Corporate Governance and the United Kingdom (Part 1)

Some of the student papers involved a comparison between the United States and the United Kingdom. 

The United Kingdom has sometimes been called a shareholder's paradise. As a common law jurisdiction with active capital markets, the UK has much in common with the United States. On the other hand, the market is more institutionally dominated. Nonetheless, it represents an interesting place to observe the impact of a number of corporate governance provisions that are hotly debated in the United States.

The United Kingdom undertook a comprehensive revision of its Companies Act in 2006. Similarly, the same year, the Combined Code on Corporate Governance was updated. We will note a handful of differences between the UK and the United States.

The Combined Code applies to listed companies but allows for a "departure from the provisions" if the departure is explained  ("comply or explain").  The comply or explain approach exists in the US, particularly in SOX.  See Section 407 of SOX (requiring SEC to adopt rules requiring companies "to disclose whether or not, and if not, the reasons therefor, the audit committee of that issuer is comprises of at least 1 member who is a financial expert"). 

The Code mandates a separation of the positions of CEO and Chairperson of the Board. See The Combined Code, at A.2.1 ("The roles of chairman and chief executive should not be exercised by the same individual.").

Similar to the US, at least half of the board (except in smaller companies) must consist of non-executive directors. The Code defines certain category of persons who are not independent, although exceptions are allowed if explained.  Many of the factors resemble those used by the NYSE.  The Code, however, goes much further and disqualifies anyone who "represents a significant shareholder" or who participates in an option or performance pay scheme.

In addition, and a subject that we will review later, the Code deals with the structural bias issue, something completely ignored in the United States, particularly by the Delaware courts. See Beam v. Stewart, 845 A.2d 1040 (Del. 2004).  Group dynamics and human nature make it less likely that directors will be willing to oppose top management or others on the board the longer they work together.  As a result, under the Code, directors lose their independence if they have served on the board for more than nine years.   

With respect to internal controls, the Code places greater responsibility on the board.  The board must undertake "at least annually" a review of the effectiveness of the system of internal controls. "The review should cover all material controls, including financial, operational and compliance controls and risk management systems."  In the US, it is the CEO and CFO who assess effectiveness, with the board informed of any “significant deficiencies."  See Section 302 of SOX.  

The Code also imposes an affirmative obligation on the board to establish "a dialogue with shareholders."  See Combined Code, at D.1.  The provision recognizes that most contact by shareholders is with the CEO but mandates that the chairperson should likewise maintain contact and that the board as a whole "should keep in touch with shareholder opinion." 

The Code, therefore, imposes greater responsibility on the board for internal controls and staying in touch with shareholders.  It promotes board independence through a definition that takes into account issues of structural bias and by separating the positions of CEO and chair.  There are other differences and we will explore them in a separate post.