ACCA F4: Chapter 12 - Corporate Governance

1 Introduction 1) Corporate governance is the system by which companies are directed and controlled. It provides the structure through which the company’s objectives are met, the means of attaining those objectives and monitoring performance. 2) - how power is divided between the board and the shareholders - the accountability of the board to the members - the rules and procedures for making decisions - the provision of controls for companies.

1 Introduction - The law must always be obeyed. - Penalties for infringement of the law may be civil or criminal. Civil remedies may allow the company to recover funds from directors who breach their legal obligations. A fine and/or imprisonment might result from certain criminal infringements.

1 Introduction - The stock exchange rules require listed companies to comply with the Combined Code it imposes disclosure requirements. If a listed company does not comply, it must specify the provisions with which it has not complied, and give reasons for its non-compliance. Unlisted companies are under no obligation to comply, although it is considered best practice to do so. - There are no formal penalties for non-compliance. However, the company may suffer loss of reputation and receive bad publicity.

1 Introduction - It is said that ethics begin where the law ends. If an action is legal, individuals generally have freedom of choice as to their conduct. However, good ethical behaviour may be above that demanded by the law. Accountants are expected to follow the code of ethics published by their professional body. - An individual who behaves unethically may suffer loss of reputation, dismissal from their job and sanctions may possibly be imposed by their professional body.

2 The history of corporate governance in the UK Set up by The Financial Reporting Council (FRC), the London Stock Exchange and the accountancy profession. Objective To help raise the standards of corporate governance and the level of confidence in financial reporting and auditing by setting out clearly the respective responsibilities of those involved and what was expected of them. Publication A Code of Best Practice (1992) was designed to achieve the necessary high standards of corporate behaviour. Recommended • It is desirable to separate the role of chief executive and chairman. • The board should include sufficient non-executive directors (NEDs) for their views to carry significant weight. • An audit committee should be appointed to review the financial statements before their submission to the full board. • A remuneration committee consisting wholly or mainly of NEDs should set the remuneration of executive directors. • The imposition of a three-year maximum term on executive directors’ service contracts. Outcome The Stock Exchange required all listed companies to state whether or not they had complied with the Code and to give reasons for any areas of non-compliance. It also required the company’s statement of compliance to be reviewed by the auditors before publication.

2 The history of corporate governance in the UK Set up by The CBI in 1995. Objective To draw up guidelines on directors’ remuneration, which was perceived to be excessive and did not seem to be linked to company performance. Publication A code of best practice in determining and accounting for directors’ remuneration. Outcome All listed companies registered in the UK were required to comply with the Code. Their annual reports had to include a statement about their directors’ remuneration. Any areas of non-compliance had to be explained and justified.

2 The history of corporate governance in the UK Issued January 1998. Objective To restrict the regulatory burden facing companies and substitute broad principles (rather than detailed regulations) where practicable. Summary A board must not approach the various corporate governance requirements in a compliance mentality: the so-called ‘tick-box’ approach. Good corporate governance is not achieved by satisfying a checklist. Directors must comply with the substance as well as the letter of all best practice pronouncements. Outcome After publishing its report, the Hampel Committee drew up a single Combined Code of Best Practice, incorporating the Cadbury, Greenbury and Hampel recommendations.

2 The history of corporate governance in the UK Objective To combine the accepted principles and best practice guidelines of Cadbury, Greenbury and Hampel into a single code. Outcome The Stock Exchange Listing Rules require a listed company in the UK to include the following in its annual report and accounts: • A narrative statement of how it has applied the principles set out in the Combined Code, providing explanation which enables its shareholders to evaluate how the principles have been applied. • A statement as to whether or not it has complied throughout the accounting period with the Combined Code provisions. If it has not complied, it must specify the provisions with which it has not complied, and give reasons for any non-compliance. This approach to compliance is known as ‘comply or explain’.

2 The history of corporate governance in the UK Issued In 1999 by the ICAEW. Objective To give additional guidance to listed companies on how to implement the provisions of the Combined Code dealing with internal control, and board responsibility. Summary • The board should look forward and not just consider past performance. • Companies should keep their shareholders informed about risks. • Directors should be aware that the company must continually adapt to its changing environment. • Risks should be reviewed regularly. Outcome The Turnbull Guidance is appended to the 2003 Combined Code.

2 The history of corporate governance in the UK Issued 2003. Objective To develop guidelines for making NEDs more effective. Outcome Most of the report’s recommendations were either written into the 2003 Combined Code or included in the best practice guidelines that are appended to it.

2 The history of corporate governance in the UK Issued 2003. Objective To give guidance to company boards in making suitable arrangements for their audit committees and to assist directors serving on audit committees in carrying out their role. Outcome The report’s recommendations are appended to the 2003 Combined Code.

3 The Combined Code on Corporate Governance - The Combined Code on Corporate Governance was first issued in 1998. It consisted of principles and provisions (best practice). - A revised version of the Code was issued in 2003. This revised Code consisted of main principles, supporting principles and provisions (practical requirements). - The most recent version, which applies to reporting years beginning on or after 1 November 2006, was issued by the Financial Reporting Council in June 2006. None of the main principles have been changed. There were a few minor changes, which are outlined later.

3 The Combined Code on Corporate Governance 1) Section one is for companies, Section two is for institutional shareholders. 2) directors, directors remuneration, accountability and audit and relations with shareholders. 3) the Turnbull Guidance on internal audit, the Smith Guidance on audit committees and the Higgs Guidance on best practice.

3 The Combined Code on Corporate Governance 1) Every company should be headed by an effective board, which is collectively responsible for the success of the company. 2) There should be a clear division of responsibilities at the head of the company between the running of the board and the executive responsibility for the running of the company’s business. No one individual should have unfettered powers of decision. 3) The board should include a balance of executive directors and NEDs (and in particular independent NEDs), such that no individual or small group of individuals can dominate the board’s decision taking. 4) There should be a formal, rigorous and transparent procedure for the appointment of new directors to the board. 5) The board should be supplied in a timely manner with information in a form and of a quality appropriate to enable it to discharge its duties. All directors should receive induction on joining the board and should regularly update and refresh their skills and knowledge. 6) The board should undertake a formal and rigorous annual evaluation of its own performance and that of its committees and individual directors. 7) All directors should be submitted for re-election at regular intervals, subject to continued satisfactory performance. The board should ensure planned and progressive refreshing of the board.

3 The Combined Code on Corporate Governance 1) Levels of remuneration should be sufficient to attract, retain and motivate directors of the quality required to run the company successfully, but a company should avoid paying more than is necessary for this purpose. A significant proportion of executive directors’ remuneration should be structured so as to link rewards to corporate and individual performance. 2) There should be a formal and transparent procedure for developing policy on executive remuneration and for fixing the remuneration packages of individual directors. No director should be involved in deciding his or her own remuneration. 3) The Code provides that service contracts and notice periods should not exceed one year.