This paper will analyse evolution and principles of corporate governance code. In addition, will consider importance of corporate social responsibility and the cause it has been the fundamental factor in reforming codes. There will be discussed nature, development, illustration and future development in corporate governance and corporate social responsibility.
Nature of Corporate Governance and Corporate Social Responsibility
Corporate Governance is the process that companies are supervised and managed to achieve prosperity by the Board of Directors (ACCA, 2012).
Lately, there has been extensive issues and domino effects with corporate’s conduct, that increased importance of corporate social responsibility (Boele et al., 2001). Stakeholders raised concerns over companies’ low interest on the impact and irresponsible behaviour to negatively affected parties. This has lead organisations to reconsider the accountability and treatment of the stakeholders and the demand for code of corporate governance to improve and nurture suitable public relations (Aras and Crowther, 2008). The code is guidelines that are encouraged to comply but not legally required, although should be declared reasons for noncompliance (ACCA, 2012; FRC, 2016).
Although code has been amended, often environmental and social issues isolated and detached from board of directors’ agenda and primarily attracted on economic performance of the business, therefore, greater attention to corporation’s profits (IFAC, 2018).
Development of Corporate Governance Codes and Practices
Since 1980s many large organisations scandals have made public and organisations consider and discuss suitable approach to regulate and conduct corporates (Haxhi, van Ees and Sorge, 2013). This was caused by agency relationship that created conflict of interest between the managers (board of directors) and the owners (shareholders) (ICAEW, 2005), due to management wanting higher returns on their short-term performance, rather long-term viability of corporation. Therefore, the Cadbury committee was established and produced code and practice to increase public confidence in government and organisation (OECD, 2004a).
The Code of Best Practice (1992)
This Code described most suitable practice of function and structure of board of directors, connection of shareholders and executives, audit and disclosed information. Secondly, code established ‘Comply or Explain’ approach (Haxhi, Van Ees and Sorge, 2013), this should initiate greater transparency and communications between organisation and public, while being voluntary. Furthermore, introducing adequate and independent non-executive directors that can observe and influence the decision. Also, maximum of three-year executive director service (OECD, 2004a). Therefore, introducing proactive safeguards for business prosperity.
The Combined Code
The combined code was released that incorporated Cadbury, Greenbury and Hampel Reports. This code outlined that public corporations are obliged to produce a narrative with justification of how principles were applied. (Kaplan, 2012). Furthermore, Code contemplate voting of shareholders and importance of internal controls (FRC, 2016). Code was rectified in 2003 and 2006 to align with two-tier boards accountability to greater scope of stakeholders (Haxhi, Van Ees and Sorge, 2013). The code tried to segregate duties to reduce the risk of falsifying or interfering with business accounts.
The UK Corporate Governance Code
The United Kingdom corporate governance code was reformed in 2010, due to large corporation scandals that negatively effected many stakeholders and economy. This has queried practicality and suitability of code. Hence committee had to scrutinise and elaborate on the matters that scandals had caused. The code tried to enhance institutional investors closer involvement with companies. Furthermore, it reiterated and underlined importance of non-executive directors’ independence and outnumbering executive directors, so that future scandals should be prevented and halted before causing enormous impact (Haxhi, Van Ees and Sorge, 2013; Kaplan, 2012).
In 2017 the code has been focused on accountability of board of directors. The change in principles is that members of board of directors should serve maximum of nine years overall, regardless their position in supervisory or management in one or more companies (Marriage, 2017). This is to prevent self-interest collisions and familiarity. Thus, fraud and falsification detection would be improved. Furthermore, new head of the board will more likely change auditor (Drennan, 2004), thus greater independence and professional scepticism, that potentially leads to better auditor’s performance.
Illustration of Problems and Failures in Corporate Governance and Corporate Social Responsibility
There are many examples of failures of corporate governance and corporate social responsibility. Below there will be discussed the major scandals that had tremendous impact and caused reforming the code.
Maxwell publishing group scandal was one of the reason why The Code of Best Practices has been established. Robert Maxwell has exploited his position as a dominant director by channelling Mirror Group Newspaper’s pension funds to other loss-making companies that he was managing. This fraud and double dealing could have been prevented should members of Board have monitored and examined Maxwell’s decisions, that gave power and control to one individual (OECD, 2004b; Mccarroll, Constable and Zagorin, 1991; Drennan, 2004).
Barings Bank scandal has raised issue of internal controls and segregation of duties, due to employee Nick Leeson misrepresenting financial losses, by creating false account. Although the internal controls were in place they were poor, therefore authority belong to one individual (Drennan, 2004; BBC, 1999). This scandal has caused release of Combined Code.
Although the codes have been updated, the Committee was unwilling to amend statutory regulations. It believed would harm professionalism, accountability and self-regulation that was fundamental elements of code (Drennan, 2004).
Enron and Worldcom
Enron and Worldcom both used ‘creative accounting’ to artificially inflate their profits (Cheung, 2006). While Enron’s losses were hidden by complex accounting procedures, expenses were capitalised (Ailon, 2001). Board of directors have allowed one individual to control and manage Enron (Dibra, 2016). Furthermore, auditor has lost its independence and professionalism by providing accounting and advise to board of directors (Cummings, 2002).
Worldcom treated expenses as investment (Cheung, 2006). Company’s auditor failed to examine information gathered and discover fraud (Global Agenda, 2002). Due to these scandals the UK corporate governance code has been established.
Tesco board of directors has manipulated its earnings to disguise decline profits (Di Fabrizio, 2017). This was done by members of the board colliding and exploiting the management role (BBC, 2017b). Although auditors notified auditing committee that there are weak internal controls and potential risk of falsifying accounts, but it had not discovered misconduct. Also, board of directors disregarded and continued fraudulent recognitions. Further, the same auditor has provided auditing and non-auditing service for a long time that jeopardised professionalism and competency. Furthermore, two Tesco board of directors were former employees of external auditors (Di Fabrizio, 2017), that reduces professional scepticism and independence of both firms. This scandal has prompted the rectification of corporate governance code that has been released in 2017.
Future Developments in Corporate Governance and Corporate Social Responsibility
Potential future developments in corporate governance could be aligning to separation of board to supervisory and management, however this might malfunction if adopted incorrectly. Furthermore, change in legislation and increase penalties of fraudulent activities might assist better corporate governance, but it also could cause further issues.
Example of two-tier board corporate governance can be found in Germany. The code is directed towards interest of stakeholders. Furthermore, there is lower conflict of interest due to less separation between owners and managers, due to shareholders and lower employees selecting members of supervisory board, though Chairman is elected by shareholders (Douma, 1997). Supervisory board appoints executive directors (OECD, 2004b). This might generate management collaboration and self-interest issues, although these problems are uncommon in German corporate governance code. Furthermore, management board is advised and supported by supervising board for creating sustainable future values, thus focusing on long-term while not undermining short-term objectives. (Wulf, Niemoller and Rentzsch, 2014). However, due to cultural differences might not be effective and adequate in United Kingdom. Also, it might be disregarded or differently interpreted (Wulf, Niemoller and Rentzsch, 2014).
Alternative is strengthened statutory laws and regulations and raise criminal sanctions might act as disincentive to abusing managing position (Drennan, 2004). An example of this is an introduction of Deferred Prosecution Agreement (BBC, 2017a) that discourages seeking self-interest and greater accountability. However, if principles approach will develop to rules based, this might cause board to behave according to the law, but might undermine the moral essence of the corporate governance and potentially might have detrimental effect on companies (Kaplan, 2012).
Although, codes were formed to manage the risk of irresponsible and self-interest behaviour from the board, organisations should have safeguards and strategies to prevent from occurring fraudulent activities (Drennan, 2004). Ultimately, individuals seeking higher returns is determined to succeed and willing to find a loophole in any legislations, even though fraud or abuse of management power might sabotage oneself and stakeholders’ foreseeable future.
There was analysed nature, development, illustration and progress of corporate governance and corporate social responsibility. Secondly there was discussed influence of corporate social responsibility in corporate governance code and practices. Although, examples of issues of codes and practices demonstrated demand for greater accountability from board of directors, enhancement of transparency, rigorous regulations. However, individual determined to succeed will be willing to find the way to undermined regulations, thus, companies should implement strategies and safeguards, so that abuse of power and self-interest could be prevented before generating detrimental effects to stakeholders.