LECTURE 6

DEVELOPMENT
OF CORPORATE
GOVERNANCE
 Development of Corporate
Governance in UK

 Formulation, implementation and

measurement of policies and corporations'
social strategy
 Cadbury Committee
 Greenbury Report
 Hampel Report
 Combined Code

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Cadbury Report

 Developed by a committee chaired by Sir

Adrian Cadbury in 1992
 In response to a series of corporate
failures in the United Kingdom
 Many of its proposals remain as reference
in future development of good corporate
governance
 Cadbury Report
 Major provisions of Cadbury Code
 Board of Directors
 Improve the effectiveness of the board
 Stating the rights of directors in getting information
 Rights of directors’ accessibility to information particularly
to the services of the company secretary and other
professionals
 The Chief Executive and the Chairman
 Division of responsibilities
 If roles were combined, must have strong independent
element
Cadbury Report
 Independent Director
 Wider use of independent non-executive
directors
 Independent directors to propose new board
member through nomination committee
 Enhancement of Audit Committee
 Minimum three of non-executive directors
with majority of them independent
Cadbury Report

 Recommend for nomination committee

(board appointments) & remuneration
committee (remuneration of executive
directors)
 Membership wholly/mainly NED
 Financial Reporting and Audit
 Improve financial reporting
Cadbury Report
 First British based corporate committee
 Issue Code of Best Practice
 Voluntary to adopt the code but companies are
required to explain in their annual reports the
extent they complied with the code and reasons
for not complying
 London Stock Exchange requirements for listing-
disclose statement of compliance or non-
compliance
The Greenbury Report
 Issued in 1995
 After widespread public concern regarding excessive
remuneration paid to directors
 Addressed issue of directors’ remuneration
(compensation)
 Recommend
 Compensation committee should consist of solely
independent non executive directors
 The chairman should response to shareholders’ question at
AGM
 Annual reports should include detail of all director
rewards
The Greenbury Report

 Directors’ contracts should run for no

more than a year
 Share option schemes for directors should
be linked to long term corporate
performance
The Hampel Report
 In 1996, chaired by Sir Ronald Hampel, review and enhance the
recommendations of Cadbury Committees
 Issued Hampel Report, covering governance issues
 The composition of the board and the role of directors
 Directors’ remuneration
 The role of shareholders (particularly institutional
shareholders)
 Communications between the company and its shareholders
 Financial reporting, auditing and internal controls
The Hampel Report

 Suggest greater flexibility

 E.g. separation of board chairman and CEO
 Good corporate governance needs broad principles, not
prescriptive
 Reject the call for broader accountability to
stakeholder groups
 Did not need any more legislation
 Avoid box ticking exercise
 Prefer self regulation, not company legislation
Combined Code
 Recommend to combine Hampell, Cadbury,
Greenbury committee into single code of
corporate governance.
 Lead to the publication of the Combined Code in
2003 by the Financial Reporting Council
 London Stock Exchange Listing Rule required
listed companies to disclose the extent of their
compliance with the Combined Code
Combined Code
 A combination of accepted principles and
practice of corporate governance
 Cadbury, Greenbury and Hampel Report
 London Stock Exchange Listing Rule (under
appendix) required listed companies to disclose
the extent of their compliance with the Combined
Code
 Although it does not become part of Listing Rule
itself, but the requirement to make a statement on
corporate governance is compulsory for listed
companies
Combined Code

 Broad Principles:
 on independence
 on diligence
 on professional development
 on boards’ performance evaluation
Combined Code
 On independence
 At least half the board; excluding chairman
should be independent non-executive
directors
 Audit and compensation committee: totally
consist of independent directors
 Nomination committee: majority by
independent directors
Combined Code
 Definition of independent
 Not being employed by the company for the past
5 years
 Having no material business relationship with the
company
 Not having a significant shareholding
 Not have served on the board for more than 9
years
 CEO should not go on to become chairman
of BOD
Combined Code

 On diligence
 Non executive should disclose their
commitments to ensure they have sufficient
time
 Transparent directors’ appointment
 No individual should chair more than one
FTSE 100 company
Combined Code

 On professional development
 All directors should receive induction
training
 All directors should have regular
updates on relevant skills, knowledge
Combined Code

 On boards’ performance evaluation

 Board should undertake an annual evaluation
of their own performance
 Also annual assessment of the performance of
individual directors and of the main board
committees
Compliance to the Code

 “comply or explain why not” – more flexible

 Principles based: the code acts as benchmarks and
norms for good corporate governance, but the
company established their own rule tailored to
their situation
 Companies are expected to voluntary comply; if
not explain why they have not
 May create more rooms for manipulation
Development of Corporate Governance
in US
 Sarbanes Oxley Act (SOX) – passed by the US
government on 30 July 2002
 Aim: to protect investors by improving accuracy
and reliability of corporate disclosures made
pursuant to the securities laws, and for other
purposes
 Sarbanes- Oxley Act is a legislative response
to corporate accounting scandals of the early
2000s that covers the financial management of
businesses.

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Sarbanes Oxley Act
 Named after US senator Paul Sarbanes and US
Representative Michael Oxley who promoted the bill
 Most significant change in federal securities law since
1930s.
 Securities Act of 1933; Securities Exchange Act of 1934
 SOX provides that publicly traded corporations of all
sizes must meet its requirements.

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Sarbanes Oxley Act
 Containing 11 titles.
 Title I (Section 101-109): Public Company Accounting Oversight Board (PCAOB)
is an independent oversight body for auditing companies.
 Title II (Section 201-209): Auditor independence
 Title III (Section 301-308): Corporate responsibility
 Title IV (Section 401-409): Enhanced Financial Disclosures
 Title V (Section 501): Analyst Conflicts of Interest
 Title VI (Section 601-604): Commission Resources and Authority
 Title VII (Section 701-705): Studies and Reports
 Title VIII (Section 801-807): Corporate and Criminal Fraud Accountability
 Title IX (Section 901-906) : White-Collar Crime Penalty Enhancements
 Title X (Section 1001): Corporate Tax Returns
 Title XI (Section 1001-1007) : Corporate Fraud and Accountability

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Sarbanes Oxley Act - PCAOB

 The PCAOB is a private-sector, nonprofit corporation

created by the Sarbanes-Oxley Act of 2002 to oversee
the auditors of public companies in order to protect
investors and the public interest by promoting
informative, fair, and independent audit reports
 The role of the PCAOB is an independent oversight
body for auditing companies.
 maintaining compliance with established standards
and enforcing rules and disciplinary procedures for
those organizations that found themselves out of
compliance.

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Sarbanes Oxley Act - PCAOB

 The Act required that auditors of U.S. public

companies be subject to external and
independent oversight for the first time in
history. Previously, the profession was self-
regulated.  
 Has authority to investigate and discipline
registered public accounting firms and persons
associated with those firms for noncompliance
with the Sarbanes-Oxley Act, PCAOB rules and
SEC

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Sarbanes Oxley Act
 Section 404: Management Assessment Of Internal
Controls.
 Requires each annual report of an issuer to contain an
"internal control report", which shall:
 state the responsibility of management for establishing
and maintaining an adequate internal control structure
and procedures for financial reporting; and
 contain an assessment, as of the end of the issuer's fiscal
year, of the effectiveness of the internal control structure
and procedures of the issuer for financial reporting.

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Sarbanes Oxley Act
 Summary of Section 802
 This section imposes penalties of fines and/or up to 20
years imprisonment for altering, destroying, mutilating,
concealing, falsifying records, documents or tangible
objects with the intent to obstruct, impede or influence
a legal investigation.
 This section also imposes penalties of fines and/or
imprisonment up to 10 years on any accountant who
knowingly and willfully violates the requirements of
maintenance of all audit or review papers for a period
of 5 years

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Compliance to the Act

 Corporate Governance adoption through legislation not

voluntary codes or stock exchange listing requirements
 Enforce “rule based compliance”
 Benefits: better accountability, reduced risk of fraud and
improved accuracy in financial reports
 Cost: large cost imposed on companies listed in the US
 Legal and accounting fees
 Corporate governance advisory and training
Compliance to the Act

 While they have an obligation to provide an

effective system of internal control that provides
assurance regarding the integrity of financial
reporting and the safeguarding of assets, there
should be a balance between the cost of those
controls and the risks they are managing

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