5.2.1 Developments in corporate governance

In the last decade, corporate and financial scandals, such as Enron, Ahold, Siemens and ABB, have led to increased public concern about corporate governance, accounting and auditing.1 As has been discussed in chapter 2, an important theme ofcorporate governance is to ensure the accountabilityofcertain individuals within an organisation. To that end, a great deal ofemphasis has been placed on ' disclosure' and 'transparency': organisations should publish and explain the roles and responsibilities of the board and its management in order to provide shareholders with a minimum level of accountability. Companies should also implement procedures aimed at independently verifying and safeguarding the integrity of the company's financial reporting. The disclosure of material matters concerning the organisation should be timely and balanced in order to ensure that all investors have access to clear and factual information.

In the EU most countries follow the Commission's approach as expressed in the Corporate Governance Action Plan (2003) discussed in section 2.6.2.2 of this study.2 The Action Plan recommends that Member States put a national corporate governance code in place and require that companies refer to this code in their annual reports on a ' comply or explain' basis. This system is referred to as a 'principle-based system.'3

In the last decade, new corporate governance regulations have been adopted in Europe, such as the Tabaksblat Code in the Netherlands in 2003 (replaced by the 'Frijns Code' in 2008). The Combined Code on Corporate Governance in July 2003 in the UK (revised in June 2008). The Belgian Corporate Governance Code (the 2009 Code replaced the 2004 previous version). The German Corporate Governance Codex (the 'Cromme Code' of 2002 was amended in 2008). And the AFG - Recommendations on Corporate Governance - 2008 (Association Francaise de la Gestion financière - Recommandations sur le gouvernement d'entreprise; version 2008; this is the sixth edition since 1998).

In addition hereto, national EU legislators have amended corporate and accounting legislation in order to create a legislative basis for corporate governance codes. In the Netherlands for example, a listed company has to report in its annual report on whether it applies the Frijns Code. When it does not do so it must explain why. Moreover, the directors must include an 'in-control statement' in their annual reports (see section 5.2.4 infra). Most EU corporate governance codes do not require that such a statement be included in the annual report. They recommend that management communicate to stakeholders how risks and internal controls are managed.4

This tolerant European system stands in contrast to US corporate governance practices which are generally rule-based, i.e. US listed companies cannot deviate from corporate governance regulations. Non-compliance can lead to serious SEC penalties. This approach was reinforced by section 404 of SOX, i.e. US federal securities legislation. SOX requires, inter alia, that directors and external auditors personally attest to the effectiveness of internal controls: the internal control statement (see section 5.2.3 infra).

Rules are typically thought to be easier to follow than principles as they draw a clear line between acceptable and unacceptable behaviour. Rules also reduce the element of discretion on the part of individual managers or auditors. In practice, however, rules can be more complex than principles. They may very well be ill-suited to new types of transactions not covered by the code. Moreover, even if clear rules are followed, one can still find a way to circumvent their underlying purpose - which is more difficult if one is bound by a broader principle. Principles, on the other hand, are a form of self-regulation. They allow the sector to determine which standards are acceptable or unacceptable, and they allow room to search for, and to establish, best practices. They also pre-empt overzealous legislation that might not be practical.

In addition to the new European corporate governance approach, new legislation has also been adopted within the EU with regard to companies' financial statements and annual reports: the Modernisation Directive (2003), discussed in chapter 4.

Consequently, the concerns about corporate governance, internal control and external accounting have been addressed in various ways. In the following sections, the focus will first be on the US regulations concerning internal control and it will then shift to the pertinent provisions of the Frijns Code.