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Codes of Corporate Governance

This Notes intends to Provide you a brief insight about Cadbury Committee

Recommendations, Greenbury Report on Corporate Governance, Report of Hampel

Committee, Combined Code, Smith Report, Key Provisions of The Sarbanes-Oxley Act -

2002 and The G20/OECD Principles of Corporate Governance

Cadbury Committee Recommendations on Corporate Governance:

The London Stock Exchange and the Bank of England set up a committee in 1991 under

the Chairmanship of Sir Adrian Cadbury to look into the financial aspects of corporate

governance. The very focus of the committee was on control and reporting functions of the

Board of Directors. It developed a Code of Corporate Governance which is known as ‘Code

of Best Practice’.

The Cadbury Code of Best practices had 19 recommendations. The recommendations are

in the nature of guidelines relating to Board of Directors, Non-executive Directors,

Executive Directors and those on Reporting and Control.

Relating to the Board of Directors, the recommendations are:

The Board should meet regularly retain full and effective control over the company

and monitor the executive management

There should be a clearly accepted division of responsibilities at the head of a

company, which will ensure balance of power and authority, such that no

individual has unfettered powers of decision. In companies where the Chairman is

also the Chief Executive, it is essential that there should be a strong and

independent element on the Board, with a recognized senior member.

The Board should include non-executive Directors of sufficient caliber and number

for their views to carry significant weight in the Board’s decisions.

The Board should have a formal schedule of matters specifically reserved to it for

decisions to ensure that the direction and control of the company is firmly in its

hands.

There should be an agreed procedure for Directors in the furtherance of their

duties to take independent professional advice if necessary, at the company’s

expense.

All directors should have access to the advice and services of the Company

Secretary, who is responsible to the Board for ensuring that Board procedures are

followed and that applicable rules and regulations are complied with. Any

question of the removal of Company Secretary should be a matter for the Board as

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a whole.

Relating to the Non-Executive Directors, the recommendations are:

Non-executive Directors should bring an independent judgement to bear on issues

of strategy, performance, resources, including key appointments, and standards of

conduct.

The majority should be independent of the management and free from any

business or other relationship, which could materially interfere with the exercise

of their independent judgment, apart from their fees and shareholding. Their fees

should reflect the time, which they commit to the company.

Non-executive Directors should be appointed for specified terms and

reappointment should not be automatic.

Non-executive Directors should be selected through a formal process and both,

this process and their appointment, should be a matter for the Board as a whole.

For the Executive Directors the recommendations in the Cadbury Code of Best

Practices are:

Director’s service contracts should not exceed three years without

shareholders’ approval

There should be full and clear disclosure of their total emoluments and those of

the Chairman and the highest-paid UK Directors, including pension contributions

and stock options. Separate figures should be given for salary and performance-

related elements and the basis on which performance is measured should be

explained.

Executive Directors’ pay should be subject to the recommendations of a

Remuneration Committee made up wholly or mainly of Non- executive Directors.

And on Reporting and Controls the Cadbury Code of Best Practices stipulate

that:

It is the Board’s duty to present a balanced and understandable assessment

of the company’s position.

The Board should ensure that an objective and professional relationship is

maintained with the Auditors.

The Board should establish an Audit Committee of at least three Non-executive

Directors with written terms of reference, which deal clearly with its authority

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and duties.

The Directors should explain their responsibility for preparing the accounts next

to a statement by the Auditors about their reporting responsibilities.

The Directors should report on the effectiveness of the company’s system of

internal control

The Directors should report that the business is a going concern, with supporting

assumptions or qualifications as necessary.

Greenbury Committee Report on Corporate Governance (1995) :

During the 1990’s the issue of director’s remuneration was becoming a

primary concern for investors and the public at large. Specifically, the levels of

remuneration of directors in privatised industries were rising and remuneration packages

were failing to provide the necessary incentives for directors to perform better.

Consequently, it was recognised that corporate governance issues relating to director’s

remuneration needed to be addressed in a more rigorous manner. This led to the

establishment of the Greenbury Committee. This Committee was set up in 1995 by the

Confederation of British Industry (CBI) under the Chairmanship of Sir Richard

Greenbury.

The Committee’s findings were documented in the Greenbury Report, which

incorporated a Code of Best Practice on Director’s Remuneration. Specifically, four

main issues which were dealt with are as follows:

The role of a Remuneration Committee in setting the remuneration packages for

the CEO and other directors;

The required level of disclosure needed by shareholders regarding details of

directors remuneration and whether there is the need to obtain shareholder

approval;

Specific guidelines for determining a remuneration policy for directors; and

Service contracts and provisions binding the Company to pay compensation to a

director, particularly in the event of dismissal for unsatisfactory performance.

As in the Cadbury Code, the Greenbury Code recommended the establishment of a

Remuneration Committee, comprising entirely of non- executive directors, to determine

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the remuneration of the executive directors. However, in terms of service contracts,

Greenbury recommended a maximum notice period of 12 months rather than three years

as suggested by Cadbury.

Report of Hampel Committee on Corporate Governance: ( 1998)

The Hampel Committee was established in 1995 to review and revise the earlier

recommendations of the Cadbury and Greenbury Committees. The Final report

emphasised principles of good governance rather than explicit rules in order to reduce the

regulatory burden on companies and avoid ‘box-ticking’ so as to be flexible enough

to be applicable to all companies. It was recognised that good corporate governance

will largely depend on the particular situation of each company. This emphasis on

principles survived into the Combined Code.

Hampel viewed governance from a strict principal/agent perspective regarding

corporate governance as an opportunity to enhance long term shareholder value,

which was asserted as the primary objective of the company. This was a new

development from the Cadbury and Greenbury Codes which had primarily focused

on preventing the abuse of the discretionary authority entrusted to management.

In particular, the report favoured greater shareholder involvement in company

affairs. For example, while the report recommended that unrelated proposals

should not be bundled under one resolution shareholders, particularly

institutional shareholders, were expected to adopt a, ‘considered policy’ on voting.

Another key advance was in the area of accountability and audit. The Board was

identified as having responsibility to maintain a sound system of internal control,

thereby safeguarding shareholders’ investments (although the Board was not

required to report on the effectiveness of the controls).

Further, the Board was to be held accountable for all aspects of risk management,

as opposed to just the financial controls as recommended by Cadbury.

Hampel did not advance the debate on director’s remuneration, choosing only to

reiterate principles inherent in Greenbury. In particular Hampel did not believe that

directors’ remuneration should be a matter for shareholder approval in general

meeting. This would not become a requirement until the introduction of The Directors’

Remuneration Report Regulations in 2002.

Following publication, the recommendations of Greenbury were also taken on board by the

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London Stock Exchange and incorporated into the UK Listing Rules. However, unlike the

Cadbury Code it was not widely accepted as many believed that the recommendations

made did not sufficiently deal with the issue of linking directors pay to the

Company’s performance in the interests of shareholders.

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Combined Code : (1998) The origins of the current Revised Combined Code stem from the report of the Committee

on the Financial Aspects of Corporate Governance (the Cadbury Report, 1992) to which

was attached a Code of Best Practice. This was further developed through a series of re-

workings including those of the Greenbury Committee, which made recommendations on

executive pay and a Code of Best Practice.

It was then decided that previous governance recommendations should be reviewed and

brought together in a single code. The work was carried out under the chairmanship of Sir

Ronald Hampel and culminated in the Final Report: Committee on Corporate

Governance with its Combined Code on Corporate Governance in 1998.

In 2002, Derek Higgs was asked to report on the role and effectiveness of non-executive

directors. His report, published in January 2003, suggested amendments to the Combined

Code.

At the same time a committee under Sir Robert Smith reported on guidance for audit

committees. The revised Combined Code which was issued in July 2003 by the Financial

Reporting Council (FRC) took into account both reports.

The 2003 Code has been updated at regular intervals since then, most recently in June

2008. The 2008 edition applies to accounting periods beginning on or after 29 June

2008.The FRC undertakes regular reviews of the impact and continues to work effectively.

Main principles of the Combined Code are:

Directors

1 The board: Every company should be headed by an effective board which is collectively

responsible for the success of the company

2 Chairman and chief executive :

There should be a clear division of responsibilities at the head of the company between the

running of the board and the executive responsibility for running of the company’s

business. No one individual should comprise imaginative powers of decision.

3 Board balance and independence :

The board should include a balance of executive and nonexecutive directors (and, in

particular, independent nonexecutive directors) such that no individual or small group of

individuals can dominate the board’s decision taking.

4 Appointments to the board :

There should be a formal, rigorous and translucent procedure for the appointment of new

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directors to the board.

5 Information and professional development :

The board should be supplied in a timely manner with information in a form and of a

quality appropriate to enable it to discharge its duties. All directors should be given

induction on joining the board and should regularly update and refresh their skills and

knowledge.

6 Performance evaluation:

The board should undertake a formal and thorough annual evaluation of its own

performance and that of its committees and individual directors

7 Re-election :

All directors should be submitted for re-election at regular intervals, subject to continued

satisfactory performance. The board should certify designed and progressive refreshing of

the board

Remuneration :

1. The level and make-up of remuneration Levels of remuneration should be

sufficient to attract, retain and motivate directors of the quality required to run

the company’s successfully, but a company should avoid paying more than is

necessary for this purpose. A significant proportion of directors remuneration

should be structured so as to link rewards to corporate and individual performance

2. Procedure : There should be a formal and transparent procedure for developing

policy on executive remuneration and for fixing the remuneration packages of

individual directors. No directors should be involved in deciding his or her own

remuneration

Accountability and audit

1 Financial reporting : The board should present a balanced and understandable

assessment of the company’s position and prospects

2 Internal control:

The board should maintain a sound system of internal control to safeguard shareholders

investment and the company’s assets

3 Audit committee and auditors :

The board should establish formal and translucent arrangements for considering how they

should apply the financial reporting and internal control principals and for maintaining an

appropriate relationship with the company’s auditors

Relations with shareholders

1 Dialogue with institutional shareholders

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There should be a discussion with shareholders based on the mutual understanding of

objectives. The board as a whole has a responsibility for ensuring that a satisfactory

dialogue with shareholders takes place.

2 Constructive use of AGM :

The board should use the AGM to communicate with investors and to encourage their

participation.

Institutional shareholders :

1 Dialogue with companies :

Institutional shareholders should enter into a dialogue with companies based on the

mutual understanding of objectives.

2 Evaluation of governance disclosures :

When evaluating a company’s governance arrangements, particularly those relating to

board structure and composition, institutional shareholders should give due weight to all

relevant factors drawn to their attention.

3 Shareholder voting :

Institutional shareholders have a responsibility to make considered use of their votes.

Smith Report (2003) :

The Smith Report was a report on corporate governance submitted to the UK government

in 2003. It was concerned with the independence of auditors in the wake of the collapse of

Arthur Andersen and the Enron scandal in the US in 2002. Its recommendations now form

part of the Combined Code on corporate governance, applicable through the Listing Rules

for the London Stock Exchange.

It was substantially influenced by the views taken by the EU Commission. One important

point was that an auditor himself should look at whether a company's corporate

governance structure provides safeguards to preserve his own independence.

The Sarbanes-Oxley (SOX) Act -2002

Introduction

The legislation came into force in 2002 and introduced major changes to the regulation of

financial practice and corporate governance. Named after Senator Paul Sarbanes and

Representative Michael Oxley, who were its main architects, it also set a number of

deadlines for compliance.

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The Sarbanes-Oxley Act of 2002 came in response to financial scandals in the early 2000s

involving publicly traded companies such as Enron Corporation, Tyco International plc,

and WorldCom. The high-profile frauds shook investor confidence in the trustworthiness of

corporate financial statements and led many to demand an overhaul of decades-old

regulatory standards.

This law set out reforms and additions in four principal areas:

Corporate responsibility

Increased criminal punishment

Accounting regulation

New protections

Key Provisions of the Act :

1. Public Company Accounting Oversight Board (PCAOB) : It establishes the

Public Company Accounting Oversight Board, to provide independent oversight of

public accounting firms providing audit services ("auditors"). It also creates a

central oversight board tasked with registering auditors, defining the specific

processes and procedures for compliance audits, inspecting and policing conduct

and quality control, and enforcing compliance with the specific mandates of SOX.

2. Auditor Independence: The Act establishes standards for external auditor

independence, to limit conflicts of interest. It also addresses new auditor approval

requirements, audit partner rotation, and auditor reporting requirements. It

restricts auditing companies from providing non-audit services (e.g., consulting)

for the same clients.

3. Corporate Responsibility: The Act mandates that senior executives take

individual responsibility for the accuracy and completeness of corporate financial

reports. It defines the interaction of external auditors and corporate audit

committees, and specifies the responsibility of corporate officers for the accuracy

and validity of corporate financial reports. It enumerates specific limits on the

behaviors of corporate officers and describes specific forfeitures of benefits and

civil penalties for non-compliance.

4. Enhanced Financial Disclosures: It describes enhanced reporting

requirements for financial transactions, including off-balance-sheet transactions,

pro-forma figures and stock transactions of corporate officers. It requires internal

controls for assuring the accuracy of financial reports and disclosures, and

mandates both audits and reports on those controls. It also requires timely

reporting of material changes in financial condition and specific enhanced reviews

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by the SEC or its agents of corporate reports.

5. Analyst Conflicts of Interest : It includes measures designed to help restore

investor confidence in the reporting of securities analysts. It defines the codes of

conduct for securities analysts and requires disclosure of knowable conflicts of

interest.

6. Commission Resources and Authority : It defines practices to restore investor

confidence in securities analysts. It also defines the SEC's authority to censure or

bar securities professionals from practice and defines conditions under which a

person can be barred from practicing as a broker, advisor, or dealer.

7. Corporate and Criminal Fraud Accountability : It describes specific criminal

penalties for manipulation, destruction or alteration of financial records or other

interference with investigations, while providing certain protections for whistle-

blowers.

White Collar Crime Penalty Enhancement: This section is also called the "White

Collar Crime Penalty Enhancement Act of 2002". This section increases the criminal

penalties associated with white-collar crimes and conspiracies. It recommends stronger

sentencing guidelines and specifically adds failure to certify corporate financial reports as

a criminal offense.

The G20/OECD Principles of Corporate Governance :

The G 20 /OECD Principles of Corporate Governance help policy makers evaluate and

improve the legal, regulatory, and institutional framework for corporate governance, with

a view to supporting economic efficiency, sustainable growth and financial stability.

First published in 1999, the Principles have since become the international benchmark. In

2015, the updated Principles were endorsed by the OECD Council and the G20 Leaders

Summit.

The Principles are intended to help policymakers evaluate and improve the legal,

regulatory, and institutional framework for corporate governance, with a view to support

economic efficiency, sustainable growth and financial stability. This is primarily achieved

by providing shareholders, board members and executives as well as financial

intermediaries and service providers with the right incentives to perform their roles within

a framework of checks and balances

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List of OECD Principles : There are 6 principles of CG as per OECD Principles

of Corporate Governance.

I. Ensuring the basis for an effective corporate governance framework II. The rights and equitable treatment of shareholders and key ownership functions III. Institutional investors, stock markets, and other intermediaries IV. The role of stakeholders in corporate governance V. Disclosure and transparency VI. The responsibilities of the board

I . Ensuring the basis for an effective corporate governance framework : The

corporate governance framework should promote transparent and fair markets, and the

efficient allocation of resources. It should be consistent with the rule of law and support

effective supervision and enforcement.

II. The rights and equitable treatment of shareholders and key ownership

functions: The corporate governance framework should protect and facilitate the exercise

of shareholders’ rights and ensure the equitable treatment of all shareholders, including

minority and foreign shareholders. All shareholders should have the opportunity to obtain

effective redress for violation of their rights.

Basic shareholder rights should include the right to:

1) Secure methods of ownership registration;

2) Convey or transfer shares;

3) Obtain relevant and material information on the corporation on a timely and regular

basis;

4) Participate and vote in general shareholder meetings;

5) Elect and remove members.

III. Institutional investors, stock markets, and other intermediaries: The

corporate governance framework should provide sound incentives throughout the

investment chain and provide for stock markets to function in a way that contributes to

good corporate governance.

IV. The role of stakeholders in corporate governance : The corporate governance

framework should recognise the rights of stakeholders established by law or through

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mutual agreements and encourage active co-operation between corporations and

stakeholders in creating wealth, jobs, and the sustainability of financially sound

enterprises.

The rights of stakeholders that are established by law or through mutual

agreements are to be respected.

Where stakeholder interests are protected by law, stakeholders should have the

opportunity to obtain effective redress for violation of their rights.

Mechanisms for employee participation should be permitted to develop.

Where stakeholders participate in the corporate governance process, they should

have access to relevant, sufficient and reliable information on a timely and regular

basis.

Stakeholders, including individual employees and their representative bodies,

should be able to freely communicate their concerns about illegal or unethical

practices to the board and to the competent public authorities and their rights

should not be compromised for doing this.

V. Disclosure and transparency : The corporate governance framework should ensure

that timely and accurate disclosure is made on all material matters regarding the

corporation, including the financial situation, performance, ownership, and governance of

the company.

A ) Disclosure should include, but not be limited to, material information on:

1. The financial and operating results of the company.

2. Company objectives and non-financial information.

3. Major share ownership, including beneficial owners, and voting rights.

4. Remuneration of members of the board and key executives.

5. Information about board members, including their qualifications, the selection

process, other company directorships and whether they are regarded as

independent by the board.

6. Related party transactions.

7. Foreseeable risk factors

8. Issues regarding employees and other stakeholders

9. Governance structures and policies, including the content of any corporate

governance code or policy and the process by which it is implemented.

B. Information should be prepared and disclosed in accordance with high

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quality standards of accounting and financial and non-financial

reporting.

C. An annual audit should be conducted by an independent, competent and

qualified, auditor in accordance with high-quality auditing standards in order to

provide an external and objective assurance to the board and shareholders that

the financial statements fairly represent the financial position and performance of

the company in all material respects.

D. External auditors should be accountable to the shareholders and owe a duty to the

company to exercise due professional care in the conduct of the audit.

E. Channels for disseminating information should provide for equal, timely and cost-

efficient access to relevant information by users.

VI. The responsibilities of the board :

The corporate governance framework should ensure the strategic guidance of the company,

the effective monitoring of management by the board, and the board’s accountability to the

company and the shareholders.

A. Board members should act on a fully informed basis, in good faith, with due diligence

and care, and in the best interest of the company and the shareholders.

B. Where board decisions may affect different shareholder groups differently, the board

should treat all shareholders fairly.

C. The board should apply high ethical standards. It should take into account the

interests of stakeholders.

D. The board should fulfill certain key functions, including:

1. Reviewing and guiding corporate strategy, major plans of action, risk management

policies and procedures, annual budgets and business plans; setting performance

objectives; monitoring implementation and corporate performance; and

2. Monitoring the effectiveness of the company’s governance practices and making changes

as needed.

3. Selecting, compensating, monitoring and, when necessary, replacing key executives and

overseeing succession planning

4. Aligning key executive and board remuneration with the longer term interests of the

company and its shareholders.

5. Ensuring a formal and transparent board nomination and election process.

6. Monitoring and managing potential conflicts of interest of management, board members

and shareholders, including misuse of corporate assets and abuse in related party

transactions

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7. Ensuring the integrity of the corporation’s accounting and financial reporting systems,

including the independent audit, and that appropriate systems of control are in place, in

particular, systems for risk management, financial and operational control, and

compliance with the law and relevant standards.

8. Overseeing the process of disclosure and communications.

E. The board should be able to exercise objective independent judgement on

corporate affairs.

F. In order to fulfill their responsibilities, board members should have access to

accurate, relevant and timely information.

G. When employee representation on the board is mandated, mechanisms should be

developed to facilitate access to information and training for employee representatives, so

that this representation is exercised effectively and best contributes to the enhancement of

board skills, information and independence.

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