The development of corporate governance during the last twenty years



The long term success requires a productive and efficient business in all its operations. Nevertheless to most shareholders are satisfied when they know that an appropriate governance structure is operating in their firm. Bringing together shareholders' satisfaction and long-term success is usually not an easy job. Corporate governance performs an important role in combining shareholders' satisfaction and long-term success. However some managers, liable for decision-making, are trying to take gains over the long-term success for their own interest and thus agency problems arise such as the conflicts of interest between managers and shareholders. Actions like those have led to spectacular corporate failures to companies such as Enron, Barings Bank, Northern Rock, WorldCom etc. As a result these facts have shown the importance for regulation in the way a business is controlled and managed. The UK business community, watching the series of corporate failures and scandals in early 1990s the Cadbury Report was created by Sir Andrian Cadbury in 1992. It was included a series of recommendations such as the relationship between the chairman and chief executive and non-executive directors' role. Furthermore in 1995 the Greenbury Report set out recommendations on directors' remuneration. In 1998 the combination of Cadbury and Greenbury reports was made in the Combined Code by Hampel. (Stuttard, Judge, Slavn, Rhind & Floud, 2006)

The development of Corporate Governance during the last twenty years

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The aim of corporate governance is to ease entrepreneurial, efficient and prudent business management that can provide the long-term success of the company. The initial improvement of corporate governance in the UK has began in the early 1990s, when it was observed a main change in the way of corporations are governed, in response to spectacular corporate failures of Anglo-American corporations.

Firstly with the Cadbury Report in 1992 many companies have been encounter with a series of great changes in their board structure and their degree of reporting on subjects of remuneration, audit and the procedure of directors' appointment. Particularly the Cadbury Report was contained recommendations: for the conduct of the board of directors, a significant number of non-executive directors should be formally selected by the board as a whole and should be independent, executive directors' could not exceed three years without shareholders' approval, the board have the duty to present a balanced and understandable assessment of the company position, the directors should report on the effectiveness of internal control. (Dunlop, 1998). A Code of Best Practice has been included in the Cadbury Report and its recommendations were incorporated in the Listing Rules of the London Stock Exchange.

Following concerns regarding director's remuneration, the Greenbury Committee was constituted to investigate the regulations about directors' pay and to make appropriate recommendations. These recommendations have included: the remuneration committee should consist entirely of non-executive directors Ë‹with no personal financial interest other than as shareholders in the matters to be decidedËŠ, there should be no potential conflicts of interest from cross-directorships, and there should be an annual report to shareholders, which may be approved by the annual general meeting. (Dunlop, 1998)

Later in 1998 the Hampel Committee was established in order to review the Cadbury code and its significance, so as to confirm that the initial objective had being achieved. Furthermore they were requested to attend any relative subjects emerging from the Greenbury report and also consider the roles of directors, shareholders and auditors in corporate governance. The Hampel Report combined the propositions of the two previous reports and suggested the establishment of a 'Combined Code' that was attached to the Listing Rules. Additionally it suggested improving communication with shareholders and bringing the restoration of balance between implementing controls and permitting companies to discover their own modes of adapting corporate governance principles. (Hampel, 1998)

After the Combined Code in 1998 corporate governance was more developed via a number of reports, reviews and some legislation. Some of these are:

the Turnbull Report in 1999 that it was established to provide assistance for companies in reporting how they had applied the Combined Code and its principles,

the Myners Report in 2001, which had aim to consider the factors distorting the investment decisions of institutions,

the Sarbanes-Oxley Act in 2002 that requires the CEO and the CFO registrants to confirm that the financial statements fairly represent the financial decisions,

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the Higgs Report in 2003, which was established to amend the Combined Code for NEDs to take on a more demanding and important role on company boards,

the Smith Review in 2003 that had intend to clarify the role and responsibilities of audit committees, and

the revised Combined Code builds upon the existing code and incorporates the recommendations of the Higgs and Smith Reports. (

Agency Theory Definition and the Shareholder-Manager Conflicts

The assistance that is given to corporate governance concerns, except from Combine Code, is the agency theory that plays an important role in giving solutions to such problems. In particular agency theory manages with agency problems arising from conflicts of interest, which can appear in contractual relationships when parties of firms are not well informed or uncertain. From the time when Jensen and Meckling (1976) recommended a theory of the corporation, Agency Theory, after from conflicts of interest between company managers and shareholders, a colossal bibliography has been established in order to analyze the aspects of these conflicts. Mainly the clash between management and shareholders is an example of what is known as a principal-agent problem. In such situation like this, is a separation of ownership and control. Mainly the clash between management and shareholders is an example of the well-known as principal-agent problem. In such a situation there is a separation of ownership and control. According to Jensen and Meckling (1976), a principal-agent relationship can be illustrated as "a contract under which one or more persons (the principal(s)) engage another person (the agent) to perform some service on their behalf which involves delegating some decision making authority to the agent". Agency theory is considered as problem-solving theory in some situations of corporate conflict.

Agency theory proposes that managers will aspire to maximize their own utility at the expense of shareholders. Agents are able to seek only for their own self-interest instead of company's best interests because of asymmetric information and uncertainty. Managers seek to increase their personal wealth by increasing their salaries in the form of perquisites and also aspire to avoid optimal risk positions of their company. On the other hand shareholders look after to maximize their wealth by investing in risky projects with higher returns. Therefore because agents are taking actions in their own self-interests a moral hazard problem arises, as it is impossible for shareholders to monitor all managerial actions. (

There are two solutions for dealing with the agency problem between shareholders and managers. The one solution is the company's managers to be compensated entirely on the basis of stock price changes and the second solution is the shareholder being able to monitor every managerial action, which would be really expensive and inefficient. The best solution is between the two, where the compensation will be given depending on performance and also some monitoring will be accomplished. (

Corporate failures and actions taken

 The poor internal control and corporate governance were the main factors of the most corporate failures such as Enron, Barings Bank, WorldCom, Tyco, Marconi, Swissair, Royal Arnold and Parmalat. Particularly the major reasons why companies fail are ordered in six categories. These are poor strategic decisions, overexpansion, dominant CEOs, greed, hubris and the desire for power, failure of internal controls and ineffective broads. In the light of these scandals, there has been a significant global pressure to develop the principles of corporate governance throughout new codes of best practice and legislation. ( Hamilton & Micklethwait, 2006)

In 2002 after the Enron scandal, which was proved to be the largest corporation bankruptcy in the American history, the US Congress introduced the Sarbanes-Oxley Act (SOX) to increase the accountability of auditing firms. Specifically the Act has four main recommendations about: the implementation of internal controls, the strengthening of the role of the audit committee, the independence of non executive directors and the requirement that directors explicitly recognise their responsibility for the company's financial statements. ( Hamilton & Micklethwait, 2006) Moreover in the UK companies on the Main Market of the London Stock Exchange are required under the Listing Rules to report if they have applied the main principles of the Combined Code in their annual reports, statements and accounts. (


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To sum up the Combined Code of best practice over the past twenty years gave a significant assistance to improve corporate governance, through a number of reviews, reports and some legislation, as a reply to the spectacular corporate failures. To be more specific the Combined Code made recommendations so as to improve the governance in the organisations and to not repeat the endings of Enron, Parmalat, Barings Bank, WorldCom, Swissair etc.

Apart from this the agency theory is regarded as problem-solving theory in the principal-agent conflicts of interest, such as the competition between managers and shareholders. In detail managers anticipate to maximize their utility against shareholders. Otherwise shareholders seek to invest in projects with higher risk with higher yields.

In addition the reasons for the corporate scandals were the result of poor internal control and corporate governance in the management of the organisations. In order to overcome the series of failures firstly the US establish the SOX to increase the accountability of auditing firms and secondly the UK enforce the companies apply the main principles of the Combined Code in their annual reports, statements and accounts.