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CORPORATE GOVERNANCE: OVERVIEW AND RESEARCH AGENDA
British Accounting Review (2000) 32, 341–354 doi:10.1006/bare.2000.0146, available online at http://www.idealibrary.com on
CORPORATE GOVERNANCE: OVERVIEW AND RESEARCH AGENDA ISTEMI DEMIRAG, SUDI SUDARSANAM AND MIKE WRIGHT INTRODUCTION The problems of corporate governance in listed companies with diffuse ownership are well-known and long-established (e.g. Berle & Means, 1932; Tricker, 1984). A number of financial scandals in the 1980s reignited a debate on how best to make managers accountable to shareholders that continues today. The publication of the Cadbury Report in 1992 introduced the first of several new corporate governance guidelines (Table 1). These were followed by the recommendations of the Greenbury and Hampel Committees, which in turn were incorporated into the Combined Code. These reports have been accompanied by further reports providing guidance as to their implementation. The Turnbull Report, for example, provided guidance for companies implementing the requirements of the Combined Code with respect to internal control. This development of corporate governance was marked by a move from narrowly defined financial accountability under Cadbury to an approach that recognized that the interests of shareholders were also served by allowing managers to exercise enterprise in terms of risk-taking and innovation (Short, Keasey, Wright & Hull, 1999). The recent publication of a consultative document on directors’ remuneration (DTI, 1999) and the establishment of a major programme to review company law to incorporate corporate governance issues (Company Law Review Steering Group, 1999; 2000a, b) represents a potential departure from these developments. While the approach adopted in the Combined Code was formulated by committees largely made up of industrialists and institutional representatives with the intention of reinforcing self-regulation, the review programme signals a government belief that self-regulation may be failing to deliver accountability The authors are respectively, Professor of Accounting, Queen’s University of Belfast, Professor of Finance & Corporate Control at Cranfield School of Management and Professor of Financial Studies and Director of the Centre for Management Buy-out Research, University of Nottingham. All are members of the BAA SIG on Corporate Governance Executive Steering Group. 0890–8389/00/040341+14 $35.00/0
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TABLE 1 Development of UK Corporate Governance Regulations—Since 1990 (Various codes and consultation papers) Internal Control—Integrated Framework report published by COSO, providing draft guidance on internal controls and financial reporting for directors of listed companies, based heavily on the Treadway Commission in the US. Cadbury Report and Code published setting out measures to enhance financial accountability to shareholders based on improved information, continued self-regulation, more independent boards through separation of CEO/Chairman roles and enhanced NEDs, and greater auditor independence UK Stock Exchange amends its Listing Rules—companies now have to show the extent of compliance with Cadbury with effect from 1 July 1993 Revision of draft guidance on internal controls published by COSO, emphasising a statement of principles with internal control seen as a process that needs to be integrated in a company’s management systems. Rutteman guidance on Internal Control and Financial Reporting published limiting directors’ reporting responsibilities to internal financial controls and to assessing their effectiveness The Greenbury proposals on setting of directors’ remuneration emphasising the role of independent NEDs and need for comprehensive disclosure of all components of remuneration. UK Stock Exchange amends its Listing Rules—companies now have to show the extent of compliance with Greenbury Stock Exchange amends its Listing Rules in the light of Greenbury’s recommendation on the phasing of share options The Hampel Report aimed to restrict regulatory burden on companies, stressing enterprise as well as accountability through flexible rules and emphasising principles not prescription and focusing on directors, directors’ remuneration, shareholders and accountability & audit. Publication of Modern Company Law for a Competitive Economy, consultation paper. The Hampel Committee Combined Code of 18 principles and 48 code provisions, the main substantive change from earlier proposals being requirement for NEDs to account for a 1/3 of board subject to a minimum of 3. Auditing Practices Board issues guidance for auditors on corporate governance suggesting a clear statement of auditors’ responsibilities be included in the annual report Publication of The Strategic Framework: Modern Company Law for a Competitive Economy a key element of which is the introduction of a stakeholder view of corporate governance and the role of directors Publication of the Turnbull guidance on internal control widening the definition of internal control on which directors are required to report including reviews of operational and compliance controls and risk management
1992
Dec. 1992
April 1993 1993
Dec. 1994 July 1995 Oct. 1995 June 1996 Jan. 1998
March 1998 June 1998
1998 Feb 1999
Sept. 1999
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TABLE 1 (Continued) Law Commission/Scottish Law Commission recommend introduction of statutory requirement of the principal duties of directors to companies and a statutory definition of a director’s duty of skill and care DTI paper outlining government intentions to amend Companies Act so that companies obtain shareholder consent prior to political donations DTI consultative paper proposing increased disclosure of linkages of performance to pay, simplification of share options disclosure and measures for shareholders to vote on remuneration reports Publication of Modern Company Law for A Competitive Economy: Developing the Framework, covering the role of directors, shareholders and reporting & accounting; simplification of reporting for private companies; and alternative vehicles. Publication of The Strategic Framework: Modern Company Law for a Competitive Economy: Completing the Structure: develops previous documents in the light of responses and invites further comments; also covers Company Law and Groups of Companies, Restructuring , Mergers and Jurisdictional Migration and Regulatory and Institutional framework for companies.
Sept 1999 1999 1999 March 2000
Nov 2000
(Short, Keasey & Wright, 2000). At the same time, the Committee on Standards in Public Life continues to make recommendations affecting the behaviour of directors. These most recent proposals, therefore, suggest that the regulation of corporate governance in the UK may be at a turning point. In the light of these developments, the three principal contributions of this Special Issue are as follows. First, we examine the effects of extant policy prescriptions. Second, we analyse the prospects for future policy developments regarding the regulation of corporate governance. Third, we consider the need for policy development to be informed by an appreciation of the objectives of corporate governance, the range of governance mechanisms available, and the interactions between these objectives and mechanisms. This Introduction summarizes the contribution of the five papers in this special issue in the context of these themes. We conclude by offering some suggestions for further research based on these papers and related literature. Clearly, as the corporate governance debate covers a vast arena, this collection of papers focuses only on a subset of the issues. THE EFFECTS OF GOVERNANCE CODES The Cadbury Report in the UK focuses attention on accountability and risk management aspects of corporate governance. It has the objective of securing ‘accountability’ of the board of directors and the chief executive whilst ensuring that effective risk management and control systems of companies are developed and maintained in order to enact this accountability function.
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Studies in the UK have generally shown high levels of compliance with recent recommendations on corporate governance (e.g. Conyon, 1997). One of the central objectives of the Cadbury Code of best practice is to reinforce director integrity and board effectiveness in promoting good quality and reliable financial information to users of accounts. Excessive powers and responsibilities given to top management without adequate controls have resulted in ‘creative accounting’ practices in many companies with the manipulation of company earnings being quite common (Demirag, 1998). Hence a central theme in the Cadbury Report is the potential association between internal corporate governance procedures and the financial reporting process. Bushman & Smith (2000) in their review of the use of publicly reported financial accounting information find that firms are moving away from using single accounting earning figures towards alternative performance measures as firm’s growth opportunities increase. They also note that, due to the lack of conceptualized operating figures in published company accounts, boards of directors are able to select earnings figures in determining their annual bonuses. They suggest that the reasons for the declining use of accounting measures for executive compensation be investigated and recommend that researchers should explore the impact of accounting information on future managerial behaviour. Murphy (1999), on the other hand, suggests that researchers should explore the relative importance of accounting-based bonuses and stock-based compensation plans for the economic performance of firms. He argues that executive incentives are not necessarily driven primarily by stock returns and that accounting performance measures may have a significant role to play. It is in this context that Peasnell, Pope and Young suggest that the role of the board should be pivotal to the Code of Best Practice. In particular, non-executive directors are crucial in helping to ensure the quality and integrity of accounting information. They argue that the quality of financial reporting lies at the heart of the Cadbury Report and that a central issue affecting the quality of financial statements is the extent to which managers can manipulate reported earnings numbers. Managers may have strong incentives to manipulate earnings as adverse earnings outcomes may have significant negative wealth effects where earnings are used as a basis for awarding bonuses and stock options. US research demonstrates that the presence of outside directors enhances the quality of accounting information (Beasley, 1996). This suggests that outside directors have a positive effect on enhancing the accountability of management. Peasnell et al. use abnormal working capital accruals to proxy for earnings management and find widespread use of accrual management to meet earning targets both before and after the introduction of the Cadbury Report. However, these techniques are found far less frequently in the postCadbury than in the pre-Cadbury period. The authors argue that this may be a result of employing a higher proportion of non-executive directors in the
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post-Cadbury period. These findings support previous research that suggests that when the proportion of non-executive directors is high, managers are less likely to make income-increasing accruals to avoid reporting negative earning or earning declines (Peasnell et al., 1999). It is important to note, however, that many of the apparent changes brought about by Cadbury may have been the result of the creation of internal codes and procedures put in place by companies themselves. Moreover confounding events, such as the external auditors’ changed perceptions of the risk of being associated with another scandal, rather than the Cadbury reform itself, maybe the source of the observed changes identified in this study.
THE DEVELOPMENT OF CORPORATE GOVERNANCE REGULATION Despite the promulgation of various codes of corporate governance, there remains a debate about the appropriate form and scope of corporate governance regulation. A major aspect of this debate is the continuing concern about the nature and desirability of self-regulation within a statutory framework. The potential arises for a lack of coherence in policy development where an ad hoc approach to the setting and monitoring of corporate governance codes occurs in response to public concerns over specific company behaviour. Moreover, further difficulties are raised by the nature of compliance required by codes and the monitoring of such compliance. In what they see as a UK environment where it is questionable whether corporate governance is regulated in any meaningful sense, Dewing and Russell consider the desirability of establishing a permanent regulatory framework. They discuss three possible models for the regulation of UK listed company audits which may also include the regulation of corporate governance: an Auditing Council, a Commission for Audit, and a UK SEC. In particular, they argue that linking corporate governance regulation and audit regulation might overcome previous criticisms about corporate governance regulation without the need to develop separate institutional arrangements. Their study canvasses the views of various parties with an interest in the regulation of corporate governance. Only limited support is found for the notion that corporate governance regulation should be assumed by an audit regulatory body. One barrier to such an assumption is considered to be the need for accounting and auditing standards to be more comparable in order to achieve meaningful guidance on the relationship between shareholders and companies. Auditing is seen to imply an ability to assess a situation in a rather objective, clinical manner, whereas assessment of the effectiveness of corporate governance involves much more subjective judgement. The study
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does, however, identify some support for regulation by an independent body with statutory powers, such as a UK SEC. A second aspect of the debate about developing corporate governance codes concerns efforts to promote disclosure on internal control and risk management, one of the neglected aspects of the recommendations in the Cadbury Report. Problems with internal controls have potentially serious implications for corporate governance as they may contribute significantly to corporate incompetence and malpractice (Mills, 1997). Appropriate internal control systems can help enterprises avoid exposure to major business risks. The Turnbull recommendations on implementing the Combined Code’s requirements for reporting on internal control emphasize their importance both for corporate accountability and for the future success of the business, a wider view than the previous restriction to just financial controls. In the light of the Turnbull recommendations, Solomons, Solomons, Norton and Joseph develop a general conceptual framework for internal control, risk management and risk disclosure, with a focus on the disclosure aspect of this conceptual framework. The authors provide evidence that institutional investors consider that increased risk disclosure would assist them in these decisions but that the views of institutional investors are not homogeneous as between different types of institution. There is some support for the view that legislation is inappropriate for implementing corporate governance, with a preference being expressed for a voluntary framework even though shareholders have a weak influence on what is disclosed. Further research on the role of internal control mechanisms in corporate governance is required. While Solomons et al. have focused on the disclosure aspects of an internal control conceptual framework, we still know little about how enterprises develop such control processes and how the information that is disclosed is interpreted and used by shareholders, institutions, and other stakeholders. A third dimension of the debate concerns the notion of ‘corporate governance for whom?’ As part of its deliberations, the steering group involved in the recent consultation paper in the UK on the reform of Company Law includes a re-examination of directors’ legal duties (Company Law Reform Steering Group, 1999). The proposals require directors to consider and take into account the whole enterprise and not just the interests of the entity, which only consists of the shareholders’ and the investors’ interests. Such a recognition of a stakeholder perspective in corporate governance has significant implications for the nature of financial reporting systems. While the stakeholder concept is well-known, in the Anglo-Saxon context its influence has yet to filter through into financial reporting. Accounting standards on both sides of the Atlantic are still dominated by the entity concept, which inevitably puts the interests of shareholders and investors first in determining accounting standards.
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There have recently been concerted efforts to obtain convergence in the application of the shareholder based model pioneered in the USA. This conflicts with the earlier view of the IASC that a choice between accounting models premised on different perspectives is appropriate. However, given that the European Commission wants all corporations to adopt IASC standards by 2005, there are now serious pressures on IASC to standardize its recommendations. These issues motivate Forker and Green to consider the influence of corporate governance structures on accounting systems for income reporting and to argue that there should be flexibility to report shareholder and enterprise based income (i.e. independent of the financial structure) in a single set of financial statements since they reflect alternative corporate governance imperatives. A recent G4C1 paper (G4C1, 1999) recommends that non-reciprocal transfers (NRTs) from non-owners (government grants, gifts and donations) should be immediately credited to revenue without guidance as to its classification as ‘operating’ or ‘non-operating’ income. In contrast, the IASC requires that such items should be credited to revenue over a period of years, matching the consumption of the grant aid resources using either the deferred credit or netting methods. The authors examine these issues by focusing on non-reciprocal transfers (NRTs) from non-owners. The arguments of the paper support the view that the flexibility of choice relating to models of the reporting entity permitted by the IASC is justified by differences in financial and corporate governance systems which exist in European Union member states, notably between common law countries such as the UK and code law countries such as Germany. The authors warn that the adoption by the G4C11 of a shareholder reporting model undermines the provision of information to reflect a broader stakeholder view of the entity in the form of a measure of operating income which is independent of the financial structure of the company. However, there may be some difficulties in implementing the authors’ suggestions on these issues given the recent IASC efforts to standardize accounting rules, resulting in the general acceptance of a strong investor/shareholder orientation in the reporting model (IASC, 1995). REGULATION AND THE SCOPE OF CORPORATE GOVERNANCE Key to the development of the regulation of corporate governance and evaluation of its effectiveness is the need to understand the scope of corporate governance. As noted above, the Cadbury Report took a narrow view of corporate governance, focusing on the financial aspects of accountability. However, as subsequent policy developments have begun
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to recognize, corporate governance is not just about controls, it also involves developing and implementing effective accounting and business polices and long term strategic objectives. From a broader perspective, therefore, corporate governance may be regarded as a framework for effective monitoring, regulation, and control of companies, which allows alternative internal and external mechanisms for achieving the underlying objectives (Keasey & Wright, 1993). These mechanisms include both those internal to the firm and its organization, and those external to the firm, such as statutory requirements and the operation of markets. Internal mechanisms include board composition, managerial ownership, and nonmanagerial large shareholding including institutional shareholding. External mechanisms include a statutory audit, the market for corporate control manifested in hostile takeovers, and the stock market evaluation of corporate performance. The effectiveness of the overall corporate governance framework depends on the interactions among these alternative governance mechanisms. In some cases the interaction involves substitutes with one mechanism such as an independent board offsetting the lack of manager-shareholder alignment arising from low managerial ownership in the firm. In other cases the mechanisms may be complementary (Short, Keasey, Wright & Hull, 1999). Sudarsanam (2000) provides a review of the possible interactions and the numerous empirical studies in the US and the UK which have investigated them. Any evaluation of the effectiveness of the corporate governance framework in a country therefore requires not only a mapping of the range of governance mechanisms available but also the identification of the potential interaction among them. The evaluation of any single mechanism, which ignores the interaction, is therefore incomplete and may lead to untenable and erroneous policy formulations to correct alleged governance failure. Thus a piecemeal approach is fraught with unhealthy implications. O’Sullivan’s paper addresses this important conceptual issue by empirically exploring the interaction between external statutory audit and other governance mechanisms including board composition, managerial ownership, and non-managerial block ownership and institutional ownership. It explores the circumstances under which these elements can be substitutes and when they are likely to be complementary. O’Sullivan uses the size of audit as a proxy for audit quality and examines, for a large cross-sectional sample of UK firms during 1992, just ahead of the impact of the Cadbury Report, the interactions among audit quality, board independence, and ownership structure. He finds that governance characteristics, such as the proportion of non-executive directors on the board and ownership, influence audit quality. More independent boards prefer higher audit quality (a complementary interaction) whereas higher levels of executive ownership are associated with lower audit quality (a substitution effect). Block ownership has little effect on audit quality perhaps pointing to the lack of dominance
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of either effect over the other. Overall, the study ‘highlights the potential for companies to utilize different monitoring mechanisms depending on their specific governance requirements’.
FUTURE RESEARCH AGENDA Recent developments in corporate governance and the papers in this special issue suggest a number of areas for future research. Although the papers in this Special Issue focus on the UK, the corporate governance debate is now an international phenomenon, with both new codes being established at national level (e.g. in France, Germany, and Italy) and by international agencies (e.g. the OECD). While there are some similarities between these codes, as they build on the UK’s Cadbury Code or the OECD guidelines, there are notable differences (Table 2). The former centrally planned economies of Central and Eastern Europe are also in the process of developing corporate governance codes (OECD, 1999), though progress with corporate governance mechanisms remains variable and fraught with difficulty (EBRD, 1999; Estrin & Wright, 1999). La Porta et al. (1997) have shown that differing corporate law regimes can have major implications for the form of external finance. Although, as the DTI’s 1998 international survey of companies law in the Commonwealth, North America, Asia, and Europe shows, the law is not static and there are some distinct international patterns of convergence. In the light of these emerging patterns, the ‘MacDonaldisation’ of corporate governance through the development of international codes of corporate governance may be somewhat misplaced. Rather, there is a need for greater understanding of the applicability of different forms of corporate governance beyond common law Anglo-American regimes where much of the previous research has been focused. The recent promulgation of corporate governance in Latinic and French Civil Code countries as well as Germanic countries (Moerland, 1995; Table 2) provides an environment for future comparative studies of their effectiveness, for example with respect to changes in earnings manipulation as identified in the Peasnall et al. paper. While there are some commonalities among the codes, there are also some notable differences that reflect local country conditions. Given the significant cross-country differences in legal protection of investors’ rights against expropriation by corporate insiders (La Porta et al., 1997), there is a need to examine corporate control mechanisms and their use of financial accounting information, including disclosures, in a cross-country setting (Bushman & Smith, 2000). The impact of financial accounting information on economic performance may vary with the auditing regime, legal protection of investor’s rights and other corporate
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TABLE 2 Selected International Development of Corporate Governance Since 1990 (Various Codes and www.ecgn.org) The King Report, the South African ‘Cadbury’ reviewed role of NEDs, trade unions on boards, directors earnings and relationships with shareholders The Vi`enot Report, in France, emphasizing self-regulation, recommends removal of removal of corporate cross-holdings, formalisation of board responsibilities, wider use of independent directors, introduction of audit committees and that directors should promote interests of the entire company not just the interests of any one group. The Australian Investment Managers Association Blue Guide on Corporate Governance published (2nd edn, 1997) setting out best corporate governance practice for Australian listed companies Peters Report in Holland; principles and procedures of supervisory boards; functioning of shareholder meetings; compliance. Corporate Governance Forum of Japan: Corporate Governance Principles a Japanese View: Interim Report followed by Final Report. Code covers accounting and disclosure; directors & boards, auditors and shareholder meetings Codigo de Buen Gobiemo, Spain modelled on Cadbury; not mandatory; proposes smaller boards with more independent directors; internal auditors to report to outside directors and requirement to refer to compliance in annual reports. Report of the Belgian Commission on Corporate Governance Cardon Report preferring voluntary code with roles and procedures for boards, enough NEDs to carry significant weight; and management controls (inc. audit committees) where have boards with large number of directors OECD Corporate Governance Principles recognising no single model of good corporate governance: protection of shareholder rights; equitable treatment of shareholders; recognition of Stakeholder rights; timely disclosure and transparency; board responsibility to the company and the shareholders International Corporate Governance Network Statement on Global Corporate Governance Principles Vi`enot Report II and recommendations on corporate governance by AFG-ASFFI, France, presents more flexible board structure including unitary board with separate CEO/Chair; increased reporting of determination of executive remuneration policy; at least 30% of directors required to be independent; directors limited to 4 years with staggered replacement; individual director pay details not required; information on committee membership Principles on Corporate Governance in Greece, modelled on OECD Code including end to multiple voting shares; limit on board size to 13; audit & remuneration committees; separation of CEO & chairman; executive pay tied to performance
1994 1995
1995 1997 Oct 1997/May 1998
Feb 1998
1998
May 1999
July 1999 July/Sept 1999
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TABLE 2 (Continued) Code of Conduct, Milan Stock Exchange. Strengthens protection for investors & minorities by regulating shareholder agreements; internal controls; minority shareholder rights; legally binding for all listed companies; does not cover procedures of boards of directors Russia: OECD-led Corporate governance roundtable on principles & laws on minority rights protection European Shareholders Association Corporate Governance Guidelines Swedish Shareholders Association Corporate Governance Policy Portugese corporate governance recommendations, 17 corporate governance principles. Based on OECD Code, encourages inclusion on board of at least one member independent of dominant shareholders USA, Calpers statements on corporate governance; US Council of Institutional Investors Policies on corporate governance; TIAA-CREFF Policy Statement on Corporate Governance Revised Code of Best Practice for Quoted German Companies: written more from a managerial perspective, the overriding objectives are to achieve a responsible, value-oriented management and control within the context of dual boards and various stakeholders. It also aims to promote more transparency of information through dissemination of published accounts and use of modern technology for shareholder voting.
Oct 1999
1999/2000 Jan 2000 Jan 2000 2000
Various dates July 2000
control mechanisms, or the relative importance of securities markets versus bank financing (Black & Gilson, 1998). This point leads to the need for international comparisons of the effectiveness of statutory versus voluntary codes of corporate governance. The evidence from studies presented here (Dewing & Russell and Solomon et al.) does not indicate support for statutory corporate governance regulation. Dewing and Russell’s study reveals a major issue concerning the reconciliation of the divergent views of interested parties. However, there is some limited support for regulation by an independent public body with statutory powers. Two papers in this special issue have identified the importance of the interaction among financial reporting, auditing regulations, and corporate governance guidelines (Dewing & Russell, and Forker & Green). This has implications for the development of prescriptive corporate governance guidelines as well as for the development of guidelines for different stakeholders. Further research might usefully examine the nature of financial reporting required for different corporate governance regimes, perhaps drawing upon international comparisons under different systems. The role of stakeholders in corporate governance is a recurrent theme and has been given prominence in the recent Company Law Review (Company
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Law Review Steering Group, 1999). While at first glance appealing, incorporating stakeholders raises a number of difficult issues (Sternberg, 2000). How are the managers to be made accountable and to whom? In an environment where they have to be accountable to shareholders, how do management achieve the substantive objectives of the business? How do managers weigh the different and potentially conflicting interests of different groups of stakeholders? Further research might usefully examine the role of stakeholders in corporate governance in other countries in the light of the various corporate governance codes now emerging. Aspects of corporate governance mechanisms may be substitutes or complements, yet we have little systematic evidence on what these are or on their implications for corporate performance. For example, further research is required to understand the effects of changing CEO incentives on subsequent company performance in the context of changes in other dimensions of corporate governance. Appreciation of these issues may also have implications for the nature of the corporate governance regime. A regime that is too prescriptive may be too inflexible to allow for substitutability and complementarity. This point applies to the need both for different systems between different countries and for policy to allow different approaches within a particular country (Roe, 1997). The O’Sullivan paper has explored the issue of complementarity and substitutability of alternative control mechanisms within a single country, the UK. His results show the rich potential for both types of interactions among these mechanisms. However, the contextual determinants of complementarity versus substitution have to be identified in a carefully constructed conceptual framework. Following such a conceptual framework, rigorous empirical testing of the emerging hypotheses about the joint impact of alternative control mechanisms is required. Such an empirical exercise across different countries, with different corporate governance regimes and across different time periods when corporate governance regimes undergo change, is a necessary pre-condition for a balanced evaluation of corporate governance and for robust policy prescriptions for future regimes. Without these conceptual and empirical foundations, policy prescriptions may resemble the proverbial five blind men describing the elephant after feeling just one part of the animal. These developments also continue to highlight the tensions between the promotion of accountability and enterprise in corporate governance guidelines. Despite changes in policy direction, research on the interactions of accountability and enterprise aspects of corporate governance remains limited. For example, there is a need for research that examines the links between internal control mechanisms and board composition, and accountability and enterprise. The papers presented in this Special Issue and the points we have raised in this Overview emphasize the need for policy to be informed by rigorous conceptual and empirical academic research. The changing direction of
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corporate governance guidelines over the past decade make the need for such evidence imperative. Finally, we would like to thank the contributors for the quality of their submissions and the referees for providing helpful and constructive comments to the authors in a timely manner. Thanks are also due to the editors of BAR, Stuart Turley and Trevor Hopper, for their support and encouragement during the preparation of this Special Issue. NOTES 1. G4 C 1 comprises members of standard setter bodies from Australia, Canada, New Zealand, the United Kingdom and the USA. Representatives of International Accounting Standards Committee attend as observers.
REFERENCES Beasley, M. (1996). ‘An Empirical Analysis of the Relation Between the Board of Director Composition and Financial Statement Fraud’, Accounting Review, 71(4):443–465. Berle, A. and Means, G. (1932). The Modern Corporation and Private Property. New York: MacMillan. Black, B. and Gilson, R. (1998). ‘Venture Capital and the Structure of Capital Markets: Banks versus Stock Markets’, Journal of Financial Economics, 47:243–277. Bushman, R. and Smith, A. J. (2000). Financial Accounting Information and Corporate Governance, Working Paper, Kenan-Flager Business School, University of North Carolina, Chapel Hill, 120 pp. Company Law Reform Steering Group (1999). Modern Company Law for a Competitive Economy: The Strategic Framework, London. Company Law Reform Steering Group (2000a). Modern Company Law For a Competitive Economy: Developing the Framework: A Consultation document from the Company Law Review Steering Group, DTI, London, March 2000. Company Law Reform Steering Group (2000b). Modern Company Law For a Competitive Economy: Completing the Structure: A Consultative document from the Company Law Review Steering Group, DTI, London November 2000. Conyon, M. (1997). ‘Institutional Arrangements for Setting Directors’ Compensation in UK Companies’. In K. Keasey, S. Thompson and M. Wright (eds), Corporate Governance: Economic, Management and Financial Issues. Oxford: OUP. Demirag, I. S. (ed.) (1998). Corporate Governance, Accountability, and Pressures to Perform: An International Study, JAI Press. DTI (1998). Modern Company Law For A Competitive Economy: An International Survey of Companies Law in the Commonwealth, North America, Asia and Europe, August 119pp. DTI (1999). Directors’ Remuneration: A Consultative Document, Department of Trade and Industry, London, July. EBRD (1999). Transition Report. London: EBRD. Estrin, S. and Wright, M. (1999). ‘Corporate governance in the Former Soviet Union’, Journal of Comparative Economics, 27:398–421. G4C1 (1999). Accounting by recipients for non-reciprocal transfers, excluding contributions by owners: their definition, recognition and measurement. Financial Accounting Standards Board, Norwalk, CT., USA.
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IASC (1995). International Accounting Standards, International Accounting Standards Committee, London. Keasey, K. and Wright, M. (1993). ‘Issues in Corporate Accountability and Governance’, Accounting and Business Research, 23(91A):291–303. La Porta, R., Lopez-De-Silanes, F., Shleifer, A. and Vishny, R. (1997). ‘Legal Determinants of External Finance’, Journal of Finance, 52(3):1131–1150. Mills, R. (1997). ‘Internal Control Practices within Large UK Companies. Ch. 4’. In Keasey, K. and Wright, M. (eds), Corporate Governance: responsibilities, risks and remuneration. London: Wiley. Moerland, P. (1995). ‘Alternative Disciplinary Mechanisms in Different Corporate Systems’, Journal of Economic Behavior and Organization, 26:17–34. Murphy, K. (1999). Executive Compensation, Working Paper, Marshall School of Business, University of Southern California, 90pp. OECD (1999). Conference on Corporate Governance in Russia Moscow 31 May-2 June 1999: Synthesis Note. Paris: OECD Center for Cooperation With Non-Members. Peasnell, K. V., Pope, P. F. and Young, S. (1999). Outside directors, board effectiveness and abnormal accruals, Working paper, Lancaster University. Roe, M. (1997). ‘The Political Roots of American Corporate Finance’, Journal of Applied Corporate Finance, 9(4): 8–22. Short, H., Keasey, K., Wright, M. & Hull, A. (1999). ‘Corporate Governance: From Accountability to Enterprise’, Accounting and Business Research, 29(4): 337–352. Short, H., Keasey, K. & Wright, M. (2000). ‘Corporate Governance: Accountability versus Enterprise’, Hume Papers on Public Policy, 8(1): 70–91. Sternberg, E. (2000). ‘How the Strategic Framework for Company Law Reform Undermines Corporate Governance’, Hume Papers on Public Policy, 8(1): 54–69. Sudarsanam, S. (2000). ‘Corporate Governance, Corporate Control and Takeovers’, Advances in Mergers and Acquisitions C. Cooper and A. Gregory (eds), JAI Press. Tricker, R. (1984). Corporate Governance, Gower, Vermont.
CORPORATE GOVERNANCE: OVERVIEW AND RESEARCH AGENDA ISTEMI DEMIRAG, SUDI SUDARSANAM AND MIKE WRIGHT INTRODUCTION The problems of corporate governance in listed companies with diffuse ownership are well-known and long-established (e.g. Berle & Means, 1932; Tricker, 1984). A number of financial scandals in the 1980s reignited a debate on how best to make managers accountable to shareholders that continues today. The publication of the Cadbury Report in 1992 introduced the first of several new corporate governance guidelines (Table 1). These were followed by the recommendations of the Greenbury and Hampel Committees, which in turn were incorporated into the Combined Code. These reports have been accompanied by further reports providing guidance as to their implementation. The Turnbull Report, for example, provided guidance for companies implementing the requirements of the Combined Code with respect to internal control. This development of corporate governance was marked by a move from narrowly defined financial accountability under Cadbury to an approach that recognized that the interests of shareholders were also served by allowing managers to exercise enterprise in terms of risk-taking and innovation (Short, Keasey, Wright & Hull, 1999). The recent publication of a consultative document on directors’ remuneration (DTI, 1999) and the establishment of a major programme to review company law to incorporate corporate governance issues (Company Law Review Steering Group, 1999; 2000a, b) represents a potential departure from these developments. While the approach adopted in the Combined Code was formulated by committees largely made up of industrialists and institutional representatives with the intention of reinforcing self-regulation, the review programme signals a government belief that self-regulation may be failing to deliver accountability The authors are respectively, Professor of Accounting, Queen’s University of Belfast, Professor of Finance & Corporate Control at Cranfield School of Management and Professor of Financial Studies and Director of the Centre for Management Buy-out Research, University of Nottingham. All are members of the BAA SIG on Corporate Governance Executive Steering Group. 0890–8389/00/040341+14 $35.00/0
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TABLE 1 Development of UK Corporate Governance Regulations—Since 1990 (Various codes and consultation papers) Internal Control—Integrated Framework report published by COSO, providing draft guidance on internal controls and financial reporting for directors of listed companies, based heavily on the Treadway Commission in the US. Cadbury Report and Code published setting out measures to enhance financial accountability to shareholders based on improved information, continued self-regulation, more independent boards through separation of CEO/Chairman roles and enhanced NEDs, and greater auditor independence UK Stock Exchange amends its Listing Rules—companies now have to show the extent of compliance with Cadbury with effect from 1 July 1993 Revision of draft guidance on internal controls published by COSO, emphasising a statement of principles with internal control seen as a process that needs to be integrated in a company’s management systems. Rutteman guidance on Internal Control and Financial Reporting published limiting directors’ reporting responsibilities to internal financial controls and to assessing their effectiveness The Greenbury proposals on setting of directors’ remuneration emphasising the role of independent NEDs and need for comprehensive disclosure of all components of remuneration. UK Stock Exchange amends its Listing Rules—companies now have to show the extent of compliance with Greenbury Stock Exchange amends its Listing Rules in the light of Greenbury’s recommendation on the phasing of share options The Hampel Report aimed to restrict regulatory burden on companies, stressing enterprise as well as accountability through flexible rules and emphasising principles not prescription and focusing on directors, directors’ remuneration, shareholders and accountability & audit. Publication of Modern Company Law for a Competitive Economy, consultation paper. The Hampel Committee Combined Code of 18 principles and 48 code provisions, the main substantive change from earlier proposals being requirement for NEDs to account for a 1/3 of board subject to a minimum of 3. Auditing Practices Board issues guidance for auditors on corporate governance suggesting a clear statement of auditors’ responsibilities be included in the annual report Publication of The Strategic Framework: Modern Company Law for a Competitive Economy a key element of which is the introduction of a stakeholder view of corporate governance and the role of directors Publication of the Turnbull guidance on internal control widening the definition of internal control on which directors are required to report including reviews of operational and compliance controls and risk management
1992
Dec. 1992
April 1993 1993
Dec. 1994 July 1995 Oct. 1995 June 1996 Jan. 1998
March 1998 June 1998
1998 Feb 1999
Sept. 1999
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TABLE 1 (Continued) Law Commission/Scottish Law Commission recommend introduction of statutory requirement of the principal duties of directors to companies and a statutory definition of a director’s duty of skill and care DTI paper outlining government intentions to amend Companies Act so that companies obtain shareholder consent prior to political donations DTI consultative paper proposing increased disclosure of linkages of performance to pay, simplification of share options disclosure and measures for shareholders to vote on remuneration reports Publication of Modern Company Law for A Competitive Economy: Developing the Framework, covering the role of directors, shareholders and reporting & accounting; simplification of reporting for private companies; and alternative vehicles. Publication of The Strategic Framework: Modern Company Law for a Competitive Economy: Completing the Structure: develops previous documents in the light of responses and invites further comments; also covers Company Law and Groups of Companies, Restructuring , Mergers and Jurisdictional Migration and Regulatory and Institutional framework for companies.
Sept 1999 1999 1999 March 2000
Nov 2000
(Short, Keasey & Wright, 2000). At the same time, the Committee on Standards in Public Life continues to make recommendations affecting the behaviour of directors. These most recent proposals, therefore, suggest that the regulation of corporate governance in the UK may be at a turning point. In the light of these developments, the three principal contributions of this Special Issue are as follows. First, we examine the effects of extant policy prescriptions. Second, we analyse the prospects for future policy developments regarding the regulation of corporate governance. Third, we consider the need for policy development to be informed by an appreciation of the objectives of corporate governance, the range of governance mechanisms available, and the interactions between these objectives and mechanisms. This Introduction summarizes the contribution of the five papers in this special issue in the context of these themes. We conclude by offering some suggestions for further research based on these papers and related literature. Clearly, as the corporate governance debate covers a vast arena, this collection of papers focuses only on a subset of the issues. THE EFFECTS OF GOVERNANCE CODES The Cadbury Report in the UK focuses attention on accountability and risk management aspects of corporate governance. It has the objective of securing ‘accountability’ of the board of directors and the chief executive whilst ensuring that effective risk management and control systems of companies are developed and maintained in order to enact this accountability function.
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Studies in the UK have generally shown high levels of compliance with recent recommendations on corporate governance (e.g. Conyon, 1997). One of the central objectives of the Cadbury Code of best practice is to reinforce director integrity and board effectiveness in promoting good quality and reliable financial information to users of accounts. Excessive powers and responsibilities given to top management without adequate controls have resulted in ‘creative accounting’ practices in many companies with the manipulation of company earnings being quite common (Demirag, 1998). Hence a central theme in the Cadbury Report is the potential association between internal corporate governance procedures and the financial reporting process. Bushman & Smith (2000) in their review of the use of publicly reported financial accounting information find that firms are moving away from using single accounting earning figures towards alternative performance measures as firm’s growth opportunities increase. They also note that, due to the lack of conceptualized operating figures in published company accounts, boards of directors are able to select earnings figures in determining their annual bonuses. They suggest that the reasons for the declining use of accounting measures for executive compensation be investigated and recommend that researchers should explore the impact of accounting information on future managerial behaviour. Murphy (1999), on the other hand, suggests that researchers should explore the relative importance of accounting-based bonuses and stock-based compensation plans for the economic performance of firms. He argues that executive incentives are not necessarily driven primarily by stock returns and that accounting performance measures may have a significant role to play. It is in this context that Peasnell, Pope and Young suggest that the role of the board should be pivotal to the Code of Best Practice. In particular, non-executive directors are crucial in helping to ensure the quality and integrity of accounting information. They argue that the quality of financial reporting lies at the heart of the Cadbury Report and that a central issue affecting the quality of financial statements is the extent to which managers can manipulate reported earnings numbers. Managers may have strong incentives to manipulate earnings as adverse earnings outcomes may have significant negative wealth effects where earnings are used as a basis for awarding bonuses and stock options. US research demonstrates that the presence of outside directors enhances the quality of accounting information (Beasley, 1996). This suggests that outside directors have a positive effect on enhancing the accountability of management. Peasnell et al. use abnormal working capital accruals to proxy for earnings management and find widespread use of accrual management to meet earning targets both before and after the introduction of the Cadbury Report. However, these techniques are found far less frequently in the postCadbury than in the pre-Cadbury period. The authors argue that this may be a result of employing a higher proportion of non-executive directors in the
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post-Cadbury period. These findings support previous research that suggests that when the proportion of non-executive directors is high, managers are less likely to make income-increasing accruals to avoid reporting negative earning or earning declines (Peasnell et al., 1999). It is important to note, however, that many of the apparent changes brought about by Cadbury may have been the result of the creation of internal codes and procedures put in place by companies themselves. Moreover confounding events, such as the external auditors’ changed perceptions of the risk of being associated with another scandal, rather than the Cadbury reform itself, maybe the source of the observed changes identified in this study.
THE DEVELOPMENT OF CORPORATE GOVERNANCE REGULATION Despite the promulgation of various codes of corporate governance, there remains a debate about the appropriate form and scope of corporate governance regulation. A major aspect of this debate is the continuing concern about the nature and desirability of self-regulation within a statutory framework. The potential arises for a lack of coherence in policy development where an ad hoc approach to the setting and monitoring of corporate governance codes occurs in response to public concerns over specific company behaviour. Moreover, further difficulties are raised by the nature of compliance required by codes and the monitoring of such compliance. In what they see as a UK environment where it is questionable whether corporate governance is regulated in any meaningful sense, Dewing and Russell consider the desirability of establishing a permanent regulatory framework. They discuss three possible models for the regulation of UK listed company audits which may also include the regulation of corporate governance: an Auditing Council, a Commission for Audit, and a UK SEC. In particular, they argue that linking corporate governance regulation and audit regulation might overcome previous criticisms about corporate governance regulation without the need to develop separate institutional arrangements. Their study canvasses the views of various parties with an interest in the regulation of corporate governance. Only limited support is found for the notion that corporate governance regulation should be assumed by an audit regulatory body. One barrier to such an assumption is considered to be the need for accounting and auditing standards to be more comparable in order to achieve meaningful guidance on the relationship between shareholders and companies. Auditing is seen to imply an ability to assess a situation in a rather objective, clinical manner, whereas assessment of the effectiveness of corporate governance involves much more subjective judgement. The study
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does, however, identify some support for regulation by an independent body with statutory powers, such as a UK SEC. A second aspect of the debate about developing corporate governance codes concerns efforts to promote disclosure on internal control and risk management, one of the neglected aspects of the recommendations in the Cadbury Report. Problems with internal controls have potentially serious implications for corporate governance as they may contribute significantly to corporate incompetence and malpractice (Mills, 1997). Appropriate internal control systems can help enterprises avoid exposure to major business risks. The Turnbull recommendations on implementing the Combined Code’s requirements for reporting on internal control emphasize their importance both for corporate accountability and for the future success of the business, a wider view than the previous restriction to just financial controls. In the light of the Turnbull recommendations, Solomons, Solomons, Norton and Joseph develop a general conceptual framework for internal control, risk management and risk disclosure, with a focus on the disclosure aspect of this conceptual framework. The authors provide evidence that institutional investors consider that increased risk disclosure would assist them in these decisions but that the views of institutional investors are not homogeneous as between different types of institution. There is some support for the view that legislation is inappropriate for implementing corporate governance, with a preference being expressed for a voluntary framework even though shareholders have a weak influence on what is disclosed. Further research on the role of internal control mechanisms in corporate governance is required. While Solomons et al. have focused on the disclosure aspects of an internal control conceptual framework, we still know little about how enterprises develop such control processes and how the information that is disclosed is interpreted and used by shareholders, institutions, and other stakeholders. A third dimension of the debate concerns the notion of ‘corporate governance for whom?’ As part of its deliberations, the steering group involved in the recent consultation paper in the UK on the reform of Company Law includes a re-examination of directors’ legal duties (Company Law Reform Steering Group, 1999). The proposals require directors to consider and take into account the whole enterprise and not just the interests of the entity, which only consists of the shareholders’ and the investors’ interests. Such a recognition of a stakeholder perspective in corporate governance has significant implications for the nature of financial reporting systems. While the stakeholder concept is well-known, in the Anglo-Saxon context its influence has yet to filter through into financial reporting. Accounting standards on both sides of the Atlantic are still dominated by the entity concept, which inevitably puts the interests of shareholders and investors first in determining accounting standards.
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There have recently been concerted efforts to obtain convergence in the application of the shareholder based model pioneered in the USA. This conflicts with the earlier view of the IASC that a choice between accounting models premised on different perspectives is appropriate. However, given that the European Commission wants all corporations to adopt IASC standards by 2005, there are now serious pressures on IASC to standardize its recommendations. These issues motivate Forker and Green to consider the influence of corporate governance structures on accounting systems for income reporting and to argue that there should be flexibility to report shareholder and enterprise based income (i.e. independent of the financial structure) in a single set of financial statements since they reflect alternative corporate governance imperatives. A recent G4C1 paper (G4C1, 1999) recommends that non-reciprocal transfers (NRTs) from non-owners (government grants, gifts and donations) should be immediately credited to revenue without guidance as to its classification as ‘operating’ or ‘non-operating’ income. In contrast, the IASC requires that such items should be credited to revenue over a period of years, matching the consumption of the grant aid resources using either the deferred credit or netting methods. The authors examine these issues by focusing on non-reciprocal transfers (NRTs) from non-owners. The arguments of the paper support the view that the flexibility of choice relating to models of the reporting entity permitted by the IASC is justified by differences in financial and corporate governance systems which exist in European Union member states, notably between common law countries such as the UK and code law countries such as Germany. The authors warn that the adoption by the G4C11 of a shareholder reporting model undermines the provision of information to reflect a broader stakeholder view of the entity in the form of a measure of operating income which is independent of the financial structure of the company. However, there may be some difficulties in implementing the authors’ suggestions on these issues given the recent IASC efforts to standardize accounting rules, resulting in the general acceptance of a strong investor/shareholder orientation in the reporting model (IASC, 1995). REGULATION AND THE SCOPE OF CORPORATE GOVERNANCE Key to the development of the regulation of corporate governance and evaluation of its effectiveness is the need to understand the scope of corporate governance. As noted above, the Cadbury Report took a narrow view of corporate governance, focusing on the financial aspects of accountability. However, as subsequent policy developments have begun
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to recognize, corporate governance is not just about controls, it also involves developing and implementing effective accounting and business polices and long term strategic objectives. From a broader perspective, therefore, corporate governance may be regarded as a framework for effective monitoring, regulation, and control of companies, which allows alternative internal and external mechanisms for achieving the underlying objectives (Keasey & Wright, 1993). These mechanisms include both those internal to the firm and its organization, and those external to the firm, such as statutory requirements and the operation of markets. Internal mechanisms include board composition, managerial ownership, and nonmanagerial large shareholding including institutional shareholding. External mechanisms include a statutory audit, the market for corporate control manifested in hostile takeovers, and the stock market evaluation of corporate performance. The effectiveness of the overall corporate governance framework depends on the interactions among these alternative governance mechanisms. In some cases the interaction involves substitutes with one mechanism such as an independent board offsetting the lack of manager-shareholder alignment arising from low managerial ownership in the firm. In other cases the mechanisms may be complementary (Short, Keasey, Wright & Hull, 1999). Sudarsanam (2000) provides a review of the possible interactions and the numerous empirical studies in the US and the UK which have investigated them. Any evaluation of the effectiveness of the corporate governance framework in a country therefore requires not only a mapping of the range of governance mechanisms available but also the identification of the potential interaction among them. The evaluation of any single mechanism, which ignores the interaction, is therefore incomplete and may lead to untenable and erroneous policy formulations to correct alleged governance failure. Thus a piecemeal approach is fraught with unhealthy implications. O’Sullivan’s paper addresses this important conceptual issue by empirically exploring the interaction between external statutory audit and other governance mechanisms including board composition, managerial ownership, and non-managerial block ownership and institutional ownership. It explores the circumstances under which these elements can be substitutes and when they are likely to be complementary. O’Sullivan uses the size of audit as a proxy for audit quality and examines, for a large cross-sectional sample of UK firms during 1992, just ahead of the impact of the Cadbury Report, the interactions among audit quality, board independence, and ownership structure. He finds that governance characteristics, such as the proportion of non-executive directors on the board and ownership, influence audit quality. More independent boards prefer higher audit quality (a complementary interaction) whereas higher levels of executive ownership are associated with lower audit quality (a substitution effect). Block ownership has little effect on audit quality perhaps pointing to the lack of dominance
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of either effect over the other. Overall, the study ‘highlights the potential for companies to utilize different monitoring mechanisms depending on their specific governance requirements’.
FUTURE RESEARCH AGENDA Recent developments in corporate governance and the papers in this special issue suggest a number of areas for future research. Although the papers in this Special Issue focus on the UK, the corporate governance debate is now an international phenomenon, with both new codes being established at national level (e.g. in France, Germany, and Italy) and by international agencies (e.g. the OECD). While there are some similarities between these codes, as they build on the UK’s Cadbury Code or the OECD guidelines, there are notable differences (Table 2). The former centrally planned economies of Central and Eastern Europe are also in the process of developing corporate governance codes (OECD, 1999), though progress with corporate governance mechanisms remains variable and fraught with difficulty (EBRD, 1999; Estrin & Wright, 1999). La Porta et al. (1997) have shown that differing corporate law regimes can have major implications for the form of external finance. Although, as the DTI’s 1998 international survey of companies law in the Commonwealth, North America, Asia, and Europe shows, the law is not static and there are some distinct international patterns of convergence. In the light of these emerging patterns, the ‘MacDonaldisation’ of corporate governance through the development of international codes of corporate governance may be somewhat misplaced. Rather, there is a need for greater understanding of the applicability of different forms of corporate governance beyond common law Anglo-American regimes where much of the previous research has been focused. The recent promulgation of corporate governance in Latinic and French Civil Code countries as well as Germanic countries (Moerland, 1995; Table 2) provides an environment for future comparative studies of their effectiveness, for example with respect to changes in earnings manipulation as identified in the Peasnall et al. paper. While there are some commonalities among the codes, there are also some notable differences that reflect local country conditions. Given the significant cross-country differences in legal protection of investors’ rights against expropriation by corporate insiders (La Porta et al., 1997), there is a need to examine corporate control mechanisms and their use of financial accounting information, including disclosures, in a cross-country setting (Bushman & Smith, 2000). The impact of financial accounting information on economic performance may vary with the auditing regime, legal protection of investor’s rights and other corporate
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TABLE 2 Selected International Development of Corporate Governance Since 1990 (Various Codes and www.ecgn.org) The King Report, the South African ‘Cadbury’ reviewed role of NEDs, trade unions on boards, directors earnings and relationships with shareholders The Vi`enot Report, in France, emphasizing self-regulation, recommends removal of removal of corporate cross-holdings, formalisation of board responsibilities, wider use of independent directors, introduction of audit committees and that directors should promote interests of the entire company not just the interests of any one group. The Australian Investment Managers Association Blue Guide on Corporate Governance published (2nd edn, 1997) setting out best corporate governance practice for Australian listed companies Peters Report in Holland; principles and procedures of supervisory boards; functioning of shareholder meetings; compliance. Corporate Governance Forum of Japan: Corporate Governance Principles a Japanese View: Interim Report followed by Final Report. Code covers accounting and disclosure; directors & boards, auditors and shareholder meetings Codigo de Buen Gobiemo, Spain modelled on Cadbury; not mandatory; proposes smaller boards with more independent directors; internal auditors to report to outside directors and requirement to refer to compliance in annual reports. Report of the Belgian Commission on Corporate Governance Cardon Report preferring voluntary code with roles and procedures for boards, enough NEDs to carry significant weight; and management controls (inc. audit committees) where have boards with large number of directors OECD Corporate Governance Principles recognising no single model of good corporate governance: protection of shareholder rights; equitable treatment of shareholders; recognition of Stakeholder rights; timely disclosure and transparency; board responsibility to the company and the shareholders International Corporate Governance Network Statement on Global Corporate Governance Principles Vi`enot Report II and recommendations on corporate governance by AFG-ASFFI, France, presents more flexible board structure including unitary board with separate CEO/Chair; increased reporting of determination of executive remuneration policy; at least 30% of directors required to be independent; directors limited to 4 years with staggered replacement; individual director pay details not required; information on committee membership Principles on Corporate Governance in Greece, modelled on OECD Code including end to multiple voting shares; limit on board size to 13; audit & remuneration committees; separation of CEO & chairman; executive pay tied to performance
1994 1995
1995 1997 Oct 1997/May 1998
Feb 1998
1998
May 1999
July 1999 July/Sept 1999
Oct 1999
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TABLE 2 (Continued) Code of Conduct, Milan Stock Exchange. Strengthens protection for investors & minorities by regulating shareholder agreements; internal controls; minority shareholder rights; legally binding for all listed companies; does not cover procedures of boards of directors Russia: OECD-led Corporate governance roundtable on principles & laws on minority rights protection European Shareholders Association Corporate Governance Guidelines Swedish Shareholders Association Corporate Governance Policy Portugese corporate governance recommendations, 17 corporate governance principles. Based on OECD Code, encourages inclusion on board of at least one member independent of dominant shareholders USA, Calpers statements on corporate governance; US Council of Institutional Investors Policies on corporate governance; TIAA-CREFF Policy Statement on Corporate Governance Revised Code of Best Practice for Quoted German Companies: written more from a managerial perspective, the overriding objectives are to achieve a responsible, value-oriented management and control within the context of dual boards and various stakeholders. It also aims to promote more transparency of information through dissemination of published accounts and use of modern technology for shareholder voting.
Oct 1999
1999/2000 Jan 2000 Jan 2000 2000
Various dates July 2000
control mechanisms, or the relative importance of securities markets versus bank financing (Black & Gilson, 1998). This point leads to the need for international comparisons of the effectiveness of statutory versus voluntary codes of corporate governance. The evidence from studies presented here (Dewing & Russell and Solomon et al.) does not indicate support for statutory corporate governance regulation. Dewing and Russell’s study reveals a major issue concerning the reconciliation of the divergent views of interested parties. However, there is some limited support for regulation by an independent public body with statutory powers. Two papers in this special issue have identified the importance of the interaction among financial reporting, auditing regulations, and corporate governance guidelines (Dewing & Russell, and Forker & Green). This has implications for the development of prescriptive corporate governance guidelines as well as for the development of guidelines for different stakeholders. Further research might usefully examine the nature of financial reporting required for different corporate governance regimes, perhaps drawing upon international comparisons under different systems. The role of stakeholders in corporate governance is a recurrent theme and has been given prominence in the recent Company Law Review (Company
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Law Review Steering Group, 1999). While at first glance appealing, incorporating stakeholders raises a number of difficult issues (Sternberg, 2000). How are the managers to be made accountable and to whom? In an environment where they have to be accountable to shareholders, how do management achieve the substantive objectives of the business? How do managers weigh the different and potentially conflicting interests of different groups of stakeholders? Further research might usefully examine the role of stakeholders in corporate governance in other countries in the light of the various corporate governance codes now emerging. Aspects of corporate governance mechanisms may be substitutes or complements, yet we have little systematic evidence on what these are or on their implications for corporate performance. For example, further research is required to understand the effects of changing CEO incentives on subsequent company performance in the context of changes in other dimensions of corporate governance. Appreciation of these issues may also have implications for the nature of the corporate governance regime. A regime that is too prescriptive may be too inflexible to allow for substitutability and complementarity. This point applies to the need both for different systems between different countries and for policy to allow different approaches within a particular country (Roe, 1997). The O’Sullivan paper has explored the issue of complementarity and substitutability of alternative control mechanisms within a single country, the UK. His results show the rich potential for both types of interactions among these mechanisms. However, the contextual determinants of complementarity versus substitution have to be identified in a carefully constructed conceptual framework. Following such a conceptual framework, rigorous empirical testing of the emerging hypotheses about the joint impact of alternative control mechanisms is required. Such an empirical exercise across different countries, with different corporate governance regimes and across different time periods when corporate governance regimes undergo change, is a necessary pre-condition for a balanced evaluation of corporate governance and for robust policy prescriptions for future regimes. Without these conceptual and empirical foundations, policy prescriptions may resemble the proverbial five blind men describing the elephant after feeling just one part of the animal. These developments also continue to highlight the tensions between the promotion of accountability and enterprise in corporate governance guidelines. Despite changes in policy direction, research on the interactions of accountability and enterprise aspects of corporate governance remains limited. For example, there is a need for research that examines the links between internal control mechanisms and board composition, and accountability and enterprise. The papers presented in this Special Issue and the points we have raised in this Overview emphasize the need for policy to be informed by rigorous conceptual and empirical academic research. The changing direction of
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corporate governance guidelines over the past decade make the need for such evidence imperative. Finally, we would like to thank the contributors for the quality of their submissions and the referees for providing helpful and constructive comments to the authors in a timely manner. Thanks are also due to the editors of BAR, Stuart Turley and Trevor Hopper, for their support and encouragement during the preparation of this Special Issue. NOTES 1. G4 C 1 comprises members of standard setter bodies from Australia, Canada, New Zealand, the United Kingdom and the USA. Representatives of International Accounting Standards Committee attend as observers.
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