HomeChapter 7: One-Tier Board Attributes in the UK7.2 Corporate Governance in the UK

7.2 Corporate Governance in the UK

Similar to the US-system, the governance structure of listed corporations in the UK is based on a classic governance structure. Directors, the chairman of the board and auditors are elected by shareholders at the Annual General Meeting (AGM). The directors appoint the chief executive of the corporation. By means of externally validated annual reports, shareholders are informed on the financial performance of the corporation (see box 7.1). According to Boyd (1996:168-169), the business scandals of the 1980s made clear that “self-interested directors could manipulate the operations of the classic governance structure for their own gain at the expense of shareholders and other fiscal stakeholders [. . .] It can be seen that corporate directors are able, if they are so motivated, to manipulate the classic governance structure in a variety of ways so as to promote their own ends. When we add in other elements of human fallibility we have the full recipe for the recent history of corporate abuses in the United Kingdom.”

 

Triggered by corporate failures and excessive remuneration plans, a series of committees have been formed to investigate the strengths and potential weaknesses of the one-tier board model in the UK. To improve the classic corporate governance model, one of the first initiatives came from the City with the Cadbury Committee in 1992. This committee was shortly followed by the Greenbury and Hampel committees in 1995 and 1998 respectively. The next paragraphs discuss in more detail the contribution of these committees to the corporate governance debate in the UK.

Box 7.1

The Classic Governance Structure

 

Directors and the chairman are elected by shareholders in the general meeting of shareholders. The Company Act requires all corporations to have at least two directors. Yet, the Company Act does not provide separate classes of directors or a distinction between executive and non-executive directors. Consequently, laws do not require corporations to have non-executive directors or independent leadership in their boards of directors. According to Sheridan and Kendall (1992), it is legally perfectly in order for companies to have only executive directors in their boards. Corporation law provides the possibility that one individual can be appointed as both chair and chief executive.

 

Sources: Sheridan and Kendall (1992); Boyd (1996).

The Cadbury Report on the Financial Aspects of Corporate Governance

The UK-system of corporate governance is to a large extent based on the same mechanisms that form the foundation of the governance system in the US. Both systems heavily rely on self-regulation and market-based sanctions to govern corporations (Short, 1996). Within the tradition of self-regulation, the Cadbury Report on “The Financial Aspects of Corporate Governance” is recognized to be the most far-reaching publication to strengthen the independence of corporate boards of directors in listed corporations (Conyon and Mallin, 1997). Set up in May 1991 by the Financial Reporting Council (FRC)[21] and the London Stock Exchange (LSE), the Committee released a draft report for public comment on May 27, 1992. The Committee issued a final version of the report in December 1992.

According to the Cadbury Committee Report (1992), the Committee’s main objective was to help to raise the standards of corporate governance and the level of confidence in financial reporting and auditing. Its recommendations are based on the core belief that self-regulation – and not statutory enforcement – is an adequate way to put pressures on corporations to improve their governance structures (Finch, 1992). The Committee strongly emphasized that financial markets are more likely to provide the necessary external controls, rather than regulators, to enforce the implementation of its recommendations. Clements (1995) indicates that the Cadbury Committee focused on three objectives to set forth new standards of corporate governance in the UK: (1) to improve the governance structure of corporations; (2) to avoid legislation that would bring the two-tier board model to the UK, and; (3) to improve the involvement of institutional investors in the governance of corporations to avoid legislative changes in the UK.

To achieve these objectives, the Cadbury Report was based on four different kinds of prescriptions: codified recommendations, mere recommendations, calls for legislative change and exhortations[22] (Finch, 1992). The codified recommendations in “The Code of best Practice” attracted the greatest attention from the business press.

 

The Cadbury Committee and the Governance Structure of Corporations

The first objective of the Cadbury Committee was to improve the governance structure of corporations. To avoid the repetition of corporate affairs like Maxwell, the Committee placed much stress on the need for strong and independent non-executive directors in corporate boards. Cadbury also stressed the need to split the positions of the CEO and chairman to achieve a clear division of power in the top of corporations. The formation of standing oversight board committee - e.g., the audit committee - was also encouraged to support boards’ control roles. In addition to these recommendations, Cadbury recommended corporations to reconsider the remuneration schemes and bonus plans for executive directors and to reconsider the position of the independent auditor. Cadbury’s main recommendations are discussed in more detail in the next paragraphs.

 

The Cadbury Committee and the Discussion on Two-Tier Boards

Another objective of Cadbury was to strengthen the position of one-tier boards in the UK and to avoid any legislation that would require corporations to form a two-tier board structure – in particular the German two-tier board structure[23]. According to ICMG (1996:85): “Some commentators have argued that the requirement for non-executive directors on the board as prescribed by Cadbury represents a step towards a two-tier board system. However, this was clearly not the intention of the Committee. In focusing its recommendations on the control and reporting functions of the board, Cadbury stated that its proposals aimed ‘ . . . to strengthen the unitary board system and increase its effectiveness, not to replace it’.”[24]

In 1995, the Institute of Chartered Accountants (ICA) published a report on the future of Britain’s boards of directors. The study concentrated on the feasibility to introduce a two-tier board model in the UK as an alternative for the one-tier board. The report states: “The role of the board, and that of non-executive directors on it, has been one of the most debated of the many issues that Cadbury raised. Many felt that it was odd that Cadbury never examined in detail the possibility of two-tier boards as an alternative to our current system” (ICA, 1995:3). Based on a comparison with the German two-tier board model, the ICA concluded that the two-tier board is not an appropriate model for corporations in the UK.

While the ICA recognized that the German two-tier board provides a “clear separation between supervision and management”, the institute also recalled disadvantages of the system: “While in principle the separation of supervision from day-to-day management is attractive, it has the practical consequence of limiting the access of the supervisors to the information which they need to perform the monitoring role [. . .] For the same reason a general requirement that all boards should have a majority of outside directors would be inappropriate. Improving the unitary board, with a strong but not necessarily dominant element made up of non-executive directors, makes more sense for Britain than the introduction of the two-tier system” (ICA, 1995:5,17). In line with Cadbury’s recommendations, the ICA therefore stated that “ . . . the priority should be to strengthen the unitary board, which requires, among other things, improved procedures for appointing non-executive directors and for ensuring that they can play an effective monitoring role . . .” (ICA, 1995:4).

In a report called “Boards without Tiers”, the Confederation of British Industry (CBI[25]) argues that the introduction of a two-tier board model would undermine the direct link between executive directors and shareholders and that it would slow the decision making processes in the corporation. The Institute of Directors (IOD) also strongly supported the unitary board model. In response to the Cadbury Report, the IOD remarked: “ . . . the IOD is also totally committed to the principle of a unitary board, under which all directors have equal responsibility to all shareholders. By highlighting the monitoring responsibilities of non-executive directors, the Committee’s recommendations come close to advocating the principle of a two-tier board, and seem to us to be unnecessarily divisive“ (Jenkins, 1993:13).

Sir Adrian Cadbury also reinforced the need to improve the one-tier board model. Although Sir Adrian Cadbury recognized the need of corporations to experiment with alternative board models, he stated: “ . . . in the context of closer European unity, should British companies be at least considering a move towards a two-tier board structure, so separating the supervisory role of the board from its management role? [. . .] What the Committee is proposing is a division of responsibilities between the members of a united board, not a division of the board [. . .] As to whether the way in which the role of the outside director is developing will nudge Britain towards two-tier boards, that is likely to remain an open question for some time to come [. . .] What would be helpful, however, would be a willingness by British companies to experiment with varieties of board structures, so that the evolution of board systems could be guided by practical experience” (Cadbury, 1993:9)[26].

Charkham (1994:333) indicates that there should not be a need to take sides: “If it is desired to put an end to fudge, the logic is to differentiate between the duties of supervisors and the managers, whether they are on a single- or two-tier board. Such a suggestion arouses deep opposition from those who are happy for the non-executive director to have a dual role as contributor and monitor. A formal differentiation is seen as a step to a two-tier system, which many distrust [. . .] There is no logical reason why all companies should be best suited at all times by a single structure; much depends on personalities and circumstances. Why not give shareholders a choice as the French do?” This is also Labor’s view. The Labour Party published a paper in 1994 that strongly advocates a statutory basis for corporations which would prefer to establish a two-tier board. The Labour Party stated: “The logic of the Cadbury report might lead some companies ‘to prefer a two-tier board in which a supervisory board of non-executives sets objectives and monitors the performance of an executive board with managerial freedom’ ” (quoted in ICA, 1995:7).

 

The Greenbury Report on Directors’ Remuneration

Cadbury was followed by the Greenbury Committee in 1995. Initiated by the CBI, the committee published a report[27] with a new Code of Best Practice related to the remuneration of directors on July 17, 1995. The key themes in the report were accountability, responsibility, full disclosure, alignment of director and shareholder interests and improved company performance (Greenbury, 1995). Due to public and shareholder concerns about excessive remuneration packages, the report emphasized the need of corporations to publicly disclose more information on the remuneration of directors. The Code contains detailed provisions that supplement the requirements of the Companies Act on the disclosure of board remuneration elements in annual financial reports. One of the controversies Greenbury had to resolve was to improve the methods of disclosing pension plans in annual reports[28]. Another requirement for listed corporations, introduced by Greenbury, was to set up a remuneration committee consisting exclusively of non-executive directors “. . . with no personal financial interest other than as shareholders in the matters to be decided, no potential conflicts of interest arising from cross-directorships and no day-to-day involvement in running the business” (Greenbury, 1995:14).

Like Cadbury, Greenbury did not seek any legislative changes in the UK to enforce compliance with the code: “The way forward as we see it lies not in statutory controls, which would be at best unnecessary and at worst harmful, but in action to strengthen accountability and encourage enhanced performance. Such action should build on progress already made” (Greenbury, 1995:11). Greenbury recommended that all listed companies in the UK should make an annual compliance statement to their shareholders. As such, the LSE should “. . . introduce continuing obligations for listed companies to the Code’s provisions . . . [and, eds.] the investor institutions should use their power and influence to ensure the implementation of best practice as set out in the Code” (Greenbury, 1995:19).

 

The Hampel Report on Corporate Governance

The Cadbury and Greenbury Committees were followed by the Hampel Committee in 1995[29]. The committee emphasized the need to review the overall governance structure of listed corporations in the UK. The committee published its preliminary report in August 1997 and its final report on January 28, 1998. The initial objective of the committee was to conduct a fundamental review of the corporate governance system in the UK. Its main objectives were to renew the code of Cadbury, to solve unresolved Greenbury issues and to compose a universal code to make an end to the confusion on codes of best practice and other guidelines in the UK. According to Sir Ronald Hampel: ”Cadbury and Greenbury were produced in response to particular concerns – corporate collapse and fraud in the first case, and remuneration excesses in the second. My committee was asked to review corporate governance in its totality . . .”[30].

 

The Financial Times (Jan 29, 1998) indicates that the contribution of the Hampel Report to “changes for the better in UK corporate governance practice” falls into three broad areas:

 

  • first, Hampel recognizes the need for board structures that provide both accountability and profitability. Similar to Cadbury, the Hampel Report - for example - supports the recommendation to separate the CEO and chair roles and to increase the number of non-executives in corporate boards;
  • second, the Hampel Committee recommends corporations to improve the transparency of their governance structures. Corporations should indicate their preferences for a certain combination of board roles and their preferences for the formation of specific board structures. The board – for example – should explain its decision to combine the roles of CEO and chair in annual reports. The board should also clearly indicate which board members are seen as independent directors. In addition, to enhance the transparency of the governance structure of the board, the biographical details of directors nominated for re-election should be disclosed to the public;
  • the third distinctive contribution of Hampel is the consolidation of its recommendations with the codes of Cadbury and Greenbury into a “super code.” According to the Hampel Report (1998b:6): “We see this Combined Code as a consolidation of the work of the three committees, not as a departure [. . .] We should in particular like to make clear, in relation to the detailed provisions in the Listing Rules on directors’ remuneration, that we envisage no change except where we take a different view from the Greenbury Committee . . . (yet, eds.) these changes are minor.”

Source: Financial Times (Jan 29, 1998).

 

The Combined Code, published in June 1998, supplements the LSE’s listing rules book (the Yellow Book). The Code itself will not be included in the exchange’s listing rules. A statement will be added to the listing rules which will require corporations to provide a statement of compliance in two parts with the principles and guidelines of the Combined Code. According to the Combined Code, the first part requires corporations to report how the principles of the Code are applied. In the second part, corporations are required to provide an explanation when they do not comply with certain provisions of the Code.

The Hampel Report received a “rather grudging reception” when it was published (Financial Times, Jan 29 1998). The TUC reported that Hampel had “a misplaced faith in the effectiveness of self-regulation.” The Institute of Internal Auditors stated that the internal reporting procedures between audit committees and auditors (both internal and external) were not clearly defined. Others strongly supported the report of the committee. Not surprisingly, the IOD welcomed “the report’s emphasis on flexible principles rather than a ‘cookbook’ of rules.” The CBI saw Hampel as a “viable framework which allows companies the flexibility they need to operate.”

 

The Future of Corporate Governance in the UK

The Hampel Committee follows the tradition of self-regulation and flexibility in corporate governance in the UK. To avoid legislation, Hampel called for time to give corporations a possibility to comply with its recommendations. In the Financial Times of January 29, 1998 Sir Ronald Hampel stated: “Public companies today recognize as never before both their formal accountabilities and their wider public responsibilities. In the context of today’s corporate governance requirements and of public scrutiny, they will have to demonstrate these over the next few years or the demands for government action will become more strident and probably irresistible. Good governance requires judgement, not prescription, and for that reason I believe it is in business’s own interest to conform, and that it will.” Sir Ronald Hampel stated the hope that the government will allow corporations time to comply with the Code. In a response to the Hampel Report, Margaret Beckett, Trade and Industry Secretary gave a “guarded welcome” to the report – although she had criticized the draft report of the Hampel Committee because it “failed to address concerns about corporate short-termism” (Financial Times, Jan 29 1998). The Department of Trade and Industry (DTI) announced that it would issue a Green Paper on proposals to review corporation laws in 1998. Consequently, the debate on corporate governance has not been ended yet in the UK and probably it will never end!

 


Related news items:
Newer news items:
Older news items:

 
You may also be interested in these articles:

PDF Download

Interested in the PDF version of the study? Click here to download.

Maassen, G.F. (2002). An International Comparison of Corporate Governance Models. A Study on the Formal Independence and Convergence of One-Tier and Two-Tier Corporate Boards of Directors in the United States of America, the United Kingdom and the Netherlands.

Maassen, G.F. (2002). An International Comparison of Corporate Governance Models. A Study on the Formal Independence and Convergence of One-Tier and Two-Tier Corporate Boards of Directors in the United States of America, the United Kingdom and the Netherlands. Amsterdam: Spencer Stuart Executive Search.