Corporate-Governance University of London PDF

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Barrister Ali Ishtiaq Company Law

Corporate governance (Corporate management) Corporate decision making are carried out by those officers who stand at the company's helm, namely the members of its board of directors. The Companies Act does not provide an exhaustive definition of the term director beyond stating in Sec 250 CA 2006, that the term includes, '' Any person occupying the position of director, by whatever name called.'' The CA does not attribute specific functions to company directors, or lay down the structure and form of corporate management generally. This is left to the Articles of Association. (Development) The 19th century view of the role of company directors was that, they were merely agents of the company's shareholders. As discussed before, there are two primary collective corporate organs, the board of directors and the shareholders in general meeting. Historically the shareholders in a general meeting had constitutional supremacy in so far as the directors, as its agents, had to act strictly in accordance with its decisions. (Isle of Wight v Tahourdin). This view of the company or shareholders in general meeting was steadily eroded by the courts of the 20th century. Not by specific law reform, but by changing practice and social phenomena. In public limited companies, also known as listed companies, share ownership is now more widespread and the attention of shareholders both private and institutional, is by in large focused upon investment returns rather than upon monitoring directorial conducts. The general meeting in large public companies particularly through the use of proxy voting (Shareholders do not personally attend the voting, but rather send a written notice or, more usually, assigned their votes to the board of directors to exercise as it's wishes). Hence it often becomes a little more than a forum for rubber stamping board room decisions. This shift of power as identified by Berle and Means in their pioneering empirical study conducted between 1929-30, demonstrated the consequences of the separation of ownership from control, taken together with the dispersion of share ownership, was that shareholders would no longer be able to control the direction of the company (This study had an immense influence over the form and approach of modern corporate governance regulation). If the shareholders disagree with the director’s management of the company, the only realistic option often open to them is to sell their shares and leave.

(The rise of directorial autonomy) In Automatic self-cleansing filter syndicate v Cuninghame, the issue was whether or not, the directors were bound to give effect to a resolution of the company in general meeting. Collins MR, having reviewed the AoA, observed that, unless a special resolution was invoked, it was impossible for a mere majority at a meeting to override the views of the director. The board of directors, therefore occupies a preeminent position in the management of companies (Towcester Racecourse v Racecourse Association). The position is that, directors who are subject either through removal by a general meeting, Sec 168 CA 2006, or by the AoA cannot be controlled by the shareholders in general meetings as if they were delegates or

Barrister Ali Ishtiaq Company Law

agents. (The relationship between the directors and general meeting) In general, it is the articles which prescribes the scope of the management powers of directors and so the relationship between the board and the company is based on a statutory contract. Table A, Article 70 (Companies (Table A-F) regulations 1985, (SI 1985/805)), which states that, the business of the company shall be managed by the directors who may exercise all the powers of the company. This has now been replaced by the companies (Model articles) regulations 2008 (SI 2008/3229). Exceptional circumstances Model article 70 of the 1985 table A, and Articles 3 and 4 of 2008 model articles, for PLC, reserve to shareholders very limited means for intervening in management affairs through special resolution. A special resolution must be carried out by 3/4 of the members entitled to vote whether in person or by proxy (Sec 283 CA 2006). Situational example- Most common is a deadlock. Also for altering Articles of association. To remove a director. (Note) 1. John Shaw and sons (Salford) v Shaw. (Two shareholders tried to discontinue a litigation by the directors, courts said, shareholders cannot interfere like that. 2. Barron v Potter. (If there is a deadlock, which basically means, board of directors is unable to come to a decision, the power to conduct company affairs will revert back to general meeting) (Note ends)

(Appointment of directors) Aside from stipulating the minimum number of directors for companies, this issue is generally dealt with by the AoA. While the first directors are appointed in accordance with Sec 9 CA 2006, their successors are elected by the shareholders in a general meeting.

(Categories of directors) Modern corporate practice particularly recent corporate governance reform, recognizes 2 types of directors. 1. Executive directors, generally executive directors are full time officers of the company who carry out the management of the company's business. 2. Whereas, the corporate governance committees (The cadbury committee, the greenbury study group, the hampel committee, and most recently the Higgs review), view non-executive directors as holding the potential to perform a monitory role over their executive colleagues to ensure that they act strictly in the interest of the company. Further categories - De facto, De jeur, Shadow directors.

Barrister Ali Ishtiaq Company Law

(Corporate governance theories) The phrase corporate governance is a malleable term. At its broadest it concerns the question of who should own and control the company and its narrowest it concerns the relationship between the shareholders and directors. At the turn of the 19th century 3 factors had converged. Most fundamentally large scale projects involving the exploitation of transport and communications technology were emerging to tap into the wealth available for investment from the largely untaxed middle class. • * First theory (Concession theory) - Weakness- The weakness of this theory is that, they have little to say to the private individuals behind corporations. State centric view. That company is given an existence by the state. •

Second theory (Corporate realism) - The company is not a fiction, but has a real existence, which does not depend on its member or state for its existence. Dodd (1932), sought to provide an answer to the key unanswered question of corporate realism. He argued that just as other real persons have citizenship responsibilities that requires personal sacrifice, a corporation has social responsibilities where managers of this citizen corporation are expected to exercise their powers in a manner which recognizes the company's social responsibility to employees, consumers and general public.

• * Third theory (Aggregate theory) Berle (1932) in his response to Dodd’s article opposed Dodd’s solution. He believed that the Dodd answer was too vague. It would be practically unenforceable and lead to the furtherance of managerial dominance. Instead he sought to focus the company’s accountability mechanism on just the shareholders. He pro-posed an aggregate theory in which managers are trustees for the shareholders not the corporation. Thus, the managers are accountable to the shareholders and shareholder wealth maximization is the sole corporate interest. • * Fourth theory (Nexus theory)

(Corporate Governance) The agency problem associated with companies are obvious, the directors may use their extensive powers for their own benefit rather than for the benefit of the passive member investors. What mechanisms are typically put in place to manage these problems? The passive attitude of members towards company general meetings means that in practice directors often ensure that they are re-elected when their terms expire and that their service contracts contain advantageous provisions regarding the directors fees, salaries and perks. Of these, the level of director’s remuneration often comes in for attack and unfavorable comment. Whilst this has been directly catered towards within the UK corporate governance code 2018, it is important to understand what is corporate governance, the

Barrister Ali Ishtiaq Company Law

various Codes that have developed it to ensure accountability*, as well as the various areas of reform and contentions. A particularly notable definition of corporate governance was provided by Sir Adrian Cadbury, who stated corporate governance is concerned with holding the balance between the economic and social hopes, and between the individual and communal goals...the aim is to align as nearly as possible the interest of individuals, corporations and society. More narrowly defined by Sifuna (2012), '' It is a system of law and sound approaches by which corporations are directed and controlled focusing on the internal and external corporate structures with the intention of monitoring the actions of management and directors, and thereby, mitigating agency risk which may stem from the misdeeds of corporate offices. Corporate governance reports 1. Cadbury report - Following a series of high profile financial scandals, such as Polly peck, the financial reporting council (FRC), The London stock exchange and the accountancy profession established a committee in 1991. It made the key recommendation of introducing the non-executive directors to the main board. Another recommendation was, to have three sub committees in listed companies to cover appointment, remuneration, audit. Another important recommendation by the Cadbury committee was, 'Comply or explain basis'. 2. The Greenbury report - This report was mostly about director’s remuneration. The report expanded on the matter. A remuneration committee comprised of independent non-executive directors who would report fully to the shareholders each year on the company's executive remuneration policies. Another was, adoption of performance measures. 3. The Hample report - It endorsed both the previous codes, and this resulted in the combined code in 1998. 4. The Turnbull report - The report confirmed that it was the responsibility of the board of directors to ensure that the company has a sound system of internal control and should assess the effectiveness of internal control and report on them in the annual report. 5. Higgs review - The recommendation was particularly regarding the independence of non-executive directors. 6. Smith review - The report stated, the importance of a company's audit committee following the EnRon scandal of USA. It emphasize that the audit committee has a particular role, acting independently from the executive to ensure that the interest of shareholders are properly protected in relation to financial reporting and internal control. 7. Walker review - In 2009, the walker review produced a report following the global financial crisis. And one key thing identified by the review was that, major governance problems have come from patterns of behavior, at board of director’s level. It suggested the reviewing of composition and skills of the board of directors and in ensuring better induction and on-going training for non-executive directors. In

Barrister Ali Ishtiaq Company Law

addition there is a need to put in place a full time chairman, who is capable of understanding key issues and facilitating appropriate analysis. Criticisms was also directed at the shareholders of financial institutions. They either encouraged or at least failed to stop excessive risk taking and generally failed to exercise their responsibilities to engage with directors - Their so called stewardship responsibilities. This paved the way for the Stewardship code of 2010. This code aims to ensure the quality of engagement between institutional investors and companies to help improve long term returns to shareholders and the efficient exercise of governance responsibilities.

(The UK corporate governance code)

The most significant instrument that aims to bring accountability within the corporate governance framework is the UK corporate governance code, which is now issued by the UK's financial reporting council (FRC). Over the years, it has been updated many times and introduced new regulations. In 2010, the combined code was renamed UK corporate governance code, was updated in 2012, that introduced regulations related to diversity disclosers. That review set a goal for the 100 largest quoted companies to have at least 25% female board members by 2015. The latest version of the code is UK corporate governance code 2018 and took effect from 1st January 2019. Enforcement of the codeThe court described best practice corporate governance for large public companies. It is not enshrined in legislation but it is soft law (No legal compulsion to obey). Nevertheless, even without statutory backing, it has become virtually obligatory for listed companies. The comply or explain regulatory regime is a fundamental requirement of the stock exchange listing rooms, so there is hardly any way around it. The FRC is opposed to a detailed regulation of companies and rather intends to establish trust and respect within the markets. So, as to enable market participants to voluntarily impose such standard to each other.

(Regulation of listed companies by the UK corporate governance code - Important issues)

The UK CGC addresses various aspects of board structure and internal management, and indicates best practice for improved standards of CG of listed companies. 1) Qualities and expertise of board and board members. 2) Separation of the roles of chairman and the managing directors. 3) Balance of executive and nonexecutive directors (Read 2018 codes). 4. Gender diversity (Expect question from this angle). In recent years there has been a

Barrister Ali Ishtiaq Company Law

heightened concern for more diverse board culture with current attention focused on increasing of representation of women on boards. In February 2011, Lord Davies of Abersoch published a report that set out a business case for gender diversity on boards. Namely, improving performance; accessing the widest talent pool; being more responsive to the market, and achieving better corporate governance. Davies urges that it is the interest of businesses and shareholders to encourage gender diversity, and although he prima facie rejected the use of quotas, his recommendation was designed to achieve 25 % female representation on boards by 2015. It should be noted that the FRC's guidance on Board Effectiveness recognizes that diversity goes beyond gender diversity and race, It includes personal attributes such as intellects, judgment, courage, honestly and tact. This can be seen enshrined within principle J, which states, ‘’ Both appointment and succession plans should be based on merit and objective criteria, and within this context, should promote diversity of gender, social and ethnic background, cognitive and personal strengths.’’ No doubt the code is effective, because following the 2012 code, a report was published, which stated that, there have been a culture change as to how women are seen within the workforce and the 25% female representation target was largely achieved by 2015. More recently, the Hampton-Alexander review, there is now a recommendation of achieving a voluntary target of a minimum of 33% women representation on FTSE 350 boards by 2020. In addition, the Parker Review committee has recommended that each FTSE 100 board should have at least one director of color by 2022 and that FTSE 250 boards should meet this requirement by 2024. 5) Directors remuneration - Generally a director is an office holder, and not an employee. And as such a consequence of this is that, directors are generally not entitled to be remunerated for acting as directors (Hutton v West Corp Railway). However, this rule is usually excluded either by providing for the payment of remuneration in the directors service contract or by including a provision in the Companies articles providing the directors with the right to be remunerated for their services. In the 1990s, concern over the level of remuneration that the directors were awarding themselves became a controversial corporate governance issue. It is now universally acknowledged, that directors remuneration and the mechanisms that determine it, are two of the most important factors that shape and direct the boards behavior. To date, perhaps the most important mechanism is the remuneration committee. (Remuneration committees) The model articles allow directors to determine their own pay. However, concern that directors would award themselves excessive remuneration packages let the Cadbury committee to conclude that the determination of remuneration should be taken from the executive directors and given to another body, mainly a remuneration committee (Chapter 5, Remuneration, of the 2018 code in its principle Q states, a formal and transparent procedure for developing policy on executive remuneration and determining directors and senior management remuneration should be established.) No directors should be involved in deciding their own remuneration outcome. Provision 32 of the code makes further recommendation of the constitution on the remuneration committee. It suggests that remuneration committees should consists only of independent non-executive directors, a minimum membership of at least 3. It should review workforce remuneration and related policies and the alignment of incentives and rewards with culture. Taking these into account when setting the policy for executive director remuneration.

Barrister Ali Ishtiaq Company Law

(Note- Greenbury report on director’s remunerations, recommendation for remuneration committee, the remuneration committees report ended up providing a reference point for directors to increase their salaries by pointing out higher salaries in other similar companies. Also, guidelines regarding independent non-executive directors is very broad, so it is being manipulated by directors.)

(Sec 172 of CA 2006) There is considerable debate as to who's interest the directors should consider when undertaking the company's management. Under the common law directors were required to act in good faith, in what they believed to be in companies best interest. This has been criticized on a number of levels, including the fact that the term company's interest was somewhat obscure and subject to wide interpretation by directors. The wording of sec 309 of CA 1985, under which directors were to have regard to the '' interest of the company's employees '', did not provide sufficient emphasis on this core group of stakeholders in terms of the decision making process. As such, the opportunity was taken under the 2006 Act to clarify this area. The current approach is now to be found in sec 172 CA 2006 and it is believed by some commentators to represent the formal incorporation of the, '' Enlightened shareholder value '' approach into corporate governance. This in turn has given rise to substantial debate and criticism from the supporters of the stakeholder’s management stance. When considering sec 172, it is important to note the wording adopted, which states that, '' A director of a company must act in a way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard to other factors in so far as they promote the company's interest...'' Consequently it is suggested, that the 2006 Act clearly equates the interest of the shareholders with the Companies success before progressing on to include other factors that may be included in the decision making process. The other factors include... • • • • • •

(a) the likely consequences of any decision in the long term, (b) the interests of the company’s employees, (c) the need to foster th...