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Fair SharesThe Future of Shareholder Power and Responsibility$

Jonathan Charkham and Anne Simpson

Print publication date: 1999

Print ISBN-13: 9780198292142

Published to Oxford Scholarship Online: October 2011

DOI: 10.1093/acprof:oso/9780198292142.001.0001

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(p.254) Appendix 3 Committee on Corporate Governance

(p.254) Appendix 3 Committee on Corporate Governance

Fair Shares
Oxford University Press

Preliminary Report

2 Principles of Corporate Governance

  1. 2.1 We draw a distinction between principles of corporate governance and more detailed guidelines like the Cadbury and Greenbury codes. With guidelines, one asks ‘How far are they complied with?’; with principles, the right question is ‘How are they applied in practice?’. We recommend that companies should include in their annual report and accounts a narrative statement of how they apply the relevant principles to their particular circumstances. This should not be an additional regulatory requirement, nor do we prescribe the statement's content. But it could conveniently be linked with the compliance statement required by the Listing Rules. Given that the responsibility for good corporate governance rests with the board of directors, the written description of the way in which the board has applied the principles of corporate governance represents a key part of the process.

  2. 2.2 Against this background, we believe that the following principles can contribute to good corporate governance. They are developed further in later chapters.

A Directors

  1. I. The Board. Every listed company should be headed by an effective board which should lead and control the company.

    1. 2.3 This follows Cadbury (report, paragraph 4.1). It stresses the dual role of the board—leadership and control—and the need to be effective in both. It assumes the unitary board almost universal in UK companies.

  2. II Chairman and CEO. There are two key tasks at the top of every public company—the running of the board and the executive responsibility for the (p.255) running of the company's business. How these tasks are carried out in each company should be publicly explained.

    1. 2.4 This makes clear that there are two distinct jobs, that of the chairman of the board and that of the chief executive officer. The wording leaves open whether the holders of the two posts need be different people, or whether one person can do both jobs. This is discussed below (3.17–3.19).

  3. III Board balance. The board should include a balance of executive directors and non-executive directors (including independent non-executives) such that no individual or small group of individuals can dominate the board's decision taking.

    1. 2.5 Cadbury highlights the need to avoid the board being dominated by one individual (code 1.2). This risk is greatest where the roles of chairman and CEO are combined, though there may be cases where there are important offsetting advantages in combining the roles. But whether or not the two roles are separated, it is important that there should be a sufficient number of non-executive directors, a majority of them independent; and that these individuals should be able both to work co-operatively with their executive colleagues and to demonstrate robust independence of judgement and objectivity when necessary.

  4. IV Supply of Information. The board should be supplied in a timely fashion with information in a form and of a quality appropriate to enable it to discharge its duties.

    1. 2.6 We endorse the view of the Cadbury committee (report, 4.14) that the effectiveness of non-executive directors (indeed, of all directors) turns to a considerable extent on the quality of the information they receive.

  5. V Appointments to the Board. There should be a formal and transparent procedure for the appointment of new directors to the board.

    1. 2.7 The Cadbury committee commended the establishment of nomination committees but did not include them in the Code of Practice. In our view adoption of a formal procedure for appointments to the board, with a nomination committee making recommendations to the full board, should be recognized as good practice.

  6. VI Re-election. All directors should be required to submit themselves for re-election at regular intervals and at least every three years.

    1. 2.8 We endorse the view that it is the board's responsibility to appoint new directors and the shareholders' responsibility to re-elect them. The ‘insulation’ of directors from re-election is dying out and we consider that it should now cease. This will promote effective boards and recognize shareholders' inherent rights.

B Directors' Remuneration

  1. 2.9 Directors' remuneration should be embraced in the corporate governance process; the way in which directors' remuneration is handled can have a damaging effect on a company's public reputation, and on morale within the company. We suggest the following broad principles.

    1. (p.256) I The Level and Make-up of Remuneration. Levels of remuneration should be sufficient to attract and retain the directors needed to run the company successfully. The component parts of remuneration should be structured so as to link rewards to corporate and individual performance.

  2. 2.10 This wording makes clear that those responsible should consider the remuneration of each director individually, and should do so against the needs of the particular company for talent at board level at the particular time. The remuneration of executive directors should be linked to performance.

    1. II Procedure. Companies should establish a formal and transparent procedure for developing policy on executive remuneration and for fixing the remuneration packages of individual directors. No director should be involved in fixing his or her own remuneration.

  3. 2.11 Cadbury and Greenbury both favoured the establishment of remuneration committees, and made recommendations on their composition and on the scope of their remit. Like Cadbury, we think that the remuneration committee should operate by making recommendations to the board, rather than by discharging functions on behalf of the board. But we would expect the board to reject the committee's recommendations only very rarely.

    1. III Disclosure. The company's annual report should contain a statement of remuneration policy and details of the remuneration of each director.

  4. 2.12 This follows Greenbury (code, B.1) except that we do not specify that the statement should be in the name of the remuneration committee. This is in line with our view of the status of the committee.

C Shareholders

  1. 2.13 This section includes principles for application both by listed companies and by shareholders.

    1. I Shareholder Voting. Institutional shareholders should adopt a considered policy on voting the shares which they control.

  2. 2.14 Institutional shareholders include internally managed pension funds, insurance companies and professional fund managers. The wording does not make voting mandatory, i.e. abstention remains an option; but these shareholders must consider the merits of an active voting policy.

    1. II Dialogue between companies and investors. Companies and institutional shareholders should each be ready, where practicable, to enter into a dialogue based on the mutual understanding of objectives.

  3. 2.15 This gives general endorsement to the idea of dialogue between companies and major investors. In practice, both companies and institutions can only participate in a limited number of one-to-one dialogues.

    1. III Evaluation and Governance Disclosures. When evaluating companies' governance arrangements, particularly those relating to board structure and composition, institutional investors and their advisers should give due weight to all relevant factors drawn to their attention.

  4. (p.257) 2.16 This follows from the discussion in Chapter 1, paragraphs 1.11–1.14 on the importance of considering disclosures on their individual merits, as opposed to ‘box ticking’.

    1. IV The AGM. Companies should use the AGM to communicate with private investors and encourage their participation.

  5. 2.17 Private investors hold about 20% of the shares in listed companies, but are able to make little contribution to corporate governance. The main way of achieving greater participation is through improved use of the AGM. We discuss a number of suggestions for this purpose later.

D Accountability and Audit

  1. 2.18 This section includes principles for application both by listed companies and by auditors.

    1. I Financial Reporting. The board should present a balanced and understandable assessment of the company's position and prospects.

  2. 2.19 This follows the Cadbury code (4.1). It is not limited to the statutory obligation to produce financial statements. The wording refers mainly to the annual report to shareholders, but the principle also covers interim and other price sensitive public reports and reports to regulators.

    1. II Internal Control The board should maintain a sound system of internal control to safeguard shareholders' investment and the company's assets.

  3. 2.20 This covers not only financial controls but operational and compliance controls, and risk management, since there are potential threats to shareholders' investment in each of these areas.

    1. III Relationship with the Auditors. The board should establish formal and transparent arrangements for maintaining an appropriate relationship with the company's auditors.

  4. 2.21 We support the Cadbury recommendation (report, 4.35(a)) that all listed companies should establish an audit committee, composed of non-executive directors, as a committee of, and responsible to, the board. The duties of the audit committee include keeping under review the scope and results of the audit and its cost effectiveness, and the independence and objectivity of the auditors.

    1. IV External Auditors. The external auditors should independently report to shareholders in accordance with statutory and professional requirements and independently assure the board on the discharge of their responsibilities under D.I and D.II above in accordance with professional guidance.

  5. 2.22 This points up the dual responsibility of the auditors—the public report to shareholders on the statutory financial statement and on other matters as required by the Stock Exchange Listing Rules; and additional private reporting to directors on operational and other matters.