The reach of The Combined Code on Corporate Governance
This article is based on UK law.
The Financial Reporting Council (FRC) may be the custodian
of the Code but compliance is a matter for the Listing Rules (see
our OUT-LAW guide A history of corporate
governance). Produced by the Financial Services Authority,
these Rules regulate companies with a full listing on the London
Stock Exchange (see our OUT-LAW guide on The
different types of company).
The Code does not apply to:
- companies whose shares are traded on AIM or other markets not
covered by the Listing Rules;
- a listed company incorporated outside the UK (though such
companies do have a lesser reporting obligation).
There is, though, nothing to stop such companies complying with
the Code if they choose to do so. Shareholder pressure, or simply a
wish to conform with “best practice”, may lead many “exempt”
companies to follow some or all of the Code’s recommendations. Most
of the Code’s principles, if not all the detailed provisions,
provide a sound basis for the governance of many companies.
Indeed, the Code’s reach increasingly extends beyond its
immediate “target group”. The Code has been the impetus for the
development of a more formalised approach to governance in other
sectors. Universities have produced their own governance code;
public sector bodies have guidance from the Independent Commission
on Good Governance in Public Services. And mutual life companies
are expected to follow guidelines on governance produced in the
wake of the Equitable Life inquiry.
The Code and the annual report
The Code is divided into “main principles”, “supporting
principles” and “provisions”. The main principles are general
statements of corporate life, which, at times, come close to
motherhood and apple pie in their level of general acceptability.
The first, for example, states: “Every company should be headed by
an effective board, which is collectively responsible for the
success of the company”. Supporting principles expand on the main
principles and give more guidance. But it is the Code’s provisions
that state the detailed requirements necessary, in the view of the
Code’s authors, to make sure the principles are upheld.
The Listing Rules seek to give the principles and provisions
some force by placing two requirements on UK listed companies:
- the annual report and accounts must contain a statement
explaining how the company has applied the main and supporting
principles. (It is taken for granted that the principles are
accepted; the only room for debate is over how they are
applied.)
- the report and accounts must state whether the company has
complied with the provisions throughout the year covered by the
report. If the company has not complied with all of the provisions,
or if it has complied with them for only part of the year, the
departures must be listed and reasons for the non-compliance
given.
The comply or explain rule
This brings us to a key feature of the listed companies’
Combined Code, copied to an extent by other codes derived from it:
its regime of “comply or explain”. UK listed companies must comply
with the Code’s detailed provisions or explain why they do not.
Ignoring the Code is not an option; but if you have good reason to
deviate from its terms, you may do so and leave it up to your
members/shareholders to decide whether your reason is good enough.
If you can talk to shareholders and demonstrate that departures
from the Code’s provisions are in the company’s best interests,
then non-compliance is unlikely to become a big issue.
Shareholders have no specific sanction if they disapprove of
what you are doing, short of voting against the Directors’
Remuneration Report if the debate is over boardroom pay, or voting
one or more directors off the board – a somewhat extreme step. What
they can do, though, is apply pressure with the aim of persuading
the board to change its mind.
As the case of the supermarket chain Morrisons shows, this can
be most effective at those junctures when a company needs the
support of its shareholders. (See box below.)
If the shareholders are not big enough or well organised enough
to exert pressure or if they are unwilling to take the
opportunities they have to do so, then the board can decide how
much it complies. The key point is that the Code and its provisions
are not compulsory; they are there for guidance and represent best
practice.
Case study: Morrisons – How shareholders
can change governance
A few years ago, the
supermarket chain Morrisons seemed unencumbered by corporate
governance principles. The company, led by the septuagenarian Sir
Ken Morrison as full-time executive chairman, had no non-executive
directors, no audit or remuneration committees and no shame in
explaining that it did not think these were necessary. It was a
FTSE 100 company and very much in the public eye. Institutional
shareholders might not have liked its public defiance of generally
accepted principles, but Morrisons was successful, and there was
little they could do about it.
Things began to change after
Sir Ken decided to bid for rival chain Safeway in 2003. The
chairman needed to raise the money for the bid from shareholders,
and one of the conditions they imposed was that he should at least
appoint two non-executive directors. Over a year later and just
before the AGM, two new non-executives duly appeared (though one
resigned 10 months later). One institutional shareholder group
commented, recognising the uphill task they still faced: "we
welcome this step towards better corporate governance and hope to
see formal board meetings established in due course."
Since then, further steps
have been taken to make management structures “more satisfactory to
the City”. And following a number of profit warnings and
acknowledged failures in its internal controls, the company now has
a full complement of board committees manned by four independent
non-executives (though they still do not equal in number the six
executive directors).
