4.2.2 What is the background of corporate governance in the country under review?

Generally the UK is acknowledged as world leader in corporate governance reform (Solomon 2007, p. 49). The corporate governance debate and reform started long before the - for other countries - eye-opening scandals of Enron and Parmalat. The UK debate was boosted by the growing interest for governance issues within the boardroom, some UK scandals (e.g. the Maxwell case of 1991, Coloroll and Polly Peck) and the economic decline in the early 1990s (Solomon 2007, p. 49) (Voogsgeerd 2006, p. 36). Moreover, the merger wave around 1987 led to criticism of boards, auditors and the (institutional) shareholders who were regarded as too strongly focused on short-term profits (Voogsgeerd 2006, p. 36). Directors were able to manipulate the company's structure to promote their own ends, a fear of lack of independence of the external auditors existed and in addition thereto the public expectation of the auditor's capabilities exceeded their statutory duties (Boyd 1996, p. 170). The publication of the Cadbury Report in 1992 (named after the chairman of the drafting committee1. the industrialist Sir Adrian Cadbury) was the first attempt to formalise the UK corporate governance best practices (Solomon 2007, p. 50) (Voogsgeerd 2006, p. 35). The Cadbury Report includes a code of best practice and consequently was followed by many other UK codes (see figure 4.2.2 below). Sometimes these codes focused on specific topics such as remuneration (e.g. the Greenbury report) and internal control (the Turnbull report), but ultimately they resulted in the UK Combined Codes and the most recent UK Corporate Governance Code 2010.

The code of best practice as included in the Cadbury Report was short (19 paragraphs) and the main topics involved the separation of the CEO and chairperson, the need for outside directors, their independence and the nomination and independence of the auditor (Boyd 1996, p. 170). The drafting committee resisted statutory regulation because it feared that legislation would impose minimum requirements that encourage compliance with the letter rather than the spirit (Cadbury Report 1992, p. 12). In general the Cadbury Report was well received by the companies it was applicable to. Nevertheless there was also criticism: it was a political document to provide a whitewash for some embarrassing scandals, a number of important dimensions of accountability and governance were not addressed and above all the code had a lack of teeth. The Sunday Times even stated: "The Cadbury Report is a typically British compromise: well-meaning, reasonable and worthless. It is based on the age-old British myth that capitalists are mild-mannered animals capable oflearning good behaviour ifonly they go to the right schools (Boyd 1996, p. 172).

Until the new millennium, the Cadbury Report of 1992 was the UK's national corporate governance code. In 2003 substantive modifications resulted in the publication of the Combined Code of 2003 and subsequently the Combined Codes of 2006 and 2008. All but the 2003 Combined Code were publicly reviewed by the Financial Reporting Council (the FRC) before being modified. Before the publication of the UK Corporate Governance Code 2010 (the latest code) an extensive consultation review of the Combined Code was performed (114 responses) as well. Consistent and recurring themes throughout these responses were the independence of non-executives (too much emphasis on independence at the expense of experience and expertise), the comply or explain principle (too little focus on the explanations offered, a 'black or white' approach) and too little supervision by institutional investors (Governance 2009, p. 3) (Review of the Combined Code 2009). After this consultation period the FRC made suggestions to amend the code which again resulted in a consultation round regarding the draft UK Corporate Governance Code 2010 (Consultation UK Corporate Governance Code 2009). This latest version of the code is has been renamed from Combined Code to the UK Corporate Governance Code to clarify its status as the UK's recognised corporate governance standard further to foreign investors and foreign companies listed in the UK (2009 Review of the Combined Code: Final Report, p. 3). In the latest 2010 code quite a number of alterations were made and some new rules were defined. An often discussed new rule is best practice provision B.7.1, stating that all directors of the FTSE 350 companies should be subject to annual re-election (UK Code 2010, p. 3). Furthermore, the provisions on institutional shareholders are placed in schedule C and have ceased to apply since the Stewardship Code for institutional investors came into effect as from 6 December 2010 (UK Code 2010, p. 36). The previous section A has been split into two new sections. Section A titled "Leadership" discusses the board's role and section B titled "Effectiveness" deals with the composition development, support and evaluation of the board. The purpose of this change in the code's lay-out is to improve clarity and to give greater prominence to board issues (Review of the Combined Code 2009, p. 36). The other new or rephrased principles and provisions mainly involve the board's role and position as well.

As from accounting periods beginning on or after 29 June 2010, the UK 2010 Code is applicable to all companies with a Premium Listing of equity shares, regardless of whether they are incorporated in the UK or otherwise (UK Code 2010, p. 1). Compared to some of the other countries under research (the Netherlands and Belgium) the UK has a relatively large number of quoted companies - i.e. companies to the comply or explain principle is applicable to -although many of them are quite small (Charkman 2005, p. 306) (see section 4.1.1). The traditional UK definition for corporate governance from the Cad-bury Report is: "the system by which companies are directed and controlled. Boards ofdirectors are responsible for the governance oftheir companies. The shareholders role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate corporate governance structure is in place. The responsibilities of the board include setting the company s strategic aims, providing the leadership to put them into effect, supervising the management of the business and reporting to shareholders on their stewardship. The board's actions are subject to laws, regulation and the shareholders in general meeting (Cadbury Report 1992, par. 2.5).

The UK Code 2010 still agrees with this classic definition but adds that: "The purpose ofcorporate governance is to facilitate effective, entrepreneurial and prudent management that can deliver the long-term success ofthe company. (...) The Code's function should be to help boards discharge their duties in the best interests oftheir companies (UK Code 2010, p. 1).

Since the beginning the comply or explain principle itself has been the trademark of UK corporate governance and is the foundation of the flexibility of the corporate governance codes (UK Code 2010, p. 4). No specific definition is provided in the code but a separate paragraph explains its working and in the appended Schedule B the manner in which the principle has to be disclosed based on listing rules is extensively explained (see key 4.2.6 below). UK corporate governance and the corporate governance code have a long history compared to many other countries. Nevertheless, the corporate governance developments and progress never stopped and are still under constant attention, which still makes the UK an example and front-runner.