UK Corporate Governance Code Research Articles

Women on boards, sustainability reporting and firm performance

PurposeAs pressures mount for women directors on corporate boards (WDOCBs) from different stakeholders, companies become more interested in finding out how WDOCBs impact sustainability disclosure. The purpose of this paper is to investigate the effect of gender-diverse boards on the association between sustainability reporting and shareholders’ welfare.Design/methodology/approachThis paper examines the implications of women on board for firm-related factors, particularly environmental, social and governance (ESG) disclosure and firm performance. The firms studied are all listed in the Financial Times Stock Exchange 350 index between 2007 and 2012. Bloomberg social disclosure score is used and panel data through a regression model are applied.FindingsThe results reveal that the presence of WDOCBs favorably influences on firm’s risk and performance through promoting a firm’s investment in effectual social engagements and reporting on them. The desirable effect of WDOCB on the ESG-performance relationship leads to increased risk-adjusted and buy-and-hold abnormal returns and reduced firm risks, measured by both volatility of returns and systematic risk.Originality/valueThe research contributes to the literature on the relationship between women participation on corporate boards and firms’ good citizenship and enhanced shareholders’ welfare. The empirical findings contribute to providing statistical and economical validity to the UK Corporate Governance Code 2014 recommendation on the importance of board gender diversity for effective board functioning.

Corporate governance as custodianship of the business model

Recently businesses have been encouraged to discuss their business models in their annual reports as a means of communicating their future intentions to readers of their financial statements. At the same time, corporate governance has continued to be a focus of attention. In this paper we set out the view that a useful way of regarding corporate governance is that of custodianship of the business model—by which we mean that the directors are responsible for sustaining and developing a company’s business model. A comparison of corporate governance and the activities required to sustain and develop the business model shows them to be essentially the same. A business model view has the advantage that it unifies the compliance and monitoring aspects of governance with the advisory and strategy-setting roles of directors, roles that have sometimes been seen as conflicting. Viewing corporate governance from a business model perspective highlights aspects of board responsibilities that are not explicitly recognised in the UK Corporate Governance Code and may have been neglected in the prevailing emphasis on compliance, but which are intimately connected to both network relationships and corporate culture which are now becoming a source of concern.

The Principle of 'Comply or Explain' Underpinning the UK Corporate Governance Regulation: Is There a Need for a Change?

The UK Corporate Governance Code, previously known as the Combined Code, has been widely regarded as one of the most influential corporate governance codes around the globe. Its main characteristic and what distinguishes it from the Sarbanes-Oxley Act in the United States, is the flexibility it offers to the companies. The voluntariness and flexibility of the Code is expressed through the “comply-or-explain” principle, a principle that has been supported not only in the UK but also at a European Union level and beyond. However, despite the undeniable advantages that the flexible principle of comply-or-explain offers, it has been the subject of severe criticisms during the last decades which call for reforms in this area of law. In particular, there are those who argue that the principle of 'comply or explain' has failed to achieve its objectives and that, in practice, it has not brought any meaningful improvement in the quality of corporate governance in the UK. This paper argues that, although comply-or-explain suffers from several practical deficiencies, it must not be completely abolished. In particular, it suggests that, instead of adopting hard laws in place of the flexible soft laws, a regulatory intervention is needed to ‘fix’ the principle’s deficiencies making comply-or-explain regime more effective and efficient and thus avoiding any destabilization of the foundations of the corporate governance in the UK. Hence, this paper concludes by proposing a way in which such a regulatory intervention can increase the overall quality of the comply-or-explain regime while at the same time preserving its advantages.

Do managers manipulate earnings prior to management buyouts?

To address the question as to whether managers intending to purchase their company by means of a levered buyout transaction manipulate earnings in order to buy their firm on the cheap, we study the different types of earnings management prior to the transaction: accrual management, real earnings management, and asset reserves revaluation. To identify the management engagement incentives, we contrast earnings management in management buyouts (MBOs) with that in (i) institutional buyouts (IBOs) and (ii) non-buyout firms. We find: (i) strong negative earnings management via both accrual and real earnings activities in MBOs supporting the above management engagement incentive, (ii) modest negative accrual management and insignificant real earnings manipulation in IBOs, and (iii) positive earnings management in non-buyout firms. Asset revaluation in MBOs is not a frequently used channel. We do not find evidence that a high external borrowing need in the levered transactions mitigates the downward earnings manipulation in MBOs. The implementation of the revised UK Corporate Governance Code of 2003 has somewhat reduced the degree of both accrual earnings and real earnings management in MBOs, but increased the relative use of real earnings management as this may be harder to detect.

Revisions to UK Corporate Governance Code and new FRC guidance on risk management ‐ Abstract of Discussion

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CEO succession in the UK: An analysis of the effect of censuring the CEO-to-chair move in the Combined Code on Corporate Governance 2003

In 2003, a new UK corporate governance Code recommended that the CEO should not become chairman of the same firm. The UK regulator, adopting an agency theory perspective, argued that this prevents powerful CEOs from clinging to power, to the detriment of firm performance. An alternative viewpoint, offered by stewardship theory, proposes that managers are inherently motivated to act in the best interests of the company and such controls are unnecessary, bringing no benefits to shareholders. This study therefore asks: (i) Does allowing the CEO to remain as chair damage firm performance? (ii) Did the changes to recommended best practice affect the number of CEOs remaining as chairman? (iii) Did the Combined Code (2003) affect the use of relay-style succession in the UK? Analysing a sample of 225 CEO routine departure events from 1996 to 2007 produces the answers: (i) this practice caused no apparent harm to accounting or stock market performance; (ii) there was a significant reduction in the practice in the period following the reform; and (iii) while UK firms were employing relay-style succession practices prior to the reforms, this has since abated. Overall, the evidence fails to support the agency view adopted by UK regulators.

CEO pay slice and firm value: evidence from UK panel data

PurposeThe purpose of this paper is to examine the relationship between CEO pay slice (CPS) – the fraction of the top five executive directors’ total compensation that is captured by the chief executive officer (CEO) – and the value of firms in the UK. Specifically, this paper examines whether CPS alters the effectiveness of board performance by influencing cooperation and cohesiveness among its members.Design/methodology/approachThis paper analyses a large sample of non-financial companies listed on the London Stock Exchange from 1997 to 2010. The empirical methodology includes the analysis of panel data by using a dynamic generalized method of moments estimator.FindingsThe evidence supports social comparison theory and demonstrates that high CPS is likely to impact negatively on executive team’s spirit and motivation. However, the tournament argument is supported when a subsample of companies with CEOs close to retirement age has been analysed. In addition, the findings suggest that companies perform better after the introduction of non-binding say on pay law in the UK in 2002.Practical implicationsThe results have major implications for the on-going debate on how to reform executive remuneration, and highlight the importance of considering remuneration issues at the board level, supporting the principles of UK Corporate Governance Code (Financial Reporting Council, 2010).Originality/valueThe results indicate that CPS can provide a useful tool for research on firm performance, and that its relation with the value of firms is an important issue to be considered in the UK context. The findings also highlight the importance of considering board-wide remuneration issues without narrowing them down simply to the details of CEO compensation.

A typology for exploring the quality of explanations for non-compliance with UK corporate governance regulations

Companies not complying with the UK Corporate Governance Code are required to provide explanations for non-compliance. This is the capstone of the ‘comply-or-explain’ system. There are no regulations about the content of those explanations, leaving shareholders and others to judge their appropriateness. The study develops a typology to assess the quality of corporate governance explanations for non-compliance of UK FTSE 350 companies based on seven quality characteristics. Code breaches generating the non-compliance explanations for analysis are identified for two accounting periods (2004/5 and 2011/12) relating to the 2003 and 2010 Codes (data for 2011/12 in brackets).There were 204 (125) non-compliant companies, 537 (253) Code breaches and 438 (208) explanations for non-compliance, an average of 2.6 (2.0) Code breaches and 2.2 (1.7) explanations per non-compliant company. Although compliance increased over the period examined, explanations were found to be of variable quality. Results suggest that companies need to improve the quality of their explanations if they are to be useful to users, notably location, complexity and specificity of explanations. There are also important questions raised about the work of auditors and their apparent silence. Companies are being encouraged to move towards compliance. We argue that this is against the ‘comply-or-explain’ philosophy which accepts that ‘one size does not fit all.’ Better quality of explanation is more important than compliance and thus companies may be unwittingly heading in the wrong direction.

Viewpoint: governing the governance of the governors

Purpose – The purpose of this “viewpoint” is to consider developments in the governance practices in UK public organizations, showing how ideas from the governance of listed companies have translated into public bodies. Design/methodology/approach – It discusses the literature of corporate governance and public service motivation and reflects it against practice evidenced in documentation for the UK Corporate Governance Code, codes for boards of different levels of public organizations, and both formal and informal evaluations of practice. Findings – The use of independent, non-executives directors in public bodies encapsulates the tension in the private sector between the service role of directors and how they control managers. The paper gives a preliminary investigation of three public bodies, comparing how reform of their governance has affected tensions in accountability and director motivation. The changes involve greater emphasis on extrinsic goals, potentially at the cost of the intrinsic ones. Research limitations/implications – The paper suggests avenues for future research, linking notions of the tensions between the service and control functions in corporate governance with the balance between extrinsic and intrinsic motivation. Practical implications – Directors in both public and private bodies face a need to hold at bay forces that push in opposing directions to accommodate demands for greater accountability while sustaining the altruism social mindedness. Originality/value – The area of public sector boards is undergoing considerable change in the UK and this paper, although preliminary, is one of the few to examine the links to motivation.

When in Rome: How Non-domestic Companies Listed in the UK May Not Comply with Accepted Norms and Principles of Good Corporate Governance. Does Home Market Culture Explain These Corporate Behaviours and Attitudes to Compliance?

Non-domestic companies are increasingly present on the London Stock Exchange. Such companies have specific governance requirements. They may seek to access capital in a more liquid market and to diversify ownership. The reputational ‘bonding’ (Coffee, Northwest Univ Law Rev 93:641–708, 1999; Columbia Law Rev 102:1757–1831, 2002) to a prestigious exchange should be a statement to the market of a propensity to disclosure and a willingness to protect minority shareholders. Yet, many non-domestic companies retain tightly controlled shareholding structures and are based in emerging regions where national culture norms differ to the UK. We hypothesise that non-domestic companies are likely to be less compliant with the principles of the UK Corporate Governance Code and suggest a correlation between lower levels of compliance and non-domestic companies from countries that demonstrate high power distance in the Hofstede (Culture’s consequences: International differences in work-related values, 1980a) cultural value framework. We find some encouraging signs of compliance with the reigning governance code principles in Board structures. However, we find only partial compliance in leadership and Board effectiveness measures in those companies from cultures high on the power-distance scale. Further, we include analysis into ownership characteristics and find companies from emerging markets are dominated by a single or controlling group of shareholders, which is likely to impact on attitudes to compliance and is particularly evidenced in terms of Board structures with no executive directors or led by an executive Chairman. Much of the prior research effort into the levels of compliance with the UK’s ‘comply-or-explain’ approach to governance has produced mixed results and focused on all companies. In our exploratory approach to analysing only the non-domestic subsample, we report some evidence linking cultural distance to lower levels of compliance with the UK standards. We develop a framework to guide future research into the context and cultural underpinnings of this sub-sample of companies, hypothesising that frequent market capitalisation-induced index changes may divert attention away from any potential compliance issues. On the one hand, our evidence is encouraging for governance regimes based on voluntary compliance disclosures such as the UK and similar European and international markets, as we report partial compliance with the principles of the current governance code. Our research may, however, be helpful in guiding future versions of the UK governance framework and other international governance regimes adopting the ‘comply-or-explain’ approach and in setting policy to improve disclosure. It contributes to the understanding of the specific context of non-domestic companies and any cultural tendencies to non-compliance. By demonstrating evidence of lower levels of compliance with key principles of the Code by non-domestic companies, we present a framework enabling lawmakers to further improve corporate governance codes.

Board Effectiveness and Short Termism

AbstractWe examine whether more effective boards in terms of size, experience, shareholding and independence, as discussed in the 2010 UK Corporate Governance Code, limit excessive short‐term risk taking or short‐termism. We use a state‐of‐the‐art asset pricing model that enables the disentangling of short‐term risk (related to short‐term returns) and long‐term risk (related to long‐term returns), and use the former as a proxy for short‐termism, where the short‐term component not only represents the time horizon for which we are interested but also the risk that is not related to fundamentals. We examine 916 firms in the UK over a possible horizon of 18 years, January 1992–December 2010, and find that more effective boards are associated with lower levels of short‐term risk and this result is robust to various types of short‐term risk (overall, downside) and specifications.

Top Management Succession: Was CEO to Chair a Bad Move?

In 2003, a new UK corporate governance Code recommended that the CEO should not become chairman of the same firm. The UK regulator, adopting an agency theory perspective, argued that this prevents powerful CEOs from clinging to power, to the detriment of firm performance. An alternative viewpoint, offered by stewardship theory, proposes that managers are inherently motivated to act in the best interests of the company and such controls are unnecessary, bringing no benefits to shareholders. This study therefore asks: (i) Does allowing the CEO to remain as chair damage firm performance? (ii) Did the changes to recommended best practice affect the number of CEOs remaining as chairman? (iii) Did the Combined Code (2003) affect the use of relay-style succession in the UK? Analysing a sample of 225 CEO routine departure events from 1996-2007 produces the answers: (i) this practice caused no apparent harm to accounting or stock market performance; (ii) there was a significant reduction in the practice in the period following the reform; and (iii) while UK firms were employing relay-style succession practices prior to the reforms, this has since abated. Overall, the evidence fails to support the agency view adopted by UK regulators.

Do Managers Manipulate Earnings Prior to Management Buyouts?

To address the question as to whether managers manipulate accounting numbers downwards prior to management buyouts (MBOs), we implement an industry-adjusted buyout-specific approach and receive an affirmative answer. In UK buyout companies, negative earnings manipulation (understating the earnings prior to the deal) often occurs, both by means of accrual management and real earnings management. We demonstrate that MBOs are significantly more frequently subject to negative manipulation than leveraged buyouts (LBOs). In non-buyout firms, positive earnings management frequently occurs because it affects managers’ bonuses and the likelihood of meeting or beating analysts’ expectations which may trigger a positive market reaction. By means of an instrumental variables approach, we examine competing incentives affecting the degree and size of earnings manipulation. Our evidence implies that the (ex ante) perceived likelihood that an MBO will be undertaken has a strong significant effect on negative earnings management, while the external borrowing capacity of the buyout company is not determined by standard capital structure factors, such as earnings numbers. The implementation of the revised UK Corporate Governance Code of 2003 has somewhat reduced the degree of both accrual earnings and real management in MBOs, but since then other manipulation techniques (related to production costs and asset revaluations) are more frequently used, which may be induced by the fact that these manipulation methods are more difficult to detect.

Accountability and the Corporate Governance Framework: From Cadbury to the UK Corporate Governance Code

At the heart of the UK’s corporate governance framework for listed companies is the UK Corporate Governance Code, which is a voluntary code. The Code has developed over many years and its genesis can be found in the legendary Cadbury Report that was published in 1992. The Code very much depends on the comply or explain principle, namely a company must comply with the Code or explain why it does not do so. Arguably it was the need for the accountability of boards of directors that was a major factor that contributed to the development of the whole code movement in the UK. It is clear that generally speaking the accountability of boards has become an increasingly critical element in any assessment of corporate governance. But it has been asserted that one of the features of self-regulatory structures such as the Code is that they are low on accountability. This paper seeks to ascertain whether this is in fact correct as far as the code system in the UK is concerned, and particularly in the way that it has developed over the years. Allied to this the paper also seeks to assess whether the system has adequately provided for accountability of boards in the UK. To this end the paper examines the reports of the corporate governance committees of the 1990s and 2000s, the various iterations of the Combined Code, and the UK Corporate Governance Code concerning what provision is in fact made for accountability of boards. The paper concludes that while the various reports and codes that have been published in the UK from 1992 onwards say the right things and this appears to enhance accountability, the Codes have been relatively weak on accountability. Further, even though the comply or explain principle purports to foster accountability, it can prevent accountability as the decision whether to comply or how to explain is completely within the discretion of the board of directors. Hence, the board that is to be accountable is in fact the arbiter of what is accounted for and how.

The Choice, Design and Strategic Implications of Executive Incentive Pay Schemes at the Time of an Initial Public Offering: A UK Perspective

This paper presents a critical analysis of the choice and design of executive pay incentive scheme arrangements implemented at the time of a company's initial public offering. Using a unique sample of 311 entrepreneurial companies over a five year period (1998–2002) it discovers that 172 companies implement executive share option schemes for the first time at their initial public offering. Taking this sub-sample, the paper evaluates and analyses the strategic choices made with regard to incentive pay schemes by the board of directors at this crucial time in a company's development. It finds that company's choices are split between schemes that have performance targets linked to reward and others that are contrary to the guidelines of the UK's Corporate Governance Code and best practice. Furthermore, it shows company characteristics that affect schemes and elaborates on the configuration of incentive schemes in respect of three critical elements: the performance target, comparator, and target level requirement for the shares to vest. In light of this, it proposes strategic reasons as to how these schemes might be set for initial public offerings and proposes that explanations for implementation are not underpinned by traditional agency theory but linked to a resource based view of the firm.

Board Effectiveness and Short Termism

We examine whether more effective boards in terms of size, experience, shareholding and independence, as discussed in the 2010 UK Corporate Governance Code, limit excessive short-term risk taking or short-termism. We use a state-of-the-art asset pricing model that enables the disentangling of short-term risk (related to short-term returns) and long-term risk (related to long-term returns), and use the former as a proxy for short-termism, where the short-term component not only represents the time horizon for which we are interested but also the risk that is not related to fundamentals (Campbell and Vuolteenaho, 2004).We examine 916 firms in the UK over a possible horizon of 18 years, January 1992-December 2010, and find that more effective boards are associated with lower levels of short-term risk and this result is robust to various types of short-term risk (overall, down side) and specifications.

Executive remuneration, and the principles of the Financial Stability Forum of 2009

PurposeAs a consequence of the global financial crisis and widespread disquiet over executive bonuses and other remuneration, in April 2009 the Financial Stability Forum enunciated principles for sound compensation as part of an effort to ensure the effective governance of compensation. The core problem this article seeks to address is the measurement of the contribution of corporate executives to the intrinsic value of the firm as part of an initial step in the process of implementing the Financial Stability Forum's principles. Unless the contribution of corporate executives can be measured in a manner that satisfies the requirements of sound research methodology, rigorous epistemology, and statutory requirements, it is doubtful whether these principles can be operationalized. Thus, the purpose of this paper is to show how the contribution of corporate executives can be estimated from audited financial statements. From the core problem and purpose of this article, its title is drawn.Design/methodology/approachRelevant sections of the report of the Financial Stability Forum 2009, the UK Corporate Governance Code of 2010, and the UK Companies Act of 2006, in conjunction with important reviews such as the Turner Review of 2009 and the Walker Review of 2009 were studied. Data inputs from audited financial statements were applied to appropriate well‐established non‐controversial valuation equations that are based on “first‐principles” of corporate finance, and the contribution of corporate executives to the intrinsic value of the firm was estimated in order to illustrate the validity of this approach.FindingsThe paper shows that contribution to the intrinsic value of the firm made by corporate executives can be measured in a non‐controversial and transparent way, and once done, can form the basis for quantifying executive remuneration on the basis of valued‐added. No attempt is made to address the fractional share of value‐added that should be placed in a bonus‐pool.Originality/valueFrom an extensive survey of publicly available literature, there is no evidence to suggest that the measurement of the contribution of corporate executives to the intrinsic value of the firm, as part of an initial step in the process of implementing the principles of the Financial Stability Forum 2009, has yet been published.