Corporate Government & Accountability. Discuss why the Cadbury Report forms the backbone of Corporate Governance still today?

Failures of Corporate Governance

However, recent board of directors that fail to guarantee a sound governance model is in place and effectively invites that failure of corporate governance it oversees. Audit committees fail to take responsibility and accountability for audit and accounting functions. Many large organizations have failed in corporate governance practices like Enron, Parmalat, WorldCom, Maxwell Communication and etc. It has been stated that “the problem is not a failure to comply with rules but a failure in governance practice”. The various reason of failure in corporate governance likes the various mechanisms of corporate governance, factors of ownership structure, financial structure, structure of board of directors and etc.

Corporate fraud is very much a core management issues need most fraud is committed by employees. Public awakes about corporate governance failures that are the result of fraud, theft, and unethical behaviors. Public seem to accept corporate governance failures if that are the result of poor decisions or judgments. Many have argues that major failures of corporate governance have been the problems of board culture, weak of CEO, conflict of interest exist and lack of transparency. Most importantly poor information, poor planning and poor

decision-making are often cause of failures in corporate governance. Poor planning and decision-making will lead to a serious breakdown of strategic direction of the company.

        Lack of transparency in financial statement and information can result in mislead public trust and confidence. In the cases of Enron, auditors’ failure to fulfill their professional responsibility to report proper financial statement and audit functions. Some companies have the intentions to hide relevant information about their performance; this make it difficult to investors recognize warning signals that the companies might actually facing financial problems. Also, most of the information comes from top management team, that is, investors can not assume that all information be published are neutral and have not been massaged.    

Failures in Major Companies

        Corporate collapse and failure of corporate governance can happen even in the strongest company. Enron was the world’s leading energy company and the 7th largest company in United Stated. The downfall of Enron had infecting and worrying every shareholding institution and company. The first sign of distress in 1997, Enron wrote off $537 million to settle a contract dispute. Operations in Enron were expanding too far; yet too little success in penetrating the market. Management of Enron appeared to mislead the market by generating financial stability. Fact is, Enron used to hide the company’s liabilities of making the financial statement look much better than they really are (The Economist, 2 May 2002).

        Both board of directors and audit committees allowed fraudulent corporate activities and unethical behaviors happening within the organizations. Conflict of interest in the audit committee, where company’s auditors are replaced and appointment by company bosses. The auditors made no aware in disclosure of financial transactions example, a joint venture with Blockbuster Video that never materialized (The Economist, 7 February 2002). Parmalat, an Italian company business in long-life milk, the company began to expand their business into 30 countries and employing 36,000 people (Tran and Jay, 2004). Further investigations found that $3.9 billion of company’s funds did not exit. A lawsuit later is filed to against Deloittee  Touche Tohmatsu and Grant Thornton international in order to recover funds (Moher 2004). Addition, there were no separate position in chairman and chief executive, both position were

held by Tanzi in Parmalat. The structures within the company’s framework were not compliance where fraud and misdoing were in place.

        When WorldCom filed for bankruptcy on July 22, 2002, its stock became virtually worthless which was once worth more than $180 billion at that time (Dennis R., Nicholas deB, Rogers, Jr., 2003). WorldCom started as a small long-distance carrier in 1984 later expand to the nation’s second largest company in the United stated. WordlCom utilized several accounting treatments such as improper recording of transactions from the reserved accruals to revenue to serve increases of business earnings. The effect of these accounting treatments was to give a picture of growing company and steadily rising income. However, in 2001, it became evident that WorldCom did not meet its expected earning target despite its dysfunctional operations.  

        In the Maxwell affair 1991, failing of auditors, and the regulatory bodies were all recognized. The audit function did not perform effectively i.e. pension fund trustees failed to examine financial activities in sufficient details. Another major problem found in corporate governance was lack of segregation of positions of power where Robert Maxwell held both positions of chief executive and chairman. The non-executive directors suppose to give the company aura respectability, and perform an independent function. However, the non- executive directors were lack of transparency in reporting financial activities to alert shareholder.

Conclusions

        Weaknesses found in Enron, WorldCom, and Maxwell was the ethics’ of individuals as a whole examples poor moral character of directors and lack of accountability generally within organizations. Corporate governance is about ethical conduct in business. No matter how many mechanisms are in place, to ensure that companies are run in an accountable manner, people at the top can act unethically. Furthermore, ethical dilemmas arise from conflicting interests of the parties involved. In this regard, board members should make decisions based on a set of principles influenced by the values, context and culture of the organization.        

        Good corporate governance ethics is quite possible to arriving the best possible financial results and business results. Ethics is concerned with the code of values and principles that enables a person to choose between right and wrong, and select from alternative courses of action. Ethical leadership is good for business as the organization is seen to conduct its business in line with the expectations of all stakeholders. What constitutes good Corporate Governance will evolve with the changing circumstances of a company and must be tailored to meet these circumstances. There is therefore no one single model of Corporate Governance. However, the Cadbury Report have formed of corporate governance in many areas of development of good governance practices across UK and globally.

QUESTION 2

Discuss why the Cadbury Report forms the backbone of Corporate Governance till today? (10 Marks)

Introduce to Cadbury Report

The Cadbury committee was established in 1991 by the London Stock Exchange, the Financial Reporting Council, and the accountancy profession, which were concerned at the lack of confidence in financial reporting. Set up by the Committee on the Financial Aspects of Corporate Governance and was chaired by Sir Adrian, the report became widely known as the Cadbury Report in December 1992. The recommendations in Cadbury Report covered wide rang of the operations of the main board, board committees and the importance of financial reporting control mechanisms within the organizations. The Cadbury Cod Report recommended a Code of Best Practice. The beginning of corporate governance Codes of Best Practice around the world in most companies after various financial scandals and collapse: - Coloroll, Polly Peck, Maxwell and etc.

Under the Cadbury report, organizations having a firm belief in build a strong broad statutory framework, self-regulation, and the way to provide the necessary protection for investors and community at the large. Cadbury aimed to put forward practical way of transparency of financial reporting and balance composition for good internal control. For example, increasing disclosure is to maintain public trust and be a key part of raising corporate governance standards. Cadbury Report also emphasised that no individual could gain ‘unfettered’ control of the decision-making process and should be a clear division of responsibility at the top of the company, ensuring balance of power. That is, Cadbury Report gives the aspect of separation role of CEO, and chairman; regulations of non-executive directors and so on.

Code of Best Practice

The Cadbury Report (1992) simply describes Corporate Governance as ‘the system by which companies are directed and controlled’. So far as corporate governance is concerned, it is financial integrity that assumes tremendous importance. This would mean that the directors and all concerned should be open and straight forthright about issues where there is conflict of interest involved in financial decision making. When it comes to even the purchase and procurement procedures, there is need for greater transparency. Furthermore, the Cadbury report recommended a Code of Best Practice with where the board of all listed company registered in the UK. The Code of Best Practices is to underlay the principles of openness, integrity, and accountability. Furthermore, a Code of Best Practice is underlying in the areas of the board of directors, non-executive and executive directors and reporting and controls. The codes also practice under most of all listed companies registered in UK. Importantly, the company should comply with the code to establish an audit committee and ensure the objective and professional relationship is maintained; disclosure of detailed information and etc.    

The Code of Best Practice in Cadbury Report has a fundamental impact on corporate governance in the UK. Under the Code of Best Practice, the board requests to meet regularly make decision for management and control within the organizations. In the meeting, the board should reserve matters especially in the direction and control of the company is. The board shall review effectiveness of internal control over financial and operation. In addition, the board should have non-executive, company secretary, directors and all board members have the fiduciary duty to maintain their independence and discipline for good performance. With that, the directors should access to the advices and services of the company secretary and other independent professionals if necessary. Non-executive directors should bring an independent judgment to bear on issues related to standards of conduct. Generally speaking, they have a duty to the company to perform their oversight functions in good faith and represent the best interest of the company. Their appointment should be appointed in specified term and should not be automatic. Their appointment must select through a formal process. Apart of non-executive directors, every executive director should not exceed three

years without the approval by the shareholders. In addition to full disclosure of directors’ total emoluments including pension contributions and stock options, and their given salary is on performances basis.

The boards have the duty to present a balanced and understandable assessment of the company’s position. The boards need to maintain that an objective and professional relationship with the auditors. An audit committee composed of at least three independent directors should be formed to implement and support the oversight functions of the board, especially in areas related to internal controls, risk management, financial reporting, and audit activities. The directors should perform responsibility for reporting the accounts and the effectiveness of the company’s internal control. That way, the boards of director are responsible for the company’s business affairs and make decisions on behalf of the shareholders.  

Combine Code

The Combined Code was first reported in 1998, which drew together the recommendations of the Cadbury, Greenbury, and Hampel reports. The Combined Code operates on “comply or explain” basis, which means the company expected to comply with the provisions of the Combine Code; if unable to comply, then company must explain why it is unable to comply. The revised of Combined Code was developed in 2003, 2006, 2008 and 2009. The changes made by the London Stock Exchange, which have contained both detailed principles and code provisions.  The revised of Combined Code cover all controls, including financial, operational, and compliance controls as well as risk management from previous code. In addition to the Combined code has had a greater impact on most organizations where codes of governance are emerging.

The revised Combined Codes give clear guidance on appointment, development, performance evaluation and re-election of board members. In Combined Code, it states that the board should maintain a sound system of internal control to safeguard shareholders, investment and company assets.  The Combined Code also clarified the roles of chairman in providing leadership to non-executive directors, communicating shareholders views to the board. Adding to the role of chairman and CEO should not be exercised by the same

individual otherwise there would be too much power vested in one individual. The board should establish remuneration committees of at least three, who shall all in independent director. The remuneration committees will make recommendations to the boards on the company’s framework of executive remuneration and its cost i.e. remuneration level should look at both performance and remuneration in other companies. The establishment of a remuneration committee is to prevent executive directors from setting their own remuneration levels.

        The audit committee is arguable the most important of the board sub-committees. Both audit committee and remuneration committee should be formed, and also stated that a nomination committee would be one possible way to make the board appointment process more transparent. The Combined Code stated that at least three, in case of small company, two members who should all be independent non-executive directors in the audit committees. The role of audit committee to review the scope and outcome of the audit, and ensure the objectivity of the auditors is maintained.

Conclusion

The UK Cadbury Report was produced in response to company collapses and particularly by the domination of boards by powerful individuals. The Cadbury Report has formed the backbone of the development of corporate governance in many countries; the Code of Best Practices have played a major role around the world. Many have argued that single model of corporate governance is not suitable for all countries. However, many countries have subsequently adopted the Cadbury Report to form of corporate governance guidelines, recommendations, and principlles. Mostly, the Combined Code set out standards of good practice on matters such as board composition, director remuneration, independent committee and etc. The board is accountable to the company’s shareholders. Most of the listed companies in UK are now required to report on how they have applied the principles in the Combined Code in their annual report to shareholders. As result, the Cadbury Report form and restore shareholders confidence in companies, generally significantly strengthen corporate governance structures and good practices.

References

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