UK Corporate Governance Code

The UK Corporate Governance Code 2010 (from here on referred to as "the Code") is a set of principles of good corporate governance aimed at companies listed on the London Stock Exchange. It is overseen by the Financial Reporting Council and its importance derives from the Financial Services Authority's Listing Rules. The Listing Rules themselves are given statutory authority under the Financial Services and Markets Act 2000^[1] and require that public listed companies disclose how they have complied with the code, and explain where they have not applied the code - in what the code refers to as 'comply or explain'.^[2] Private companies are also encouraged to conform; however there is no requirement for disclosure of compliance in private company accounts. The Code adopts a principles-based approach in the sense that it provides general guidelines of best practice. This contrasts with a rules-based approach which rigidly defines exact provisions that must be adhered to.

Origins

The Code is essentially a consolidation and refinement of a number of different reports and codes concerning opinions on good corporate governance. The first step on the road to the initial iteration of the code was the publication of the Cadbury Report in 1992. Produced by a committee chaired by Sir Adrian Cadbury, the Report was a response to major corporate scandals associated with governance failures in the UK. The committee was formed in 1991 after Polly Peck, a major UK company, went insolvency after years of falsifying financial reports. Initially limited to preventing financial fraud, when BCCI and Robert Maxwell scandals took place, Cadbury's remit was expanded to corporate governance generally. Hence the final report covered financial, auditing and corporate governance matters, and made the following three basic recommendations:

• the CEO and Chairman of companies should be separated
• boards should have at least three non-executive directors, two of whom should have no financial or personal ties to executives
• each board should have an audit committee composed of non-executive directors

These recommendations were initially highly controversial, although they did no more than reflect the contemporary "best practice", and urged that these practices be spread across listed companies. At the same time it was emphasised by Cadbury that there was no such thing as "one size fits all".^[3] In 1994, the principles were appended to the Listing Rules of the London Stock Exchange, and it was stipulated that companies need not comply with the principles, but had to explain to the stock market why not if they did not.

Before long, a further committee chaired by chairman of Marks & Spencer Sir Richard Greenbury was set up as a 'study group' on executive compensation. It responded to public anger, and some vague statements by the Prime Minister John Major that regulation might be necessary, over spiraling executive pay, particularly in public utilities that had been privatised. In 1995 it produced the Greenbury Report. This recommended some further changes to the existing principles in the Cadbury Code:

• each board should have a remuneration committee composed without executive directors, but possibly the chairman
• directors should have long term performance related pay, which should be disclosed in the company accounts and contracts renewable each year

Greenbury recommended that progress be review in three years and so in 1998 Sir Ronald Hampel, who was chairman and managing director of ICI plc, chaired a third committee. The ensuing Hampel Report suggested that all the Cadbury and Greenbury principles be consolidated into a "Combined Code". It added that,

• the Chairman of the board should be seen as the "leader" of the non-executive directors
• institutional investors should consider voting the shares they held at meetings, though rejected compulsory voting
• all kinds of remuneration including pensions should be disclosed.

It rejected the idea that had been touted that the UK should follow the German two-tier board structure, or reforms in the EU Draft Fifth Directive on Company Law.^[4] A further mini-report was produced the following year by the Turnbull Committee which recommended directors be responsible for internal financial and auditing controls. A number of other reports were issued through the next decade, particularly including the Higgs review, from Derek Higgs focusing on what non-executive directors should do, and responding to the problems thrown up by the collapse of Enron in the US. Paul Myners also completed two major reviews of the role of institutional investors for the Treasury, whose principles were also found in the Combined Code. Shortly following the collapse of Northern Rock and the Financial Crisis, the Walker Review produced a report focused on the banking industry, but also with recommendations for all companies.^[5] In 2010, a new Stewardship Code was issued by the Financial Reporting Council, along with a new version of the UK Corporate Governance Code, hence separating the issues from one another.

Contents

Companies

A Directors

This sets out the requirements for non-executive directors. The appointments committee should be run by NEDs and their independence should be assured by absence of any previous or present personal or business links.

B Remuneration

This sets out guidance for the committee which determines director remuneration. Its principle is that of performance related pay. It is meant to complement the rules in the Companies Act 2006 which require a say on pay by the general meeting. The remuneration committee is meant to be composed of NEDs, although it allows for the Chairman of the board of directors to sit in.

C Accountability and Audit

Here rules are discussed about the audit committee, which is meant to be composed of only independent non-executive directors. In the wake of the Enron scandal, more emphasis has been placed on high standards of integrity.

D Relations with Shareholders

This part sets out the best practice of maintaining good relationships with shareholders and keeping them well informed on company affairs.

E Effectiveness

Institutional shareholders

E Institutional Shareholders

These provisions deal with a unique part of the UK financial market structure, which is great involvement and influence of institutional investors.

Schedules

Schedule A Provisions on the design of performance related remuneration

This goes into more detail about the problem of director pay.

Schedule B Guidance on liability of non-executive directors - care, skill and diligence

Under the Companies Act 2006 s 174 the board of directors' duty of competence was codified. Always pre-existing in the common law, directors are liable on ordinary principles of negligence for a failure to show a reasonable standard of competence. This statement is designed to strengthen a presumption that non-executive directors will be liable for poor board performance only to the extent of their involvement in the affairs. According to Dorchester Finance v Stebbing,^[6] a case on wrongful trading under the Insolvency Act 1986 s.214, non-executive directors are liable just the same as executive directors. What Schedule B here is trying to make clear is that the contribution towards negligent default will differ between executives and non-executives.

Schedule C Disclosure of corporate governance arrangements

This sets out a checklist of which duties must be complied with (or explained) under Listing Rule 9.8.6. It makes clear what obligations there are, and that everything should be posted on the company's website.

Code compliance?

In its 2007 response to a Financial Reporting Council consulation paper in July 2007 Pensions & Investment Research Consultants Ltd (a shareholder representative body) reported that only 33% of listed companies were fully compliant with all of the Codes provisions.^[7] Spread over all the rules, this is not necessarily a poor response, and indications are that compliance has been climbing. PIRC maintains that poor compliance correlates to poor business performance, and at any rate a key provision such as separating the CEO from the Chair had an 88.4% compliance rate.

The question thrown up by the Code's approach is the tension between wanting to maintain "flexibility" and achieve consistency. The tension is between an aversion to "one size fits all" solutions, which may not be right for everyone, and practices which are in general agreement to be tried, tested and successful.^[8] If companies find that non-compliance works for them, and shareholders agree, they will not be punished by an exodus of investors. So the chief method for accountability is meant to be through the market, rather than through law.

An additional reason for a Code, was the original concern of the Cadbury Report, that companies faced with minimum standards in law would comply merely with the letter and not the spirit of the rules.^[9]

The Financial Services Authority has recently^[when?] proposed to abandon a requirement to state compliance with the principles (under LR 9.8.6(5)), rather than the rules in detail themselves.

See also

• Corporate Governance
• Corporate Social Responsibility
• Stewardship Code
• OECD Principles of Corporate Governance 2004
• Deutsche Corporate Governance Codex (online)

Company reform reports

• Wrenbury Committee (1918) (concerned with "alien shareholders" and key industries)
• Greene Committee (1926) Report of the Company Law Amendment Committee (Cmnd 2657, 1926)
• Cohen Committee (1945)
• Jenkins Committee (1962)
• Alan Bullock (1977) Report of the committee of inquiry on industrial democracy, on worker codetermination
• Cork Report, Insolvency Law and Practice, Report of the Review Committee (1982) (Cmnd 8558)
• Cadbury Report (1992), Financial Aspects of Corporate Governance, on corporate governance generally. Pdf file here
• Greenbury Report (1995) Directors' Remuneration, Report of the Study Group Pdf here
• Hampel Report (1998), Review of corporate governance since Cadbury, here and online with the EGCI here
• Turnbull Report (1999) on internal controls to ensure good financial reporting
• Myners Report (2001), Institutional Investment in the United Kingdom: A Review on institutional investors, Pdf file here and Review of Progress Report here
• Higgs Report (2003) Review of the role and effectiveness of non-executive directors. Pdf here
• Smith Report (2003) on auditors. Pdf here
• Myners Review (2004) Myners principles for institutional investment decision-making: review of progress .pdf here

• Walker Review (2009) in response to the financial crisis, and focusing on institutional investors, .pdf document

Notes

1. ^ Financial Services and Markets Act 2000 s 2(4)(a) and generally Part VI
2. ^ Listing Rule 9.8.6(6)
3. ^ See generally, V Finch, 'Board Performance and Cadbury on Corporate Governance' [1992] Journal of Business Law 581
4. ^ See A Dignam, 'A Principled Approach to Self-regulation? The Report of the Hampel Committee on Corporate Governance' [1998] Company Lawyer 140
5. ^ David Walker, A review of corporate governance in UK banks and other financial industry entities (2009)
6. ^ Dorchester Finance v Stebbing [1989] BCLC 498
7. ^ PIRC, Review of the impact of the Combined Code (2007)
8. ^ e.g. this humorous grumbling from a Financial Times columnist
9. ^ para 1.10 of the Cadbury Report

References

• S Arcot and V Bruno, ‘In Letter but not in spirit: An Analysis of Corporate Governance in the UK’ (2006) SSRN
• S Arcot and V Bruno, 'One Size Does Not Fit All, After All: Evidence from Corporate Governance' (2007) SSRN
• A Dignam, 'A Principled Approach to Self-regulation? The Report of the Hampel Committee on Corporate Governance' [1998] Company Lawyer 140

External links

• Full text UK Corporate Governance Code 2010
• Full text of the Combined Code 2008
• Full text of the combined code 2006
• Full text of the combined code 2003

• The Financial Services Authority Listing Rules online and in pdf format, under which there is an obligation to comply with the Combined Code, or explain why it is not complied with, under LR 9.8.6(6).

• The Financial Reporting Council's website