In a sense, the response by most companies is more reactive than proactive. As various rules and regulations are introduced in different countries, they impose obligations on companies to reform and adopt good corporate governance practice. But it would be misleading to say that prior to the Enron scandals, no company practised good corporate governance. Many companies did, and still do, for they are keenly aware that investors look for good companies to invest in. Moreover, the practice of corporate governance principles is not a complete guarantee against company failure.
The principles of good governance
The UK’s 1992 Cadbury Report laid the foundations of a set of corporate governance codes, not just in the UK but also in countries as diverse as Russia, India and Malaysia. These countries have incorporated the Cadbury Report’s main principles into their own corporate governance codes.
Although the term ‘corporate governance’ has become widely known and accepted, it is nevertheless a term that is hard to define as it has many facets. Sir Adrian Cadbury defined it as “the system by which companies are directed and controlled”. The OECD Principles of Corporate Governance 2004 described corporate governance and its objectives as follows:
- a set of relationship between a company’s management, its board, its shareholders and other stakeholders. Corporate governance provides the structure through which the objectives of the company are set, and the means of attaining those objectives, and monitoring performance are determined. Good corporate governance should provide proper incentives for the board and management to pursue objectives that are in the interest of the company and its shareholders and should facilitate effective monitoring.
Putting it into practice
From the definitions, it is clear that corporate governance involves both the internal aspects of the company, such as internal control and board structure, as well as external aspects such as the relationship with shareholders and stakeholders. Importantly, it also provides the mechanism through which corporate objectives may be set, monitored and achieved. Although, there have been subsequent reports, the Cadbury code, published in 1992 still forms the basis for what is regarded as good corporate governance the world over, not only in the UK. The key recommendations of the Cadbury code were:
- separation of the roles of chairman and chief executive
- at least three independent non-executives on the board
- audit, remuneration and nomination committees, comprising mainly of non-executives
- directors to report on internal controls.
Separation of power
Following the publication of the Cadbury report, there were profound changes in British boardrooms but no change has been more important than the move away from the single autocratic figure at the head of the public corporation. Companies increasingly separated the role of chief executive and chairman, with the chairman taking a backroom role for the good reason that they are more able to discharge their principal function of handling and managing crisis and change when required. Today, a full 95 per cent of the top 1000 UK companies split the roles of chief executive and chairman. While this does not mean 950 UK firms are flawless, it does indicate that UK boards have notched up progress in developing a culture of independent oversight that is necessary to ensure a balance of corporate power that could advance shareholder interest. Perhaps for this reason, UK has seen nothing like the scandal exemplified by Enron in the US. In that country, companies are often led by powerful dynamic executives – as was the case with both Jeffrey Skilling at Enron and Bernard Ebbers at WorldCom – and the same person is often chairman. There is no one on the board that can stand up to them. Up to March 2004, CEOs in the US directly ran the board at no fewer than 76 per cent of the S&P 500 companies. However, the trend in the US is also changing towards one of split roles between the chairman and the chief executive. Michael Eisner, chief executive of Walt Disney, was shocked at not being elected as the chairman at the 2004 annual general meeting.
Independence valued
The Cadbury report also saw independent non-executive directors as the principal instruments for better corporate governance. The report called for non-executive directors of sufficient calibre and number for their views to carry significant weight. They would be expected to bring independent judgement to bear on issues of strategy, performance, resources including key appointments and standards of conducts.
The non-executive directors’ independence is questionable if they allow themselves to be in a position of conflict of interest. Non-executive directors were also to form the audit, remuneration and nomination committees.
These principles were ratified by the OECD 2004 guidance, still the current standard, which states: “objectivity requires that a sufficient number of board members not be employed by the company or its affiliates and not be closely related to the company and its management through significant economic, family or other ties.”
