Chapter 4 Governance Context

Corporate governance (CG) “Way businesses are structured and controlled” CG varies across national boundaries: cultural reasons social contexts historical reasons commercial focus CG regime impacts nature of accounting Strong shareholding culture will require strong reporting culture Importance reasserted by recent frauds etc. Chapter 4 © Philip O’Regan 2016

Corporate governance in UK Anglo-American CG model common to English-speaking world Characterized by: gulf between owners and managers board of directors Stock Exchange as major source of finance Financial accounts seen as one means of bridging gulf between directors and owners Chapter 4 © Philip O’Regan 2016

Best practice Frauds and Financial Crisis have led to model being questioned Flaws: too rigid open to abuse too focused on rights of investors Accounting bodies, government proactive Various reports address different aspects Best practice reports and codes Chapter 4 © Philip O’Regan 2016

Cadbury Report Commissioned by FRC, Stock Exchange, etc. Chaired by Sir Adrian Cadbury Reviewed CG with specific reference to: responsibilities of directors nature of accounting information required audit committees relationship between owners, boards and auditors, etc. Championed “comply or explain” culture Chapter 4 © Philip O’Regan 2016

Cadbury recommendations Board importance of efficient, diverse board separate CEO and Chairman Executive Directors service contracts to be limited to 3 years disclosure of remuneration Non-Executive Directors greater role independence important Chapter 4 © Philip O’Regan 2016

Cadbury recommendations ctd. Reporting and controls responsibility of board in relation to accounts importance of supplementary narrative information Audit Committee critical role in liaising with auditor should comprise of three non-executive directors has emerged as critical element of CG regime Chapter 4 © Philip O’Regan 2016

Greenbury Code CBI formed group to produce code in relation to directors’ remuneration Chaired by Sir Richard Greenbury Recommendations in respect of: remuneration committee disclosure provisions remuneration policy service contracts and compensation Directors’ remuneration still source of controversy Chapter 4 © Philip O’Regan 2016

Hampel Report Group formed to continue work of Cadbury Chaired by Sir Ronald Hampel Reiterated much of Cadbury and Greenbury Important in maintaining momentum Recommendations include: Different individuals as Chairman and CEO Directors’ contracts not to exceed one year Non-executives on remuneration committee Training of directors Chapter 4 © Philip O’Regan 2016

Turnbull Report ICAEW set up group to pursue Cadbury ideas on internal control and risk Chaired by Sir Nigel Turnbull Assigns a strategic importance to control and risk in context of CG Shows directors how these areas are to be integrated into CG model In future may be seen as seminal report Chapter 4 © Philip O’Regan 2016

Turnbull Report ctd. Focus on principles rather than rules Emphasis on: successful risk management adding value internal control only possible if embedded in internal processes role of board in reviewing and implementing key risks to be identified and managed Chapter 4 © Philip O’Regan 2016

Higgs Focus on Non-Executive Directors (NEDs) Reflects increasingly important role: independent diverse strategy, control and governance roles Higgs Report (2003) recommended: NEDs to comprise at least 50% of board Separation of CEO and Chairman roles Ideally NEDs might serve two three-year terms Commended for avoiding excesses of SOX Chapter 4 © Philip O’Regan 2016

Smith Reflected increased importance of Audit Committee Now seen as vital element of CG architecture Recommended that Audit Committee: Be comprised of at least three independent NEDs One member to have significant, recent and relevant financial experience Monitor and review integrity of financial statements, controls, etc. Chapter 4 © Philip O’Regan 2016

Combined code Cadbury, Greenbury and Hampel formed basis of original Combined Code adopted by LSE Supplemented by Turnbull, Higgs and Smith Code based on “comply or explain” approach different from US essentially “principles-based” Significantly impacts company disclosure, e.g. in Annual Report FRC issues CG code Chapter 4 © Philip O’Regan 2016

Total Shareholder Value (TSV) Prioritizes shareholder agenda Emphasis on shareholder wealth (share price + dividends) Criticised as: Limited in perspective Short-term focus Open to abuse Key player in Global Financial Crisis Chapter 4 © Philip O’Regan 2016

Stakeholder theory Looks beyond investors and their needs Recognizes a broader constituency, e.g.: employees environmentalists others Challenges primacy of financial markets Champions greater transparency and accountability Potential for radical reform of CG model Chapter 4 © Philip O’Regan 2016

Summary CG a critical influence on nature, content and focus of the accounting process CG regime in UK part of Anglo-American scheme Characterized by investor emphasis Frauds, scandals were catalysts for change Cadbury, Greenbury, Hampel, Turnbull, Higgs and Smith “Comply or explain” UK now world-leader in “best practice” Chapter 4 © Philip O’Regan 2016