Chapter 12 Corporate governance Flashcards
1.1 UK corporate governance code
The UK corporate governance code is a code of practice embodying a shareholder-led approach to corporate governance. The code applies to all premium listed companies, compliance with the code is not a legal requirement, but premium companies are expected to comply. A comply or explain approach is taken to the code, companies are required to explain any non-compliance in their annual report.
There are three ways a company can be listed on the London stock exchange, a premium listing, a standard listing and via the high growth segment. Premium listed companies have more regulatory and governance requirements.
1.2 contents of the UK corporate governance code
The code has five sections with a series of main principles including: board leadership and company purpose, division of responsibilities, composition succession and evaluation, audit risk and internal control and remuneration.
2.1 Board leadership and company purpose
The responsibilities of the board should include:
- long term sustainability, generating wealth and contributing to society
- engage with stakeholders, particularly shareholders and encourage participation from these groups
- set the purpose, values and strategy and ensure the culture is in line
- make sure necessary resources are in place to meet objectives
- make sure company values are supported by appropriate policies and procedures
The board should meet regularly enough to discharge their duties effectively, the annual report should include a statement of how the board operates and the decisions taken by the board, and which are delegated to management.
The board should have a chair (who discusses governance and strategy with major shareholders), senior independent director (attend meetings with major shareholders to understand their issues and concerns) and non-executive directors (attend shareholder meetings when requested). If 20% or more of shareholders vote against a board recommendation, effective action must be planned and communicated to consult with shareholders over the issue.
3.1 Division of responsibilities – composition of the board
Structure is a board of directors, then a chief executive and executive directors (manage the business day to day), other side is the chair and non-executive directors (NEDs) who help develop proposed strategies.
The chair: leader of the board, they should be independent on appointment and not the chief executive. The chief executive should not go on to be the chair of the same company. The chair sets the board’s agenda, promotes a culture of openness and debate, and ensures effective communication with shareholders.
Non-executive directors: they challenge and help develop proposals on strategy. The responsibilities include reviewing financial controls and risk management, appoint, remove, and set remuneration of executive directors, scrutinise performance, meet without the chair present at least annually to appraise the chair’s performance, chair holds meetings with them without the executive directors present and on resignation NEDs should submit a written statement of concerns to the board.
4.1 Composition, succession, and evaluation: appointments to the board
There should be a nomination committee to lead the process for board appointments and make recommendations to the board. Over 50% of members should be independent non-executive directors, NEDs should be appointed for specified terms subject to re-election, NEDs serving longer than 6 years should be subject to review. The chair or an NED will be the chair of the committee, but the chair should not appoint their successor. The annual report should identify the chair and members of the nomination committee.
4.3 Performance of directors
The board should undertake a formal annual evaluation of its performance and its committees and individual directors. The chair should act on the performance evaluation proposing the need for appointments or resignations, each director evaluated based on their contribution and time commitment and the chair should ensure that directors continually update their skills.
4.4 Commitment of directors
Directors should allocate time to the company to discharge their responsibilities. Executive directors should not take on the role of chair of a premium listed company, they should not take on more than one NED role in a premium listed company.
The chair and NEDs: the chair may chair more than one premium listed company, both should disclose any other significant commitments to the board before appointment and inform them of any significant changes, and for the chair these should be disclosed in the annual report.
5.1 Audit, risk, and internal control: financial and business reporting
The board’s responsibility covers the financial statements and other price sensitive information or reports to regulators. In the annual report the directors should:
- confirm their responsibility for preparing the report
- state they consider it a true and fair view of the company
- confirm whether the going concern basis of accounting has been adopted
- report any material uncertainties regarding going concern
- confirm they have carried out a robust assessment of principle risks
The board should maintain risk management and internal control systems and review the effectiveness of these systems at least annually.
5.2 Audit committee
The board should establish an audit committee to maintain an appropriate relationship with the company’s auditors. At least three NEDs for premium listed companies, at least two NEDs for smaller listed companies, at least one member of the audit committee should have recent and relevant financial experience and in smaller companies the board chair may be a member in addition to the NEDs should be on the committee. The committee must be chaired by an NED and the chair should not chair this committee. The annual report should identify the chair and members of the audit committee.
5.3 Responsibilities of the audit committee
The responsibilities include:
- financial statements: reviewing the FS and any formal announcement of financial performance, also report on whether the financial statements are fair, balanced, and understandable
- financial controls: reviewing the internal financial controls and the effectiveness of the internal audit function, if the internal audit function does not exist, they should consider whether one is needed
- external auditor: making recommendations regarding the appointment, re-appointment, and removal of external auditors. Approve the remuneration of external auditor and monitor independence and provision of non-audit services
- whistle-blowing: reviewing arrangements by which staff of the company may raise concerns, arrangements should be in place to the process of investigating and following up these concerns
6.1 Remuneration
The remuneration committee should determine the remuneration of all executive directors, the board does this for NEDs. Remuneration should be designed to promote the long term success of the company for executive directors and for NEDs should reflect time commitment and responsibilities but should not include performance related elements or share options. Shareholders should be invited to approve all long-term incentive schemes or changes to existing schemes for Eds, for NEDs if share options are granted shareholder approval is needed and any shares exercised should be held at least one year after the NED leaves the board.
6.2 Setting remuneration
The board should establish a remuneration committee for executive directors, chair, and senior management. At least three NEDs for premium companies (2 for smaller listed companies) need to be on the committee and the chair may be a member. The committee must be chaired by an NED. The annual report should identify the chair and members of the remuneration committee.
7.1 Responsibility for corporate governance
The board has overall responsibility, but institutional shareholders, external auditors and internal auditors are expected to provide assistance.
7.2 Stewardship code
Stewardship is the accountability of management for the resources entrusted to them as agents of the company’s owners. The stewardship code states institutional investors should:
- publicly disclose their policy on how they discharge their stewardship responsibilities
- have a robust policy in managing conflicts of interest
- monitor their investee companies
- establish guidelines on when and how to escalate their activities as a method of protecting and enhancing shareholder value
- willing to act collectively with other investors
- clear policy on voting and disclosure of voting activity
- report periodically on their stewardship and voting activity
7.3 External audit
The purpose is to issue an opinion in an audit report on whether the accounts give a true and fair view of financial performance and position. To act as an external auditor, the corporate body or individual must be a member of a recognised supervisory body (ICAEW) and must hold an appropriate qualification. The responsibility for preventing and detecting fraud still lies with the directors. The auditor reports an independent and expert opinion on how the company complies with UK corporate governance code, the overall responsibility remains with the directors and shareholders, however.
