Best Practice in Corporate Governance

Building Reputation and Sustainable Success

Adrian Davies

• Editore: Routledge
• Anno: 2016
• ISBN:
  9781317175087
• Edizione: 1
• Argomento: Betriebswirtschaft
• Categoria: Unternehmensführung

An earlier book, A Strategic Approach to Corporate Governance (Gower, 1999), examined corporate governance from a philosophical and 'big picture' standpoint. This book digs deeper and explores the operational issues around corporate governance, giving examples of good practice. It is a 'how to' book, which focuses on processes and practical issues, making the case for corporate governance in terms of measurable business benefits and competitive advantage. The author explores a number of key themes: ¢ How corporate governance has expanded in scope and importance worldwide. ¢ How to engage with the wider range of stakeholders whose support is essential for success in a competitive world. ¢ How to distribute power to those who need to use it to perform effectively at all levels in the organisation. ¢ How to encourage the behaviours needed to effect good governance. ¢ How to embed best practice in the daily routine of the organisation. ¢ How to adapt best practice to meet the needs of different organisations. ¢ How effective corporate governance can build sustainable business success. ¢ How corporate governance may evolve to meet the needs of the future. Corporate governance should address the needs of people seeking to cooperate effectively in a shared endeavour. It should be adopted, not imposed and Adrian Davies provides an eloquent and authoritative guide to this process.

Part 1 Organising for Effective Governance

DOI: 10.4324/9781315569086-1

CHAPTER 1 What is Corporate Governance? Why is it Important?

DOI: 10.4324/9781315569086-2

An early definition of corporate governance may be found in the Cadbury Committee Report of December 1992: ‘Corporate governance is the system by which companies are directed and controlled. Boards of directors are responsible for the governance of their companies. The shareholders’ role in governance is to appoint the directors and the auditors and to satisfy themselves that the appropriate governance structure is in place.’ Ten years later the Higgs Report had a different focus: ‘Corporate governance provides an architecture of accountability – the structures and processes to ensure companies are managed in the interests of their owners.’ An international view of corporate governance is provided by the OECD Report ‘Corporate Governance’ of April 1998: ‘Corporate governance comprehends that structure of relationships and corresponding responsibilities among a core group consisting of shareholders, board members and managers designed to best foster the competitive performance required to achieve the corporation’s primary objective.’

Corporate governance is a development of the concept of government, which has existed from the earliest days of social organisation and has evolved into the elaborate constitutions of many of today’s nations. Governance principles and structures apply to organisations with varying degrees of complexity ranging from international bodies, such as the United Nations, through national, regional and local levels, down to small clubs and special interest groups. Most of these groups have rules which regulate their conduct of affairs and facilitate the settlement of disputes between members.

The governance of corporations began with the charters for early commercial voyages and enterprises, for example, the East India Company, and business partnerships followed by joint stock companies, limited liability companies and consortia, for example, between airlines. Over time the constitution of corporations became more detailed and complex, incorporating customs and practices which had grown up round the early basic charters. These customs and practices were also codified into company law (statutes and case law) so that corporate governance became multi-layered.

The early days of corporations were characterised by frequent frauds and scams, for example, the South Sea Bubble, and Victorian novels are full of corporate misdemeanours and lawsuits. The introduction of the limited liability company in 1856 led to a rapid increase in incorporation. The ability to trade shares on a stock exchange helped to boost the value of successful companies and to weed out failures.

Initially most limited liability companies had close links between their shareholders and their directors, many of whom were also shareholders. This link facilitated communication and the rights issues of shares needed to fund expansion. As companies grew they required more professional full-time management, initially appointed below board level (as in many US companies today) but later some professionals became executive directors. This was necessary to provide depth and continuity in directing the company, most of whose directors were part-time non-executives with a portfolio of other directorships and interests. A typical company in the early twentieth century would have a part-time chairman, often a nobleman or a person with City connections, and a managing director who was answerable to the board for controlling the company’s business. Later it became usual to have a finance director, particularly when the company had a large number of institutional investors who required briefing on the company’s financial performance in detail. A few other executive directors were appointed to reflect activities of prime importance such as sales, research, and manufacturing.

This model remained in balance for many years but came under pressure after World War II. The end of Empire (and Imperial Preference), the growing economic might of the USA and the resurgence of Germany and Japan, in particular, created competitive pressures to which British companies were not accustomed. Their shareholder profile had changed; there were proportionately fewer individual shareholders and the weight of institutional investors increased as pension funds were channelled into equities rather than bonds. Two groups of shareholder emerged, individual and institutional, and their power and influence diverged. Individual shareholders had become numerous but most had small stakes in the company and few had links to individual directors. Their contact with the company was limited to receiving an annual report, a dividend cheque and an invitation to the annual general meeting. Institutional shareholders were able to demand more regular and detailed briefing on the company’s progress and prospects, and were in a position to time the sale of their stake in whole or in part, if they were not satisfied. Institutional shareholders are key players in the City and have close links to the investment banks, lawyers and accountants whose activities drive the City machine. Another group whose influence was becoming increasingly felt by companies was the news media; their agenda was to exploit weaknesses in company performance and to find negative stories about individual directors.

Why corporate governance became important

Corporate governance became important partly because the classic model of meeting shareholder expectations delivered declining relative results and also because the primacy of shareholders began to be challenged. Between 1900 and 2000 Britain’s share of world GDP declined from some 25 per cent to 5.6 per cent. British companies were driven out of major markets, such as shipbuilding, vehicle manufacture, computers, investment banking, and so on, despite sustained efforts to concentrate in order to build critical mass. Britain saw its lead in innovating key new products lost to American and other competitors (in jet propulsion, body imaging, genetically modified crops, for instance). These setbacks were reinforced by a number of company disasters from the 1970s onwards, forcing the rescue of Rolls Royce, Jaguar and others, and latterly by several major scandals (BCCI, Maxwell, Polly Peck, Guinness, and so on). It seemed that British business was not only failing to compete globally but was also at risk of internal decay. Such a situation was not only damaging to the British economy; it represented a direct threat to the credibility of the City of London as a market for investors. As a result the Stock Exchange launched the Cadbury Inquiry into the financial aspects of corporate governance in 1990.

Developing the codes and revising company law

The Cadbury Inquiry began soon after the Companies Act of 1985. This was a major piece of legislation which consolidated all previous Companies Acts. For this reason, and to effect change in the practice of corporate governance by persuasion rather than force of law, the output of the Inquiry was a set of codes of behaviour, against which companies were expected to report annually to their shareholders. This procedure was followed for the output of all subsequent inquiries – the Greenbury Committee Report on directors’ remuneration, the Hampel Report, which consolidated and replaced both the Cadbury and Greenbury Reports, the Turnbull Report on managing risk, the Smith Report on audit and the Higgs Report on non-executive directors.

Following the Hampel Report, directors are expected to ‘comply or explain’ rather than tick boxes. This has made reporting against the Combined Code (Hampel) and subsequent codes more flexible and specific to company circumstances. It also opens the door to ‘spin and window-dressing’ to present company practice in the most favourable light.

In parallel with the development of codes of behaviour, the movement for improving corporate governance has helped to drive a revision of company law, to be integrated into a new Companies Act. Consultations on the proposed Companies Bill began in March 1998 with a major consultation exercise, around ‘The Strategic Framework’ starting in February 1999. The purpose of the consultation was to modernise core company law (excluding the Insolvency Act and the regulation of financial services), recognising the European dimension, with 11 directives to date, the EC Treaty and the European Convention of Human Rights (now incorporated in UK law). This process has now completed its consultations and the Final Report of the Company Law Review Steering Group was submitted to the Secretary of State for Trade and Industry in June 2001. One of the key innovations will be the need to publish an Operations and Finance Report, ‘to provide a discussion and analysis of the performance of the business and the main trends and factors underlying the results and financial position and likely to affect performance in the future, so as to enable users to assess the strategies adopted by the business and the potential for successfully achieving them’ (Company Law Review). Work on drafting the new Companies Bill continues and it is now well past the original deadline for legislation for reasons which are not revealed.

Beyond the codes – alternative models

We have seen that the Cadbury Report was commissioned to explore the financial aspects of corporate governance, since the impact of failure and scandal on the City had been financial, primarily through loss in the value of shares. The Cadbury Code and its successors to date have continued to focus on financial outcomes, though Hampel and Higgs touch on some wider issues, for example, the need to involve stakeholders other than shareholders and the need to create more dynamic company boards.

One month after the issue of the Cadbury Report in January 1993, the RSA (The Royal Society for the encouragement of Arts, Manufactures and Commerce) began an inquiry into the form ‘Tomorrow’s Company’ would take. The inquiry was sponsored by a wide range of British businesses, under the leadership of Sir Anthony Cleaver, Chairman of IBM UK. It involved a significant number of interviews with chairmen and chief executives, together with the development of selected case studies into the sources of business success, supported targetted research on competitiveness and board-room values from a wide range of sources. The inquiry was concluded in June 1995 and reported as follows:

• British companies would need to change radically to cope with global competition.
• The fundamental change needed was to identify and work with stakeholders in order to maintain a ‘licence to operate’ from society as a whole.
• Directors’ duties needed to be redefined to support this ‘inclusive approach’.
• People involved with companies would need to be included in this ‘inclusive approach’ in order to motivate them and maximise their contribution to the enterprise.
• The financial community would also need to be included in this process in order to maximise their support.
• Companies would need to build relationships with communities and government to underpin their ‘licence to operate’.

These findings represent a much wider view of corporate governance than that taken in the Codes. No longer is the company responsible solely to shareholders but it now has to seek and maintain a ‘licence to operate’ from society as a whole. All stakeholders need to be identified and included in the considerations of the company, more as if they were family members rather than through arms-length legal contracts. The range of stakeholders was seen to be very wide, and such stakeholders were expected to contribute to the success of the enterprise, rather than exploit it.

It is perhaps significant that the new Companies Bill adopts the concept of responsibility to stakeholders, and the ‘inclusion’ approach needed to meet it. Legislation usually lags original thinking and best practice, it consolidates them and generalises them by which time most of the competitive advantage of distinctiveness has been lost. This book aims to focus on the areas of corporate governance which legislation has not reached or which may not be appropriate for legislation.

The stakeholders in corporate governance

Corporate governance is a system for optimising the contribution of a number of disparate parties to a purpose which they are persuaded to share. These disparate parties are often referred to as the ‘stakeholders’ in the enterprise, and their potential for support or damage to the enterprise may vary depending on circumstances. The interplay of these stakeholders is the theme of this book, but it is useful at this stage to introduce them and explore their potential roles. This list does not include uninvited stakeholders, such as the media or special interest groups.

Shareholders

Shareholders have traditionally been the key stakeholder in companies. In earlier organisations they would have been partners, and the partnership model survives into modern times, largely in small businesses and the professions. The function shareholders and partners have in common is ownership of their organisation. In English law the rights of property have traditionally had precedence over most other rights, so that ownership of a company gives its shareholders pole position in the ranking of stakeholders.

For smaller companies share ownership may still be a matter of pride and involvement, but the owners of larger companies have changed since the early days of limited liability. The growing involvement and power of executives has tended to make owners into spectators rather than participants; this tendency has been compounded by the increasing involvement of institutions as shareholders. Institutions do not think or act as involved owners – they hold shares as an investment and buy and sell purely for financial gain. Shareholders in most large companies are less likely today to think as owners, most will be using the company as a stake in their own financial game – some will be using their shareholding to advance other causes, for example, NGOs seeking to subvert company policy through pressure.

Lack of involvement by shareholders has been a major contribution to problems of corporate governance. The activities of corporate raiders in the 1960s, especially in the USA, were facilitated by shareholders who had no sense of ownership and were eager to sell their shares, irrespective of any consequences for the company or other stakeholders, such as employees. Executive directors became too powerful in recent years and have been allowed to indulge in take-overs, most of which have destroyed shareholder value. Concern about excesses in rewards for poor performance have only recently led to any action by shareholders. It remains to be seen whether shareholders will become more active stakeholders in their companies.

The Board of Directors

Historically the board of directors has been the agent of shareholders to direct their company. In the past many directors were shareholders or representatives of shareholders, creating conflicts of interest with their prime duty of care to the company as a whole. Even today it is not unusual for directors to be appointed by major individual shareholders, so that this conflict remains a governance issue.

Earlier boards comprised solely non-executive directors, with company management delegated to a general manager and a small team of specialists. As business became more complex and decisions needed to be made more rapidly, some of the managers were appointed to the board, initially the managing director, then the finance director and sometimes a few specialists. UK boards tended to have more executive directors than those in the USA, where often the only executive director was the CEO, supported off-line by a full management team. In Germany, Holland and Austria a two-tier board structure was favoured, with a supervisory board of non-executive directors (with representatives of labour, banks, and so on) and an executive board of managers. In the USA company boards were for many years virtually ‘out of the loop’ in terms of controlling their company, so that real decisions were taken by managers. Recently a spate of scandals (Enron, World.Com, and so on) has drawn attention to the weakness of company boards and the need to increase their ability to exercise control.

One of the key issues in corporate governance is the working of the ‘agency principle’. This is the doctrine that shareholders are the owners of their company and that company directors are solely agents to exercise the will of shareholders. Company law enshrines this do...

Indice dei contenuti

• Cover Page
• Half Title Page
• Title Page
• Copyright Page
• Table of Contents
• Foreword
• Acknowledgements
• Introduction
• Part 1 Organising for Effective Governance
• 1 What is Corporate Governance? Why is it Important?
• 2 Different Approaches to Corporate Governance. How Can Corporate Governance be Made to Work?
• 3 Leadership and Corporate Governance
• 4 Implementing Corporate Governance
• Part 2 Different Models Of Corporate Governance
• Part 3 Appendices
• Appendix A BusinessTown.com
• Appendix B Gerard International
• Appendix C Johnson & Johnson
• Appendix D The SPL Corporate Health Check
• Bibliography
• Index