This essay considers whether the global financial crisis of 2008 ought to be considered as a crisis for corporate governance in England and Wales. With a view to contextualising this analysis, it is first necessary to provide an understanding of what corporate governance is along with the modern foundations of UK corporate governance and the associated agency problem more specifically. In so doing, there is also a need to recognise that, whilst many soft law developments have been forthcoming with a view to resolving this dilemma, their success has proved somewhat questionable. As part of this analysis, it will be recognised that ‘comply-or-explain’ founds a considerable amount of this soft law in an effort to solve the agency problem through the creation of investors-directors dialogue bur is also not without its disadvantages in practice. On this basis, this essay then examines the developments to have arisen as a response to the financial crisis in an effort to solve corporate governance’s problems in the UK to have already been identified. Finally, there is a need to conclude with a summary of the key points derived from this analysis with regard to the answer to the aforementioned question.
With a view to contextualising this essay’s analysis, it is to be noted that corporate governance specifically “deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment”. Arguably, the significance of this concept has been made clear as a result of the global financial crisis of 2008 and its resultant fallout. Such a view is supported by big companies like Northern Rock and Royal Bank of Scotland’s failing in the UK that highlighted the significant problems with the way companies were being governed domestically. By way of illustration, in 2009, the salary of the average director in the biggest corporations in the UK was over 80 times more than the average full time worker despite it appearing to be completely unrelated to performance.
However, it is arguably all too easy to blame companies from corporate governance problems when questions also need to be asked of shareholders and their institutional investors who are considered to have a reputation for their apathy. Such a view is reflected by the fact Lord Myners has described such shareholders as “absentee landlords” since many do not exercise all of their rights (including voting rights) or responsibilities (including attending meetings) resulting in “ownerless corporation[s]”. With this in mind, Sir David Walker’s review of this area highlighted investors’ activism’s significance for the purpose of better regulating directors’ behaviour in the UK banking sector. Therefore, as a result of these kinds of criticisms, corporate governance domestically has been significantly reformed including encouraging shareholders and institutional investors in particular to monitor companies especially in the wake of the global financial crisis of 2008.
Regarding corporate governance in the UK, the matter of to whom directors are trustees for is considered fundamental to the development of an effective framework of corporate governance as it also founded the Dodd-Berle debate where Dodd believed directors should act for the wider community and Berle thought they should act for shareholders. However, it is also to be noted that, whilst the debate was ultimately won by Dodd, section 172 of the Companies Act 2006 (henceforth, the CA 2006) is clearly shareholder-centred since company directors are duty-bound “to promote the success of the company for the benefit of its members”. Nevertheless, whilst there is also a need to consider other issues including the interests of employees and a company’s actions influence upon society, shareholders interests are of primary importance when promoting a company’s success in practice.
The agency relationship refers to “a contract under which one or more persons (the principal(s)) engage another person (the agent) to perform some service on their behalf which involves delegating some decision making authority to the agent” which, in this context, means shareholders delegate authority to the director as their agent. Nevertheless, there is a principal-agent problem since company directors preside over other people’s money so they may be inclined to act carelessly and take advantage and act in their own interests rather than for shareholders since many institutional investors, in particular, are apathetic. It is believed such problems may be resolved by engaging with the agent to guarantee they act appropriately and penalise them if they do not. However, this is likely to prove somewhat problematic since active engagement in corporate governance involves time and effort and many investors prefer the resulting ‘liquidity and diversity in their portfolios’ to the costs linked with engagement.
Before the global financial crisis arose in 2008, efforts by the UK to resolve the agency problem had typically relied upon soft law instruments including codes of practice and voluntary guidelines. For example, the Institutional Shareholder’s Committee (henceforth, the ISC) statement on the ‘Responsibilities of Institutional Shareholders in the UK’ provided guidelines regarding the actions of institutional investors. The Cadbury Committee then explicitly recognised the importance of investment monitoring to improve corporate governance through the introduction of the ‘comply-or-explain’ principle. Therefore, it would seem to be clear that efforts to encourage the engagement of shareholders engagement are not new so as to make it all the more surprising a lack of poorly managed companies was one of the principal reasons for the UK financial crisis.
However, few recommendations were made regarding institutional investors under the Cadbury Report and those that it included largely repeated the aforementioned ISC’s statement including using their votes. The Cadbury Report was then followed by the Reports of the Greenbury Committee and the Hampel Committee which also did not serve to bring about many significant improvements except for where, for example, the Greenbury Report provided the connection between salary and performance should be expressly disclosed. This specific improvement was then to be subsequently incorporated into the terms of the Combined Code of Corporate Governance itself to help reduce the costs of information-gathering whilst also reducing the time and effort for board monitoring.
On this basis, the first Combined Code of Corporate Governance of 1998 included recommendations for institutional shareholders that did little more than replicate the ISC and Cadbury principles. The Myners Report then served as the next significant attempt (and failure) to resolve corporate governance’s agency problem since the Combined Code’s later editions never substantially built upon the first version. Nevertheless, whilst the ISC did change their original statement into a formal ‘Code on the Responsibilities of Institutional Investors’ in response to Lord Myners criticisms in 2009, their formal Code did not substantially build upon the recommendations made under the original statement since institutional investor apathy, in particular, should have been something they improve upon.
Overall, failure in this area is arguably most effectively demonstrated by the fact that, whilst the Companies Act 2006 (henceforth, the CA 2006) was meant to help shareholders effectively engage with company directors to resolve the agency problem, the global financial crisis of 2008 actually arose because applicable provisions were insufficiently used. Moreover, there is a need for any long term service contract to receive shareholder approval whilst they also reserve the right to remove a director. Therefore, it would seem to be true to say that the hard law of the CA 2006 has looked to provide for the resolution of company directors negative behaviour and help shareholders themselves realise the importance of moving beyond their own passivity when measured against the largely ineffective array of soft law Codes and guidelines. With this in mind, it is also to be noted that the Act also permits civil proceedings to be initiated where regulations are ignored that serve to effectively firm up the law in this regard.
Nonetheless, there is still also a need to consider the principle of ‘comply-or-explain’ which means that, instead of setting legal rules, a company must either comply with a given Combined Code’s (now the Corporate Governance Code’s) provisions or explain why it has not done so to create investor-company dialogue otherwise ‘hard questions’ may be asked of the board. Consequently, it could be argued that this principle aims to solve the agency problem by way of a market-based approach whereby a company’s share price may drop where it fails to adhere to this principle. Therefore, it is arguable that ‘comply-or-explains’ main benefit is that it promotes flexibility in recognising the fact all companies are different.
That many companies failed during the global financial crisis of 2008 centred upon the fact investors did not sufficiently monitor companies’ boards of directors’ activity so as to imply the principle of ‘comply-or-explain’ was failing in practice to this point. This is because some explanations for non-compliance with the Combined Codes of Corporate Governance have historically been ‘brief and uninformative,’ with ‘boilerplate statements’ deployed so shareholders may not have been able to ask the necessary hard questions to hold boards of directors sufficiently to account in this period. Nevertheless, whilst the figures have largely improved more recently, many companies still do not explain their compliance sufficiently. By way of illustration, it has been argued that, as opposed to assessing, these uninformative and non-existent explanations have meant some investors will use a company’s financial performance to determine if non-compliance if warranted.
Nonetheless, even when useful explanations are present, they are not always assessed, particularly in widely-held companies which may explain why they provide either poor statements or even no statement. However, if their shareholders are not undertaking monitoring, companies will be less likely to apply the principle of ‘comply-or-explain’. Instead, the reality is that institutional investors often employ a ‘box-ticking’ approach supported by the Association of Certified Chartered Accountants comments on the Walker Review so investors could say they are monitoring but are actually doing little or nothing in practice. On this basis, some companies may be deemed guilty of adopting a similar approach so there is some significant concern abiding by soft law like the examples to have been given will become just another compliance exercise instead of a concentrated effort to establish shareholder-company dialogue. Therefore, theoretically at least, it is possible a company could have believed it was complying but could actually fail to do so.
Decent company disclosures are also not always assessed due to the fact many institutional investors are unaware about how to carry out their responsibilities of engagement since most director engagement arises from voting at general meetings. However, investors could believe this is their only means of being heard by a board of directors and that more direct communication is either impossible or unknown. Therefore, it is essential to make investors aware of the other avenues available to them, including attendance at meetings, otherwise the trend of not evaluating disclosures of companies will continue. Nonetheless, the majority of shareholders are aware of the tools available to them for the purpose of establishing a more direct dialogue with a board of directors, particularly under the terms of the CA 2006, but do not typically make use of them in practice.
The principle of ‘comply-or-explains’ application has also proved to be somewhat lacking in terms of its enforcement since there are insufficient penalties for those who do not abide by it supported by the work of the European Commission because voluntary law systems typically fail due to there being no penalties so as to thus impact upon their effectiveness. This is because there could be a concern that applying legal sanctions to a company, for example, for poor disclosure may cross into hard law. A market sanction is meant to exist alongside the principle of ‘comply-or-explain,’ but there is no such thing when it fails due to uninformative company disclosures and investor apathy. However, the Listing Rules of the UK Listing Authority provides individual companies must state how the Combined Code of Corporate Governance applies or explain why not to avoid public censure or even a fine; although it is to be noted there has been a significant lack of action taken in this regard to date in practice. Therefore, it could be said that the UKLA Listing Rules operate merely as a ‘scare tactic’ for the purpose of encouraging companies to be compliant with provisions of the Combined Code of Corporate Governance or effectively explain why they deviate.
As has already been alluded to, in the wake of global financial crisis of 2008, the Walker Report served to condemn institutional investors passivity whilst also blaming fund managers. Additionally, Walker determined both the ISC and Combined Codes include positive principles that permit effective monitoring but with a lack of sufficient guarantees for abiding by these provisions. In looking to provide beneficial reforms to this area, Walker recommended the ISC Code be renamed the ‘UK Stewardship Code’ for the purpose of encouraging institutional investors in particular to take their company owner role more seriously and eliminate criticism of them as being little more than ‘absentee landlords’. Of course, arguably such an approach little more than replicates similar soft law developments prior to the crisis. As a result, it is also necessary to encourage institutional investors to utilise their rights and adopt a more long-term approach to avoid further crises.
Arguably, this understanding also sits well with Myners’ understanding “a share certificate is a right and entitlement of ownership which carries with it certain responsibilities” whilst also recognising it is “not a piece of paper to be traded, to be bought or sold” because “[c]ompanies are too important”.78 Allied to this, the Stewardship Code inspires fund managers to be more active in corporate governance and encourage service providers to adhere to it which is different to the Corporate Governance Code (replacing the Combined Codes of Corporate Governance Code) focused upon companies. For example, the Stewardship Code’s main provisions provide institutional shareholders need to state the way in which their stewardship responsibilities are to be satisfied, conflicts of interest are managed, investee companies are engaged with, and willingly collaborate with other investors to more easily monitor company directors’ activities.
One of the key disadvantages of the UK Stewardship Code is the application of the principle of ‘comply-or-explain’ that has already been described so no one needs to comply with the principles of the Code which also lessens its potential for significantly impacting upon investor engagement’s promotion. However, for those that choose to abide by its principles, there many inherent weaknesses since, when compared to its previous editions, the Code may even be said to have regressed. Therefore, it is arguable ‘guidelines’ should also perhaps be changed to ‘policies’ to imply adherence to these provisions in the future.
It is also true to say the Stewardship Code does not address other significant matters since, for example, due to the fact the Code functions based on the principle of ‘comply-or-explain’, some institutional investors that do not elect to monitor will benefit from the time expended and those others that do engage leading to potential problems. Therefore, there is a need to offer bonuses including, for example, significant dividends to those that engage. Moreover, although the Code seemingly encourages institutional investors to set aside any short-termism, it does not explicitly advise a more long-term trading approach because investors do not want to be pressured about whether or when their holdings may be sold.
That the Stewardship Code has a number of weaknesses is because, whilst there was industry consultation prior to its 2010 adoption, the Financial Reporting Council (henceforth, the FRC) failed to consider many of its proposals. This is because the principles of the Stewardship Code repeated verbatim the provisions of the ISC Code due to an apparent desire to maintain the Walker Review’s impetus that may also have significant ramifications internationally. The reason for this is that, largely due to the UK being deemed a corporate governance global leader, the Stewardship Code would be expected to encourage other countries to progress in this regard but is instead considered to be a ‘missed opportunity’.
Of course, despite the nature of such criticism, the FRC has shown it will respond to criticism with the implementation and enactment of the 2012 version of the Stewardship Code. However, the changes to have been made therein have proved to be largely superficial with it still being largely founded upon the same principles as both the 2010 version of the Code and the ISC Code with no real plans to change in the foreseeable future. Additionally, matters have not been helped by the fact the remit of the Stewardship Code is territorially limited which is something of a problem since a rather significant percentage of UK shares (still growing as a result of the principle of globalisation’s application) are held by foreign investors beyond the Code’s ‘jurisdiction’. At the same time, however, whilst it was recommended by the Walker Review that the Stewardship Code should be kept largely ‘UK-centric,’ it was believed foreign investors may still elect to comply with its provisions. Therefore, it is arguable that there is a potential disadvantage in the potential confusion which may arise if foreign investors act in keeping with a UK-centred Code set against rules they are to act in accordance with in their own jurisdiction. Nevertheless, it is arguable bigger changes will have to be implemented to achieve the significant move in the culture of investment needed to stop another global financial crisis in the future.
Nonetheless, it is also to be noted that the Enterprise and Regulatory Reform Act 2013 introduced significant changes to the policy of director remuneration. Such a view is supported by the fact company shareholders now possess significantly greater combined power by way of a binding vote on the payment of company directors along with an obligation on the part of shareholders to provide this remuneration policy’s enhancement on a three yearly basis Therefore, the payment of directors needs to either adhere to the policy or be provided with shareholder approval so they then have a direct say in the remuneration received. However, although this Act is only applicable to quoted companies directors that had the most significant role in the global financial crisis of 2008, it is not applicable to overseas companies that are listed on the UK stock market so it may be said that the legislation’s scope has been reduced somewhat.
The Large and Medium-sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013 is also significant in that it outlines both companies’ future remuneration policies and Annual Reports reporting requirements. These Regulations also provide companies need to state the salary each director receives, clarify their performance and recognise how the company decides upon directors’ level of remuneration. Consequently, investors are able to guarantee directors are not rewarded for failure or paid more than is merited by their performance in the manner that previously arguably contributed to the global financial crisis of 2008. It is also incumbent upon the company to make it clear how the remuneration of a director supports the immediate and future plans of a company. Therefore, the Regulations also provide for the improvement of transparency in this regard to reduce the informational costs shareholders are typically left to bear. However, whilst these Regulations do not apply to small businesses, it is arguably somewhat less likely directors companies would be rewarded for poor performances since their behaviour will arguably come under greater scrutiny due to their activities proving significantly more visible
Another law has been implemented in this area in the form of the Companies Act 2006 (Strategic Report and Directors Report) Regulations 2013 provides for certain companies to publish a strategic report including annual performance and its future plans and business model. As a result, it is believed that investors will be able to obtain significantly more insight into the effective governance of their investee companies whilst also permitting them to more effectively evaluate the performance of company director performance. Additionally, this legislation should mean investors will be more able to ask company directors hard questions if the aforementioned strategic report shows they are under-performing in relation to their company’s success’ promotion. However, these Regulations do not apply to those able to claim the exemption for small companies to reduce the scope whilst the FRC have also recognised the strategic report is not substantially different from the business review replaced.
Finally, there is also a need to recognise the fact that the investor forum to have been mooted in the wake of the Kay report and to have been in operation from June 2014 serves to represent another significant initiative in the field of corporate governance with shareholders representing other investors. On this basis, it is to be noted that the investor forum looks to aid the control of the behaviour of companies directors by, among other things, serving to banish short-term thinking via an ‘engagement action group’s’ creation that was meant to consist of a number of different investors from countries around the globe. As a result, it is arguable that such an approach could serve to benefit investors to be able to satisfy the remit of the Stewardship Code that provides for collective action’s encouragement.
To conclude, it is clear from this analysis that the global financial crisis of 2008 could indeed be looked upon as a crisis for corporate governance in England and Wales. The reason for this is that it is arguable that the aforementioned crisis served to make policy makers domestically realise not only how many problems there were in this area but also how significant such problems were for companies when it came to their effective corporate governance. As a result, it became clear there was a need for significant action to be undertaken in this area with a view to preventing similar crises from arising in the future that may serve to impact upon both individual companies along with those that are involved in business collectively. Therefore, based upon the research undertaken for the completing this essay, it would seem that some significant progress has been made in this regard but there is also still scope for further improvements in the future as this area of law continues to develop according to the needs of individual companies and the corporate environment as a whole.