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‘Bubble Act’ 1720 Recognised the ‘moral hazard (Risk)’ of the

relationship in the principle-agent relationship A key theme that was established and

continues to today is that directors are accountable to shareholders

Companies Act (CA) 1844 Required audited balance sheet (a ‘value

statement’ at year-end) to be presented to shareholders▪ Problem: Anyone could be the auditor.

Companies Act 1856 The CA 1844 audit provision was removed

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Companies Act 1900 Reintroduction of balance sheet audit Auditor to be appointed by shareholders

CA 1929 P&L a/c required

▪ Shows how the company has fared over the year.

CA 1948; CA 1967 Required auditor to be qualified Auditor to express ‘an opinion’ A lot of disclosures to shareholders

required3

CA 1981 Aspects of GAAP introduced into law Directors’ report to be audited Directors’ report to contain comment on the

companies future development Small and medium sized companies exemptions

CA 1985; CA 1989; CA 2006 (Mainly consolidation) Director’s ‘duty of competence’ (Common Law)

codified▪ Negligence where a failure of a reasonable standard of

competence IFRS for listed companies

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The government’s role in a capitalist economy To protect the public interest

Most of the statutes have resulted from a public scandal Usually involving fraudulent activity Thus legislation has attempted to make

directors increasingly more accountable to shareholders over time

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Cadbury 1992Greenbury 1995Hampel 1998Turnbull 1999Higgs 2003Tyson 2003Smith 2003

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Corporate governance (CG) - not a ‘new’ thing Based on existing, implicit CG behaviour It may thus be considered a ‘codification’ exercise of

good CG practice in the UK in 1992 Public concern over several corporate

failures Particularly the Pollypeck and Maxwell Communications

Corporation cases in 1991 The rapid growth in executive remuneration and

conflicts of interest between directors and shareholders The Stock Exchange initiated the Cadbury

enquiry7

‘The committee on the financial aspects of corporate governance’

The Code of Best Practice’ (1992) Voluntary code

▪ But for listed companies a compliance statement was required▪ ‘Comply or explain’ – Principles rather than rules

The ‘principles v rules’ argument (UK v USA) The following example is a true case, but in a

non-financial setting (from China Daily, December 2007)

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Hospital Doctor – What will he or she

do here?

Underlying principles of medical

professionRules of the hospital

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In financial accounting – Should there be strict and detailed rules trying

to cover all situations (US approach) or Limited rules with ‘overriding’ principles (true

and fair / fair presentation) (UK/International approach)

In practice there is a concerted effort to bring US and UK/International accounting standards together.

Back to UK CG…10

‘This, more than any other initiative in corporate governance reform, has led to the shift of directors’ dialogue towards greater accountability and engagement with shareholders…’ and

‘…has generated the more significant change of corporate responsibility toward a range of stakeholders, encouraging greater corporate social responsibility in general’

Solomon, 200711

The report covered three areas Directors

▪ It defined the composition of the board, its responsibilities, and the responsibilities of the chairman, and the audit and remuneration committees.

Auditing

Shareholders12

‘Fat cats’

The Greenbury Report released in 1995 was the product of a committee established by the United Kingdom Confederation of Business and Industry on corporate governance. It followed in the tradition of the Cadbury Report and addressed a growing concern about the level of director remuneration.

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‘Fat cats’ Continued public concern over several

incidences of very high directors’ remuneration

Objective to set up a Code of Practice for directors’ remuneration

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The Committee on Corporate Governance (the Hampel Committee) was established in November 1995 to review the Cadbury Committee's recommendations on corporate governance. The Hampel Committee released a preliminary report in August 1997, followed by a final report in January 1998.

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Continued public concern over corporate failures

Notably that of Barings Bank, 1995 The Hampel Committee

The intention was to ‘combine, harmonise and clarify’ the Cadbury and Greenbury recommendations and create an overall code of corporate governance

Issue of a revised and extended ‘Combined Code’, 1998

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More extensive, covering… Board performance Disclosure of information Remuneration Role of the audit committee Training Role of the nomination committee Conduct of AGM’s Role of the remuneration committee Roles of chairman and chief executive Directors’ contracts

Key elements incorporated in the Stock Exchange Rules (1998)

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It also underlined the voluntary, ‘principles-based’ approach as a key element

Refocused the emphasis on accountability primarily to the shareholders, then to other stakeholders

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The report covered two areas1. Principles

▪ Directors▪ Directors’ remuneration▪ Relations with shareholders▪ Accountability and audit

2. Institutional shareholder provisions

The ‘Codes’ issued after Hampel’s are mainly modifications of the basic Cadbury-Greebury-Hampel model

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The Turnbull Report was first published in 1999 and set out best practice on internal control for UK listed companies. In October 2005 the Financial Reporting Council (FRC) issued an updated version of the guidance with the title 'Internal Control: Guidance for Directors on the Combined Code'.

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Public concern over risk management and control Barings Bank, 1995

At this point we need to re-consider what risk management, systems and internal control are…

21

It initiated the Higgs Report on “The Role and Effectiveness of Non-Executive Directors” (Non-working director of a firm) does not participate in the day-to-day management of the firm) which was published in January 2003. Recommendations from Higgs included a definition of ‘independence’ and the proportion of independent non-executive directors on the board and its committees; added emphasis on the process of nominations to the board through a transparent and rigorous process.

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Around the same time, the Financial Reporting Council published the Smith Report, “Guidance on Audit Committees”. Both the Higgs and Smith Reports were published in January 2003.

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