The UK Corporate Governance Code And The Efficacy Of Self-Regulation Essay.

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Overview of Corporate Governance and Self-Regulation

Corporate Governance is the system of practices, processes and rules by which control is exercised over the corporate firms. An effective corporate governance framework ensure striking balance between the interest of the several company stakeholders which includes management, shareholders, financiers, suppliers, customers, shareholders, government and the community.  The notion of corporate governance is framed within the ‘self-discipline or self-regulation’ discipline phenomenon which refers to a system wherein corporations adopt ethical rules or conduct to which such companies adhere while carrying out the business activity. The essay shall provide a critical evaluation of the statement that the UK Corporate governance code and its predecessors exemplify the efficacy of self-regulation as opposed to direct governmental intervention in the context of implementation of the corporate principles under “the Code”. The essay shall outline the historical background in which the UK Corporate Codes have been developed highlighting the drastic changes that changed the nature of corporate governance in Britain (Code 2010). While assessing the efficacy of the implementation of the UK Combined Code of Corporate Governance principles, the essay shall also discuss about the three essential reports by the Bullock, Cadbury, Hampel and Greenbury Committee wherein recommendations have been made with respect to its effective implementation of the corporate governance principles.

To understand definition of self-regulation, it is important to understand the meaning of regulation. Regulation refers to the act in which an institution or an individual is regulated. There are three essential elements of regulation, namely, legislation, enforcement and adjudication. Firstly, legislation refers to the definition of the rules and enforcement implies that necessary actions shall be undertaken against infringers of such rules (Soltani and Maupetit 2015). Lastly, adjudication refers to a situation where it is determined if the legal rules have been violated and if necessary measures have been initiated against such contravention. In other words, self-regulation may be defined as the delegation of public policy chores to private actors in an institutional form with the objective where the players (participants) within the industry shall regulate the industry (market) (Kaufmann 2017). On the contrary, mandatory regulations refer to regulations or rules that are intended to carry out a particular piece of legislation and are usually enforced by a regulatory agency that is mandated to uphold the provisions of the legislation.

The concept of corporate governance is distinct from the control and command model as it is comprises companies that are allowed to structure and design their own practices within particular boundaries. Elmagrhi, Ntim and Wang (2016) states that while various aspects of corporate governance have become subjected to mandatory regulation, other legal jurisdictions have selected to adopt partially mandatory structures by enabling companies to make choices regarding their governance but mandating disclosure obligations upon the companies with respect to such choices. The question that arises under such circumstances is whether a wholly voluntary or mandatory or some compromise with respect to the governance regime shall be most favorable.

Pros and Cons of Self-Regulation

According to Du Plessis, Hargovan and Harris (2018), as a response to this question, supporters of free market may argue that a mandatory regime might not be necessary if advanced corporate governance practices are desired and advantageous to investors, then, the competitive firms shall implement such practices immediately as well as effectively. On the contrary, Dimopoulos and Wagner (2016) believe that the advocates for the investors may argue that a voluntary regime might not be sufficient. This is because in case of voluntary regime there is no assurance that all the firms would implement the reforms that are necessary to provide the investors with adequate checks on board control and management. In this regard, mandatory rules become necessary to safeguard investors, thereby, building confidence in the capital markets. Therefore, Keay (2014) states that an optimal regime may be defined as  a regime that considers the expenses and benefits of all the stakeholders especially the investors and issuers.

The pros and cons of self-regulation and mandatory regulation is associated with accountability of governance regime and the corresponding costs or compliance. In case of a mandatory structure, a high level of compliance is likely to ensure high level of compliance at lower cost compared to a complete mandatory regime. Rose (2016) states even if a wholly mandatory structure may ensure better compliance, its expenses are likely to be much higher. Under such circumstances, it can be said that a regime that is partially mandatory reduces expense but encourage high level of compliance is considered optimal.

The establishment of corporate governance code in the UK can be traced back to the 1990s after landmark report from Sir Adrian Cadbury on financial aspects of corporate governance that issued the code of best practice (Cadbury 2015). The ‘Cadbury Code’ aimed at listed companies, especially at its standards of corporate ethics and behavior. It set a benchmark of good boardroom practice, evolving into the Combined Code on Corporate Governance (Price et al. 2018). Due to persisting shareholder unrest regarding the deficiencies within corporate structures and their incompetency along with the threats of legislation in case of failure of the corporate sector, the corporate governance was subjected to further reviews. Thereafter, provisions were incorporated with respect to risk management, remuneration, audit committees and internal control. Eventually, after several reviews, a new version of corporate governance was issued known as ‘UK Corporate Governance Code’ that was applicable to companies on or after June 29, 2010.

UK Corporate Governance Code and its Predecessors

The Code comprises five sections namely, Accountability, leadership, effectiveness, remuneration and relations with Shareholders. Each of the sections includes Main Principles, Supporting Principles along with Code provisions. The main principles stipulate broad theories or rules while the supporting principles and other provisions expand on the main principles. While the Main Principles within the Code is considered as fundamental to the Code and its implementation is upon the Board to determine, as they must ensure that its application complies with the Code. Further, the Code does not form any strict set of rules as the Supporting Principles have been incorporated to provide the companies with the flexibility to select methods of their choice with respect to the implementation of such principles (Devine and Shrives 2017).

The Bullock Report inquiry committee initiated the first research into the corporate governance in the UK. Bain and Band (2016) states that the establishment of the Bullock Committee of Inquiry on Industrial Democracy resulted from a series of political and economic developments that took place in the 1950s. The Committee emphasized on the definition of ‘industrial democracy’ that considered the representation of employees on the boards of directors of the companies for which such employees. This definition portrayed the realities of political debate regarding industrial democracy that has been dragged into the arena of public as well as parliamentary debate. The Commission has put forward four sets of proposals, which aims at harmonizing various provisions of member states for employee representation on a supervisory board.

In 1979, the Thatcher government transformed British industrial relations and restrained union power. The government hardly consulted the trade union and their influence declined in part as an outcome of the abandonment of the income policies along with the incline in the unemployment rate. Page and Spira (2016) believes that the broadening of privatization of the major utilities have changed the balance of the mixed economy. The government claimed that it cannot remain, as a universal provider for long rather more should be left to the voluntary sector, market and self-help. The replacement of dependency culture with an enterprise culture that was introduced by Thatcher was subjected to several criticisms as people favored a more equal society that ensures collective welfare more than Thatcher’s perspective of people responsible for their own good. Thatcher was criticized for wiping out approximately 15 percent of Britain’s industrial base and replaced it with her dogmatic monetarism (Jessop 2015)

Assessment of the Corporate Governance Code

Nevertheless, successive defeats in general election gradually convinced Labor to accept most of the new settlement. Since the complete denial of the policies in the 1983 general election, Labor firmly accepted the tranches of Thatcher’s policies. According to Scharpf (2018), privatization did not feature in the Conservative election campaign and by mid 1980, the economic policy of Conservative government was based on few essential principles. Firstly, the macro-economic strategy focused more on controlling inflation  instead of ensuring full employment as the government was simply responsible for keeping the inflation low and not to increase growth through demand management.

Secondly, balance of power pertaining to industrial relations was shifted in favor of employers significantly. During the general election in 1983, trade unions operated within a tighter legal framework that ended requirement for pre-strike ballots and ending the union membership requirement as a pre-condition of employment within a specific industry. The unions are held liable for damages that are incurred during the illegal strikes. Thirdly, industrial policy was abandoned and the state was subjected to the control of certain nationalized industries. According to Zalata and Roberts (2016), Thatcher had an industrial strategy to make Britain a destination for Japan car companies and shift focus of the economy towards financial services from manufacturing. Consequently, growth had been affected due to weak trade unions that could not guarantee an incline in the wage in pace with inflation. The investment and innovation in Britain have been significantly affected adversely while incompetency in manufacturing has caused the city to be dependent on the de-regulated City.

Several attempts have been made to improve corporate governance in different nations resulting in numerous semi-voluntary codes of conduct and other related legislative measures. UK is an example of a country that has led to better corporate governance in listed companies during 1990s and 2000s. As it is believed that the adoption of corporate governance practice is significant for maintaining relationship between shareholders and managers for achieving better corporate behavioral standards (Devine and Shrives 2017). The issues related to managerial transparency, accountability and regulation have been intricate and is subjected to further assessment. The publication of the Cadbury Report [1992] has proved to be crucial in developing number of corporate governance codes universally. The voluntary adoption of the corporate governance recommendations and the use of the ‘explain or comply’ principle is marked as a significant achievement of the Cadbury Report [1992].

During early 1990s, the reputation of the London as financial centre would have suffered dramatically due to high level of director malfeasance, corporate fraud for which a private sector initiative made by the Financial Reporting Council, the London Stock Exchange [LSE] established a committee to review the Financial Aspects of Corporate Governance. The Cadbury Report 1992 was adopted with an objective to provide a code of best practice. The report recognized three themes to fortify the unitary board system of all listed companies and summarize its recommendations in the form of code of best practice (Cadbury 2015). The three themes include the responsibilities and structure of boards of directors, the right and responsibilities of shareholder and the role of auditors. It also provides recommendations to the accountancy profession.

Key Reports by Bullock, Cadbury, Hampel, and Greenbury Committee

Although the recommendations ensured good corporate governance but the recommendations did not apply globally. The recommendations stated that all quoted companies must comply with the best practice as stipulated in the Code. The Code must be accepted voluntarily but companies must explain in their annual report and accounts the extent to which they had adhered to the code and reasons for non-compliance, if any, of the code.  One of the recommendations state that audit committee is crucial for the board committee and the directors shall be responsible for risk management to the shareholders. The adoption of the recommendations in the Report was made to develop a board comprising partial directors that are acting in the best interests of the company (Veldman and Willmott 2016).

During the early 1990s, institutional investors were concerned about failure of remuneration packages to provide an appropriate incentive for directors. The Greenbury Committee issued a code of best practice with respect to remuneration of the directors. It recommended that all the listed companies in the UK must comply with it. The Greenbury Report also recommended including the director’s remuneration in the annual account and report. This was adopted as it would ensure extent of the compliance by the company with the Greenbury recommendations with respect to the remuneration committees and must justify in case of non-compliance. The Greenbury Committee recommended that a remuneration committee must determine the remuneration of the executive directors and the committee must include non-executive directors, to ensure that executive directors do not stipulate his or her own remuneration.

Further, the Hampel Committee was established in 1996 to continue with the review of corporate governance practices in the UK after the publication of the Cadbury and Greenbury Committee Reports. The report of this committee was adopted to restrict the regulatory burden on the companies and that principles are preferable than rules as it would enable the companies to select the most appropriate corporate governance depending on the circumstances of individual companies. This report was introduced to ensure that good corporate governance can ensure positive contribution unlike the other two reports that was concerned about the deterrence of abuses. This committee firmly supported the shareholder view of corporate governance according to which the directors are primarily responsible towards the shareholders and must aim at enhancing the value of the shareholder’s investment over time but the directors are not responsible towards any other stakeholders.

In 2003, the Higgs Report was issued with the objective to make the role of the non-executive directors (NEDs) more effective. As per the recommendations made in the Report, the board comprising the directors and the NEDs must be collectively accountable for promoting the success of the company by directing the affairs of the company (Chambers 2017).

After the publication of the Hampel Report, it was decided that the accepted best practice and principles of Greenbury, Cadbury and Hampel must be combined together into a single code. The Combined Code was established that set out principles of good corporate governance. It was included within the UK Listing Rules, however, it is a principle-based document that does not stipulate any perspective rule that should be complied with by the companies (Dedman 2016). Nevertheless, the companies must make disclosure about non-compliance and provide reasons for the same stipulating the ‘comply or explain’ rule.

This ‘comply or explain rule’ approach with the Combined Code implies that listed companies are not obligated to adhere to or comply with all the provisions set out in the Code. It is often identified that under certain circumstances, departures from the Code might become appropriate in case of which, companies must provide reasons for such non-compliance. Further, the institutional investor states that such reasons must be convincing if the companies wish to win support of the shareholders. Nevertheless, the UK Combined Code was updated in 2016 and is designed to comply with EU regulations on statutory audit. The ‘comply or explain’ approach is said to provide flexibility to a company to adopt the governance structure that is more effective to carry out the operation that is likely to lead to better governance consequences.

The ‘comply or explain’ approach states that regulator specifies a set of codes and principles that acts as norms or guidelines for all companies, however, given that compliance is not mandatory, companies may deviate from any particular principle or code giving reasons to the regulator for such deviation (Keay 2014). In case of deviation, penalty is imposed upon the regulator. This comply-or-explain approach is adopted to provide flexibility to the company enabling them adopt a governance structure appropriate for carrying out the operations of the business.

Du Plessis, Hargovan and Harris (2018) states that this poses a serious question with respect to efficacy in self-regulation in the context of corporate governance as if company deviates from any prescribed rules, the company must provide an explanation for doing the same which acts as a deterrence for the company. This is because the company shall comply with the rules that ensure effective corporate governance and prior to non-compliance; the company shall have to be prepared to provide a justified explanation for the same. Moreover, the justification must be such that it is reasonable for the shareholders to accept such justification for non-compliance. Shrives and Brennan (2015) argues that in case of UK, the combined code on corporate governance provides provisions for ensuring that the companies comply them and have an effective corporate governance framework in place. However, the regulator permits the companies to deviate from such code and adopt a corporate governance structure that is most suited to the business operations depending upon its circumstances.

Further, it is further argued that the business conditions for companies are not the same and may vary from one business situation to another based on their individual size and intricacies associated with it. Under such circumstances, in case of justification given for non-compliance will also vary, making the application of the corporate governance principles more complicated and inconvenient in its implementation. Therefore, it would be more appropriate to have a uniform set of rules applicable to every business operations. This is because, given the distinct business conditions, the different business organizations will deal with such situations differently creating a chaos and irregularity. In case the companies become self-regulatory, they might not take into consideration the interest of all the stakeholders of the company.

As mentioned earlier, that the combination of the Greenbury, Hampel and Cadbury report has led to the establishment of the Combined Code of corporate governance and which ensures that the companies must make disclosure about non-compliance of any stipulated provisions within the Code. In case the companies become self-regulatory, it might not make any disclosure or merely ignore the interest of the company and earn personal profits. However, Davies (2016) states the fact that self-regulatory companies might not ensure best interest of the company including the shareholders and all its stakeholders does not imply that permitting the companies to adopt desirable governance structure would not be appropriate. The effectiveness of the comply-or-explain approach relies critically on the sufficiency of the explanations that is provided by companies on non-compliance. Therefore, departing from the ‘uniform standards’ and enabling business adopt corporate governance structure as per the needs of the company operations would be better provided such deviation from the particular codes and principles is justified effectively. Nevertheless, it is assumed that the managers, in particular, while deviating from specified codes are doing so in the best interest of the shareholders.

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