by which companies are directed and controlled.' Cadbury (1992).This means the manner in which money is distributed and allocated and to who and who by. This paper is going to critically analyze the development of U.K governance reform by looking at literature scoping from1990-2011 and investigate it's effectiveness on Corporate Governance in the U.K. By doing this, an evaluation as to whether the regulations have become more or less effective and the impact this has had on confidence in financial reporting should be highlighted. In order to do this, thorough analysis is required of relevant research papers to ensure an accurate picture is generated of the regulations. Currently it is not clear how effective the reforms are and so therefore in the first section of this paper The Cadbury Report 1992 and The Greenbury Report 1995 are going to be discussed in depth , with small reference to the Hampel Report 1998, all of which show the early progression of U.K governance reform.
Over the past twenty years there has been an increased interest in 'the quality of corporate governance' O'Sullivan et al (2003) especially the adequacy of financial reporting O'Sullivan (2000) and concern over creative accounting, failure of several companies in the U.K and U.S, increasing directors remuneration unrelated to performance and short termist pressures exerted on firms by the stock exchange (Short,1996) developments in terms of financial reporting was needed, especially to restore confidence in all the stakeholders. This led to the first topic of discussion in this paper the Cadbury Report, described by many as a landmark in U.K governance reform (Conyon and Mallin,1997).
The Cadbury Report
This was developed in 1991 by the Financial Reporting Council, the London Stock Exchange and the accountancy profession. The role of the Cadbury Committee was to examine 'those aspects of corporate governance specifically related to financial reporting and accountability' and focus on the auditor-management relationship in which an 'appropriate' one needed to be established. Cadbury (1992) was particularly concerned with this relationship, highlighting the extreme importance it has in the governance process. This is illustrated very predominantly in businesses such as Enron where independent auditing and therefore verification of financial accounts was lacking. It has been said that 'the statutory audit is an important governance mechanism through which shareholders can seek to monitor management' O'Sullivan (2000). Perhaps it can be said that due to this catastrophic omission, the collapse of these companies occurred. This therefore resulted in efforts to improve information to shareholders, self regulation and increasing the number of independent directors on the board. In addition, the report recommended no duality of roles; the CEO and Chairman should be separated to ensure vision and focus isn't compromised and prevent CEO entrenchment and a decline in board independence (Mace 1971: Mizruchi, 1983). However, on a report by Baliga et al (1996) it was found that in fact duality has no significant impact on performance and creates no explicit advantage for shareholders either. So why would companies follow Cadbury's advice? This notion was supported by Dalton et al 1998 and Boyd 1995 where a meta-analysis found only a weak negative relationship of -0.02 between CEO duality and performance. In opposition to this, 69% of corporate directors from five hundred small and large firms supported the separation of CEO and chairman (Felton et al, 2002) indicating recognition of the Cadbury (1992) reform. In terms of the executive directors, it was suggested that contracts do not exceed three years without the approval of shareholders and their remuneration would be dependent and decided by a 'remuneration committee' of which would consist on the most part, non executive directors. However, it was speculated that these committees were just put in place to act as a façade, where in fact they just legitimized high pay outs. On the contrary, some saw it as an opportunity to prevent the perceived self interested executives from taking excessive payouts. In addition, in terms of CEO pay the committee are an 'economic institution that in theory helps to solve agency problems inherent in managing an organization' (Hermalin and Weisbach, 2003) and in fact remain independent from the CEO, acting as a mechanism of monitoring and protecting shareholder interests.
This was an attempt to restore confidence in shareholders that their money is in fact not fuelling executives pay cheques. Furthermore, Cadbury (1992) advised that the board of directors consist of three non executives two being independent. Research has shown that in fact a firm's board composition in terms of independent and non-independent directors is not correlated with performance. Outside directors would play a monitoring role and help ensure the correct decisions were made. However, according to Fama and Jensen (1983) incentives for directors are ambiguous. On the one hand they want to be seen as 'expert monitors' and on the other incentives to stay on side of CEO's may outweigh doing the right thing. Therefore, despite the Cadbury Report's (1992) advise on boards, it may not have been genuinely adopted as Holstrom (1999) said 'wanting to be seen as doing the right thing and doing the right thing are not always the same'.
However, in terms of effectiveness, it would appear that the new suggestions of the
Cadbury Report was adopted. In a survey carried out by Other Developed Economies
(2003) an 'overwhelming majority' had followed the Cadbury Report (Thompson, 2005).
In addition, a survey by Coynon (1997) supports this stating that again and
'overwhelming majority' of large U.K firms implemented Cadbury's proposals
immediately. However, not all companies implemented the Code and 'comply or
explain'. This requirement was in fact extremely far removed
from previous practice where companies didn't need to report whether they
complied with the code or not. However, it was not compulsory in the Cadbury Report
and many critics stated that the report hadn't gone far enough in tightening up the
regulations. Some believed it had gone too far with the new code creating a'box
ticking' ethos that businesses resented. Others found that it helped to achieve a balance
between meeting standards for corporate governance and sustaining the entrepreneurial spirit. It would appear that critics believed it to be an enhancement of bureaucracy that
slowed down corporations to react to market change and inhibited first mover advantage. However, the main failing of the Cadbury Report was that compliance was not compulsory, an issue recognized by the Hampel Report. If compliance is not compulsory it is not as easy to monitor financial reports of corporations and the likelihood of scandals occurring is higher for instance like Maxwell BCCI. It is necessary for compliance to be compulsory to protect shareholders and any other stakeholders, particularly financial ones. However, whether the codes are voluntary or compulsory it is still viewed as a set of bureaucratic instructions that many despise as it can inhibit business prosperity and although can prevent scandals from occurring it is still not totally 'scandal proof'(Martin, 1992). The Cadbury Report (1992) also highlighted the need for internal controls such as financial management and risk assessment which could also be perceived as restricting business activity but also protecting companies from fraud and damage to external reputation.
The Greenbury Report and The Hampel Report
The determination of directors pay is a major element in corporate governance reform. Although the Cadbury Report did address remuneration, Sir Richard Greenbury Chief Executive of Marks and Spencer was asked to report on director' remuneration specifically. The focus was on remuneration itself but emphasis was also placed on timely and accurate disclosure of accounts (Sheridon et al, 2006). Jensen and Meckling (1976) reported that although this was a good step in the right direction for financial reporting, managers may only disclose information that protects their employment hence only presenting positive information giving a distorted view of reality. However, contrary to this, Skinner (1994) said in his report that this was not the case; managers presented both good and bad information generating a more honest and transparent view to shareholders.
The question is has the Greenbury Report been successful along with its predecessors in changing the executive pay setting process or not? Or is it a 'seriously flawed process?'. U.K governance reforms since Cadbury have attempted to increase the independence of pay allocation of executive directors and make the process more transparent in nature. After the failures witnessed in the 1990s, public hostility was high in light of the gains received by directors. Some of these firms were nor particularly run well, for instance regional water companies, yet their executives received great pay offs generating an attitude of 'Heads they win, tails they win as well' (Thompson,2005). The Greenbury Report (1995) stated that options were 'a source of undeserved largesse for such executives and it advocated the use of restricted share grants'. Greenbury extended Cadbury's reform by enlarging the job and autonomous nature of the remuneration committee. The committee would be entirely made up of non-executives with no financial interest in the business in any way, they should not be involved in the day to day running of the business and only act as shareholders. They would be directly accountable to shareholders, with the committee chair attending the annual general meeting. They would cover all aspects of remuneration and this would be fully disclosed in the committees report.
In addition, Greenbury also adapted Cadbury's suggestion of a three year rolling contract in response to Hermes Asset Management who threatened to vote against them, with a compromise of one year rolling contracts. In 2002, a report by DTI Green paper stated that 80% of FTSE 350 executives were on a one year rolling contract.
However, what form of compensation do executives receive if fired or a victim of a takeover? Two approaches are at hand; one being liquidated damages and the other mitigation. Greenbury suggested that mitigation was the best option as it reduced severance pay and could be paid in installments however The Hampel Committee (1998) argued that mitigation was difficult in cases where individual performance was arduous task to assess. Liquidation allowed for a 'swift clean break' and so therefore overall Hampel believed liquidation was the better out of the two alternatives (Thompson, 2005). The Hampel Report (1998) has been seen as 'a fine tuning of previous reports' building and reinforcing its many predecessors stating that 'disclosure is the most important element of accountability to shareholders and encourages company disclosure'.
Overall, it is apparent that the quality of the reforms in the 1990s have been effective and successful as they are 'internationally recognized' and have catalyzed the development of corporate governance reforms.