Behind the corporate constitution and corporate governance codes lies one of the primary players in a corporation, the directors. The board of directors is the top governing body, elected or appointed members who jointly oversee the activities of a company. The board of directors have a legal duty to act as the shareholders' agent with fiduciary responsibility. Directors are responsible for ensuring the success of the business and compliance with corporate governance. Essentially the board has to act as the corporate conscience of the company.
On an individual level, directors come in two forms, executive and non-executive. There is no legal distinction made between executive and non-executive directors, the difference is that non-executive directors do not get involved in the day-to-day running of the business (Business Link, 2011). Executive directors are valuable because they possess knowledge of the company and its operations and can effectively report information about the firm's activity and perform operational and strategic business functions. Executive directors are also advantageous because they exercise a degree of skill and care and act in good faith in the interests of the company as a whole. However the possibility of agency theory could happen in which the interests and goals of executive directors may not be aligned with that of the shareholders, they may vary immensely and in turn these directors may not fulfil their role and responsibility of acting in the best interest of the shareholders (Nyberg et al, 2010).
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From an agency theory perspective, non-executive directors help reduce the notorious conflicts between shareholders and company management; they are advantageous because they perform the function of monitoring the board and introduce an independent voice in the boardroom (Solomon, 2007). They contribute both expertise and objectivity in evaluating management's decision, help maintain a balance of power and ensure accountability of companies. Non-executive directors also bring awareness of the external world and the ever-changing nature of public expectations to board discussions (Clarke, 1998). However companies may feel non-executive directors are superfluous in a company that runs well without one. Non-executive directors determine remuneration of executive directors and vice versa, therefore there is the tendency to discourage conflict which can hinder the ability to contribute effectively to the monitoring of the company and its' strategy (Keasey, Thompson & Wright, 1997).
On a collective level, board of directors operate with sub-committees, typically an Audit Committee, remuneration committee and a nomination committee. Committees are there to establish formality and transparency and ensure independence. Potentially the role of the board of directors can protect minority shareholders against majority shareholders but also have the power to protect non-shareholder stakeholder interests such as employees. However the board of committees consists of multiple individuals who may differ in opinion and many bring personal prejudices, political behaviours and power plays to board affairs.
The corporate board with all its mix of expertise, independence and legal power is a potentially powerful corporate governance mechanism. In addition to business and financial issues, boards of directors must deal with challenges and issues relating to agency theory and conflict of interests. Corporate governance reforms and best practices issued by a number of organisations recommend continuous education and evaluation of the directors but ultimately the responsibility of good corporate governance and the success of the company rest with the board of directors.
In recent years the audit committee has become one of the main pillars of the corporate governance system in public companies. Following the publications of the Higgs and Smith Reports in 2003, there is now a greater understanding of the requirements of the audit committee in addition to the strengthening of the role of the audit committee.
The audit committee is the most important of all board committees (Mallin, 2011); it is beneficial to the company because it monitors the integrity of the company's financial reporting process, strengthening of internal control systems, reinforces the independence of external auditors and reviewing the management of financial and other risks (Clarke, 2006). Audit committees have the advantageous role of ensuring external auditors of public limited companies are carrying out their role effectively. However according to proposals from the Financial Reporting Council (2010), the UK governance watchdog, audit committees are not providing detailed-enough reports about business risks to shareholders.
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The audit committee pay particular attention to management's use of the going concern assumption in the financial statements with the right to investigate suspected problems with accounting practices or senior management (Lipman & Lipman, 2006), this role enforces internal controls and ensures management and businesses are complying with corporate governance. The Audit committee is important because it has the role of acting independently from the executives and ensuring the interests of the shareholders are properly protected. However audit committees do not always communicate well, disclose all their responsibilities and the extent to which the committee has filled its responsibilities to the shareholders (Keinath & Walo, 2009) even though all disclosures should be made in the audit committee charter.
The role and the requirements of the audit committee is one that is of importance in a public limited liability company such as a FTSE100 company as well as in corporate governance. The audit committee essentially are in place for verification purposes, it is however a role that requires time, experience and skills. Consequently it is imperative that those executives bring with them the necessary maturity, judgement and process management skills to ensure that an appropriate degree of pragmatism is shown while continuing to look after shareholder interests.
Companies have responsibilities to a number of interested parties; these parties are known as the stakeholders. Stakeholders range from shareholders and customers to directors and employees to lenders and suppliers. It is these stakeholders that are active participants in determining the performance of the company and play an important role in influencing how corporate governance systems work. Over time, markets have become largely institutionalised and the scope of stakeholders has now exceeded the traditional expectations of stakeholders. Companies have now been introduced to additions such as institutional shareholders, external auditors and credit rating agencies. A greater assessment of their roles and responsibilities will allow companies to assess the roles they play in corporate governance.
A stakeholder is defined as individuals and groups who are affected by the activities of an organisation. Stakeholder theory states that the business owes a responsibility beyond their shareholders to those who have a 'stake' in whomever the entity impacts whilst completing its business (Hannagan, 2007). Overall organisational stakeholders are active participants with an interest in the company and determining the performance of the business. Stakeholders are also beneficial to the company as they play an important role in influencing the future strategy and the corporate governance systems. However the goals and objectives of each stakeholder vary immensely and may have completely conflicting measurements of success. The most common type of conflict is between shareholders and the company's management, this conflict is better known as agency theory (Nyberg et al, 2010).
Institutional shareholders are organisations, such as life insurance companies and mutual and pension funds, that invest in various firms by pooling a large sum of money from individual investors. Institutional shareholders offer the advantage of safe investments; they also lower risk than that faced by non-institutional investors owing to a broad and diversified investment portfolio. These firms tend to hold large shareholdings and can therefore wield considerable influence and have an active involvement in the governance of the companies. Institutional shareholders have become more active in monitoring companies and also have the ability to influence a company's solvency. The growth of institutional shareholders was thought to be the answer to the problem of separation of ownership and control (Goergen et al, 2010). However the interest and competence of the institutional shareholders to do so is questionable. Majority of the large UK institutional shareholders groups do not directly manage their investments and are usually without backgrounds that would help them take a long term view about the value of the company.
An external audit reviews an organisation's financial statements by an independent body. External auditors are advantageous because they are an additional resource to fulfil a full range of internal auditing responsibilities; they have access to expertise such as auditing systems and treasury skills that may be unavailable to an internal auditor and can also provide comparative experience (O'Regan, 2002). Essentially external audits are imperative to give confidence to investors, regulators and the public that the financial data and representations in the statements are true and not misleading. However external auditors can come with disadvantages as an inadequate understanding of the organisation may seriously hamper the auditor's effectiveness (O'Regan, 2002). Auditors may be isolated from the informal networks of the organisation, putting them at a disadvantage when navigating the environment. Furthermore confidentiality may be compromised if external individuals have access to sensitive information.
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At the corporate level, it is usually in the best interest of a company to look for a credit rating agency to rate their debt. Creditor is a person or company to whom money is owed, the term derives from the notion of credit (Blum, 2006). Credit ratings are an important tool for borrowers to gain access to loans and debt. They have also been used to determine the reputation and trustworthiness of a company. Investors often base part of their decision to buy bonds, or even the stock on the credit rating of the company's debt. Credit rating agencies that provide companies with good credit can only enhance their ability to borrow from future creditors. However a negative rating, possibly as a result from experience with a previous creditor can often minimize or worsen a companies' chance of obtaining credit in the future. It can also be a difficult process to get negative information off of a credit report.
Stakeholders are vital to the performance of any company; however each has its own goals and objective for an interest in the business. Corporate governance is a system for optimising the contribution of a number of stakeholders to a purpose which they are persuaded to share (Davies, 2006). Companies have to achieve a balance to satisfy all stakeholders whilst obtaining the organisations goals. The Organisation for Economic Co-operation and Development (2011) states that the corporate governance framework should recognise the rights of stakeholders as established by law and encourage active co-operation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprise.
Regulatory bodies in corporate governance are public authorities that are responsible for exercising independent authority over corporate institutions, aiming to maintain the integrity of the financial system. In the UK the main regulatory bodies relating to corporate governance are the Financial Reporting Council and the Financial Services Authority (FSA). As independent advocates they aim to actively promote confidence in corporate reporting and governance. With strong beliefs of their roles and responsibilities affecting effectiveness, the regulatory bodies regulate most financial services markets, exchanges and firms (Financial Services Authority, 2011) as well as oversee the regulatory activities of the professional accountancy bodies. There are other regulatory bodies in the UK for example the Office of Fair Trading and the Financial Ombudsman Service that significantly contribute to corporate governance.
The roles of the main regulatory bodies contribute greatly to corporate governance in the UK by increasing market confidence, establishing financial stability and consumer protection and attempting to reduce financial crime (Financial Services Authority, 2011). Regulatory bodies also enforce corporate governance codes such as the Revised UK Combined Code (2008) that set out standards of good practice in relation to board leadership and effectiveness, remuneration, accountability and relations with shareholders (Financial Reporting Council, 2011). In doing so the regulatory bodies publishes a series of guidance notes to assist companies in applying the principles of the UK Corporate Governance Code.
Regulatory bodies have often been criticised. They have often been regarded as reactive rather than proactive, with particular focus on the perceived lack of action in many cases in addition to question being raised about the number of staff and their competence (Friedrichs, 2009). The Economist (2005) stated that FSA's procedures are flawed; regulator cannot use flawed procedures without destroying its effectiveness. Similarly, the FSA relies on continuous monitoring of financial-services companies to keep it informed and allow it to issue warnings when necessary. If the monitoring is poorly constructed, then the FSA will find itself struggling. The FSA has also failed intellectually by focusing too much on processes and procedures rather than looking at the bigger economic picture. These regulatory bodies increasingly rely on computers to uncover illegal activities (Friedrichs, 2009) but the use of computers raises concerns about excessive intrusion and invasion of privacy. In general regulatory bodies have been criticised for its supposedly weak enforcement program.
The combination of legal framework, regulations and guidelines for companies, provided by the corporate governance codes and administered through the main regulatory bodies in the UK are a means of engendering public confidence in companies (Mead, Sagar & Bampton, 2009). Regulatory bodies are necessary in enforcing regulation requirements in the corporate world. By doing so, they provide a system that ensure companies are complying with corporate governance.
At the core of good corporate governance are the pillars of transparency and disclosure (Mallin, 2006). Transparency has become a popular term amongst organisational leaders and stakeholders (Garsten & De Montoya, 2008). The term refers to organisations that are open and candid with information. An authentic, transparent organisation intentionally discloses information beyond the board room with members and non-members alike. Despite its desire for stakeholders' trust, every association has information, or history it doesn't want accessed by competitors or perhaps publicised to all members. But in this day and age greater organisational transparency and disclosure is rapidly becoming a requirement for associations and effective way of complying with corporate governance.
Transparency and disclosure is beneficial because it encourages, honours and engages with public input by embracing access to information, participation, and decision making (Meyer, 2003), which ultimately creates a higher level of engagement within the company and instils trust among stakeholders. The benefits of transparency can have a direct impact on top line performance and cost savings, and spur competitive advantage which in turn drives the company's performance (Berggren & Bernshteyn, 2007). Increased and improved disclosure is likely to reduce agency costs as better information flows from the company to the shareholder, which in turn reduced asymmetry (Solomon, 2007). However, it does not guarantee that the right decisions will be made or that information will not be manipulated or misconstrued. Meyer (2003) states that plenty of bad decisions are being made in transparent organisations, more practically, increased transparency may require additional time and resources at all organisational levels.
The need for organisational transparency have led to more disclosure and information, benefiting market participants, lowering the cost of capital (Dallas, 2004), and providing more accurate information about the performance of executives such as the chief executive officer and chief financial officer. However within this lays the challenges of organisational transparency. There may be distortion of information as companies may not be willing to disclose areas of the business dealing with those most sacred of things such as profit, margins and cash-flow, evidently meaning that true transparency is not achieved.
Modern companies are taking steps to drive company performance through increased efficiency delivered by increased transparency. The ability to encourage a high level of unquestioning trust and true transparency requires the company mindset to be ready to execute this goal. Despite the challenges associated with transparency and disclosure, current conditions and future assumptions are driving organisations to ponder on how greater organisational transparency can be achieved (Meyer, 2003). The steps companies are taking to further achieve organisational transparency are aiming to align as nearly as possible the interests of individuals, corporations, and society (Fernando, 2009) which is said to be fundamental with effective corporate governance.