UK Corporate Governance: Developments, Best Practices, And Future Directions

The Emergence of Corporate Governance in the UK

The term corporate governance came into use only in the early 1990s. The first major public document to explicitly address this concept was the 1992 Cadbury Report in the United Kingdom. This was followed by a series of other reports. The idea of better governance quickly raised hopes. In the late 1990s, reports from the World Bank and the International Monetary Fund (IMF) proselytized that the world would be better off if others adopted Anglo-American techniques of corporate governance. UK has since then put in place additional measures to foster corporate governance.

One of the measures entails a positive motivation provided through executive compensation, proportional to the performance that retains and motivates both. The effectiveness of executive can be explained through agency theory (Sison, 2008, p. 89). The theory is anchored on a number of assumptions. It assumes that (a) the problem of executive reward can be solved by adequate compensation that includes stock options by the owners’ managers; (b) a change in the composition and procedures of the Board of Directors may provide control over the Directors General; (c) the financial market is an external disciplinary agent, and (d) the government is an independent guarantor of the frameworks and codes of practice and a policeman serving the public interest. The agency theory, in particular, assumes that senior managers can act opportunistically to pursue their own interests, even at the expense of shareholder interests (Sison, 2008, p. 89).

In response to these assumptions, UK adjusted most of its corporate governance accordingly. UK created code that covers the proposal and recommendations associated with the agency theory (Du Plessis & Low, 2017, p. 47). The Code is part of a framework system that includes legislative acts, regulations and standards of best practices, the goal of which is to ensure the high quality of corporate governance systems with the flexibility to allow companies to make changes to their own practices to take into account certain existing realities. Similarly, investors should have the opportunity to form an accurate understanding of the methods and approaches used by companies to implement the provisions of this Code. In any case, there is always the possibility of improvements, both in terms of ensuring the relevance of the provisions of the Code, and in improving the quality of reporting (Du Plessis & Low, 2017, p. 63). According to the code, the Board of Directors of the company must continue to perform a thorough analysis of its general tasks and the impact of those on the roles of individual members of the Board of Directors. The obligatory pledge of such activities is the involvement of the Chairman of the Board of Directors, the support given to the head of the company and, on his part, to other employees, as well as the fairness and openness of directors when reviewing and resolving emerging issues. The code also believe that constructive and fair dialogue is a prerequisite for ensuring the effective functioning of the Board of Directors (Tricker, 2015 p. 489). During the review of the company management activities, certain difficulties related to “group template thinking” were revealed, in particular with regard to the consequences of the financial crisis. One way to ensure a constructive dialogue is to encourage diversity among the members of the Board of Directors. This includes, among other things, the inclusion of representatives of both sexes and races in the Board of Directors. At the same time, the diversity of the members of the Board of Directors in itself is not a guarantee of successful and correct resolution of issues. The diversity also concerns the presence of different approaches and experience of members of the Board of Directors. In addition, it is especially important to ensure the effective involvement of key stakeholders to implement the company’s business strategy.

Key Measures for Effective Corporate Governance in the UK

It is also important to note that one of the basic concepts underlying the approaches to corporate governance in the UK is the approach that requires “compliance or clarification” (Du Plessis & Low, 2017, p. 89). This principle is applied with the introduction of the Code and is fundamental for providing flexibility in the use of its provisions. This principle deserved broad support from companies and shareholders: it is highly valued and adopted in other countries. Under this requirement, it is recognized that the company may decide in favor of actions that are alternative to applying the provision under certain conditions, where proper management can be provided in a different way (Du Plessis, et al 2012, p 433). The prerequisite for such actions is the need to provide accurate and reliable explanations for such measures for shareholders who may express an intention to discuss the position with the company and whose opinion may be affected in the voting (Du Plessis, et al 2012, p 435). While shareholders have the right to express disagreement with the explanations provided by the company, if they are not convincing, their assessment should be carried out objectively, taking into account all the circumstances in each case, and cases of deviation from the requirements of the provisions of the Code should not automatically be considered as violations. Shareholders must provide thoughtful answers to company statements, taking into account the application of the “compliance or clarification” process and the goal of an appropriate corporate governance system (Vitols 2011 p. 125).

Additionally, the compliance or clarification requirement is effective because it is anchored on the fact that the proper nature of the interaction between the company’s Board of Directors and investors plays a key role in ensuring the proper functioning of management systems introduced in accordance with the requirements set by the UK regulations. Companies and shareholders should share responsibility for ensuring that the principle of “compliance or clarification” continues to be an alternative to a rule-based system. The interaction with the board and the directors can be hampered by circumstances related to aspects of practical application and administration. However, there is undoubtedly an opportunity to increase confidence, which can create the prerequisites for continuous improvements when considering the provisions of the Code and their constructive application.

Another feature that makes UK corporate governance effective is the management (Gourevitch & Shinn, 2007 p. 73). UK’s corporate governance is designed such that any decision made by a company must pass through different parties. For example, each company is recommended to form a Board of Directors, which carries out effective activities and bears joint responsibility for the long-term success of the company.

Additionally, UK’s corporate governance ensures that remuneration is done accordingly so as to avoid cases where top management are tempted to use their position to commit accounting fraud (Spira, & Slinn, 2013 p 11). The remuneration system for executive directors should be designed in such a way as to contribute to the achievement of the company’s long-term goals. The components of the remuneration system associated with the effectiveness of the activity must be transparent, stimulating and binding. In addition, as far as remuneration is concerned, the company is recommended to implement a formalized and transparent procedure for the development of policies for the remuneration of executive employees and the definition of compensation packages for individual directors. Do not allow situations where directors take part in the procedure for determining their own remuneration.

The Role of Stakeholders in Ensuring Proper Governance

However, in the last quarter of 2015, the Volkswagen Fake Engine Scandal put corporate governance back in the limelight (Ewing, 2018, p. 57). It is becoming increasingly clear that in the global economic ecosystem, with many types of organizations and a wide range of stakeholders, a consistent approach to corporate governance is inadequate. This means that during the bubble and bursts, the tendency of CEO’s to violate the code of conduct is high. UK should therefore focus on how to smooth the income generated by companies so as to prevent the tendency of CEOs to misbehave. I propose the idea of financial diversification. Financial diversification when a company expands its field of action, by developing its portfolio of activities to distribute the sources of income for example. It is often used to neutralize the effects of seasonality: a ski resort can for example turn to summer mountain activities or the organization of off-season events (Baker & Anderson, 2010, p. 73). The income of one activity increases, while that of another decreases: this phenomenon is called income smoothing. Potentially, this is good news for the CEO. Structuring the business portfolio in such a way increases the size of the organization. He can thus increase his remuneration while assuring his position within the company. It should be noted that the theory of the agency is that CEOs are reluctant to take risks. And yet, the most popular alignment method – variable compensation – introduces uncertainties about compensation and thus increases the “risk” for the CEO. As a result, CEOs naturally use income smoothing to make them less volatile and improve their chances of meeting their performance targets. It is also important to focus on corporate ethics. Without good ethical culture, the top management are more likely to commit fraud because they have the opportunity, authority and temptations.

References

Baker, H. K., & Anderson, R., 2010, Corporate Governance A Synthesis of Theory, Research, and Practice. Chichester, Wiley.

Bloomfield, S., 2013, Theory and practice of corporate governance: an integrated approach. Cambridge, Cambridge University Press. Pp. 11-25

Du Plessis, J. J., & Low, C. K., 2017, Corporate Governance Codes for the 21st Century: International Perspectives and Critical Analyses. New York, Springer. https://link.springer.com/openurl?genre=book&isbn=978-3-319-51867-1.

Du Plessis, J. J., Grossfeld, B., Luttermann, C., Saenger, I., Sandrock, O., & Casper, M., 2012, German Corporate Governance in International and European Context [recurso electrónico]. Alemania, Springer Healthcare Ltd. Pp 433-441

Ewing, J. (2018). Faster, Higher, Farther. Random House UK. Pp 57-79

Fernando, A. C., 2011, Business environment. New Delhi, Pearson. Pp 28-35

Gourevitch, P. A., & Shinn, J. J., 2007, Political power and corporate control: the new global politics of corporate governance. Princeton, NJ, Princeton Univ. Press.

Hassan, H., Islam, S. M. N., & Rashid, K., 2018, Corporate governance, agency theory and firm value advanced econometric analysis and empirical evidence. New York Nova Science Publishers. Pp. 111-117.

Sison, A. G., 2008, Corporate governance and ethics: an Aristotelian perspective. https://www.elgaronline.com/view/9781845427467.xml.

Spira, L. F., & Slinn, J., 2013, The Cadbury Committee: a history. Oxford : Oxford University Press pp. 5-13

Tricker, R. I., 2015, Corporate governance: principles, policies, and practices. Pp. 488-501

Vitols, S., 2011, The sustainable company: a new approch to corporate governance. Brussels, ETUI aisbl. Pp. 123-127