To date, Corporate Governance reforms have relied heavily on non-executive directors and institutional investors as enforcers of good corporate practice - These mechanisms are inadequate for effective corporate governance and more will be required - Do yo

Greenbury and Hampel  Report

The Greenbury report was the first public report on corporate governance since the Cadbury committee but had a single remit which was to look at the composition and reporting of director’s remunerations, after fears amongst large city corporations of overpaying their directors. It failed to mention exactly what directors should be paid but looked at what measures should be taken to avoid excessive pay. It used the Cadbury report in recommending the use of non-executive directors but suggested that they should compose the entire remuneration committee.

        The Hampel report described its task as ‘reviewing the substance and implementation of the Cadbury code.’ It for the first time stated the role and impact that non-executive directors could have by describing them as the ‘link between managers and shareholders.’  It also took the independence of shareholders further by introducing the concept of the ‘independent non-executive director’. This introduced a formal title of non-executive director that had the characteristics of the Cadbury code of independence. There was also a suggestion that there should be a senior independent director who should be available to have concerns expressed to him by shareholders. The Hampel report also gave more substance to the Cadbury report of having a balanced board of ‘sufficient weight and calibre’ by suggesting that non-executive directors should make up at least a third of the board. As regards to the use of non-executive directors on audit, remuneration and nomination committees. Hampel recommended the use of nomination committees, which differed, from Cadbury, which merely endorsed them. It also endorsed the use of audit committees and remuneration committees in line with Cadbury and Greenbury respectively. However, while greenbury suggested that the remuneration committee should decide executive remuneration, hampel suggested that remuneration should be the decision of the board as a whole on the advice of the remuneration committee. Similarly, the remuneration of non-executive directors should be for the board as a whole. Hampel took further the role of institutional investors in corporate governance where Cadbury merely suggested that it should be left to the institutes themselves to decide to what extent they want to get involved. Hampel included in its code that institutes ‘have a responsibility to make considered use of their votes.’ And that institutes should always be willing to talk with directors over any concerns. This accounts to pushing the institutes to become actively involved in corporate governance. Hampel mentioned ways to strengthen the AGM. This involved votes on each issue, the counting of all proxy votes and having the chairman of nomination, remuneration and audit committees to answer questions at the AGM although these issues weren’t mentioned in the final Hampel code. Having the chairman of the committees at the AGM along with the other recommendation of the AGM being a tool to ‘communicate with private investors’ suggests that Hampel wanted private investors to take a more active role in corporate governance rather than just rely on institutional investors.  

Higgs Report

The question as to whether the latest corporate governance report by a committee chaired by Derek Higgs looked further at non-executive directors can be answered by its title of ‘review of the role and effectiveness of non-executive directors.’ Higgs finally expressed what exactly the role of non-executive directors should be. In its code it stated that they should ‘challenge and contribute to development of strategy’ while stating they have a role in monitoring aspects of the company and scrutinizing the performance of management. Higgs also took further the independence characteristics of non-executive directors with wide ranging criteria before deeming a non-executive director to be classed as independent. This now included that non-executives have no past working experience with the company and even no links with any senior employees. There was also again extension of the composition of the board with a recommendation that now independent non-executives make up at least half the board.  Non-executives also have a role in attending regular meetings with investors, which seems to come as a response to non-executives being the link between managers and shareholders. There was however no other other mention of exactly how this will be achieved. Higgs primary focus was on non-executive directors and hardly any new considerations were given to institutional investors with the main recommendations focusing on non-executive directors and their role in scrutinizing corporate governance matters.

Did they rely exclusively on these concepts?

Although so far is seems that reforms on corporate governance have focused mainly on non-executive directors and at times institutional investors, many other recommendations were made. Other recommendations include dividing the responsibilities of the chairman and the chief executive officer. The chairman is responsible for the leadership of the board while the CEO has the task of leading the company and primarily setting long-term strategy. Cadbury maintained that there should be a division between these responsibilities as did hampel but also stated that if these powers were invested in the same person, then the reasons for this should be clearly explained and there should be another senior independent element on the board, which would be the senior independent director. Higgs states outright that there should be a total split of the chairman and CEO roles with no compromise. The reforms rely generally on principles that companies should comply with. These include directors having access to all information and the board maintaining ‘effective control over the company.’ There has also be an emphasis on boards becoming more open about their activities. These include having to report on the effectiveness of internal control, providing an assessment of the companies financial position, having regular internal audits and generally giving shareholders access to more information with statements of how directors are carrying out their roles and areas where they aren’t performing quite up to standard.

        Generally, the focus has been on non-executive directors to maintain the heart of corporate governance and this is especially true since the Higgs report has been published as it gives light into the fact that non-executive can provide a link between shareholders and the company. With regards to institutional investors, which although were mentioned widely in the reforms, no light has been shed on exactly what  their role is in maintaining effective corporate governance. The reforms have focused mainly on how the company can strengthen relations with institutes. As previously stated, the main spirit of the reforms has been to give general principles which companies should follow to allow them to become more open and accountable to shareholders which is what the concept of effective corporate governance is looking to achieve.

Are these reforms adequate?

The question that needs to be addressed is whether these reforms will have any effect on corporate governance? Surveys show that in the period after the London stock exchange merged the Cadbury, Greenbury and Hampel reports into a single code, nearly all FTSE 100 companies showed a 100% compliance with the code. To comply with the codes, then companies must report whether they have replied with the code or not. Even if they haven’t complied strictly with the code, then they can still comply if they state areas where they haven’t complied and reasons why.

Does this suggest that companies may have poor corporate governance records but can still appear to be governed properly by stating reasons why they haven’t complied which may seem quite legitimate? This leads to another question of how we can determuine effective corportate governance? Is it fair to say that a company complying  with a greater proportion of the code is more effectively governed? This is a difficult concept as corporate governance is an abstract matter and it is almost impossible to determine just what is an effectively governed company. The general consensus is that shareholders are willing to pay a premium for shares in a well governed company so perhaps the notion of what is a well governed company is up to the individual.         

There are also arguments that the codes are becoming too rule based and this is especially true since the Higgs report has been published.The codes and requirements of them may be complied with but the general principles behind them may still be weak. e.g. non-executive directors may fill all the criteria of them in the code but what is to say that they will carry out their supervisory roles appropriately. There have been criticisms that because of the high requirements for a non-executive director to be deemed independent then there might not be a sufficient number of effective candidates to carry out the role. This may cause small companies even more problems, as the costs associated with appointing the extra non-executive directors to comply with the code may be too high. Does this then mean that these companies are governed ineffectively?

        Problems may also arise with regards institutional investors. The codes clearly state that these institutes should use their votes and take an interest in corporate governance matters. However, these institutes control an overwhelming number of shares in many hundreds of  different companies. They will also be a high turnover of shares as they seek to maximise the capital gains returns for their clients. Do they really have the time to take an active interest in corporate governance matters of all the companies they have shares in?

Conclusion

The reforms so far have relied primarily on non-executive directors and have tried to persuade institutes to become more involved in corporate governance. The codes are primarily principle based but there is a general shifts to more rules since the Higgs report was published. Compliance is up to the companies and the only real incentive to comply is that they may be perceived unfavourably. The problem with relying on just a few individuals or institutes is that as Enron in the US has shown, they can be manipulated. Enron’s activities, which were carried out with its auditor, sent shockwaves through American and world stock markets. A number of leading investment banks such as JP Morgan Chase have come under inquiry as to their dealings with Enron as have some major political figures. Even though events like these are rare it shows that if institutes and individuals want to manipulate they can. The US response was to publish the Sarbanes-Oxley act introducing tough new penalties for companies with up to 20 years imprisonment for directors. Perhaps this is what is needed in the UK with a regulator equivalent to the Securities and Exchange Commission to oversee corporate governance in the UK with powers to punish those that are ineffectively governed if this could be deemed. Another response could be to encourage companies to become more socially responsible by developing stakeholder relationships. This may cause problems with the primary relationship that managers should put shareholders first. There are arguments that long term shareholder value can only be achieved through short term stakeholder relationships. Perhaps this together with the introduction of penalties perhaps contained in legislation holds the key to better corporate governance in the future.

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