Combined Code
Encyclopedia
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
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'. 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.
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 insolvent 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:
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". 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:
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,
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. 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. 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.
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
These provisions deal with a unique part of the UK financial market structure, which is great involvement and influence of institutional investors.
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, 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.
(a shareholder representative body) reported that only 33% of listed companies were fully compliant with all of the Codes provisions. 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. 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.
The Financial Services Authority has recently proposed to abandon a requirement to state compliance with the principles (under LR 9.8.6(5)), rather than the rules in detail themselves.
Company reform reports
Corporate governance
Corporate governance is a number of processes, customs, policies, laws, and institutions which have impact on the way a company is controlled...
aimed at companies listed on the London Stock Exchange
London Stock Exchange
The London Stock Exchange is a stock exchange located in the City of London within the United Kingdom. , the Exchange had a market capitalisation of US$3.7495 trillion, making it the fourth-largest stock exchange in the world by this measurement...
. It is overseen by the Financial Reporting Council
Financial Reporting Council
The Financial Reporting Council is the UK's independent regulator responsible for promoting high quality corporate governance and reporting to foster investment.-Structure:...
and its importance derives from the Financial Services Authority
Financial Services Authority
The Financial Services Authority is a quasi-judicial body responsible for the regulation of the financial services industry in the United Kingdom. Its board is appointed by the Treasury and the organisation is structured as a company limited by guarantee and owned by the UK government. Its main...
's Listing Rules. The Listing Rules themselves are given statutory authority under the Financial Services and Markets Act 2000
Financial Services and Markets Act 2000
The Financial Services and Markets Act 2000 is an Act of the Parliament of the United Kingdom that created the Financial Services Authority as a regulator for insurance, investment business and banking.-Outline:...
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'. 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 ReportCadbury Report
The Cadbury Report, titled Financial Aspects of Corporate Governance, is a report of a committee chaired by Adrian Cadbury that sets out recommendations on the arrangement of company boards and accounting systems to mitigate corporate governance risks and failures. The report was published in 1992...
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
Polly Peck
Polly Peck International was a small and barely profitable United Kingdom textile company which expanded rapidly in the 1980s and became a constituent of the FTSE 100 Index before it collapsed in 1990 with the then colossal debts of £1.3bn...
, a major UK company, went insolvent after years of falsifying financial reports. Initially limited to preventing financial fraud, when BCCI
Bank of Credit and Commerce International
The Bank of Credit and Commerce International was a major international bank founded in 1972 by Agha Hasan Abedi, a Pakistani financier. The Bank was registered in Luxembourg with head offices in Karachi and London. Within a decade BCCI touched its peak...
and Robert Maxwell
Robert Maxwell
Ian Robert Maxwell MC was a Czechoslovakian-born British media proprietor and former Member of Parliament , who rose from poverty to build an extensive publishing empire...
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". In 1994, the principles were appended to the Listing Rules of the London Stock Exchange
London Stock Exchange
The London Stock Exchange is a stock exchange located in the City of London within the United Kingdom. , the Exchange had a market capitalisation of US$3.7495 trillion, making it the fourth-largest stock exchange in the world by this measurement...
, 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
Marks & Spencer
Marks and Spencer plc is a British retailer headquartered in the City of Westminster, London, with over 700 stores in the United Kingdom and over 300 stores spread across more than 40 countries. It specialises in the selling of clothing and luxury food products...
Sir Richard Greenbury was set up as a 'study group' on executive compensation
Executive compensation
Executive pay is financial compensation received by an officer of a firm, often as a mixture of salary, bonuses, shares of and/or call options on the company stock, etc. Over the past three decades, executive pay has risen dramatically beyond the rising levels of an average worker's wage...
. It responded to public anger, and some vague statements by the Prime Minister John Major
John Major
Sir John Major, is a British Conservative politician, who served as Prime Minister of the United Kingdom and Leader of the Conservative Party from 1990–1997...
that regulation might be necessary, over spiraling executive pay, particularly in public utilities that had been privatised. In 1995 it produced the Greenbury Report
Greenbury Report
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...
. 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
Imperial Chemical Industries
Imperial Chemical Industries was a British chemical company, taken over by AkzoNobel, a Dutch conglomerate, one of the largest chemical producers in the world. In its heyday, ICI was the largest manufacturing company in the British Empire, and commonly regarded as a "bellwether of the British...
, chaired a third committee. The ensuing Hampel Report
Hampel Report
The Hampel Report in 1998 was designed to be a revision of the corporate governance system in the UK. The remit of the committee was to review the Code laid down by the Cadbury Report . It asked whether the code's original purpose was being achieved. Hampel found that there was no need for a...
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. 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
Derek Higgs
Sir Derek Alan Higgs was an English businessman and merchant banker. He was knighted in 2004. His father, Alan Higgs, was a multimillionaire through property businesses in the Midlands.-Early life:...
focusing on what non-executive directors should do, and responding to the problems thrown up by the collapse of Enron
Enron
Enron Corporation was an American energy, commodities, and services company based in Houston, Texas. Before its bankruptcy on December 2, 2001, Enron employed approximately 22,000 staff and was one of the world's leading electricity, natural gas, communications, and pulp and paper companies, with...
in the US. Paul Myners
Paul Myners
Paul Myners, Baron Myners, CBE was the Financial Services Secretary in HM Treasury, the UK's finance ministry, during the Labour Government of Gordon Brown. He held the position from October 2008 until May 2010, and was made a life peer in consequence of his appointment, as he was not an elected...
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
Northern Rock
Northern Rock plc is a British bank, best known for becoming the first bank in 150 years to suffer a bank run after having had to approach the Bank of England for a loan facility, to replace money market funding, during the credit crisis in 2007. Having failed to find a commercial buyer for...
and the Financial Crisis
Financial crisis
The term financial crisis is applied broadly to a variety of situations in which some financial institutions or assets suddenly lose a large part of their value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and many recessions coincided with these...
, the Walker Review produced a report focused on the banking industry, but also with recommendations for all companies. In 2010, a new Stewardship Code
Stewardship Code
The Stewardship Code is a set of principles or guidelines released in 2010 by the Financial Reporting Council directed at institutional investors who hold voting rights in United Kingdom companies...
was issued by the Financial Reporting Council
Financial Reporting Council
The Financial Reporting Council is the UK's independent regulator responsible for promoting high quality corporate governance and reporting to foster investment.-Structure:...
, along with a new version of the UK Corporate Governance Code, hence separating the issues from one another.
Companies
A DirectorsThis 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
Companies Act 2006
The Companies Act 2006 is an Act of the Parliament of the United Kingdom which forms the primary source of UK company law. It had the distinction of being the longest in British Parliamentary history: with 1,300 sections and covering nearly 700 pages, and containing 16 schedules but it has since...
which require a say on pay
Say on pay
Say on pay is a term used for a rule in corporate law whereby a firm's shareholders have the right to vote on the remuneration of executives.Often described in corporate governance or management theory as an agency problem, a corporation's directors are likely to overpay themselves because,...
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
Board of directors
A board of directors is a body of elected or appointed members who jointly oversee the activities of a company or organization. Other names include board of governors, board of managers, board of regents, board of trustees, and board of visitors...
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
Enron scandal
The Enron scandal, revealed in October 2001, eventually led to the bankruptcy of the Enron Corporation, an American energy company based in Houston, Texas, and the dissolution of Arthur Andersen, which was one of the five largest audit and accountancy partnerships in the world...
, 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 ShareholdersThese 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 remunerationThis 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
Companies Act 2006
The Companies Act 2006 is an Act of the Parliament of the United Kingdom which forms the primary source of UK company law. It had the distinction of being the longest in British Parliamentary history: with 1,300 sections and covering nearly 700 pages, and containing 16 schedules but it has since...
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, a case on wrongful trading
Wrongful trading
Wrongful trading is a type of civil wrong found in UK insolvency law, under s 214 Insolvency Act 1986. It was introduced to enable contributions to be obtained for the benefit of creditors from those responsible for mismanagement of the insolvent company....
under the Insolvency Act 1986
Insolvency Act 1986
The Insolvency Act 1986 is an Act of the Parliament of the United Kingdom that provides the legal platform for all matters relating to personal and corporate insolvency in the UK.-History:...
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 LtdPensions & Investment Research Consultants Ltd
Pensions & Investment Research Consultants Ltd is one of the largest pension representation and lobby groups in the United Kingdom. It deals with well over £200b of assets invested by pension holders. It does research work on corporate governance Pensions & Investment Research Consultants Ltd (or...
(a shareholder representative body) reported that only 33% of listed companies were fully compliant with all of the Codes provisions. 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. 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
Market
A market is one of many varieties of systems, institutions, procedures, social relations and infrastructures whereby parties engage in exchange. While parties may exchange goods and services by barter, most markets rely on sellers offering their goods or services in exchange for money from buyers...
, rather than through law
Law
Law is a system of rules and guidelines which are enforced through social institutions to govern behavior, wherever possible. It shapes politics, economics and society in numerous ways and serves as a social mediator of relations between people. Contract law regulates everything from buying a bus...
.
An additional reason for a Code, was the original concern of the Cadbury Report
Cadbury Report
The Cadbury Report, titled Financial Aspects of Corporate Governance, is a report of a committee chaired by Adrian Cadbury that sets out recommendations on the arrangement of company boards and accounting systems to mitigate corporate governance risks and failures. The report was published in 1992...
, that companies faced with minimum standards in law would comply merely with the letter and not the spirit of the rules.
The Financial Services Authority has recently 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 GovernanceCorporate governanceCorporate governance is a number of processes, customs, policies, laws, and institutions which have impact on the way a company is controlled...
- Corporate Social ResponsibilityCorporate social responsibilityCorporate social responsibility is a form of corporate self-regulation integrated into a business model...
- Stewardship CodeStewardship CodeThe Stewardship Code is a set of principles or guidelines released in 2010 by the Financial Reporting Council directed at institutional investors who hold voting rights in United Kingdom companies...
- 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 BullockAlan BullockAlan Louis Charles Bullock, Baron Bullock , was a British historian, who wrote an influential biography of Adolf Hitler and many other works.-Early life and career:...
(1977) Report of the committee of inquiry on industrial democracyReport of the committee of inquiry on industrial democracyThe Report of the committee of inquiry on industrial democracy Cmnd 6706, also the Bullock Report for short, was a report proposing for a form of worker participation or workers' control, chaired by Alan Bullock...
, on worker codetermination - Cork Report, Insolvency Law and Practice, Report of the Review Committee (1982) (Cmnd 8558)
- Cadbury ReportCadbury ReportThe Cadbury Report, titled Financial Aspects of Corporate Governance, is a report of a committee chaired by Adrian Cadbury that sets out recommendations on the arrangement of company boards and accounting systems to mitigate corporate governance risks and failures. The report was published in 1992...
(1992), Financial Aspects of Corporate Governance, on corporate governance generally. Pdf file here - Greenbury ReportGreenbury ReportThe 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...
(1995) Directors' Remuneration, Report of the Study Group Pdf here - Hampel ReportHampel ReportThe Hampel Report in 1998 was designed to be a revision of the corporate governance system in the UK. The remit of the committee was to review the Code laid down by the Cadbury Report . It asked whether the code's original purpose was being achieved. Hampel found that there was no need for a...
(1998), Review of corporate governance since Cadbury, here and online with the EGCI here - Turnbull ReportTurnbull ReportInternal Control: Guidance for Directors on the Combined Code also known as the "Turnbull Report" is a report drawn up with the London Stock Exchange for listed companies. The committee which wrote the report was chaired by Nigel Turnbull of The Rank Group plc...
(1999) on internal controls to ensure good financial reporting - Myners ReportMyners ReportInstitutional Investment in the UK: A Review was a report to HM Treasury in March 2001 on institutional investors. It was delivered by Paul Myners....
(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 ReportSmith ReportThe Smith Report was a report on corporate governance submitted to the UK government in 2003. It was concerned with the independence of auditors in the wake of the collapse of Arthur Andersen and the Enron scandal in the US in 2002...
(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
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 CouncilFinancial Reporting CouncilThe Financial Reporting Council is the UK's independent regulator responsible for promoting high quality corporate governance and reporting to foster investment.-Structure:...
's website