This supports the case towards entity theory as the events that took place were only allowed to happen as a result of Robert Maxwell taking a propriety view upon running his businesses. His reckless action brought about the introduction of the Cadbury report in an attempt to prevent the same action occurring in the future.
The Cadbury Report
The Cadbury report was brought forward in 1992 through a report entitled the ‘the financial aspects of corporate governance’ through a committee chaired by Adrian Cadbury. The contents of the report was aimed at the internal control and accounting systems of the business to minimise the risk of corporate governance risk and failure. Since its introduction the report has been adopted throughout the EU, US, and other nations.
Suggestions brought forward by the Cadbury report was a greater involvement from non executive directors on board meeting and to maintain their independence when acting on decision brought forward within board meetings. The report also made reference to the selection process of non executive directors to ensure that their views were to the business as an entity as opposed to the shareholders. This process would involve non executive being granted access to the business strategies also indicating the businesses performance to make informed decisions on behave of the business.
The Cadbury report also gave rise to the combined code which outline a set of principles that all UK listed companies would have to abide by to provide a greater sense of the internal control working towards a more entity theory based structure.
The combined Code
The combined code is simply a set of principles which provide a code of conduct for companies listed upon the London Stock Exchange. The combined code is governed by the Final Services Authorities; who assign the task to the Financial Reporting Council. The emphasis behind the code is a ‘comply or explain’ principle where companies must state in their final accounts where they have complied with the code; and explain to investors with just cause where and why they haven’t. For limited companies this process while advised remains optional.
The contents of the combined code follows the approach pioneered by the entity theory in stating that the actions of management should be centred around the survival of the entity and not towards the expectations of the investors. To achieve this; the combined code looks toward non executive directors to deter the first signs of board room corruption through increased presence within board meetings. It also points towards auditors to make sure that the internal control system of the business can prevent the misrepresentation of accounts and provide increase transparency with greater representation of the business performance towards auditors.
The combined code also looks towards ideas for the shareholders on improving the long term objectives of the business in order to work together with directors on the behalf of the business which also points towards the effect of entity theory on modern corporate governance. Issues regarding the appointment of the chairman stated in the combine code require that the chairman should meet certain independence criteria at the time of their appointment. It is also recommended in the combined code that the division of responsibilities between the chairman and CEO be clearly established, set out in writing and agreed by the board. These are measure taken toward corporate governance that look to ensure that the chairman of these companies act within the interest of the companies and are free of any biased opinion towards the way it should be ran. .
Turnbull Report
The Turnbull report (1999) ’Internal Control: Guidance for directors on the Combined Code’; ensures that the contents of the combined code are enforced by public limited companies on the London Stock Exchange. The name derives from Nigel Turnbull of the Turnbull committee; which was established by the Institute of Chartered Accountants in England and Wales (ICAEW). The contents of this report reminded directors of their obligations to keeping good ‘internal control’ through addressing the issue within the company’s final report. It report also included the safeguarding of company assets from improper use including the possibility of loss or fraud; while also ensuring that the liabilities are managed correctly. It also stated the importance of good audits to minimise the treat of corporate fraud. These address the points raised in the Cadbury report of having an internal structure within businesses that limited the possibility of fraud through the appointment of more independent management; who would operate in the best interest of the company.
Enron Scandal
In this instance Enron’s chairperson created ghost subsidiaries through friends and families to offload the bad debts of Enron towards these subsidiaries in order to manipulate the true financial performance of the firm. As a result management of these ghost subsidiaries where run by Enron personnel instead of acting on its separate plans towards ensuring its own survival.
This in turn led to one of the biggest corporate frauds in history as Enron filed for bankruptcy in December 2001. Imposing repercussions on US accounting standards towards a more globally accepted frame of accounting principles.
WorldCom
Similarly in the WorldCom scandal of 2002, through substantial growth made by the company through numerous acquisitions purchased through the company’s stock; the company experience a downturn which one major shareholder and CEO of WorldCom Bernard Ebbers would benefit from. He accomplished this by convincing the directors’ of the company to give him $400million in exchange for not selling his stock within the company. The board agreed to this to prevent a subsequent fall in share price but this plan would later prove insufficient; resulting in the removal of Ebbers from his CEO responsibilities although inevitably the company would file for bankruptcy in 2002.
This turn of events arose as a result of Ebbers being put under increasing pressure by banks over the underperformance of his private business ventures. Similarly to Robert Maxwell; Bernard Ebbers’s actions influenced the downfall of a major corporation due his dual interests overshadowing his responsibility at WorldCom to act in the interest of the company.
Higgs Report
The Higgs report was a report chaired by Derek Higgs in 2003 acted towards corporate governance commissioned by the UK government. The purpose of the Higgs report was to compliment the combined code by recommending stating the amount of board meeting within the annual reports as well as suggesting that non executive directors should meet once a year without the directors being present.
Its main issue was to drive the responsibility of non executive directors within companies to impose a greater presence on towards their respective companies to reduce the possibility of fraud. It also focused again on the responsibility of audit teams to ensure that the financial book of listed companies showed a true and fair view of the company’s performance. The Higgs report was written in response to address the issues that assisted the fall of Enron and WorldCom.
The Higgs report sought to provide a more stringent approach by placing greater restriction on the way that companies would adhere to the rules of the combined code by placing greater emphasis on the comply or explain principle set about by the combined code itself.
Higgs himself believed that had the Cadbury report been in force prior to the Robert Maxwell scandal then evidence of his going on would have been discovered at a much earlier date and as such would have been discovered before more damage would have been done.
The Sarbanes-Oxley
The Sarbanes-Oxley act looked towards ensuring greater financial transparency within companies listed on the New York Stock Exchange to ensure a greater degree of responsibility toward the entity. The increased rule implemented with the act deterred main non US listed companies to enlist in other stock exchanges; most notability the London Stock Exchange.
Smith Report
The Smith report was introduced in 2003; primarily following the wake of the Enron and Arthur Anderson scandals in the US. It states how auditors should address issues regarding the structure of the companies they audit in order to ensure that the shareholders or directors are not in any way having an adverse effect on the company which could lead to fraudulent actions as seen in the afore mentioned scandals. Since the Smith report has been included as part of the combined code; particularly through the listing rule for the London Stock Exchange.
Conclusion
All of these events have been brought about to comply with the entity theory set out by Paton in the 1920s. They look to achieve a greater sense of independence through the board room towards improving the internal control structure of the entity to ensure that the assets, liabilities and interest of the entity are protected from those that seek to infringe upon it, thus committing fraud.
Word Count: 1,992
References
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Journal – J Unerman, BO’Dwyer; Enron, WorldCom, Andersen et al: A Challenge to Modernity, 2004 - Elsevier
