Thirty years of corporate governance

December 2022 marks the 30th anniversary of the publication of the Cadbury code.

Contained within the report of the Committee on the Financial Aspects of Corporate Governance, established in 1991 in response to investor concerns at a string of high-profile scandals in listed companies (Polly Peck, BCCI, the Maxwell Group), the Cadbury code is only two pages long. This succinct code of best practice, which was originally controversial, has proved hugely influential not only in the UK but around the world.

Most significantly, the report established the direction of travel for the UK’s corporate governance regime right at the start of its journey. Rather than proposing a mandatory framework, with certain boardroom practices set out in law, it advocated an approach based on compliance with a voluntary code, coupled with disclosure to shareholders in the annual report.

The Cadbury code (named after committee chair Sir Adrian Cadbury) became the first ‘comply or explain’ governance code in the world.

The corporate governance landscape has shifted significantly since 1992 – a combination of gradual evolution reflecting societal changes and urgent responses to periodic business scandals. The key milestones along this journey may be traced in the major revisions to the UK codes over time.

Early reports

Three reports laid the foundations, each addressing issues that remain topical today.

In 1992, the Cadbury Report, in addition to introducing the concept of ‘comply or explain’, developed a set of good governance principles that were incorporated in the London Stock Exchange’s listing rules. They included three key recommendations:

• The positions of CEO and chair should be separated.
• Boards should have at least three non-executive directors (NEDs), two of whom should have no financial or personal ties to executives.
• Each board should have an audit committee composed of NEDs.

The Greenbury Report in 1995 addressed concerns over senior executive pay. It produced a best practice code for executive remuneration, including establishing a remuneration committee of NEDs to determine executive directors’ compensation, disclosure in the annual report with shareholder approval at the AGM, and remuneration linked more explicitly to performance.

In 1998, the Hampel Report advised against ‘prescriptive box-ticking’. The report reviewed Cadbury and Greenbury, and evaluated implementation of their proposals. It recommended a single code of corporate governance – leading to the Combined Code, applied to all UK listed companies.

Combined Code

The Combined Code on Corporate Governance was issued in 1998. It sets out a series of best practice principles of good governance and addresses directors, directors’ remuneration, relations with shareholders, accountability and audit, and institutional investors. In later versions, the principles were supplemented by more detailed code provisions.

The Combined Code was updated four times and became the responsibility of the Financial Reporting Council (FRC) in 2003. Three reports were key drivers in its development:

• Turnbull (1999), setting out best practice on internal control and providing guidelines for directors on how to meet their obligations in the Combined Code. It was updated in 2005 and was superseded by the FRC’s risk guidance in 2014.
• Smith (2003), published in the aftermath of the Enron scandal and collapse of Arthur Andersen. It addressed auditor independence and clarified the role and responsibilities of audit committees. The committee developed guidance for directors on audit committees, most recently updated in 2016.
• Higgs (2003), reviewed the role and effectiveness of NEDs, highlighting the importance of NED independence. The report influenced the Combined Code, including the provision that at least half of a board (excluding the chair) should comprise independent NEDs, and the introduction of criteria that could impair that independence. The FRC published good practice suggestions from the report in 2006 – since adapted into the Guidance on Board Effectiveness.

Corporate governance code

The global financial crisis (2007-08) led to extensive consultations on the effectiveness of the Combined Code – was it fit for purpose? Among many revisions, the most visible was renaming the Combined Code as the UK Corporate Governance Code (the Code) in 2010.

Responding to the crisis, the Code was strengthened in two significant areas in 2010:

• Board diversity. To encourage boards to be well balanced and avoid ‘group think’, new principles on board composition and selection were added, including the need to appoint directors on merit, against objective criteria and with due regard to the benefits of diversity, including gender.
• Risk. To improve risk governance, the board should be responsible for determining the nature and extent of the significant risks it is willing to take.

After further revisions, the Code was last updated in 2018 when concerns about poor corporate governance at BHS and Carillion triggered a major review. This review aimed to update and improve governance practices, thereby promoting both long-term business success and the attractiveness of UK capital markets.

The Code retains many elements from previous versions, but it has now been adapted to reflect the changing economic and social climate. For example, Principle A states that the role of an effective board is to promote the long-term sustainable success of the company, not only generating value for shareholders but also contributing to wider society.

The changes mean that the Code:

• is shorter, sharper and more accessible
• focuses more on stakeholders – the board should communicate effectively with all stakeholders, especially employees, rather than concentrating on shareholders
• highlights the importance of diversity and succession planning
• acknowledges for the first time that sustainable success depends upon the board establishing the company’s purpose, values and strategy, and aligning these with its culture.

What next for the Code? Further revisions are scheduled for 2024, with stronger provisions relating to internal controls already promised. The UK’s corporate governance journey is set to continue.