7.1.1 Cadbury Committee

The Financial Reporting Council, the London Stock Exchange and the accountancy profession asked a committee chaired by Adrian Cadbury (hereafter: Cadbury Committee) to address financial aspects of corporate governance in May 1991 (Cadbury Committee 1992: 13). The request followed various scandals and collapses in the United Kingdom, such as Maxwell, Coloroll and Polly Peck. The publication of a consultation document generated over 200 written responses, which ultimately led to the publication of the final document in December 1992. The Cadbury Report consists of an analysis of the board, the audit process and the shareholders.

The analysis in the section on the board of directors stresses that executive directors and NEDs have different tasks and contribute in their own way to the performance of the total board. As a consequence of their independence from executive management NEDs have two important tasks: (1) reviewing the performance of the board and the executives and (2) taking the lead where potential conflicts of interest arise (Cadbury Committee 1992: 4.3-4.6). Hence, there should be balance of power and authority within the board, such that no single person on the board has unfettered power. Independence is a main topic. As a consequence, the Cadbury Report recommends separating the CEO and Chairman positions, because a combination of both positions would lead to a considerable concentration of decision power (Cadbury Committee 1992: 4.9). However, if the company decides to combine both positions, the Cadbury Committee recommends having a strong and independent element on the board. If the position is combined and board members want to address concerns about the combined CEO and chairman, they should be able to communicate their concerns to a senior NED, who might be the deputy chairman (4.5).

The independent element on the board must consist of NEDs, who carry significant weight in the decision-making of the board. In addition to the advice to include a strong independent element in the case of CEO duality, independent NEDs should definitely have a position on the board. The Cadbury Committee advises having at least three NEDs on the board, of which at least two should be independent (1992: 4.11). For the whole board, the majority of the NEDs should be independent (4.12). Their independent judgement is especially important for decisions on issues of strategy, performance, resources, key appointments and standards of conduct (4.11). The Cadbury Committee considers NEDs as independent, when they are ‘independent of management and free from any business or other relationship which could materially interfere with the exercise of their independent judgement’, apart from their fees and shareholdings (4.12). The Cadbury Report does not mention the criteria for determining whether a NED is independent. A source of non-independence, which is mentioned, is the fee a director receives (4.13). The fee should reflect the time he devotes to the company, while it may not undermine his independence. To prevent the payment package from undermining his independence, the Cadbury Committee considers it a good practice not to reward a NED with share option plans and pension rights. The Cadbury Report adds to the specifications of independence that a long tenure may result in the loss of the independent edge of a NED (4.16). Therefore a NED should be appointed for a specified term. Automatic reappointment should be avoided and reappointment should be based on a conscious decision.

The analysis of the board, together with the analysis of the audit function and that of shareholders, resulted in nineteen best practice provisions. These best practice provisions are divided into four parts: the board of directors (6 best practice provisions), NEDs (4), executive directors (3), and reporting and control (6). In order to enforce the best practices, the Cadbury Committee recommends that listed companies should state whether they comply with the code and identify and give reasons for any areas of non-compliance (Cadbury Committee 1992: 3.7). It believes that if the ‘Code such as ours [had] been in existence in the past, […] a number of recent examples of unexpected company failures and cases of fraud would have received attention earlier’ (Cadbury Committee 1992: 1.9). In order to keep the code up-to-date, the Cadbury Committee proposes appointing a new committee to examine ‘how far compliance with the Code has progressed, how far our other recommendations have been implemented, and whether the Code needs updating in line with emerging issues’ (Cadbury Committee 1992: 3.12).