Examine And Analyse The Mechanisms Of Corporate Governance Finance Essay - Free Essay Example

In 2008 a paper by Dr. Roger Barker was published which remained on the website of Institute of Directors. This paper provided that there is a good balancing among self-regulation and law in the UK model of corporate governance1. International Monetary Fund during 2003 assessment found out that the UK is one of the leading countries internationally for setting standards about corporate governance2 including public disclosure practices. Its success have made almost all (26 out of 27) European Unions (EU) Member States to adopt UK-style corporate governance codes during the past few years.3 As regards to present crisis in financial market the paper argues that the fiasco in the financial sector should not be interpreted as the UKs failure of corporate governance regime, and thus, there is a requirement to focus upon improving the practical application of the present corporate governance framework rather than taking new initiatives. For example, the revised Combined Code 2003 and various amendments carried out in 2006 and 2008 have few of the worlds best recommendations recognised internationally in the fields of the separation of the CEO and chairman positions, board independence, and information disclosure. Th e Financial Reporting Council 4in March 2009 made another review of the Combined Code for strengthening and further updating their recommendations in the light of the current developments. There is a requirement to follow the Comply-or-Explain5 rule for the companies to report on their corporate governance practices annually and account for deviation from the codes recommendations. There have been various changes incorporated in the Companies Act 6 2006 in order to increase directors accountability to the company as a whole; strengthen the rights of the shareholder, particularaly the minority; and requiring a Business Review for encouraging transparency and improve shareholders ability for assessing the progress, or lack thereof.7 Furthermore, the EUs Takeover Directive and Transparency Directives have provided the new criteria for transparency and disclosure.8 The effectiveness of the governance system will depend upon type of the company under consideration. In small companys where shareholders are the directors the problem of alignment is not present, however if shareholders are not the directors, they may well find worrying how they can influence what directors are doing. In the dispersed-ownership company the control of directors, how shareholders will do it, becomes acute specially the ways in which shareholders can bring litigation in respect of failures of corporate governance. The other stakeholders like customers, regulators, employees, NGOs and also the tax and treasury departments plays an important role in the corporations performance. There is widespread agreement that shareholders have a dominating role in ensuring good governance. For some, good governance requires a restoration of shareholder supervision and control.9 Therefore, it means that on one hand the companies should be ready to review and explain their governance policies, including any special circumstances in which they view justification in departure from the best practice, and on the other hand that shareholders and others should show flexibility in the interpretation of the governance code and should listen to directors explanations and judge them on their merits.10 5. 2nd code Combined Code on Corporate Governance. https://www.frc.org.uk/documents/pagemanager/frc/Combined_Code_June_2008/Combined%20Code%20Web%20Optimized%20June%202008(2).pdf 6.https://www.opsi.gov.uk/acts/acts2006/pdf/ukpga_20060046_en.pdf 7.https://www.estandardsforum.org/report_generator/report.pdf?best_practices=truecountry_id=18 8.https://www.simmons-simmons.com/index.cfm?fuseaction=service_industry.display_leftpage=2071 9. https://kar.kent.ac.uk/1939/1/Myth_of_Shareholder_Ownership.pdf 10.https://www.econsense.de/_CSR_INFO_POOL/_CORP_GOVERNANCE/images/hampel_report.pdf 3.3 The Role of Shareholders In the UK during 1990, institutional investors 11 insurance companies, pension funds, unit and investment trusts, were holding most of the shares in listed companies (more than 50%), this share has now dropped down to less than a third. 12 The recent statistics13 of 2006 provides that foreign institutional investors owned 40% of UK shares. The foreign investment in UK plc reached at 41.5% in 2008. By following the pattern of the current rate, foreign investors will hold the majority of UK shares by 2018.14 This shows the importance of the role that could be played by the institutional investors in corporate governance. Institutional investors have an overriding responsibility to their clients with different investment objectives, as they are not a homogeneous group. The prime objective of these institutional investors is for income and capital growth. These institutions did not take much interest in corporate governance. Mostly these institutions made an effort to achieve the desired target performance by buying and selling share, with their reliance basing on the judgement of the underlying strength of companies and their ability to exploit anomalies at the stock exchange share prices. Institutions were not habitual to vote their shares regularly, and tried to contact directly with company managements during the circumstances of crisis. The recent credit crunch shockwaves and the UK banking industry turmoil have given a call to the companies (and the government) for a fresh look at corporate governance. Therefore, then Chancellor Alistair Darling tasked Sir David Walker 15 to review the corporate governance systems of UK banks. The Walker Review recommends strengthening the role of non-executives and giving them new responsibilities to monitor risk and remuneration; it also recommends a stewardship duty on institutional shareholders to play a more active role as owners of businesses.16 11 Institutional investors mainly include: all types of investment funds, social security funds, insurance funds, securities companies and QFII (Qualified Foreign Institutional Investors). https://www.ccsenet.org/journal/index.php/ijbm/article/viewFile/1633/1543 12https://www.iod.com/intershoproot/eCS/Store/en/pdfs/policy_publication_The_UK_Model_of_Corporate_Governance.pdf 13. Office for National Statistics; Share Ownership: A report on ownership of UK shares as at 31 December 2006; 2007 14 https://www.efinancialnews.com/story/2010-03-15/foreign-investors-pour-onto-uk-plc-shareholder-register 15.https://www.telegraph.co.uk/finance/newsbysector/banksandfinance/5840342/Sir-David-Walker-to-shake-up-bank-boards.html 16. https://www.hm-treasury.gov.uk/walker_review_information.htm The number of shares, which they posses has increased, and they are facing difficulty to sell shares in large number without depressing the market. Few of the institutions are now aiming to match their portfolio to the components of a share index index tracking which they think may have better long-term results than an active trading policy. This has resulted that most of the institutions now have started taking active interest in corporate governance. Their participation can be by either by voting on resolutions in General Meetings, or informally making contact with the company. Institutions are not experienced business directors and cannot substitute for them. However, it is believed that they can take a constructive interest in, and test strategy and performance over time. As an investor organisation, Hermes Investment Management Limited (Hermes), one of the largest fund managers in Britain (a pension fund ) with approximately 36 billion 17 under management and managed assets. On 31 March 2003 took an active stance on corporate governance in its relation with its clients and emphasised that companies should be run in the long-term interest of shareholders having a vision of their clients interests first. 18 It is believed that companies following this principle will not only benefit their shareholders but the wider economy of the country where the company and its shareholders participates. Hermes approach for engaging the investee companies, is based on the fundamental belief that those companies with shareholders involvement having active participation and interest would likely to achieve superior long-term returns than those without. In short, it believes that good stewardship creates value. Hermes has given greater importance on engagement with all companies in which it invests and has enjoyed as a leader in promoting better corporate governance for over a decade. Walker has stressed in the recommendations about institutional investors to follow the Code on the Responsibilities of Institutional Investors which was prepared by the Institutional Shareholders Committee (ISC) in November 2009. Walker Review also provide that ISC Code is good starting point for the Stewardship Code. 19(Para 1.15 -FRC Stewardship Code for institutional investors 2010) There was a requirement that it should be ratified by the FRC and should operate as a Stewardship Code on a comply or explain basis, and should be reviewed by the FRC on a regular basis.20(Para 1.7-FRC Stewardship Code for institutional investors 2010) FRC is seeking views on the proposals of Stewardship Code for institutional investors by 16 April 2010. 21(P.6- FRC Stewardship Code for institutional investors 2010) 17.https://www.article13.com/A13_ContentList.asp?strAction=GetPublicationPNID=578 18.https://www.article13.com/A13_ContentList.asp?strAction=GetPublicationPNID=578 19https://www.frc.org.uk/images/uploaded/documents/Stewardship%20Code%20Consultation%20January%202010.pdf 20https://www.frc.org.uk/images/uploaded/documents/Stewardship%20Code%20Consultation%20January%202010.pdf 21https://www.frc.org.uk/images/uploaded/documents/Stewardship%20Code%20Consultation%20January%202010.pdf The company law is reinforced by the Listing Rules; the companies are under obligation to follow them. 17 There is a further provision in the Listing Rules for the rights of the shareholders (i.e. that major transactions must be put to a vote), and require certain information should be disclosed to the market. There is also a formal requirement regarding the provision of a corporate governance statement in the annual report, showing how the company applied Combined Code. 18 The corporate governance behaviour provides an incentive for boards and shareholders for engaging with one another in a constructive dialogue on non-statutory aspects of corporate governance. 3.4 Shareholder Activism One of the writers wrote about Corporate Governance with a title, Watching the Boss 19 published in Economist January 29, 1994 highlights the intensity of Investor Activism, in following words: Everywhere shareholders are re-examining their relationships with company bosses what is known as their system of corporate governance. The accountability of bosses has been around since 19th century. 20 However, the litigation in the form of class action filed by World Com shareholders in 2005 resulted in a US$ 6 Billion payout, shareholders of Enron got a pay out of US$ 7 Billion. 21 The shareholders with a simple majority by calling a special meeting of the members, can vote to remove any any (or indeed all) of the directors.22 Does Shareholder activism really provide a tangible return real pounds and pence that boost investors portfolios? The answer could be: May be. Shareholder activism does boost the possible returns, said by Richard Cohen, a senior partner with the law firm of Lowey Dannenberg Bemporad Selinger Cohen in White Plains, NY. 23 After 2 years of miserable performance, the largest shareholder of a publicly traded closed-end venture capital fund, a hedge fund, took action. The two advisers were sued for the recovery of excessive compensation, also sued the 17. Listed on the Main Market of the London Stock Exchange (and which are policed by the Financial Services Authority). 18.https://www.iod.com/intershoproot/eCS/Store/en/pdfs/policy_publication_The_UK_Model_of_Corporate_Governance.pdf 19. https://www.highbeam.com/doc/1G1-14965217.html 20. https://www.highbeam.com/doc/1G1-14965217.html 21. https://thefirm.moneycontrol.com/news_details.php?autono=407987 directors for breach of duty, and fought an NYSE policy that did not allowed the firm to renew the advisory contract. In these circumstances, the new board hired a new, CEO, cut costs, cut executive and director compensation, and there was an over hauling of the policies. After four years of the changes, the fund was consistently profitable, the share price has boosted and net asset value, paid hefty dividends. Cohen says, Frankly, people invest to make money. When management becomes holier-than-thou about someone looking to make a buck, theyre living in a glass house,24 Shareholder (investor) activism could also force for better corporate governance. Historically it has been observed that individual shareholders, whether institutions or private persons, have had little chance of influencing the board or management given the fragmentation of ownership. There is a provision that shareholders can ask questions at the annual general meeting, but they would need a majority of votes in order to pass a motion that was binding on management. Even the institutional shareholders do not, in most countries, hold as much as 5 per cent of the ordinary shares of one company. However, it is worth noting that in Germany there are cases, such as Volkswagen 25 and Daimler where single institutions hold much larger proportions. In fact, the shares are mostly held by multinationals in Europe are held by financial institutions rather than private individuals. Such investors, in the past have preferred to sell their shares in case of disagreeing with company policy, rather than intervene in the management of the company. However, this attitude has changed with the passage of time. Presently the Institutional investors have become more aggressive, and individual investors have formed associations, which enable them to work together and command more votes in investee companies. 26 22.https://corporategovernanceoup.wordpress.com/category/shareholder-proposals/ 23. https://pview.findlaw.com/view/1461772_1 24. https://pview.findlaw.com/view/1461772_1 25.https://dailynews.muzi.com/news/ll/english/10085776.shtml?cc=25548ccr=) 26.https://openlearn.open.ac.uk/file.php/2785/formats/print.htm The California Public Employees Retirement System (CalPERS) is the biggest pension fund in the United States with $160 billion investments. It started its corporate governance process in 1984. It has its own website, and its annual Focus List is a hit list of companies that need, in the view of the fund, to improve their performance. 27 CalPERSs general strategy of public naming and shaming forces the change where it is sluggish. It is one of the few funds making its proxy votes public; it is there practice to publish them on its website in advance of company annual meetings. There has been a requirement for those institutional investors to disclose how they vote. CalPERS asked for the resignation of the chief executive of the New York Stock Exchange, in 2003, and he was ultimately obliged to resign. 28 In the UK, the National Association of Pension Funds (NAPF) 29 is an establishment representing the interests of employer-sponsored pension funds. The investment made by its members is more than 600 billion. NAPF has become increasingly active. NAPF is carrying out a practice of publishing position papers and advice to institutional shareholders about what standards they should expect from multinational companies in which they invest. Few of the pension funds ask the board of directors of a company in which they are planning to invest for signing a document that sets out minimum governance undertakings. Recently, NAPF joined hands with the forces of the Institutional Shareholder Services to reinforce its lobbying for shareholders rights The International Corporate Governance Network (ICGN) is an example of a worldwide multi-stakeholder coalition within the investment community with its members holding assets exceeding $10 trillion. The ICGN originates from the corporate governance endeavours of CalPERs, the College Retirement Equities Fund (TIAA-CREF), the Council of Institutional Investors in the USA, the Association of British Insurers, the Cadbury and Hampel Committees on Corporate Governance, NAPF and the Corporate Governance Forum of the Centre for European Policy Studies in Belgium. 30 ICGN tries to develop a global consensus on capital market corporate governance and, for laying down best practice for both issuers and investors. It seeks to promote best practice through its annual meetings, studies, toolkits, and awards programme. In case, informal negotiations among shareholder and the boards prove inadequate. Shareholders can in extreme cases resort to their rights through the courts. According to the UK co mpany law, shareholders have the voting rights among them the right for appointing and dismissing the individual directors and, in special circumstances, for calling an Extraordinary General Meeting. There are certain requirements pertaining to the AGM, having the provision regarding providing the information to shareholders, and various arrangements needed for voting on resolutions, are also set out in company law. 27..https://www.calpers.ca.gov/ https://www.lowey.com/SiteData/docs/LostInTranslation/722f802cc285d463f2343e9919327337/LostInTranslation.pdf 28..https://openlearn.open.ac.uk/file.php/2785/formats/print.htm 29.https://www.napf.co.uk/DocumentArchive/Policy/Reports%20and%20Responses%20to%20Consultations/10_2007/20070122_Institutional%20Investment%20in%20the%20UK%20Six%20Years%20On%20-%2022%20Jan%202007.pdf 30..https://openlearn.open.ac.uk/file.php/2785/formats/print.htm 3.5 The strength of the UK corporate governance The key strength of the UK approach to corporate governance lies in its ability to provide high standards of corporate governance with relatively low associated costs. The Combined Code measures although voluntary in nature have been successful in driving significant changes in governance behaviour. For example, there were very few companies with split role of Chairman and CEO prior to 1992. But today this division exist among 94% of FTSE 350 companies. 31 NEDs and board committees have increased in numbers and could influence and play a major governance role. As a result, the UK outperforms the US and most other countries in terms of governance standards.32 The reports published in 2005, by the FTSE ISS Corporate Governance Index and Governance Metrics International both have placed the UK at the top of the list of countries by average corporate governance score. 33 A latest review of UK corporate governance was carried in 2007 by the Financial Reporting Council (FRC) 34 The conclusion made by the board was that the current UK framework was working reasonably well, and was of the view that there was no need for major changes. However, only two relatively minor changes were made to the Combined Code in 2008:35 ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ The restrictions on chairing more than one FTSE 100 company were removed. ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ The chairman of a listed company outside the FTSE 350 was permitted to be a member of the audit committee, provided he was regarded as independent on appointment 31. (Grant Thornton 2007). https://www.grant-thornton.co.uk/pdf/Corporate-Governance-Review-2008.pdf 32.https://www.iod.com/intershoproot/eCS/Store/en/pdfs/policy_publication_The_UK_Model_of_Corporate_Governance.pdf 33.https://www.iod.com/intershoproot/eCS/Store/en/pdfs/policy_publication_The_UK_Model_of_Corporate_Governance.pdf 34..https://www.frc.org.uk/CORPORATE/COMBINEDCODE.CFM 35. https://www.frc.org.uk/corporate/reviewCombined.cfm The UK model although is in good shape, but it is not very pleasing. There are numerous areas which are worthy of renewed attention from market participants and policy makers. Following areas need attention for improving the system: Improving Dialogue Between Companies and shareholders A leading authority on corporate governance, late Jonathan Charkham once famously described UK institutional investors as supine, reflecting their lack of engagement with the companies that they owned. A constructive dialogue among shareholders and companies is a key element of the UK model of corporate governance. This sentiment is reflected in the recommendations made by Cadbury 36 that Institutional investors should encourage regular, systematic contact at senior executive level to exchange views and information on strategy, performance, board membership and quality of management (report, 6.11). Company performance will be influenced by the initiatives and decisions of the shareholder that they directly or indirectly, actively or passively take. As most the principles of best practice of the UK approach in corporate governance are not defined by company law, but arise from the Combined Code, which are monitored and enforced by shareholders. The best practice in corporate governance thus, highlight that the governance should promote both accountability to shareholders and the boards ability to manage the company effectively in the best possible manner. These codes have undergone further changes to the combined Code in 2006 and 2008 pointing out that the governance should promote both accountability to shareholders and the boards ability to manage the company effectively. The combined Code 2006 provides that The board as a whole has responsibility for ensuring that a satisfactory dialogue with shareholders takes place, (Main principle D.1). 37 The Code also states that instit utional shareholders should enter into a dialogue with companies based on the mutual understanding of objectives (Main principle E.1).38 Furthermore, it also acknowledges that there exist a strong commonality of interest among shareholders and companies that should be encouraged by giving shareholders a central role in the enforcement of corporate governance standards. 39 36. https://www.ecgi.org/codes/documents/cadbury.pdf 37.https://www.frc.org.uk/documents/pagemanager/frc/Combined%20Code%20June%202006.pdf 38.https://www.frc.org.uk/documents/pagemanager/frc/Combined%20Code%20June%202006.pdf 39.https://www.iod.com/intershoproot/eCS/Store/en/pdfs/policy_publication_The_UK_Model_of_Corporate_Governance.pdf Combined code 2006 provides that Institutional shareholders should enter into a dialogue with companies based on the mutual understanding of objectives. (Main Principle- combined code 2006) 40 Institutional shareholders should make an effort to apply the principles as provided in the Institutional Shareholders Committees The Responsibilities of Institutional Shareholders and Agents Statement of Principles 41 which should be reflected in fund manager contracts. Resultantly, corresponding to these efforts, now more institutions publish their engagement policies and voting records. Furthermore, about 55% of shareholder cast votes (on average) at company AGMs, 42 which is not considered to be suggestive a real good degree of shareholder engagement. Dr Roger Barker, institute of directors report on Corporate Governance, that this lack of dialogue puts business at risk, and makes a mockery of claims of good corporate governance. 43 In nutshell, a strong dialogue is very essential between boards and shareholders for the UK model of corporate governance. Without it, there is a fear of the risk that government might take to fill the vacuum in a corporate governance by transferring responsibility to regulators from shareholders for corporate governance enforcement. This might reduce the flexibility of the UK model, and impose some additional compliance costs on UK companies. 44 Implementation of comply or explain code in more meaningful manner There is a provision in the combined code offering an advice that, If a company chooses not to comply with one or more provisions of the Code, it must give shareholders a careful and clear explanation which shareholders should evaluate on its merits. In providing an explanation, the company should aim to illustrate how its actual practices are consistent with the principle to which the particular provision relates and contribute to good governance 45 (paragraph 5). 40.https://www.frc.org.uk/documents/pagemanager/frc/Combined%20Code%20June%202006.pdf 41.www.investmentuk.org/news/research/2005/topic/corporate_governance/isc0905.pdf 42.https://www.ethicalcorp.com/corporategovernance/agenda.asp 43.https://www.ethicalcorp.com/corporategovernance/agenda.asp 44.https://www.iod.com/intershoproot/eCS/Store/en/pdfs/policy_publication_The_UK_Model_of_Corporate_Governance.pdf 45.https://www.frc.org.uk/documents/pagemanager/frc/Combined_Code_June_2008/Combined%20Code%20Web%20Optimized%20June%202008(2).pdf The companies are required to justify their corporate governance behaviour in their annual reports. However, the explanations given by the companies of non-compliance should be meaningful. The FRC, in recent reviews have argued that there is a need for more informative explanations of non-compliance in annual reports. The company is under obligation to provide indications of the likely future development of the business in a business review which should contain a fair review of the companys business. 45 It also include that the company to provide a balanced and comprehensive analysis of the development and performance of the companys business during the financial year. 46 The company by law must provide in the business review, the description of the principal risks and uncertainties facing the company. 47 It has emphasised by the combined code that When evaluating a companies governance arrangements, particularly those relating to board structure and composition, institutional shareholders should give due weight to all relevant factors drawn to their attention. 48 (Main Principle E.2). It was advised by the code that Institutional shareholders should consider carefully explanations given for departure from this Code and make reasoned judgements in each case. They should give an explanation to the company, in writing where appropriate, and be prepared to enter a dialogue if they do not accept the companys position. They should avoid a box-ticking approach to assessing a companys corporate governance 49.(E.2 Supporting Principle) In fact, this widespread box-ticking approach, undermines the entire comply or explain concept, which is about retaining flexibility in corporate behaviour. Keeping that in mind, a suggestion is offered that the term apply or explain to be replaced with comply or explain, for avoiding the impression that failure to comply means non-compliance, i.e. rule-breaking. Smaller companies and their governance needs Smaller companies as per the FRC are increasingly adopting the provisions of the Combined Code, despite not being subject to the comply or explain requirements of the LSEs Listing Rules. 50 45. Companies Act 2006 s417; 3 46. Companies Act 2006 s417; 4 47. Companies Act 2006 s417; 3 48..https://www.frc.org.uk/documents/pagemanager/frc/Combined_Code_June_2008/Combined%20Code%20Web%20Optimized%20June%202008(2).pdf 49.https://www.frc.org.uk/documents/pagemanager/frc/Combined_Code_June_2008/Combined%20Code%20Web%20Optimized%20June%202008(2).pdf 50..https://www.frc.org.uk/documents/pagemanager/frc/Combined%20Code%20review%20main%20findings%2018%20January%202006.pdf Small and medium-sized enterprises (SMEs) often look Code compliance as a means of inspiring confidence in their operations with other stakeholders, or possibly with an eye to a future listing. The smaller firms with their meagre resources are unable to develop their own corporate governance template. So they require off-the-shelf solution, and look towards the combined code as providing such a solution. 51 Facing the challenge of a changing ownership structure The UK institutions owned more than 50% of UK equities during 1990 (at the time of the Cadbury Report), this share has now dropped down to less than a third. The foreign investors 52 and the Hedge funds 53 have managed to increase their share of UK corporate ownership. 54 The foreign investment in UK plc reached at 41.5% in 2008. By following the pattern of the current rate, foreign investors will hold the majority of UK shares by 2018.55 There is growing uncertainty about this new ownership structure; as the new investors may not share the corporate governance perspectives of traditional UK institutional investors. Consequently, it would be harder for boards and shareholders for establishing relationships. Resultantly, the UK model of corporate governance might be at risk, as it relies on shareholders for monitoring and enforcing corporate governance standards (in partnership with boards). However, this change in the composition of corporate ownership may not necessarily disrupt the effective functioning of the UK model. The codes on the content of corporate governance can be adapted with the passage of time reflecting the new priorities of owners. However, the advantage of voluntary codes is with their greater flexibility in adjusting with the changing governance perspectives in comparison with formal company law. However, there may be a problem, which could arise if the new owners simply do not show any interest in engaging with companies over governance. Alternatively, the foreign investors may seek to use their ownership stakes in the pursuit of the foreign policy of their controlling governments. These are the main concerns about the growing role of foreign wealth in the UK corporate ownership. 51..https://www.iod.com/intershoproot/eCS/Store/en/pdfs/policy_publication_The_UK_ Model_of_Corporate_Governance.pdf 52..https://www.iod.com/intershoproot/eCS/Store/en/pdfs/policy_publication_The_UK_Model_of_Corporate_Governance.pdf 53.https://www.herbertsmith.com/NR/rdonlyres/CE2AD02B-EE94-456A-B108-169D8B26FBEF/0/7818HedgeFundsWhiteListBriefing.pdf 54..https://www.efinancialnews.com/story/2010-03-15/foreign-investors-pour-onto-uk-plc-shareholder-register 55..https://www.efinancialnews.com/story/2010-03-15/foreign-investors-pour-onto-uk-plc-shareholder-register The present success in the UK model of corporate governance is basing on the consent and participation of shareholders. In case if that does not exist, it could tend to encourage for a shift towards a legislative approach, e.g. where national policy makers and the EU decide that comply or explain is no more viable, and there is increasing requirement to hand over governance enforcement to Securities and Exchange Commission (SEC) style regulators. Approach to form proportionate corporate social responsibility Corporate social responsibility (CSR) is an essential part of any corporate governance framework, though no part of the Combined Code  is specifically elaborates the Corporate social responsibility. However,the combined code on corporate goverance provides that, The board should set the companys values and standards and ensure that its obligations to its shareholders and others are understood and met56 (supporting principles, A.1.) In this regard the Turnbull Guidance provides that risk assessment should cover not only narrow financial risks but also those related to health, safety and environmental, reputation, and business probity issues 57. The Association of British Insurers 58 has about 20% of the companies trading on the London Stock Exchange, provided guidelines on CSR-related issues for both investors and companies. In 2007, its report on the subject of Socially Responsible Investment Guidelines provided that there should be a companys environmental, social and governance (ESG) risks included in the annual report. It also provided that whether the remuneration committee considered and disclosed about corporate performance on ESG issues before deciding remuneration for senior executives.59 There is a requirement set by law that directors must give due regard to community and environmental issues during the process of the consideration of their duty in order to promote the success of their company 60 and any such action be disclosed in the Business Review. 61 The big companies like Unilever and BP 62 have talked in detail regarding social and environmental issues in their annual reports, and most of the people argue that complying with CSR guidelines have contributed a lot to attract customers, it differentiate you from the competition as such can have a positive effect on the share price. 56.https://www.frc.org.uk/documents/pagemanager/frc/Combined_Code_June_2008/Combined%20Code%20Web%20Optimized%20June%202008(2).pdf 57.https://www.accaglobal.com/pubs/general/activities/library/sustainability/sus_archive/turnbull.pdf 58. . https://www.abi.org.uk/ 59.https://www.abi.org.uk/ 60. S. 172 CA 2006) 61.https://www.cipd.co.uk/nedresource/information/boardperf.htm 62.https://www.emeraldinsight.com/Insight/viewContentItem.do?contentType=ArticlehdAction=lnkpdfcontentId=869562 The increasing number of green and ethical investment funds seeking to find green and ethical businesses to invest in.63 As regards to bigger companies in particular, it can be argued, corporate social responsibility (CSR) guidelines is, not an add-on or an optional extra: it is an integral part of good governance. 64 Engagement between boards and shareholders over remuneration The directors Report introduced the introduction of a major reform in the field of remuneration in the UK in 2002.65 This has placed a legislative requirement for companies publishing the details regarding the remuneration of the executives in the annual reports and also allowed an advisory vote of the shareholders on the issue. It was thought at the time that this would encourage sufficient engagement between boards and shareholders over remuneration. However, it did not produce the results as anticipated. There have been concerns shown by the UK business community in recent years over executive remuneration with a range of voluntary actions. There has been an appreciation for this approach and it did work well in many respects. Significant changes in respect of directors service contracts have been observed in CA 2006, which provide that contracts of more than two years duration need to be approved by shareholders in general meeting. In the absence of such an approval, the term is void and the contract terminable on reasonable notice 66 The current financial turmoil has once again raised the spectre of the executive remuneration issue. The media blamed highly rewarded bankers for the adoption of excessively risky and short-termist trading strategies. This has demanded, for taking measures that should control executive pay. The UK Government asked Lord Turner in October 2008 to review the reasons of the global financial problem. Lord Turner Review was issued in March 2009, with the recommendation for the redesigning of regulation and supervisory approach required to create a more robust banking system for the future. In the review, it was stressed that there is a requirement to improve the effectiveness of internal risk management and corporate governance. 67 63.https://www.iii.co.uk/articles/articledisplay.jsp?article_id=10092961special_id=10060887 64..https://www.lawsociety.org.uk/documents/downloads/corporate%20social%20responsibility.pdf 65..https://www.opsi.gov.uk/si/si2002/20021986.htm 66..https://www.acca.org.uk/pubs/general/activities/library/company_law/tech-tp-cdd.pdf 67..https://www.fsa.gov.uk/pubs/other/turner_review.pdf In these circumstances of financial turmoil, the UK Prime Minister, in 2009 asked Sir David Walker (ex-City regulator) to review corporate governance in the banks of the UK in the light of the current critical loss and the failure throughout in the banking system. The Walker Review with the recommendation was published in November 2009 stressing more transparent pay and bonus structures for all highly paid earners following serious and ongoing corporate governance failing in the financial sector. 68 After Walkers recommendations, the Chief Risk Officers role may fundamentally change. Walker suggested that the Chief Risk Officer mandate should include all material risks and become, at least in part, the eyes and ears of the Board Risk Committee. 69 However, no automatic link exist between the current financial crisis and remuneration levels in banking. The recent problems in the UK financial institutions mainly arisen due to the freezing-up of wholesale funding markets, on which, the business models of certain UK banks (e.g. Northern Rock, HBOS, Alliance and Leicester, Bradford and Bingly) had grown highly dependent. The link is tenuous between remuneration and these problems. Any measure taken by regulators in contrast, to micromanage remuneration structures would be counterproductive. These measures will not solve the underlying causes of financial sector instability. Furthermore, they will create the negative effects of undermining the spirit in UK competitiveness, and distorting the allocation of resources within the enterprises. It would be, however, appropriate that the shareholders must increase their engagement with companies over remuneration. In case if they feel necessary, they could make use of their voting rights more effectively if they believe that levels of director remuneration, in the end are not consistent with long-term value generation. Shareholders should have an opportunity and the right to participate in, and be equipped with sufficient information on, decisions about fundamental corporate changes, such as authorization of additional shares, amendments to constitutional documents, major acquisitions or dispositions, and closure of businesses Thus in the UK model of corporate governance, shareholder voting right on directors pay is an important safeguard which is not present in the United States. The US corporate governance framework arguably could benefit from the grant of similar voting rights to US shareholders. 68.https://www.hm-treasury.gov.uk/walker_review_information.htm 69.https://www.hm-treasury.gov.uk/walker_review_information.htm Recommendations Following recommendations are offered: In all listed companies shareholders should have an advisory vote at the AGM on risk. There is evidence to suggest that in the recent financial crisis number of bank boards were unable to exercise effective oversight of risk. There was lack of engagement among shareholders and boards on this issue. The advisory votes at company AGMs by the shareholders would be an effective way of focusing their (investors) minds on particular issues. As in 2002 an advisory vote on remuneration was introduced which increased investors interest in firms remuneration arrangements. Thus it is proposed that shareholders should have the an advisory vote at the AGM on risk basing on the forward looking risk disclosures provided in the Business Review. Investors should be subject to their own combined code, with regard to which they should either comply or explain. In order to increase an incentive for investors to engage with boards, there is a requirement that shareholders should be subject to a Combined Code for investors in relation to which they should either comply or explain[emailprotected] There should be a code containing statements of best practice in respect of investors engagement with boards. This will increase the moral pressure on fund managers to be good owners. Institutional investors have the best practice codes which was published in 2007 by the International Corporate Governance Network providing Institutional Shareholder Responsibilities. The best practice principles in respect of both the internal governance of investment institutions and with regard to the exercise of their ownership rights are included in it. Institutional Shareholders Committee also published similar set of principles The Responsibilities of Institutional Shareholders and Agents: Statement of Principles in June 2007. The primary aim focuses on the ownership responsibilities of shareholders. As a result the need is for an officially sanctioned code of best practice for investors based on the comply or explain principle which can be used by beneficiaries to hold investors to account, both in terms of investors own internal governance and the exercise of their ownership rights vis--vis investee Companies. The FRC should produce guidance on remuneration to assist in the implementation of the principles and provisions of section B of the Combined Code. There is a requirement to encourage boards to implement a remuneration policy for rewarding long-term performance, and avoids creating perverse incentives that encourage excessive risk-taking. A non-binding Recommendation on the Remuneration of Directors of Listed Companies (IP/09/673) was published by the European Commission in April 2009. There is a requirement for the FRC to promote the application of these principles through guidance on remuneration (similar to the Turnbull and Smith Guidance on internal control and audit committees) Such guidance would support boards in their implementation of section B of the Combined Code. It would be worthwhile that the guidance to promote the following remuneration principles in respect of executive board members: a limit on severance pay (2 years maximum) and an end to severance pay in case of failure; a balance between fixed and variable pay, and the linkage of variable pay to predetermined and measurable performance criteria; the use of remuneration to promote the longer-term sustainability of companies, e.g. through a balance between long and short term performance criteria (financial and non-financial); deferment of variable pay; a minimum vesting period for stock options and shares (at least three years); and retention of part of shares until the end of employment; The reclaim of variable pay paid on the basis of data which subsequently proves to be manifestly misstated (clawback). In addition, the role and operation of remuneration committees should be strengthened. The remuneration committees should incorporate members having specific experience in the design of remuneration. At the AGMs the remuneration committee should be present to provide explanations to shareholders. https://www.frc.org.uk/documents/pagemanager/frc/Responses_to_March_2009_combined_code_consultation/Institute%20of%20Directors.pdf In order to encourage UK institutional investors to become more engaged in corporate governance issues, an idea of shareholder-led nomination committees, as used in Sweden, 70 could be a practical solutions to bridge the engagement gap. The nomination committee which is a sub-committee of the board and made up of board members, appoints the UK boards of directors. In contrast, four or five of the largest shareholders form part of Swedish shareholder-led nomination committees headed by the non-executive chair of the board. The recommendations made by the committee are directly coomunicated to the annual general meeting with the details of the structure and amount of remuneration for each director, which is then voted on by investors. 71 Further more there is nothing in the existing comply or explain UK corporate governance code to stop UK companies from adopting similar arrangements for their nomination committees. It would solve the engagement gap to tackle the issue of ownerless corporations as described by Lord Myners. 72 This would increase the confidence and trust in the board by improving transparency. However, it depends upon the willingness of institutional investors to participate for making this process a success. In order to increase the insufficient dialogue between investors and companies another obvious solution could be the nomination of their own non-executive board members by the institutional investors. However, this recommendation might not be embraced by the investment community, because it might reduces their flexibility in buying and selling a companys shares as it would exposes them to insider dealing legislation. Thus, there is arguably a need for a code of responsibilities for institutional investors to match the Combined Code that relates to companies. In short, a strong dialogue among shareholders and boards is essential and important for the company in the UK model of corporate governance. In order to achieve the success for the UK model, it should be based on the consent and participation of shareholders. If in case that is no longer present, it could encourage a shift towards a legislative approach. 70https://www.ecgi.org/codes/documents/code_sweden.pdf 71.https://www.forceforgood.com/Uploaded_Content/tool/303201018345974.pdf 72. Myners says trustees must meet governance legal duty and Myners wants legal governance duty for managers In order to increase a discipline among the companies and their management the UKs takeover rules continue to make the UK as a leading destination for foreign investment and as a leading location for corporate HQs and operations.73 However, it is believed that there is need for reforming certain aspects of the existing rules. Hostile Takeovers a last resort with an approval of two-thirds majority support The threat of hostile takeover would provide a source of discipline for improving the most underperforming companies and their management. However, it should be noted that hostile takeovers should be used as a last resort because it is believed that it constitutes a short-termist management approach. 74 As regards to approval of takeovers, it would be a matter for shareholders to decide. Since such a decision is likely to exert a crucial impact on all of the companies involved. So it is important to ensure that as many shareholders as possible are fully supportive of such a step. Thus the threshold for approval of a hostile takeover should be raised to a shareholder majority of two-thirds (rather than a simple majority, as at present). 75 Summary The UK corporate governance framework is governed by the Listing Rules issued by the FSA, the Combined Code issued by the FRC and the Companies Act. 76 The first Combined Code was issued in 1998, and has been updated at regular intervals with 2003, 2006, 2008 versions since then. However, the June 2008 edition incorporates minor changes.77 Relations with shareholders A key component of UK model of Corporate Governance is for having a constructive dialogue among shareholders and companies. This is also reflected in the recommendations of the Combined Code which says that The board as a whole has responsibility for ensuring that a satisfactory dialogue with shareholders takes place 78(Section 1, D.1). The Code also states that institutional shareholders should enter into a dialogue with companies based on the mutual understanding of objectives79 (Section 2, E.1). 73. https://corporatelawandgovernance.blogspot.com/ 74.https://press.iod.com/2010/04/22/takeover-rules-need-reform-says-iod/?utm_source=rssutm_medium=rssutm_campaign=takeover-rules-need-reform-says-iod 75.https://press.iod.com/2010/04/22/takeover-rules-need-reform-says-iod/?utm_source=rssutm_medium=rssutm_campaign=takeover-rules-need-reform-says-iod 76.https://www.estandardsforum.org/united-kingdom/standards/principles-of-corporate-governance 77.https://www.flmemo.co.uk/newsletters/afr/2008/issue_1_files/combined_code.htm 78.https://www.frc.org.uk/documents/pagemanager/frc/Combined_Code_June_2008/Combined%20Code%20Web%20Optimized%20June%202008(2).pdf 79.https://www.frc.org.uk/documents/pagemanager/frc/Combined_Code_June_2008/Combined%20Code%20Web%20Optimized%20June%202008(2).pdf The UK Combined Code encourages Institutional shareholders to take an active role in governance enter into a dialogue with companies based on the mutual understanding of objectives. 80 (Main Principle- E.1 combined code 2008) Constructive use of AGM The board has the provision of making use the AGM to communicate with the investors and to encourage their participation 81(Main Principle D.2). At any AGM, a separate resolution on each separate issue should be proposed by the company, including to the report and accounts 82(Code Provisions D.2.1) The chairman should ensure attendance by all directors and chairmen of the audit, remuneration and nomination committees to answer questions at the AGM. It is recommended by the combined code for major shareholders to attend AGMs where appropriate and Practicable 83(Supporting Principles E.3) Evaluation of governance disclosures The combined code has emphasised about the evaluation of the companies governance arrangements and provide that When evaluating a companies governance arrangements, institutional shareholders should give due weight to all relevant factors drawn to their attention. (Main Principle, E.2). It was advised by the code that Institutional shareholders should consider carefully explanations given for departure from this Code and make reasoned judgements in each case. They should give an explanation to the company, in writing where appropriate, and be prepared to enter a dialogue if they do not accept the companys position. They should avoid a box-ticking approach to assessing a companys corporate governance.84 (Supporting 80.https://www.frc.org.uk/documents/pagemanager/frc/Combined_Code_June_2008/Combined%20Code%20Web%20Optimized%20June%202008(2).pdf 81.https://www.frc.org.uk/documents/pagemanager/frc/Combined_Code_June_2008/Combined%20Code%20Web%20Optimized%20June%202008(2).pdf 82.https://www.frc.org.uk/documents/pagemanager/frc/Combined_Code_June_2008/Combined%20Code%20Web%20Optimized%20June%202008(2).pdf 83.https://www.frc.org.uk/documents/pagemanager/frc/Combined_Code_June_2008/Combined%20Code%20Web%20Optimized%20June%202008(2).pdf 84.https://www.frc.org.uk/documents/pagemanager/frc/Combined_Code_June_2008/Combined%20Code%20Web%20Optimized%20June%202008(2).pdf The combined code has also emphasised to follow the Comply-or-Explain85 rule for the companies to report on their corporate governance practices annually and account for deviation from the codes recommendations. The directors are accountable to the company as a whole under the 2006 Act; which has strengthened the rights of the shareholder, particularaly the minority; and requiring a business review for encouraging transparency and improve shareholders ability for assessing the progress.86 In addition, the EUs Takeover Directive and Transparency Directives have provided the new criteria for transparency and disclosure.87 Shareholders should have an opportunity and the right to participate in, and be equipped with sufficient information on, decisions about fundamental corporate changes, such as authorization of additional shares, amendments to constitutional documents, major acquisitions or dispositions, and closure of businesses. The companies are also required for ensuring shareholders effective participation in key corporate governance decisions on the nomination, election and removal of members of the board as well as external auditors and give shareholders the opportunity to express their views on remuneration policies for top managers and board members. 88 The 2008 Barker paper indicates that the shareholders in extreme cases resort to legally-underpinned shareholders rights if informal negotiations with the board are not adequate. However, the Company Law provide that shareholders have comparatively extensive voting rights which include the right to appoint and dismiss individual directors and under special circumstances call an EGM. Requirements with regards to AGM , including the provision of information to shareholders arrangements for voting on resolutions are also laid out in Company Law. The Listing Rules provide further rights to Shareholders major transactions being put to vote or disclosure of information to the market. The new Companies Law, introduces a new procedure for shareholders to bring proceeding, on behalf of the company, against a director for negligence, default, breach of duty or breach of trust, enabling minority shareholders to better bring action against those in control. 85. 2nd code Combined Code on Corporate Governance. https://www.frc.org.uk/documents/pagemanager/frc/Combined_Code_June_2008/Combined%20Code%20Web%20Optimized%20June%202008(2).pdf 86.https://www.estandardsforum.org/report_generator/report.pdf?best_practices=truecountry_id=18 87.https://www.simmons-simmons.com/index.cfm?fuseaction=service_industry.display_leftpage=2071 88.https://www.iod.com/intershoproot/eCS/Store/en/pdfs/policy_publication_The_UK_Model_of_Corporate_Governance.pdf