UK financial institutions

The main aim of any company is the prosperity and success of the company whether it is for financial gain or for the production of services. The main driving force behind these goals is the successful management of the company.

Mayson (2011) highlights that a company needs people to represent it and act on its behalf.

The Companies Act 2006 (CA 2006) s. 154 states that every private company must have at least one director and every public company there must be two directors in place, thus all companies have someone to act on their behalf.

The management of a company, however, under UK law is to be decided by its members through their articles of association and constitution. The majority of companies use the model articles, under which it states that the directors have control of the companies under Article 3, and therefore are responsible for corporate governance. Cadbury (1992) identifies corporate governance as the system by which companies are controlled and directed. Since 2008 there has undoubtedly been a global financial crisis which has lead to many company failures.

However, there have been few legal consequences of arguably poor strategic management and risk management by directors, and little new regulations affecting the boards of listed companies in the financial sector as a result. This essay discusses the changes that have taken place as a result of the financial crisis and evaluate the proposed changes in preventing recurrence of the financial crisis and the prosperity of companies.

As stated above the main management responsibilities of a company rests with the directors. However, a key duty of a director under s.172 CA 2006 is to act in a way he considers to be in good faith and to promote the success of the company for the benefit of its members as a whole. Directors also have a duty under s.174 CA 2006 to exercise reasonable care, skill and diligence. The appointment of directors is made in accordance with the articles of association, for publicly listed companies it is regulation 19 of the model articles.

Common practice throughout the European Union (EU) is to have a 2-tier board structure, however this is not governed by law. Through good practice of UK companies the boards are commonly made up of half independent non executive directors, however with the financial crisis there has been many questions raised over the suitability of ‘the long established conventional wisdom and practice that non executive directors make an essential contribution to corporate governance.’. (Walker, 2009)

There is however no reference to non-executive directors specifically in the Companies Act 2006. The input from non-executive directors has at best been questioned due to their ‘lack of Knowledge’ (FSA, 2009,Turner Review). This caused an adaption in the code in 2010 under principle B.2 in which “the search for board candidates should be conducted, and appointments made, on merit, against objective criteria and with due regard for the benefits of diversity on the board, including gender”. As well as this criteria for selection there is call for further development by the OECD steering group in 2010 to make sure the directors ‘remain abreast of relevant new laws, regulations and changing commercial risks through in-house training and external courses.’

The fundamental issue in which corporate governance has come into question is that after researching the downfalls of many companies during the crisis, mainly banks, that there is in fact very little evidence of breaking the codes of corporate governance and that in fact they had complied with these codes, as disclosed in their annual reports.

The review of this by the HM Treasury (HM Treasury, 2010) still decided that although the codes were followed, as stated through their annual reports there were still mass corporate governance failures by the respective boards and especially in relation to risk management. Hannigan (2011) suggest that there are many reasons for corporate collapse but that poor risk anticipation and management by the board is a common feature.

This theory is further backed up by the De Larosi�re report (J. de Larosi�re, 2009), commissioned to deliver policy recommendations on strengthening EU financial market supervision and regulation in the context of the current crisis, has recognised corporate governance as ‘one of the main failures of the present crisis.’

This lack of judgment plays a big role in focusing on the suitability of non-executive directors. The main role of non-executive directors was seen as to question executive directors over their decisions and to account for their actions, however in truth this was something that rarely happened. It was more commonly seen as ‘like minded directors on a cosy board, with their fellow executive directors’ (Hannigan, 2011).

It is reported that due to the increase in remuneration received by non – executive directors due to larger work loads being introduced, there is less want to upset the executive directors, as a long term deal with such large money involved is too rewarding to turn down by irritating the executive directors (reference). Therefore it is thought that the independence of these non executive directors according to Baginsky et al (2011) ‘It is important that the non executive directors should not be reliant on the company for a significant part of their income otherwise their independence may be jeopardized’ as they will solely reliant on the company and therefore are less likely to question the decisions made by the executive directors.

The Corporate Governance Code holds the concept that non executive directors are liable for their actions, this meaning they will now have to meet their responsibilities to an acceptable level otherwise they can subsequently face penalties enforced by the FSA. The FSA believes that this will act as a “credible deterrence” (FSA, 2010) for directors to think about their actions.

The Financial Reporting Council (FRC) sought a review of the combined code in 2009, to examine the effectiveness of it, and to see if it played a part in the downturn of the economic crisis. From this review, there has been limited change to the codes despite the obvious need for concern as to the role it had during the crisis.

The new adoption of principles through the UK Corporate Governance Code 2010 has in real terms only slightly altered the previous Combined Code the changes are in fact relatively small, with most already contained in the previous code. It has also been said by Arcot et al (2010) that the changes are in fact just a rewording of previous codes but bringing other aspects into the main focus of the new Corporate Governance Code. The code is enforced and regulated by the Financial Services Authority (FSA), and gives principles and a code of good practice for all companies that are listed on the London Stock Exchange.

Under s. 415 CA 2006 companies are obliged to publish a corporate governance statement in the directors report as part of their yearly accounts, which also means as this is made public then the perception of the company will be judged via this, and therefore this can be detrimental to how the company looks to the people outwith the company, possible investors for example.

This statement must follow the ‘comply or explain’ concept and therefore explain and show to what degree the company has applied the code, and if not, why they have not. A lack of compliance may result in poor public perception of the company, which will in the long term have negative effects in attracting potential investors.

Another code of practice that is in place is the Stewardship Code. The Stewardship Code is a set of principles or guidelines announced in 2010 by the FRC directed at investors with voting rights in companies. Its main aim is to encourage shareholders are active and engage in corporate governance in the interests of their beneficiaries. Remember that these investors are subject to their own codes too which also assist with this

This theory is backed up by the minister for corporate governance who states, “we can agree that it must help long term healthy growth if shareholders engage with the companies in which they invest.” (Davey, 2010)

As mentioned earlier in this current economic crisis it is very important that companies are able to convey confidence, the stewardship code aids this by encouraging the public disclosure of shareholders’ voting activities. Davey (2010) believes that, ‘Voting at company meetings is one of the most effective ways of providing long-term stewardship.’

The code is used as an aid to engage the shareholders by questioning the decisions made by the directors in the running of the company, and therefore in essence are ‘stewarding’ the company in view of their long term goals. This two way engagement is also governed by the CA 2006 under s.188 which forces directors to have the members consent to enter into contracts greater than two years, which also reduces the chance of directors receiving bribes to accept long lucrative contracts for personal benefits.

As can be seen, since the start of the crisis there has been slight differences to the ruling of corporate governance, looking forward, there is a general consensus that an independent board has to be set up to

‘provide a forum for the review on an ongoing basis of governance issues.’ (Hannigan, 2012).

They would act under the FRC and be composed of experts of all corners of the governance field from the legal aspect, the accounting side , and to the representatives of institutional shareholders. Since the crisis there has been numerous reviews in relation to corporate governance and its effects on the economic downturn, from this there is currently speculation coming from the government that the architecture of regulations is subject to change, to create a “powerful” (Hannigan,2012) new regulator to govern corporate issues as well as the stewardship code, with the possible merger of the FRC and the UK Listing Authority according to the HM Treasury (2010).

Since the start of the crisis in 2008, it can be seen there has been changes to regulation in relation to this, however, it can also be seen that the changes made have been very minimalistic, the continuation of soft law, showing that they instead have tried to changes peoples thinking behind corporate governance, rather than forcing it through.

Since the Economic crisis in 2008 there has been obvious changes to the regulations, however the substance of these changes is where there are questions over it. As shown it is widely believed that the changes are in fact just a rewording of previous codes but bringing other aspects into the main focus of the new Corporate Governance Code. There is a consensus that the way forward is through transparency and in setting long term goals as well as taking into account the concept of risk to ensure the prosperity of the company and allow it to reach its full potential.