This report aims to evaluate the American and British mechanisms of corporate governance through the comparison and contrast, and to analyze the influences of the corporate scandals from 1991to 2001 on the present corporate governance systems. The report suggests that since each mechanism has its own characteristics, it is unlikely to get an exact conclusion of which is more effective. Corporate failures continue happening, so it is still necessary to better the existing mechanism timely.
Tables of Content
2.0 Definition of Corporate Governance1
3.0 Corporate Governance in US1
4.0 Compare and Contrast1
5.0 Influences of Corporate Failures1
5.1 Corporate Collapses1
5.2 Sarbanes-Oxley Act1
5.3 Combined Code of Corporate Governance1
8.0 Reference List1
Appendix 1 Governance principles of OECD1
Appendix 2 Collapse of Enron1
Corporate Governance (CG) has been a central and dynamic aspect of business, and recent years have witnessed the exceptional growth in CG practices. This report selects 2 representative definitions of CG from diverse understandings, examines the existing CG frameworks in UK and US, discuss the influences from corporate scandals, and then evaluate the 2 approaches. After the analysis, it can be suggested that since CG is a dynamic area, policy-makers should continuously adjust existing mechanism to meet the bran-new challenges.
2.0 Definition of Corporate Governance
Since corporate governance (CG) is a fascinating subject covering diverse areas like management, finance and accounting, different people would give different understanding towards this phrase from their own perspective, such as policy-makers, practitioners, researchers or theorists. It seems that the existing definitions fall along a spectrum. (Solomon, 2010) At one end, a fairly narrow definition is given by Shleifer and Vishny (1997): “corporate governance deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment”, and this definition is utilized in Agency Theory. At the other hand, a broader definition is provided by the Organization for Economic Co-operation and Development (1999): “corporate governance is a set of relationships between a company’s board, its shareholders and other stakeholders”; and such view is expressed in Stakeholder Theory.
3.0 Corporate Governance in US
In December 2009, the US approach to corporate governance was expressed as “the snarling head of American Regulation” at the ICAEW, which implies the high-regulatory characteristics in American system. America relies on a regulator-led approach through rules relating predominately to disclosure, which are mainly enforced by the Securities and Exchange Commission. This approach is “one-size-fits-all”, requiring all corporations listed in US to comply with it.
4.0 Compare and Contrast
Scholars of corporate governance intend to divide the world into two systems: the Anglo-American shareholder system and the Continental European/Japanese stakeholder system. (Aguilera, Williams, Conley & Rupp, 2006) The Anglo-American corporate governance system emphasizes the features shared by the US and the UK, especially the primacy of shareholders as beneficiaries of fiduciary duties, therefore, the Anglo-American system is termed as shareholders-related system. (Solomon, 2010)
The major similarities could be summarized as below:
Ÿ Dispersed share ownership.
Ÿ The primacy of shareholders as beneficiaries of fiduciary duties, and emphasize creating wealth for shareholders.
Ÿ Appreciate the generic corporate governance principles of OECD: Responsibility, Accountability, Transparency and Fairness. (ICAEW, n. d.) Detailed explanations of each principle can be seen in Appendix 1.
Ÿ Adopt a mix of company law, stock exchange listing rules and self-regulatory codes to address the interest conflicts.
Ÿ Active markets for corporate control as a mechanism of managerial accountability.
Ÿ Flexible labor markets.
Ÿ More and more institutional investors control the equity market as a whole in the last 20 years, and they have the potential to exercise coordinated, collective power. (Clark and Hebb, 2004)
Ÿ Corporate governance in these two countries aim to protect shareholder rights, enhance the disclosure of information and the quality and accuracy of disclosed information, facilitate effective functioning of the board, and provide an efficient legal and regulatory enforcement framework.
Ÿ Constraints on the exercise of CEO power
In approximately 80% of American companies, the CEO is the Chairman of the Board (Higgs, 2003), stressing the effective monitoring from the concentrated power; while 90% of the largest companies follow a dual strategic leadership pattern in the UK (Higgs, 2003), which splits the roles of CEO and the Chairman of the Board. This arrangement complies with recommendations of the Combined Code on Corporate Governance (2003).
Ÿ Roles of shareholders and board directors
American shareholders can do little to influence board composition, except withholding votes to express their dissatisfaction; while British shareholders have the authority to appoint or remove a director, and board directors are responsible for managing the affairs of the corporation and are accountable to shareholders for the stewardship of their investment. (Waring, 2007)
Ÿ Level of control
The larger market in US and the greater number of institutions imply it is difficult to mobilize shareholders to pursue collective interests. There is a higher concentration of shareholding among fewer institutions in UK, and governments permit dialogue between boards and investors to support shareholder collegiality. (Waring, 2007)
Ÿ Payment of CEO
Murphy and Conyon (2000) demonstrate that payment of CEO and stock-based incentives in US are much higher than those in UK, as American CEO has greater power.
Ÿ Composition of ownership
Although institutional investors have become the key owners in both countries, the composition of those investors differ. Mutual funds and money management firms are the largest in US, while insurance companies and pension funds are predominant in UK. (Aguilera, Williams, Conley & Rupp, 2006) Besides, different institutional investors would have different performance strategies, and exert distinct pressures on the corporation and its stakeholders.
Ÿ Relationship of the corporation with its investors
Jensen (2005) suggested the relationship in US is characterized by communications between analysts and corporate investor relations departments and high turnover of institutional investors, while British institutional investors engage in a substantive way with portfolio companies towards enhancing firm performance and reducing strategic risk. (Clark & Hebb, 2004)
5.0 Influences of Corporate Failures
Between 1991 and 2002, there are various corporate collapses in the US and UK, and they have significant and unneglected influences on the corporate governance frameworks in both countries.
5.1 Corporate Collapses
The collapse of Enron is the largest and the most notorious in America, and it attracted widely international attention on corporate failures and the significance of corporate governance to prevent such things from happening. The collapse process is demonstrated in Appendix 2. Enron’s collapse had repercussions on the accounting and auditing profession, and the misdoings of Arthur Andersen reflected conflicts of interests in the audit profession. (Solomon, 2010) Then, America published the Sarbanes-Oxley Act in 2002, along with the Higgs Report and the Smith Report in Britain.
WorldCom is the largest American company to file for bankruptcy. In March 2002, SEC conducted an investigation into accounting irregularities at WorldCom, and it admitted to misclassifying capital expenditures.
5.2 Sarbanes-Oxley Act
Influenced by the collapse of Enron and the bankruptcy of WorldCom, Sarbanes-Oxley Act (2002) was promoted by Paul Sarbanes and Michael Oxley.
Section 103 required “the Board must require a 2nd partner review and approval of audit reports registered accounting firms must adopt quality control standards”.
Section 201 recommended “it shall be ‘unlawful’ for a registered public accounting firm to provide any non-audit service to an issuer contemporaneously with the audit ”, except some special cases.
Section 203 required “the lead audit or coordinating partner and the reviewing partner must rotate off of the audit every 5 years”.
Section 302 stressed the corporate responsibility for financial reports to certify the “appropriateness of the financial statements and disclosures contained in the periodic report”. Those financial statements and disclosures fairly present the operations and financial condition of the issuer.
Section 401 (c) required SEC to study and to report on special purpose entities.
Section 404 emphasized the management assessment of internal controls.
Section 806 required to protect whistleblowers, who provide evidence of fraud.
5.3 Combined Code of Corporate Governance
The closure of Bank of Credit and Commercial International was one of the biggest banking frauds of the twentieth century. (Mitchell, Sikka, Arnold, Cooper and Willmott, 2001)
In 1995, the downfall of Barings Bank, which was one of British oldest established banks, illustrated the importance of effective internal controls and appropriate supervision. (Mallin, 2007)
After the scandals at Maxwell and BCCI, the Cadbury Report was issued to call for clearly division of responsibilities at the head of corporations to balance power and authority, and to define the importance of and contribution that can be made by non-executive directors.
The Turnbull Report provided guidance to directors on the internal control procedures, which was considered as vital to manage risk in the organizations. This view seemed to be achieved from the collapse of Barings.
Higgs review emphasized the role and effectiveness of non-executive directors, which was extracted from the Maxwell case.
The Smith review focused on the audit committee, which was influenced by the collapse of Enron.
Incorporating revisions from Turnbull, Higgs and Smith, the Combined Code on Corporate Governance was published in 2003. This code recommended good practices in terms of board composition and development, remuneration, accountability and audit, and relations with shareholders.
It is widely recognized the American corporate governance mechanism is “regulator-led”, which is a “one-size-fits-all” approach that every corporation should comply with. (Tafara, 2007) In this framework, investors know exactly what they should do, and regulators try to avoid failures through the prospective, fixed limits.
On the other hand, the British mechanism is “shareholder-led”, which is flexible and can be tailored to meet specific needs. (Tafara, 2007) Institutional investors in UK take a long-term perspective, and are more likely to evaluate their investment decisions against corporations’ social and environmental behaviors.
Since, everyone has its own pros and cons, governance of regulator- versus shareholder-led is not an either-or proposition. (Tafara, 2007) Both of them are necessary, with own sphere of application. It is significant to select and tailor the more suitable corporate governance system, according to the environment and the corporate endowment, for the sake of the maximum corporate social responsibility.
Corporate governance is a central and dynamic aspect of business, and its principal function is to direct the operations and strategies of corporations in the way of corporate success and social welfare, rather than controlling. Massive corporate collapses between 1991 and 2002, such as collapses of Enron and the bankruptcy protection of WorldCom, mainly contributed to the weak systems of corporate governance, which highlight the need to improve and reform corporate governance at an international level. Going alone with this period of corporate failures, the United States issued the Sarbanes-Oxley Act in July 2002, while the United Kingdom published the Higgs Report and the Smith Report in January 2003. However, it should be noticed that since the corporate governance failures still happen, it is still necessary to keep the timely adjustments and improvements of the existing corporate governance mechanisms.
8.0 Reference List
1. Solomon, J. (2010) Corporate Governance and Accountability. (3rd edition) Wiley.
2. Shleifer, A. & Vishny, R. (1997) A Survey of Corporate Governance. Journal of Finance, 2:737-783.
3. Organization for Economic Co-operation and Development. (1999)
4. Aguilera, R. V., Williams, C. A., Conley, J. M. & Rupp, D. E. (2006) Corporate Governance and Social Responsibility: a comparative analysis of the UK and the US. Corporate Governance and Social Responsibility, 14(3): 147-158.
5. ICAEW. (n. d.) An Overview of Corporate Governance. Accessed: 5 December 2010.
6. Clark, G. & Hebb, T. (2004)Why Should They Care? The Role of Institutional Investors in the Market for Corporate Global Responsibility, Environment and Planning A, 37: 2015-2031.
7. Higgs, D. (2003) Review of the Role and Effectiveness of Non-Executive Directors. Available at: http://www.ecgi.org/codes/documents/higgsreport.pdf. Accessed at: 7 December 2010.
8. Waring, K. (2007) Beyond the myth of Anglo-American corporate governance. AccountabilityMagazine.com
9. Murphy, K. J. & Conyon, M. (2000) The Prince and the Pauper? CEO Pay in the United States and the United Kingdom. Economic Journal, 110: 640-671.
10. Jenson, M. (2005) Agency Costs of Overvalued Equity. Financial Management, 5-19.
11. Mallin, C. A. (2007) Corporate Governance (2nd edition). Oxford: Oxford University Press.
12. Mitchell, A., Sikka, P., Arnold, P., Cooper, C. and Willmott, H. (2001) The BCCI Cover-Up. Basildon: Association for Accountancy and Business Affairs.
13. Wearing, R.T. (2005) Cases in Corporate Governance. London: Sage Publications.
14. Tafara, E. (2007) Speech by SEC Staff: Remarks on UK and US Approaches to Corporate Governance and on the Market for Corporate Control. U.S. Securities and Exchange Commission. Available at: http://www.sec.gov/news/speech/2007/spch020807et.htm. Accessed: 7 December 2010.
Appendix 1 Governance principles of OECD
Responsibility of directors
Including approve the strategic direction of the organization, and employ, monitor and reward the management.
Accountability of the board to shareholders
Shareholders have the right to receive sufficient and timely information on the financial stewardship of their investments and exercise power to reward and remove the directors.
Transparency of information
The disclosure includes meaningful analysis of the corporation and its actions, financial and operational information, and internal processes of management oversight and control, which enable outsiders to understand the corporation.
All shareholders are treated equally and have the opportunity for redress for violation of their rights.
Appendix 2 Collapse of Enron
In 2001, Enron was one of the largest energy groups in the world, and had been ranked as Fortune’s most innovative company for 7 years. During 2000, the stock price peaked at over $90, while in December 2001, stock reached less than $1. (Wearing, 2005) In 2001, numerous special-purpose entities were disclosed and the reported profits were reported to be overstated. Finally, in late 2001, the corporation filed for Chapter 11 bankruptcy.