Chapter 4 Governance Context

Financial Information Analysis Corporate Governance ‘Way businesses 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. Copyright 2006 John Wiley & Sons Ltd Financial Information Analysis

Corporate Governance in UK Anglo/American CG model common to English-speaking world Characterised by: gulf between directors and owners board of directors stock exchange as major source of finance Financial accounts seen as one means of bridging gulf between directors and owners Copyright 2006 John Wiley & Sons Ltd Financial Information Analysis

Financial Information Analysis Best Practice Frauds have led to model being questioned Flaws: too rigid open to abuse too focused on rights of investors Accounting bodies, government have been proactive Various reports address different aspects Best Practice reports and codes Copyright 2006 John Wiley & Sons Ltd Financial Information Analysis

Financial Information Analysis 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. Copyright 2006 John Wiley & Sons Ltd Financial Information Analysis

Cadbury recommendations Board: importance of efficient board emphasised separate CEO and Chairman Executive Directors service contracts to be limited to 3 years disclosure of remuneration Non-Executive Directors greater role independence important Copyright 2006 John Wiley & Sons Ltd Financial Information Analysis

Cadbury recommendations ctd. Reporting and Controls: responsibility of board in relation to accounts importance of supplementary narrative info. Audit Committee critical role in liaising with auditor should comprise of 3 non-executive directors has emerged as critical element of CG regime Copyright 2006 John Wiley & Sons Ltd Financial Information Analysis

Financial Information Analysis Greenbury Report 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 Copyright 2006 John Wiley & Sons Ltd Financial Information Analysis

Financial Information Analysis Hampel Report Group formed to continue work of Cadbury Chaired by Sir Ronald Hampel Reiterated much of Cadbury & Greenbury Important in maintaining momentum Recommendations: different individuals as Chairman and CEO directors contracts not to exceed 1 year non-executives on remuneration committee training of directors Copyright 2006 John Wiley & Sons Ltd Financial Information Analysis

Financial Information Analysis Turnbull Report ICAEW set up group to pursue Cadbury ideas on internal control & risk Chaired by Sir Nigel Turnbull Assigns a strategic importance to these areas in context of CG Shows directors how these areas are to be integrated into CG model In future may be seen as seminal report Copyright 2006 John Wiley & Sons Ltd Financial Information Analysis

Turnbull Report (Continued). Focus on principles rather than rules Emphasis on: successful risk management as means of 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 Copyright 2006 John Wiley & Sons Ltd Financial Information Analysis

Financial Information Analysis Higgs Focus on Non-Executive Directors (NEDs) Reflects increasingly important role: Independent 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 perceived excesses of SOX Copyright 2006 John Wiley & Sons Ltd Financial Information Analysis

Financial Information Analysis Smith Reflected increased importance of Audit Committee Now seen as vital element of CG architecture Recommended that Audit Committee: Be comprised of at least 3 independent NEDs One member to have financial experience Monitor and review integrity of financial statements, controls, etc. Copyright 2006 John Wiley & Sons Ltd Financial Information Analysis

Financial Information Analysis Combined Code Cadbury, Greenbury and Hampel formed basis of original Combined Code adopted by SE Supplemented by Turnbull, Higgs and Smith Code based on “Comply or Explain” approach Different to US Essentially ‘principles-based’ Significantly impacts company disclosure, e.g. in Annual Report Copyright 2006 John Wiley & Sons Ltd Financial Information Analysis

Financial Information Analysis Stakeholder theory Looks beyond investors and their needs Recognises 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 Copyright 2006 John Wiley & Sons Ltd Financial Information Analysis

Financial Information Analysis Summary CG a critical influence on nature, content and focus of the accounting process CG regime in UK part of Anglo-American scheme Characterised by investor emphasis Frauds, scandals were catalysts for change Cadbury, Greenbury, Hampel, Turnbull, Higgs & Smith “Comply or Explain” UK now world-leader in ‘best practice’ Copyright 2006 John Wiley & Sons Ltd Financial Information Analysis