CG: The Development of the Concept
The need for CG came about with the idea of the limited company once the roles of ownership and control were spelled out and the agency theory6 was coined. At the same time, however, the issue of conflict of interest (Peters and Handschin 2012) and the risk of dishonest or incompetent managers were also introduced,7 both of which have an impact on good governance for the public or private sectors. But it was not until 1992 and in the wake of some well-known company collapses in the United Kingdom that the first version of the UK CG Code was produced by the Cadbury Committee. As Gwilliam and Jackson (2011, 383) surmised, the opacity of the financial statements of the Bank of Credit and Commerce International, the Mirror Group, and Polly Peck illustrated “weaknesses of internal governance and control mechanisms” (p. 397), which enforced the need for “far reaching changes in terms of” (p. 400) CG. Thus, in May 1991 a committee, described as the milestone on CG under the chairmanship of Sir Adrian Cadbury, was commissioned to report on “the perceived low level of confidence both in financial reporting and in the ability of auditors to provide the safeguards which users of company reports sought and expected” (Cadbury 1992, par. 2.1, 2.2). Gwilliam and Jackson (2011, 400) argued that “there is little doubt that the collapse of Polly Peck was one of those ‘unexpected failures’ which prompted the setting up of this committee; and although the setting up of the Cadbury Committee predated the [Bank of Credit and Commerce International] and Mirror
Group failures, these two cases significantly influenced the committee in its deliberations and in the drafting of its final report.”
The 1992 Code defined CG as “the system by which companies are directed and controlled” and stated that “governance of companies is the responsibility of the board of directors” (par. 2.5). The key principles of accountability, probity, and transparency underpinned the code. At the same time the code emphasized the governance responsibilities of nonexecutive directors and the responsibility of directors in maintaining adequate systems of internal controls, and it advocated for establishing audit committees and the separation of the positions of chairman and chief executive. Following further scandals in the United Kingdom, the Greenbury Report (1995),8 the Hampel Report (1998),9 and the Turnbull Report (1999)10 brought together the Combined Code,11 which was later revised to include the establishment of culture, values, and ethics of the company and the risks affecting longer term viability. Under the revised code “companies will now need to present information to give a clearer and broader view of solvency, liquidity, risk management and viability” (Financial Reporting Council 2014, 2).12 As in the United Kingdom, in the United States, the Committee of Sponsoring Organizations (COSO) of the Treadway Commission was formed in 1985 to improve organization oversight, reduce fraud, and improve organization performance.
It was evident that over time corporate scandals, collapses, and failures “brought about an erosion of public confidence in companies” (Ungerechts 2014, 2) and raised the interest in CG.
As mentioned earlier in this book, financial crises and failure of CG are not recent phenomena. Not surprisingly, therefore, academics, various practitioners, and legislators have a keen interest in CG, which is a significant topic today in most countries worldwide and one that is hotly debated, especially in the wake of a financial crisis. Not forgetting that the 2007—2008 crisis, termed the most serious financial crisis after the Great Depression of the1930s, was a global one, the fact remains there were several aspects of failure in that crisis, and CG was a key one (Kumar and Singh 2013). Similar to the situation in the United Kingdom 10 years earlier, the Sarbanes—Oxley Act of 2002 (SOX) was enacted in response to a number of scandals by such well-known corporations as Enron and WorldCom in the United States. This federal law strengthened new standards for all US publicly listed companies, boards, management, and public accounting firms. The act also applied to privately owned firms regarding, for example, the intentional destruction of evidence to hinder an investigation by a federal authority. Furthermore, the act detailed the responsibilities of a public corporation’s board of directors and provided for criminal penalties for certain misconduct. According to SOX, top management would have to individually certify the accuracy of financial information, and penalties for fraudulent financial activity became much more severe. Also, SOX placed higher overseeing responsibility on the chief financial officer and the chief executive officer (CEO) in expecting them to certify the financial reports they issue. The Act also strengthened the independence and oversight of external auditors and increased the oversight role of the board of directors through the independence and effectiveness of audit committees and forbidding loans to be granted to the executive officers.