UK Corporate Governance Framework Analysis

How the UK Corporate Governance mechanisms Focus on Shareholders and Suggest How They Could be Reformed to achieve a shift towards stakeholders

Most studies have made various comparisons of the UK framework of corporate governance with the US-based system due to their similarities. Most reviews state that the UK based procedures of corporate governance is more similar to the US one when compared to those systems used in mainland Europe and Japan, among other markets where the interests of the shareholder are placed overhead those of other business shareholders like suppliers, personnel, and creditors among others. This hypothesis will guide this discussion in terms of analysing the efficacy of the United Kingdom corporate governance system. The focus will be on the directions and applications that govern the restructuring in large corporations with external shareholders. A striking fact about the United Kingdom corporate governance system is how it is fixated on the shareholder value framework. The same can be witnesses through an analysis of various fundamental governance apparatuses, which are hostile takeovers, board composition, and the duties of directors. It is also evident in the fact that shareholder predominance has prevailed to be unrestricted and that the internal inconsistencies of the stakeholder value framework are replicated in the existing policy discussion.

Hostile Takeovers

In the context of the shareholder value framework, a hostile take is used as a framework for bring into line the interests of the manager with the interests those of the stockholders. The scope at which hostile takeovers can function as a punitive device in this manner is mostly pegged on the legal framework of the respective state. This is especially evident in situations where incumbents could deploy defensive tactics (Armour, Deakin, and Konzelmann, 2003, p. 545). So far, the UK commercial governance policies have restrictive measures on the use of defensive tactics. The City Code controls takeover on public corporations on Takeovers and Mergers; this is a monitoring system that was established in the 1960s and is implemented by the Panel on Takeover and Mergers, which is an agency made up of experts who have been drawn from regulatory bodies. As much as the policy does not have the backing of the act, it could be obligated through the monitoring agencies that are exercising constitutional authorities, such as the Financial Services Authority. Therefore, the UK corporate governance system ought to be amended so that it can be more flexible to allow for the implementation of such policies and framework.

In the United Kingdom, Senior managers can be substituted after a takeover irrespective of whether the company is performing or not. Such a situation led to Deakin (2005, p. 12) to conclude that in the UK, takeovers are a poorly designed disciplinary system. A study by, Williamson (2003, p. 515) on accounting performance revealed that the targets of successful UK hostile takeover had revealed small but numerically significant improvements after a bid. Besides, the same trend opposes the ideology that stakeholders are disciplining managers. Though, the evidence from various studies is in tandem with the ideology that managers could face takeovers if their projected strategies are not as efficient as they portrayed to be. It for this reason that Kirkbride and Letza (2004, p. 85) reported that the takeover bids in the UK highlight some of the most fundamental tensions in the corporate governance system. The more a hostile appropriation is promoted as a punitive measure, the more challenging it could develop for companies to make a reliable commitment to their workers that implied agreements to share quasi-rents not to be broken. Ultimately, this will cause staffs to be less enthusiastic to make company-specific investment ex ante and could lead to value loss for all the stockholders in an organisation. Hibbitt and Collison (2004, p.111) reported that between 1987 to 1996, hostile takeovers were linked to important falls in employment and production for the companies concerned and determined that the ultimate impact of such measures was dire.

The Duties and Responsibilities of Directors to Stakeholders

As much as the Takeover policy actively gives priority to the interests of the stakeholders, the overall corporation law observes a legal code that managers and managers ought to act in decent faith and the interest of the business and not on those of the stakeholders. However, there have been various discussions on how much freedom this stipulation gives to directors and managers. At the same time through the ‘enlightened shareholder value’ policy that was founded by the Company Law Review Steering Committee, the management is compelled to take various views from shareholders and implement them as discussed that is balancing the balancing the interests of multiple stakeholders and those of the company, to benefit both entities in long run. From this classical point, it ought to be legally possible for managers to track a policy of lowest severances if the long run objective of the system is to advance the interests of shareholders (Castka, Bamber, Bamber, and Sharp 2004, p. 221). The Companies Act of 1985 (Sec. 309) further compels the management to deliberate the interests of their respective workers in tandem with that of their stakeholders when exercising their obligation of working in the interest of the corporation. In deliberation of the above issues and contradictions, the Company Law Review Steering Committee considered two options. The first one was referred to as the ‘enlightened share value,’ while the second one was a pluralist spot upon which the business law should change to comprise other points, such that a business is essential to serving a broader assortment of interests and not to disregard any or use it a way of attaining shareholder value (Williamson and Lynch-Wood 2008, p. 133). However, ultimately, the group disregarded the call for director duties in this manner. Instead, it comes up with a suggestion for new legal requirements for registered entities to document their operation purview and financial reviews. The new rule only compelled managers to consider a more comprehensive range of facets by recording them clearly and transparently when making any decision. However, the guideline did not stipulate clearly on the consequences of not considering the interests of other parties, how directors ought to consider and integrate these interests to benefit the company. In short, the proposed policy was ambiguous and cannot solve the problem of balancing the interests of the firm, stakeholders, and personnel.

The Structure of the Board and Accountability in the Code of Corporate Governance

Various debates have emerged in how to use soft law to encourage corporate transparency and accountability in multiple firms. The business environment in the United Kingdom since the 1990s has been improved by a sequence of quasi-voluntary principles, which have different ranges of governance that are intended to enhance the responsibility of directors. These principles originated from the Cadbury Committee Report in 1992 and another report from the Greenbury Committee in 1995, which made the Combined Code (Roach 2005). As much as the code is voluntary, listed companies in the United Kingdom are required to disclose how the complied with the code in their annual reports, and if they did not, they should give reasons for the same. Therefore, this approach has been regularly denoted to as ‘comply or explain.’ The governance laws were established in contrast to the supposition that the highest standards at the boardroom governance can only help is bridging the production breach that exists in various companies. It means that the Company Law Review concerns itself with the issues of gaining competitiveness, and not on shareholder supremacy alone. As much as the Company Law Review is advocates against the adverse effects of shareholder supremacy, other committees that have the mandate of establishing these codes do not concern themselves with the issue of stakeholder supremacy (Goddard 2003, p. 402). This discrepancy is noteworthy since the process of making codes has been more productive in terms of revolutionising the corporate environment in comparison to the Review. Therefore, as much as the core institutions of commercial governance have been mainly impacted by share-holder oriented program, they have not been modified because of the pressure to retain the status quo.

How Corporate Governance Failure Led to The Collapse of Enron Or Worldcom

Both Wordcom and Enroll were successful organisations in their respective industries. The period between 1995 to 2000, WorldCom acquired over sixty telecommunication companies. In 1997, it acquired the MCI for about $37 billion, which was the largest business merger in USA. In the mid-90s the company expanded from a voice carrier to an internet and data provider and was handling 50% of all the internet traffic recorded in the USA, and 50% of all emails globally. By 2001 the company controlled a third of all data cables the USA. This information shows the success that this company had attained within a decade (Armour 2005, p. 510). On the other hand, Enron was established in 1985 as a merger of two gas pipeline cooperation. In not more than 16 years, the entity changed from small gasp pipe company into a global oil and gas exploration company and was listed as the largest trading company in the US stock markets. The company grew to become one of the ten most prominent companies in the world. Both companies were successful in terms of controlling a larger market share, which meant a substantial annual turnover. However, these companies did not have good internal management. Among the corporate governance issues reported include;

Lack of Strategic Planning

Kakabadse (2009) wrote that WorldCom did not possess an appropriate corporate governance protocol. As much as the company had drafts titled “strategic plans,” they only had an outline of the corporation’s financial position in case WorldCom ceased from the belligerent acquisition but did not have a genuine strategic plan. The company did not have any strategic committee and the sole decision makers majorly comprised of the Chief Financial Officer, the Chief Operations Officer, and two more. Besides, after WorldCom had purchased new entities, it failed to appropriately assimilate them into its arrangements and strategies, which led to high levels of overhead ration to the incomes received and a fragile internal controls system. The fact that the company was acquiring other companies at a high rate and the administration’s neglect to the accounting schemes, WorldCom was not able to keep up with efficacy and successful integration of new companies. Since the company did not have internal controls, there was room for manual adjustments to made in systems without any suspicions.

Acquisition Problems

The acquisition of MCI led WorldCom to incur huge debts. Besides, MCI had a suburban clientele base which recorded a slower growing rate, while WorldCom factually served a customer base which comprised of big margins and less revenue. The first sign of WorldCom failure was seen in its effort to acquire the second major telecommunication firm (Sprint). However, these efforts were derailed by the Department of Justice because this acquisition will compromise the competitiveness in the telecommunication industry. Left with no other acquisition to take over, WorldCom’s strategy came to a halt. Thornburgh (2004) stated that a competitive approach looks for a constructive viable spot in the industry, targeting to create a status in which the organisation is gainful and bearable against its competitors. The directors at WorldCom were very focused on growing the company such that they failed to establish a competitive approach and did not realise the need to maintain their status as they prosper. Ultimately the lack of strategy barred the company form efficiently planning and establishing a position in the market to acquire the needed prosperity.

The Board of Directors

Sidak (2003) states that an active Board of Directors acts as an essential internal control for any business. In WorldCom, the appointed directors had different backgrounds, as much as other had lots of knowledge and experience in business and in other fields such as law, other directors were only appointed because of their relationship with the company’s founder. The section of the Board that was selected due to their relationship with the organisation’s founder misled the others not to concentrate on the issues facing the company; therefore, the board was completely unaware of the problems facing the company. Besides, the company only gave these directors a small token for compensation, and therefore, the board majorly depended on the appreciation of the company’s stock as compensation. The company’s managers also relied on the business growth and share appreciation for the benefit, and the same was experienced among the employees and management. Therefore, these groups mainly approved WorldCom decisions to acquire other company’s since it is a symbol of growth, which translates to higher stock prices, and ultimately a massive amount of compensation. The managing director’s dependence on this sort of enormous issuance of the company’s stock was an unhealthy system and led to a conflict of interests, where their particular objectives were more focused on the growth of equity than in the best interest of the business. The closeness of the board of directors to the business’s founder hindered the board of directors from becoming independent from the business and its management. Therefore, the board was reduced to a mere rubber stamp of the management’s decisions.

Loans to Ebbers

Ebbers (the founder of the company), made various personal acquisitions, through loans acquired from Banks. When buying these loans, Ebbers used WorldCom stock as security. Ebbers purchased costly assets such as the biggest ranch in Canada, motels, a yacht building company, and even a hockey team, among others. When the equity prices of the company were losing value in the stock market, banks asked Ebbers to pay for the margins between the values of his credits and the reduced net worth of his shares. Instead of surrendering his shares, which at the time he perceived to be detrimental since it would lead to a further decline of WorldCom stocks in the market, Ebbers compelled the Board to approve a personal loan, which would be used to fill in the margins. Due to lack of autonomy from the board members, this decision was approved without any questions or further thoughts. These loans accrued to more than 400 million USD; a situation, which further deteriorated the financial position of the company (Harmantzis 2004.). This case shows why it is essential for any company to inform their directors about the policies of the company, its visions, missions, and culture because this group plays an integral role in the management of any company and its operations.

This is the same situation with Enron. In 1999 the board of Managers at Enron waived some policies on conflict of interest to permit the chief financial officer to do business with the company as a partner. Through this partnership, the chief financial officer covered the debts and liabilities the Enron faced due to the trade, which eventually impacted on the profitability of the establishment. The occurrences in Enron raises the question of how director capabilities will challenge questionable dealings through corporate managers.

The changes subsequently made to the UK corporate governance as a result of the collapse of Enron and Worldcom

As an aftermath of the collapse of WorldCom and Enron, the United Kingdom authorities amended various policies that would help in deterring the same problems faced by Enron and WorldCom. The policy changes include;

The 2006 Company’s Act

The 2006 company’s act was a result of the findings from a study conducted by Higgs in 2003. Therefore, the 2006 companies act aimed at revolutionising and changing the composition of the board members and managers. This constitutional review was majorly touched on the following areas;

The Board

As per the recommendations of the Higgs report, more than half of the board associates should be autonomous non-executive managers who have been chosen relatively and ethically based on their professional or academic qualifications apart from the chairman. However, as currently constituted in the Combined Code, only a third of directors should be non-executives. The policy envisions that this portion of non-executives should stay independent to help in balancing the interests of stakeholders and the company’s interests. Collis (2012) documented that for more clarity and distinction, the Combined Code ought to include the definition of independent. Even so, the policy is clear on who is to be considered as an independent non-executive director. The policy states that a director could be regarded as separate if he or she has not been an employed in the company within the last five years, he or she has not had any form of business relationship with the company in focus within a period of last three years, he or she does not collect any form of remuneration from the entity separately from the non-director’s payment, if he or she is not a close family member to or does not have any form of cross-directorships, and lastly he or she should not be a significant shareholder in the organisation or has been serving in the board for more than a decade.

The Duties of Non-executive Directors

The Higgs report did not include the mandate of the non-executive directors. However, the Combined Code addressed this issue and highlighted the part of the Non-executive directors as Strategy, which includes to constructively contribute to the progress of the firm’s policy or challenge it when necessary. Secondly, Performance, which involves scrutinising the management performance and reporting on the same. Third, Risk, which consists of analysing the reliability of the fiscal data and the suitability of the monetary control systems. Lastly, People who give the non-executive director the power of determining the suitable heights of compensation for executive managers and a significant role in remuneration and removal of management in planning. In this proposal, nonexecutive directors should meet the team at least once every year, and the company’s report should document this event. The review also states that before accepting an appointment, the incoming non-executive director should conduct a diligence test on the Board and the entity so that they can be sure that they have the right knowledge, and experience to contribute to the organisation positively.

Independent Director

The Combined Code proposed that every entity ought to have a senior and autonomous director. This independent director must meet the independence requirements and avail himself or herself to shareholders whenever there are concerns that have not been solved through the right protocol of contact with the chairperson or the chief executive.

The Appointment Process

Every organisation should have a nomination committee- this is according to the endorsements of the Higgs account. However, according to the Combined Code, a nomination board should only exist if there is a small board. In the Combined Code, the nomination commute ought to be made up of majorly non-executive directors. However, the review refines the same by stipulating that the majority of the nomination committee should be comprised of autonomous non-executive managers. Besides, an autonomous non-executive director should lead this committee.

References

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