CAMPUS KÖLN

CAMPUS MAINZ
CAMPUS POTSDAM

Corporate Governance Session 3

Historical Developments of CG Codes
Mallin Chapter 3 & Tricker Chapter 1
Prof. Dr. Laxmi Remer
Cologne Business School

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Purpose of this Module

• to understand the key factors affecting the

development of corporate governance codes
• to get to know the most important CG codes
• to be aware of the main developments in CG codes

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Background

• CG was not an issue before the 1980s

• governance was based on
– company law
– corporate regulation (disclosure requirements)
– accounting standards
– stock exchange rules (for listed companies)
• late 1980s/early 1990s: CG scandals in the UK (Polly Peck, Maxwell) and
the US (Savings and Loan Crisis)

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1. UK - Cadbury Report (1992)

• ‘Financial Aspects of Corporate Governance Committee’ led by Sir Adrian

Cadbury
• number of recommendations on CG:
– The wider use of independent non‐executive directors
– The introduction of an audit committee of the board having a minimum of three non‐executive
directors with a majority of them independent
– The division of responsibilities between the chairman of the board and the chief executive. If the
roles are combined, the board should have a strong independent element
– The use of a remuneration committee of the board to oversee executive rewards
– The introduction of a nomination committee with independent directors to propose new board
members
– Adherence to a detailed code of best practice

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1. UK - Cadbury Report (1992)
• included a Code of
Best Practice
• its recommendations
were incorporated
into the Listing Rules
of the London Stock
Exchange
• many of the
proposals remained
at the heart of CG

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2. UK - Further Codes

• Greenbury Report (1995)

– mainly addressed issues of directors’ remuneration
– emphasis on the role of independent directors
– publication of directors’ remuneration
• Hampel Report (1998)
– demand for broad principles instead of specific rules
– acceptance of the unitary‐board!
– self‐regulation instead of legislation
– “the directors as a board are responsible for relations with the stakeholders, but they are
accountable to the shareholders”

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2. UK - Further Codes

• Combined Code (1998)

– combination of the Cadbury, Greenbury, and Hampel reports
– incorporated in the LSE listing rules
– one section aimed at companies, one at investors
– operates on a “comply or explain” basis
– “comply or explain” has become standard for most CG codes
• Higgs (2003) (Non Execs)
• Smith (2003) (Audit Committees)

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3. UK - Combined Code (2003)
• published by the Financial Reporting Council
• broad principles in four areas
– Independence
• At least half the board, excluding the chairman, should be non‐ executive directors who are
independent of the company
• Audit and remuneration committees should be formed with only independent directors
• The definition of independence includes
– not being employed by the company in the past five years,
– having no material business relationship with the company in the past three years,
– not having a significant shareholding,
– and not having served on the board for more than nine years

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3. UK - Combined Code (2003)
– Diligence
’
• Directors appointments should be rigorous and transparent
• Non‐executive directors should disclose their other commitments to ensure that they have sufficient
time.
• No individual should chair more than one FTSE 100 company
– Professional development
• All directors should receive induction training
• All directors should have regular updates on relevant skills, knowledge, familiarity with the
company
– On Board’s Performance Evaluation
• Boards should undertake an annual evaluation of their own performance
• There should also be an annual assessment of the performance of individual directors and of the
main board committees

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4. US – Sarbanes-Oxley Act
• Specific background
– in the US, companies are not incorporated at the federal, but at the state level
– legislation differs from state to state
– 1933: Foundation of the Securities and Exchange Commission for
oversight
development of regulation by the SEC
CG in the US is mostly regulation based, and not based on voluntary codes like in
the UK

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4. US – Sarbanes-Oxley Act
• passed in 2002
• named after Paul Sarbanes and Michael Oxley
• resulted mostly from the Enron and Arthur Andersen scandal
• central aim: to reform CG and auditing of corporations in the US
• contains provisions in 11 areas

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4. US – Sarbanes-Oxley Act
• Auditing
– Created Public Company Oversight Board
– Listed companies must have audit committee with entirely independent outside directors or an
entirely outside board
– Regulation of auditors – one year cooling off before employment of audit staff or partner of auditor
– rotate audit partner every 5 years
– Restrictions on non-audit work: management, investment, legal services
– Disclosure of all fees paid to auditor

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4. US – Sarbanes-Oxley Act
• Assessment of internal control (Section 404)

– Management to produce an “internal control report”

– Report affirms “the responsibility of management for establishing and maintaining an
adequate internal control structure and procedures for financial reporting”
– Report must also “contain an assessment of the effectiveness of the internal
control structure and procedures of the issuer for financial reporting”
– Independent outside auditors must attest to managers internal control assessment
'

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4. US – Sarbanes-Oxley Act
• Board Structure
– Board must have majority independent outside directors
– Establish corporate governance committee (to develop CG principles
and ensure board and director evaluation)
– Require compensation (remuneration) committee to ensure CEO rewards
aligned with corporate objectives
– Require audit committee to produce and disclose CG guidelines and
codes of business conduct and to review external auditors reports on
internal controls

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Discussion Questions
What is the CG Combined Code in UK? - discuss in detail.

Discuss critically with examples the SOX Act in the context of Auditing.

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