The growth in corporate governance codes

During the last decade, each year has seen the introduction, or revision, of a
corporate governance code in a number of countries. These countries have
encompassed a variety of legal backgrounds (for example, common law in the UK,
civil law in, France), cultural and political contexts (for example, democracy in
Australia, communism in China), business forms (for example, public corporations
compared to family-owned firms), and share ownership (institutional investor-
dominated in the UK and USA, state ownership in China). However, in each of the
countries, the introduction of corporate governance codes has generally been
motivated by a desire for more transparency and accountability, and a desire to
increase investor confidence (of both potential and existing investors) in the stock
market as a whole. The development of the codes has often been driven by a
financial scandal, corporate collapse, or similar crisis.
The corporate governance codes and guidelines have been issued by a variety of
bodies ranging from committees (appointed by government departments and
usually including prominent respected figures from business and industry,
representatives from the investment community, representatives from professional
bodies, and academics), through to stock exchange bodies, various investor
representative groups, and professional bodies such as those representing directors
or company secretaries.
As regards compliance with the various codes, compliance is generally on a
voluntary disclosure basis, whilst some codes (such as the Uk Corporate
Governance Code (2010)) are on a 'comply or explain basis’: that is,either a
company has to comply fully with the code and state that it has done so; or it
explains why it has not.
In this chapter, the development of corporate governance in the UK is covered in
some detail, particularly in relation to the Cadbury Report (1992), which has
influenced the development of many corporate governance codes globally.
Similarly, the Organisation for Economic Co-operation and Development (OECD)
Principles are reviewed in detail as these have also formed the cornerstone of many
corporate governance codes. The impact of various other international
organizations on corporate governance developments, including the World Bank,
Global Corporate Governance Forum (GCGF), International Corporate
Governance Network (ICGN), and Commonwealth Association for Corporate
Governance (CACG), are discussed. Recent developments in the EU, which have
implications both for existing and potential member countries' corporate
governance, are covered. There is also a brief overview of the Basle Committee
recommendations for corporate governance in banking organizations.
Corporate collapses in the USA have had a significant impact on confidence in
financial markets across the world and corporate governance developments in the
USA are discussed in some detail.
In addition, a section on the governance of non-governmental organizations
(NGOs), the public sector, non-profit organizations, and charities is included, as
there is an increased focus on the governance of these organizations. The adoption
of good governance should enable them to spend public money wisely and to
strengthen their position.
The impact of the global financial crisis has had ramifications for corporate
governance internationally, as countries seek to restore confidence in their
financial markets and, in particular, in banks and other financial institutions.
Corporate governance in the UK
The UK has a well-developed market with a diverse shareholder base, including
institutional investors, financial institutions, and individuals. The UK illustrates
well the problems that may be associated with the separation of the ownership and
control of corporations, and hence has many of the associated agency problems
discussed in Chapter 2. These agency problems, including misuse of corporate
assets by directors and a lack of effective control over, and accountability of,
directors' actions, contributed to a number of financial scandals in the UK.
As in other countries, the development of corporate governance in the UK was
initially driven by corporate collapses and financial scandals. The UK's Combined
Code (1998) embodied the findings of a trilogy of reports: the Cadbury Report
(1992), the Greenbury Report (1995), and the Hampel Report (1998). Brief
mention is made of each of these three at this point to set the context, whilst a
detailed review of the Cadbury Report (1992) is given subsequently in this chapter
because it has influenced the development of many codes across the world.
Reference is made to relevant sections of various codes in appropriate subsequent
chapters.
Figure 3.1 illustrates the development of corporate governance in the UK. The
centre oval represents the UK Corporate Governance Code, and the UK
Stewardship Code, both published in 2010 by the Financial Reporting Council
(FRC). Around the centre oval, we can see the various influences since 1998 (the
original Combined Code, published in 1998, encompassed the Cadbury,
Greenbury, and Hampel reports recommendations). These influences can be split
into four broad areas. First, there are reports that have looked at specific areas of
corporate governance:
 the Turnbull Report on internal controls;
 Myners Report on institutional investment;
 Higgs Review of the role and effectiveness of non-executive directors;
 Tyson Report on the recruitment and development of non-executive
directors
 the Smith Review of audit committees;
 the Davies Report on board diversity.
Secondly, there has been the influence of institutional, investors and their
representative groups; of particular note here is the work of the Institutional
Shareholders' Committee (ISC) as their statement on the responsibilities of
institutional shareholders formed the body of the first UK Stewardship Code
(2010). Thirdly, influences affecting the regulatory framework within which
corporate governance in the UK operates have included the UK company law,
review, the Walker Review for HM Treasury and the Financial Services Authority
Review. Fourthly, there have been what might be termed 'external influences' such
as the EU review of company law, the EU Corporate Governance Framework and
the US Sarbanes-Oxley Act. Each of these is now discussed in turn.

Cadbury Report (1992)

Following various financial scandals and collapses (Coloroll and Polly Peck, to
name but two) and a perceived general lack of confidence in the financial reporting
of many UK companies, the FRC, the London Stock Exchange, and the
accountancy profession established the Committee on the Financial Aspects of
Corporate Governance in May 1991. After the Committee was set up, the scandals
at Bank of Credit and Commerce International (BCCI) and Maxwell (which
respectively involved maintaining secret files for fraudulent purposes and using
secret loans to try to disguise financial collapse) occurred, and as a result, the
Committee interpreted its remit more widely and looked beyond the financial
aspects to corporate governance as a whole. The Committee was chaired by Sir
Adrian Cadbury and, when the Committee reported in December 1992, the report
became widely known as 'the Cadbury Report’.
The recommendations covered: the operation of the main board; the establishment,
composition, and operation of key board committees; the importance of, and
contribution that can be made by, non-executive directors; and the reporting and
control mechanisms of a business. The Cadbury Report recommended a Code of
Best Practice with which the boards of all listed companies registered in the UK
should comply, and utilized a 'comply or explain' mechanism. This mechanism
means that a company should comply with the code but, if it cannot comply with
any particular aspect of it, then it should explain why it is unable to do so. This
disclosure gives investors detailed information about any instances of non-
compliance and enables them to decide whether the company's non-compliance is
justified.
Greenbury Report (1995)
The Greenbury Committee was set up in response to concerns about both the size
of directors' remuneration packages, and their inconsistent and incomplete
disclosure in companies' annual reports. It made, in 1995, comprehensive
recommendations regarding disclosure of directors' remuneration packages. There
has been much discussion about how much disclosure there should be of directors'
remuneration and how useful detailed disclosures might be. Whilst the work of the
Greenbury Committee focused on the directors of public limited companies, it
hoped that both smaller listed companies and unlisted companies would find its
recommendations useful.
Central to the Greenbury Report recommendations were strengthening
accountability and enhancing the performance of directors. These two aims were to
be achieved by (i) the presence of a remuneration committee comprised of
independent non-executive directors who would report fully to the shareholders
each year about the company's executive remuneration policy, including full
disclosure of the elements in the remuneration of individual directors; and (ii) the
adoption of performance measures linking rewards to the performance of both the
company and individual directors, so that the interests of directors and
shareholders were more closely aligned.
Since that time (1995), disclosure of directors' remuneration has become quite
prolific in UK company accounts. The main elements of directors' remuneration
are considered further in Chapter 9.

Hampel Report (1998)

The Hampel Committee was set up in 1995 to review the implementation of the
Cadbury and Greenbury Committee recommendations. The Hampel Committee
reported in 1998. The Hampel Report said: 'We endorse the overwhelming
majority of the findings of the two earlier committees'. There has been much
discussion about the extent to which a company should consider the interests of
various stakeholders, such as employees, customers, suppliers, providers of credit,
the local community, etc, as well as the interests of its shareholders. The Hampel
Report stated that 'the directors as a board are responsible for relations with
stakeholders; but they are accountable to the shareholders' (emphasis in original).
However, the report does also state that 'directors can meet their legal duties to
shareholders, and can pursue the objective of long-term shareholder value
successfully, only by developing and sustaining these stakeholder relationships'.
The Hampel Report, like its precursors, also emphasized the important role that
institutional investors have to play in the companies in which they invest (investee
companies). It is highly desirable that companies and institutional investors engage
in dialogue and that institutional investors make considered use of their shares; in
other words, institutional investors should consider carefully the resolutions on
which they have a right to vote and reach a decision based on careful thought,
rather than engage in 'box ticking'.
Turnbull (1999)
The Turnbull Committee, chaired by Nigel Turnbull, was established by the
Institute of Chartered Accountants in England and Wales (ICAEW) to provide
guidance on the implementation of the internal control requirements of the
Combined Code. The Turnbull Report confirms that it is the responsibility of the
board of directors to ensure that the company has a sound system of internal
control, and that the controls are working as they should. The board should assess
the effectiveness of internal controls and report on them in the annual report. Of
course, a company is subject to new risks both from the outside environment and
as a result of decisions that the board makes about corporate strategy and
objectives. In the managing of risk, boards will need to take into account the
existing internal control system in the company and also whether any changes are
required to ensure that new risks are adequately and effectively managed.

Higgs (2003)
The Higgs Review, chaired by Derek Higgs, reported in January 2003 on the role
and effectiveness of non-executive directors. Higgs offered support for the
Combined Code whilst making some additional recommendations. These
recommendations included: stating the number of meetings of the board and its
main committees in the annual report, together with the attendance records of
individual directors; that a chief executive director should not also become
chairman of the same company; non-executive directors should meet as a group at
least once a year without executive directors being present, and the annual report
should indicate whether such meetings have occurred. Higgs also recommended
that chairmen and chief executives should consider implementing executive
development programmes to train and develop suitable individuals in their
companies for future director roles the board should inform shareholders as to why
they believe a certain individual should be appointed to a non-executive
directorship and how they may meet the requirements of the role, there should be a
comprehensive induction programme for new non-executive directors, and
resources should be available for ongoing development of directors; the
performance of the board, its committees and its individual members, should be
evaluated at least once a year, the annual report should state whether these reviews
are being held and how they are conducted. Higgs went on to recommend that a
full-time executive director should not hold more than one non-executive
directorship or become chairman of a major company, and that no one non-
executive director should sit on all three principal board committees (audit,
remuneration, nomination). There was substantial opposition to some of the
recommendations but they nonetheless helped to inform the Combined Code. Good
practice suggestions from the Higgs Report were published in 2006.
Following a recommendation in Chapter 10 of the Higgs Review, a group led by
Professor Laura Tyson, looked at how companies might utilize broader pools of
talent with varied skills and experience, and different perspectives to enhance
board effectiveness. The Tyson Report was published in 2003.
Smith (2003)
The Smith Review of audit committees, a group appointed by the FRC, reported in
January 2003. The review made clear the important role of the audit committee:
‘While all directors have a duty to act in the interests of the company, the audit
committee has a particular role, acting independently from the executive, to ensure
that the interests of shareholders are properly protected in relation to financial
reporting and internal control’ (para. 1.5). The review defined the audit
committee's role in terms of a high-level overview, it needs to satisfy itself that
there is an appropriate system of controls in place but it does not undertake the
monitoring itself.
Cadbury Report (1992)
The Cadbury Report recommended a Code of Best Practice with which the boards
of all listed companies registered in the UK should comply, and utilized a 'comply
or explain mechanism. Whilst the Code of Best Practice is aimed at the directors of
listed companies registered in the UK, the Committee also exhorted other
companies to try to meet its requirements. The main recommendations of the Code
are shown in Box 3.1.
The recommendations-covering the operation of the main board, the establishment
composition, and operation of key board committees; the importance of, and
contribution that can be made by, non-executive directors, and the reporting and
control mechanisms of a business-had a fundamental impact on the development of
corporate governance not just in the UK, but on the content of codes across the
world, amongst countries as diverse as India and Russia.
Today the recommendations of the Cadbury Report and subsequent UK reports on
corporate governance are embodied in the UK Corporate Governance Code.
Various sections of the Code are referred to in appropriate chapters and the full
text of the UK Corporate Governance Code (2010) is available for download from
the FRC website at: <http://www.frc.org: uk/documents/pagemanager/Corporate
Governance/UK%20Corp%20Gov%20Code%20 June%202010.pdf>
Box 3.1. The Code of Best Practice
1.The Board of Directors
1.1 The board should meet regularly, retain full and effective control over the
company, and monitor the executive management.
1.2 There should be a clearly accepted division of responsibilities at the head of a
company, which will ensure a balance of power and authority, such that no one
individual has unfettered powers of decision. Where the chairman is also the chief
executive, it is essential that there should be a strong and independent element on
the board, with a recognized senior member.
1.3 The board should include non-executive directors of sufficient calibre and
number for their views to carry significant weight in the board's decisions.
1.4 The board should have a formal schedule of matters specifically reserved to it
for decision to ensure that the direction and control of the company is firmly in its
hands.
1.5 There should be an agreed procedure for directors in the furtherance of their
duties to take independent professional advice if necessary, at the company's
expense.
1.6 All directors should have access to the advice and services of the company
secretary, who is responsible to the board for ensuring that board procedures are
followed and that applicable rules and regulations are complied with. Any question
of the removal of the company secretary should be a matter for the board as a
whole.
2. Non-executive Directors
2.1. Non-Executive directors should bring an independent judgement to bear on
issues of strategy, performance, resources, including key appointments, and
standards of conduct.
2.2 The majority should be independent of management and free from any
business or other relationship which could materially interfere with the exercise of
their independent judgement; apart from their fees and shareholding. Their fees
should reflect the time which they commit to the company.
2.3 Non-executive directors should be appointed for specified terms and
reappointment should not be automatic.
2.4 Non-executive directors should be selected through a formal process and both
this process and their appointment should be a matter for the board as a whole. 3.
3.Executive Directors
3.1 Directors' service contracts should not exceed three years without shareholders'
approval.
3.2 There should be full and clear disclosure of directors' total emoluments and
those of the chairman and highest paid UK director, including pension
contributions and stock options. Separate figures should be given for salary and
performance-related elements and the basis on which performance is measured
should be explained.
3.3 Executive directors' pay should be subject to the recommendations of a
remuneration committee made up wholly or mainly of non-executive directors.
4. Reporting and Controls
4.1 It is the board's duty to present a balanced and understandable assessment of
the company's position.
4.2 The board should ensure that an objective and professional relationship is
maintained with the auditors.
4.3 The board should establish an audit committee of at least three non-executive
directors with written terms of reference which deal clearly with its authority and
duties.
4.4 The directors should explain their responsibility for preparing the accounts next
to a statement by the auditors about their reporting responsibilities.
4.5 The directors should report on the effectiveness of the company's system of
internal control.
4.6 The directors should report that the business is a going concern, with
supporting assumptions or qualifications as necessary.
OECD Principles of Corporate Governance (1999) as revised (2004)
The OECD published its Principles of Corporate Governance in 1999, following a
request from the OECD Council to develop corporate governance standards and
guidelines. Prior to producing the Principles, the OECD consulted the national
governments of member states, the private sector, and various international
organizations, including the World Bank.
The OECD recognizes that 'one size does not fit all’, that is, that there is no single
model of corporate governance that is applicable to all countries. However, the
Principles represent certain common characteristics that are fundamental to good
corporate governance. The OECD Principles were reviewed and revised in 2004.
The revised Principles are shown in Box 3.2.
The OECD Principles focus on publicly traded companies but, as in the Cadbury
Report, there is an encouragement for other business forms, such as privately held
or state-owned enterprises, to utilize the Principles to improve corporate
governance.
The OECD Principles are non-binding but, nonetheless, their value as key elements
of good corporate governance has been recognized and they have been
incorporated into codes in many different countries. For example, the Committee
on Corporate Governance in Greece produced its Principles on Corporate
Governance in Greece in 1999, which reflected the OECD Principles, whilst the
China Securities Regulatory Commission published its Code of Corporate
Governance for Listed Companies in China in 2001, which also drew substantially
on the OECD Principles.
In 2006 the OECD published its Methodology for Assessing implementation of the
OECD Principles of Corporate Governance. This was followed in 2008 by the
publication Using the OECD Principles of Corporate Governance: A Boardroom
Perspective which gives guidance on how the principles have been put into
practice in different companies using real life examples
In 2009 the OECD-launched an action plan to address weaknesses in corporate
governance related to the financial crisis with the aim of developing a set of
recommendations for improving board practices, risk management, governance of
the remuneration process, and the exercise of shareholder rights. In 2010 Corporate
Governance and the Financial Crisis: Conclusions and Emerging Good Practices to
Enhance Implementation of the Principles was published. The OECD's Corporate
Governance Committee noted that the ability of the board to effectively oversee
executive remuneration-including both the amount and also the way in which
remuneration is aligned with the company's longer term interests-appears to be a
key challenge in practice and remains one of the central elements of the corporate
governance debate in a number of countries. The OECD underlines the importance
of boards being able to treat remuneration and risk alignment as an iterative
process, recognizing the links between the two, and disclosing in a remuneration
report the specific mechanisms that link compensation to the longer term interests
of the company. The capacity of a firm's governance structure to produce such a
balanced incentive system is critical and therefore ways to enhance governance
structures have received more emphasis recently including the role of independent
non-executive directors and the 'say on pay', whereby shareholders may have either
a binding or non-binding vote on executive pay.
Box 3.2 OECD Principles of Corporate Governance (2004)
Principle
1. Ensuring the basis for an effective corporate; governance framework
Narrative: The corporate governance framework should promote transparent and
efficient markets, be consistent with the rule of law, and clearly articulate the
division of responsibilities among different supervisory, regulatory, and
enforcement authorities.
II. The rights of shareholders and key ownership functions rights.
The corporate governance framework should protect and facilitate the exercise of
shareholders’ rights.

III. The equitable treatment of shareholders

The corporate governance framework should ensure the equitable treatment of all
shareholders, including minority and foreign shareholders. All shareholders should
have the opportunity to obtain effective redress for violation of their rights.

IV. The role of stakeholders in corporate governance

The corporate governance framework should recognize the rights of stakeholders
established by law or through mutual agreements and encourage active co-
operation between corporations and stakeholders in creating wealth, jobs, and the
sustainability of financially sound enterprises.
V. Disclosure and transparency
The corporate governance framework should ensure that timely and accurate
disclosure is made on all material matters regarding the corporation, including the
financial situation, performance, ownership, and governance of the company.
VI. The responsibilities of the board
The corporate governance framework should ensure the strategic guidance of the
company, the effective monitoring of management by the board, and the board's
accountability to the company and the shareholders.

Subsequently, in 2011 the OECD published Board Practices, Incentives and

Governing Risks in which it looked at how effectively boards manage to align
executive and board remuneration with the longer term interests of their companies
as this was one of the key failures highlighted by the financial crisis. The OECD
highlights that 'aligning incentives seems to be far more problematic in companies
and jurisdictions with a dispersed shareholding structure since, where dominant or
controlling shareholders exist, they seem to act as a moderating: force on
remuneration outcomes'.
Basle Committee
The Basle Committee (1999) guidelines related to enhancing corporate governance
in banking organizations. The guidelines have been influential in the development
of corporate governance practices in banks across the world. Sound governance
can be practised regardless of the form of a banking organization.
In 2006 the Basle Committee issued new guidance comprising eight sound
corporate governance principles.
 Principle 1-board members should be qualified for their positions, have a
clear understanding of their role in corporate governance, and be able to
exercise sound judgement about the affairs of the bank.
  Principle 2-the board of directors should approve and oversee the bank's
strategic objectives and corporate values that are communicated throughout
the banking organization.
 Principle 3-the board of directors should set and enforce clear lines of
responsibility and accountability throughout the organization.
 Principle 4-the board should ensure that there is appropriate oversight by
senior management consistent with board policy.
 Principle 5-the board and senior management should effectively utilize the
work conducted by the internal audit function, external auditors, and internal
control functions.
 Principle 6-the board should ensure that compensation policies and practices
are consistent with the bank's corporate culture, Tong-term objectives and
strategy, and control environment.
 Principle 7-the bank should be governed in a transparent manner.
 Principle 8-the board and senior management should understand the bank's
operational structure, including where the bank operates in jurisdictions, or
through structures, that impede transparency (i.e. 'know your structure
Source: Enhancing Corporate Governance for Banking Organisations (Basle
Committee on Banking Supervision, 2006).
However, following on from various corporate governance failures and lapses that
came to light in subsequent years, the Committee revisited the 2006 guidance.
Taking into account the lessons learned during the financial crisis, the Committee
reviewed and revised the Principles and reaffirmed their continued relevance and
the critical importance of their adoption by banks and supervisors. The Committee
issued its Principles for Enhancing Corporate Governance (2010) and identified
some key areas-board practices; senior management risk management and internal
controls; compensation, complex or opaque corporate structures; and disclosure
and transparency--which it believed should be the areas of greatest focus and lists
fourteen Principles in relation to these, as follows.
A. Board practices-the Committee identified four Principles relating to:
 the board's overall responsibilities; which it discussed under three main
headings: the responsibilities of the board; corporate values and code of
conduct; and oversight of senior management;
 board qualifications, which it discussed under the headings of qualifications;
training and composition;
  board's own practices and structure; which it discussed under the headings of
the organization and functioning of the board; the role of the chair; board
committees (audit committee; risk committee and other committees);
conflicts of interest; and controlling shareholders;
 Group structures, which it discussed under the headings of board of parent
company, and board of regulated subsidiary.
B. Senior management-the Committee identified one Principle in this area which
is that the senior management, under direction of the board, should ensure that the
bank's activities are consistent with the business strategy, risk tolerance/appetite
and policies approved by the board.
C. Risk management and internal controls-the Committee identified four
Principles relating to risk management versus internal controls; chief risk officer or
equivalent; the scope of responsibilities, stature and independence of the risk
management function; resources; qualifications, and risk methodologies and
activities.
D. Compensation-the Committee identified two Principles relating to the board
being actively involved in the design, implementation, monitoring and review of
the compensation system, and compensation being appropriately linked to, and
aligned with, the various risks of the firm.
:
E. Complex or opaque corporate structure-the Committee identified two
Principles for this area, relating to the board and senior management being aware
of the business and its risks, i.e. 'know your structure'; and the board being aware
of, and mitigating against, risks arising when special purpose or related structures
are used, or when operating in a less transparent jurisdiction.
F. Disclosure and transparency-the Committee identified one Principle here,
being that the bank's governance should be adequately transparent to its
shareholders, depositors, other relevant stakeholders and market participants'.
The Committee also included a section in the Principles for Enhancing Corporate
Governance (2010) on the role of supervisors and emphasized the importance of
supervisors regularly evaluating the bank's corporate governance policies and
practices as well as its implementation of the Committee's Principles.
Basle committee revise guidelines for corporate governance
Area A: Board Practices: (4) 4 principle:

P-1 Boards overall responsibility

P-2 Board's Qualification

P-3 Board practices & structure

P-4 Group structure

Area B: Senior Management: 1 principle

P-5 Senior Management should ensure that bank's activities are constant with the
business strategy, risk tolerance and policy approved by broad

Area C: Risk Management and internal controls: (4)

P-6 Risk officer and their responsibility

P.7 Risk management function

P-8 structure of risk.

P-9 Risk methodology and activities

Area D: Compensation: (2)

P-10 Design of compensation

P-11 Linked with various risk of the firm

Area E: Complex corporate structure: (2)

P-12 Board and senior management should be aware of the business

P-13 Operating in a less than transparent jurisdiction Area F: Disclosure

and transparency: (1)

P-14 Bank’s governance should be adequately transparent