2.1.2 History of UK company governance

The most obvious difference between UK and Dutch systems of corporate governance is their opposing approach to the power of shareholders vis-à-vis directors. From the early 1600s and all through the 20^th century this difference has continued.

In the Netherlands the Dutch East India Company (VOC) of 1602 and its later successors were oligarchic in character, with control concentrated in a small circle of directors. Shareholders had few, if any, powers. In the UK, on the other hand, the English East India Company of 1600 and its successors were less oligarchic. All shareholders had a say and could vote on matters of strategy and the appointment and dismissal of directors.1

On 31 December 1600 a royal charter was granted to the English East India Company.

It began with 218 members called the General Court or Court of Proprietors and was governed by a Court of Directors, also called the Court of Committees.

The Court of Proprietors had voting rights and each share was subscribed at £200. Soon there were several hundred proprietors. The court met infrequently, but it held supreme authority. Its sanction was needed for the raising of funds, and it elected the directors.

The Court of Directors was the executive body and was responsible for the running of the company, although its policy decisions were to be ratified by the Court of Proprietors. The Court of Directors consisted of the Governor, the Deputy Governor and twenty-four directors. It met frequently and had numerous sub-committees for functions such as purchasing, sales and correspondence.

This Court of Directors had the classic functions of a board of today. They selected the chief executive. They were careful to choose someone in whom they had confidence. They were also responsible for the financing of enter-prises. They proposed new shipping voyages to the Court of Proprietors. It was they, who developed the strategy of switching the trading focus from the East Indies to India.2

The governance continuity is striking. Not only was the governance structure of the English East India Company comparable to that of UK companies today, but so were the issues that faced the board. Even then shareholders differed in their motives. Short-term investors wanted to receive a return after each voyage, whereas others took a longer view and only looked for a possibly larger return after many trips to a certain area. The board also had to monitor its appointees, some of whom took advantage of their remoteness from London to act not only for the company but also for their own account. For this reason the selection of the company's captains and factors was a crucial responsibility.

It is interesting to see that the structure and responsibilities of the board of Britain's most influential company some four hundred years ago are clearly recognizable in those of UK companies today.3

The past 400 years have seen many stock market crashes, vicissitudes of fortune, and endless debate about the balance of power in companies. However, some things remain the same: over time there has been consistent respect for democratie ownership, the power of shareholders, the protection of investors, and the responsibility and accountability of the board for running the company and developing strategy. In many instances, problems have been resolved by quick informal solutions or codes.

The Glorious Revolution followed after the only, or at least last, violent British revolution, the one of 1648, which ended with the beheading of King Charles I. In 1688 parliament threw the Catholic James II out in favour of his Protestant son in law, the Dutch William III. Because this revolution took place without much bloodshed so easily and the Bill of Rights limiting Royal power was so smoothly accepted, it was called the Glorious Revolution. After 1688 the UK has had no more revolutions.

From 1688 a stock market boom started in London. The public (i.e. wealthy aristocratie families and/or those who had made money in business) had a lot of money to invest. The number of charters issued for new companies in a variety of industries rose from 12 in 1691 to 53 in 1694. The main stock exchange trade had moved from Amsterdam to London. In 1694, onder William III, Parliament created the Bank of England and raised 12 million pounds in government bonds.4 The fact that the government could raise money on the capital market proved a great advantage in Britain's battles against the French. It made the government economically independent. Even the East India Company lent money to the government in 1698 and 1708 in exchange for a further charter. This was all of supreme importance for the political and military power of Britain at the start of the 18^th century.

1718 to 1720 were the years of the Bubbles. In France the Scotsman John Law set up a system, which led to five Bubbles and Crashes. The system was designed to raise money and infiate the market price of shares in the Mississippi Company. There were issues in tranches. Only 10% had to be paid on the first tranche and the first shareholders had priority on the further tranches, which were announced from the start. A run on shares resulted. The price went up from 500 livres in March 1719 to 1,000 livres in December of that year. The system failed, the Bubbles burst and lelt France with an economie disaster.

In the UK, at about the same time, the South Sea Company also artificially boosted its share price. Shares were offered to the public in four tranches, with the price rising from £300 per share in April 1720 to £1,000 in the beginring of June of that year. Instalment payment was permitted. Loans were offered against shares. Euphoria gave way to mania. Generally the stock market was still booming.5 By 1720 there were 196 new companies in the UK that raised money on the capital market, many of them financial institutions and insurance companies. Stock prices went up. The South Sea Company share price increased by a factor of 9.5 (compared with the Mississippi Company increase of 19.6). However, the South Sea Company prices dropped again before the end of July, when the last tranche was to be issued, because so many new companies drew money from the market. The last tranche did not succeed and directors had to inject liquidity.

Upon the proposal of the South Sea Company the Bank of England took measures to block the formation of new joint stock companies. This enabled the South Sea Company to be maintained, as it was protected from suddenly losing its investors to other entrants. Parliament introduced the "Bubble Act", barring all other joint stock companies and this situation continued to exist for more than 100 years. So until 1824 the UK only had partnerships of associates and closed companies and no trading of shares. This meant that for many decades the UK did not have joint stock companies, except those that had received a charter from parliament (and charters were only given for public utility companies for canals or railroads).

In 1791 there were 81 of these public utility companies.6 Adam Smith considered that only these companies could be joint stock companies because they had a predictable and steady flow of income. He was one of the chief sceptics about companies that were governed by non-owners. In The Wealth of Nations (1776) he famously wrote: "The directors of such companies, being the managers rather of other people 's money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance."7

After the Napoleonic wars the British economy thrived and in 1824 there were 250 requests for charters. The Bubble Act was abolished, but this was immediately followed by a market crash and the Bubble Act was re-introduced. It was simply too difficult for investors to discipline managers.

Managers often managed companies to their advantage and took too many risks and there was fraudulent activity in the capital market. The English created new systems for the rights of shareholders and regulation of the capital market. In 1844 the Bubble Act was finally abolished and the Joint Stock Companies Act gave legal status to these entities and created a register where the articles of association and the accounts of the company had to be filed. The Act required a "full and fair balance sheet" to be presented. Royal charters were no longer necessary.

The British remained leaders in Europe in the area of company investment law since 1840 and through to the 21^St century.8 The process started with the steel industry and railroad companies, many of which were founded by families and relatively small groups of local investors.

In the first 70 years of the 19^th century Britain was the world's strongest economy. In fact its Industrial Revolution had already started in the mid-18^th century; earlier than in any other country. Why? The freedom of private enterprise had gained room. Since the Magna Carta of 1225, which laid down elements of the Rule of Law, kings were limited in their power and powers were shared with the aristocracy, cities and the church. There was a feeling of one nation and cooperation. First farms became bigger, then industry developed, inventions led to more efficient production and use of natural resources (coal and iron ore), while on the continent most countries were involved in destructive revolutions. Furthermore, English society managed to give new entrepreneurs and intellectuals a chance.9

During the Industrial Revolution the UK was the workplace of Europe. At the high point, in 1851 the First World Fair known as the "Great Exhibition of the Works of Industry of all Nations" was held in the Crystal Palace in London. The UK led the way in the Industrial Revolution. The Test Act of 1620, which forced anyone wishing to take public office or go to university to adhere to the Church of England, was lifted in 1830, thereby empowering more sections of the upper middle class, such as the Quakers, who were often imbued with a strong sense of entrepreneurship, discipline and social responsibility. This government policy was to create a breed of young men who could be leaders of the expanding UK economy and represent the government and business all over the world.10 The first investors in a new company often had experience of the business or were family of the founders. It was still the general conviction that limited liability companies invited fraud and speculation and that only unlimited liability held investors back from speculation. The Limited Liability Act of 1855 and the Joint Stock Companies Acts of 1856 and 1860 gave the right to any group of at least seven investors to have the privileges of limited liability, provided the word "limited" was added to its name, which, so it was believed, should avoid misuse. From 1863 to 1866 about 3,500 "limited companies" were founded. Most businesses were family businesses with more or less closed groups of shareholders. The Companies Act of 1879 repeated the need for a "full and fair balance sheet to exhibit a Crue and correct view" of the company's affairs.11

Proposals were also drafted to enable workers to acquire shares in the companies where they worked.

Gradually private savings grew and the larger public started to buy shares. Family companies merged with others and started raising outside capital. By 1905 the economie model had slowly shifted from "family capitalism" to "financial capitalism". Representatives of financial institutions had held board positions in the companies in which they invested and could thus monitor whether there would be a regular dividend.12 Few industrial companies had their shares listed in 1909: 41 in Britain, 16 in Germany and 2 in France. Public companies were still managed as if they were family businesses.

But family influence waned before the dawn of the "Managerial Revolution" and "Managerial Capitalism". An oligarchy developed in Europe. Bank directors monitored boards. In Germany one baraker could be supervisory director of 100 companies. In Britain the maximum was 30 board memberships.13 While directors became oligarchie, ownership was fragmented and split up among many small shareholders. The fragmentation of ownership limited the power of shareholders. They had no difficulty selling shares and could "vote with their feet".

Berle and Means,14 the American writers who argued in favour of the primacy of directors as they considered the small shareholders to be incapable of developing a strategy, were cited in the UK. The UK already had an investigation committee in 1926. It was known as the Liberal Industrial Inquiry. It concluded "the truth is that a strong and possibly efficient management rather likes to have an ineffective board, which will know too linie to have views or to interfere". In terras of power, it was executive management that was in the driving seat.15 In the years 1928-1935 protection of shareholders became important due to the Great Depression. The Companies Act was changed in 1929. From then on the board had to publish accounts each year and the Annual General Meeting of Shareholders (AGM) appointed an auditor annually. Britain stayed true to its tradition of not having over-powerful boards nor boards that paid no attention to shareholders.16 However, as industry became increasingly complicated, it became ever more difficult to monitor managers.17

1958-1959 saw the first unfriendly takeover of British Aluminium by the joint venture of the US Reynolds and the Midlands Tube Investments Ltd. led by Sigmund Warburg, the founder of S.G. Warburg.18 The intermediaries in the City felt some order should be introduced and within three months the Notes on Amalgamations of British Business (City Notes) were introduced. These were the first of many informal regulations.

Since 1964 the British developed the concept of groups, conglomerates of interrelated companies, to compete with US and German concerns. An example was ICI, which tried to take over Courtaulds. Mergers and large conglomerates were encouraged by the Labour government of Harold Wilson with the Industrial Reorganization Corporation (IRC) in order to compete with huge US and German competitors. British Leyland was formed in 1968 with government support by the merger of Leyland and British Motor Holdings, but was not successful.19

In 1968 the City Code on Takeovers and Mergers and the Panel on Takeovers and Mergers were introduced.

This self-regulation (with no sanctions other than loss of reputation — a very important commodity in the City) was supplemented by the Panel on Takeovers and Mergers. Shareholders were to get equal information and takeover targets could not introduce defence mechanisms without permission of the shareholders. A member of the Panel summarized the City Code as prescribing "How a decent chap behaves".20

Subsequently from 1974 onwards, the UK tried to convince Europe to introduce the Takeover Directive, the 13^th European Directive, which was introduced after 30 years of negotiation in 2004, but the Directive is full of opt-outs and exceptions for Member States.21

The takeover threat continued as a disciplinary measure for lax boards. Freedom of the market is the British motto. Only on 1 June 2010, after the Cadbury and Kraft case, has the Takeover Panel issued a consultation paper aimed at raising the standards for tender offers.

In 1977 there was a discussion in the UK about the introduction of a two-tier board especially to facilitate "worker directors" (the Bullock Report), but even the unions did not want this. Managers also started to take account of the interests of employees. Such managers were likely to be popular.22

From 1979 Margaret Thatcher reintroduced the power of the market. She promoted denationalisation. She wanted a nation of shareholders to counter the power of the unions. In her first years she fought a "social war" (i.e. an ideological clash between nationalised inefficiency and control on the one hand and potential private profit-making services on the other). All of this led to more profit for companies. Corporate governance had not been a subject of debate. Companies had grown steadily.

The UK used "market control" to discipline boards. It was the market which really sounded the alarm for sluggish boards. The takeover threat was seen as alerting the boards of all companies to the need to achieve higher levels of performance.23

From 1695 to 1995 the City was all British and consisted of many different professions: jobbers, brokers, merchant/investment banks and commercial/ clearing banks. This complicated organization of separate professions kept foreign — and essentially US — entrants out. As recently as December 1983 Minister Alex Fletcher said, "I think a British-owned securities industry is important".24 By 2000, the then Chancellor of the Exchequer remarked that the "absence of a single British-owned investment bank is a serious deficiency".25

At the same time the governor of the Bank of England light-heartedly noted that "the City is like Wimbledon, it does not matter that foreigners play in the finals, as long as the game is played here". Augur does not agree with the comparison: "the British own Wimbledon, determine that players must play in white and make the money; the same does not apply to the manvers of all the foreign investment banks that have taken over the City".26

Merchant bankers tended to be upper class, whereas commercial and clearing bankers were middle class. Merchant bankers' contacts were with CEOs and chairmen and concerned Mergers & Acquisitions (M&A) and equity funding. Commercial bankers had contacts with treasurers and CEOs.27 Values of order and self-confidence, which were taught at the public schools, which are actually private,28 were good preparation for merchant bankers. Clearing banks were dominated by grammar school boys and were totally different in style and values. They tended to come from the provinces, the North and the Midlands, whereas merchant bankers were from the home counties, Gloucestershire and Edinburgh. Clearing bankers were trained to keep records, but merchant bankers looked down on bureaucracy. There was considerable antipathy between the two groups. This became a serious business issue when clearing banks tried to establish or buy investment banks.29

In 1983 Margaret Thatcher announced the "Big Bang" for Monday, 27 October 1987. That put an end to the split between the foor professions. The government issued its White Paper in 1985 and the Financial Services Act in 1986.30 Old values crumbled and old honour codes broke down. The cult of the individual was growing. As part of the ethos of Thatcherism, maximum tax rates went down from 84% to 60% and then to 40%.31

Three pillars of the establishment in the UK were the public schools, the gentlemen's clubs and country houses.32 Eton set the standards for the old city: my word is my bond: "Dictum meum pactum".33 As grammar school-based institutions senior managers of clearing banks lacked the verve to challenge the overbearing and usually misplaced confidence of the public school boys.

Foreign banks were better equipped to cope with changes. They had the size, experience and flexibility to adapt to the new world. They were unencumbered by class-based historical experience. In fact, by imposing so many changes on a City that was manifestly unfit to adapt to new challenges, government, the stock exchange and the Bank of England ensured that only foreign firrns would survive. There was another element: UK merchant bankers were relationship banks, while US investment bankers were product led banks, which aggressively pushed their products to customers. Merchant banking became investment banking.

One after the other the once powerful UK merchant banks disappeared. While in 1995 S.G. Warburg was still world leader with a 15% share of all listings in that year, a couple of poor decisions in 1994 blew the firrn away.34 Barings collapsed in 1995, when the board failed to monitor Mr Leeson.35 Failure of control at Barings occurred at the highest levels in the firrn. At Kleinworth the misjudgment of a handful saw the firm give up its independence.36

Barclays and Nat West shared one characteristic: the CEO did not believe in investment banking.37 At Nat West the CEO Derek Wanless and the chairman, Lord Alexander, a former barrister, did not want to enlarge their investment banking activities. The non-executive directors, however, all wished to continue to grow in investment banking. In board meetings, where the opportunity to buy the large investment bank, S.G. Warburg, was discussed, the chairman, Lord Alexander, listened to his colleague non-executive directors, who were in favour of the acquisition. He went along with the majority, as did the CEO Derek Wanless,38 but he left soon afterwards, feeling let down. Because Wanless had actually been against the acquisition and had to experience that the board did not agree with his policy, he left. Nat West continued with its plan to buy S.G. Warburg. The problem between Nat West and Warburg, however, was social class (Nat West's new CEO, Owen, had not attended Oxbridge, nor been to a major public school, neither had Derek Wanless for that matter). The gentlemen capitalists of Warburg instead turned to Credit Suisse recommending their offer, although the price was low, Warburg was sold to Credit Suisse, and Owen was left in the cold to look for smaller fry. Class had cold shouldered him

In the UK investment banks had been working in a barely regulated environment where it was permitted to "warm up" the market in the press, as occurred in the case of Eurotunnel. During the British Airways Initial Public Offering (IPO) of 1986 a top UK solicitor commented that there was "too much information in this document", implying that he did not see the legal necessity of informing the public properly at that time.39

It is interesting to note that the big Dutch commercial banks have not been successful in investment banking for similar reasons. ING bought Barings, but did not know the business. ABN AMRO had continuous interaal scrimmages about its costly investment banking. Every year it turned out that ABN AMRO made losses in their investment banking department, which was directed by Wilco Jiskoot, who was in continuous disagreement with his CEO, Rijkman Groenink, while the supervisory directors were not aware of this disagreement.40

US investment banks had grown up in a much more toughly regulated and profitable environment. "Conditioning" was forbidden.41 US bankers received 5%-7% of Initial Public Offering (IPO) value as their fee, whereas in the UK bankers received 0.75%.42 Freud and Augur imply that the US way of setting the price smells of a cartel.43 So Swiss, German, Dutch and, in the end, mainly US investment banks took over all their London counterparts. Japan had collapsed, New York had flourished, London had sold out and continental Europe had developed larger banks that also embarked successfully on investment banking.44 Now the City was in the hands of the "Bulge Bracket", i.e. senior syndicate members bracketed together in deal announcements, specifically by the Super Bulge (MGM) Morgan Stanley, Goldman Sachs and Merrill Lynch.45 Now, after the crisis, these three, be it that Merill Lynch was taken over by Bank of America after its collapse, are still in the lead. Goldman Sachs is now one of the top two, with its special risk management practice called "The Edge".46

Some aspects of the "class society" have remained, but the same cannot always be said of the gentlemanly manners. American bonuses and tougher methods have been introduced. And yet manners and appearance do still count. Whether in Park Avenue or in Canary Wharf, the prevailing decor is Old England, with hunting scenes, gilt-framed mirrors, Regency striped curtains, antique dining tables and traditional chairs.47

The extensive description of the "Death of Gentlemanly Capitalism" in the UK shows how class difference until recently spoiled the atmosphere of the City and how the tougher US banking culture took over the industry. Investment banking in London survived and remains one of the most profitable businesses in the UK, even though nearly all the investment banks are owned by foreigners.

Nat West's decision to want to stay and grow in investment banking was backed by the majority of the non-executive directors despite the opposition of the CEO and the chairman. It shows how important the non-executive directors on a board are. But in this case the board was unable to explain this strategy, of the majority of the board to want to buy an investment bank, to its shareholders, who did not block the following acquisition, but were unhappy, which created problems for Nat West's future.48

In due course the shareholder scene changed: no longer were most shares in hands of private — small — investors, companies started to feel the presence of institutional investors, such as pension funds with larger stakes, who could not so easily sell their shares and guit if they did not like what they saw. "Exit" was giving way to "voice". These shareholders wanted a greater say and a better insight in what was happening in their companies.

There was growing concern over the reliability of accounts of UK companies. The collapse of the seemingly well performing listed companies Colorell and Polly Peck,49 whose accounts prior to their failure appeared to give no indication of the true state of their finances, cast doubt on the trust, which could be placed in accounts and audit statements attached to them. This in turn, it was feared, could limit confidence in UK accounting practices and the reputation of London as financial centre. Therefore, the Financial Reporting Council, the London Stock Exchange and the accountancy profession set up the Cadbury Committee, which drafted a code and created the "comply or explain" concept. The establishment of the Cadbury Committee was soon followed by the failure of BCCI and the collapse of Robert Maxwell's business empire.

The Committee's report attracted huge publicity and was yet again an example of English informal self-regulation, which was followed by about 70 codes of best practices all over the world, often copying each other. Here Britain showed real leadership in the corporate investment world.

Britain can thus be said to have taken the lead in new corporate governance and the promotion of independent non-executive directors (NED5) and an independent chairman. In the last 10 years non-executive directors (NED5) have become prominent in Britain.