Keith Johnstone and Will Chalk

Also boards will frequently look carefully at what comparator companies are doing on various issues, particularly in the field of remuneration.

Corporate social responsibility

Companies and boards have generally seen wealth creation for shareholders as their principal objective. Over the years, legislation has widened that objective for the benefit of other stakeholders, including employees and creditors. In addition, the concept of corporate social responsibility (CSR) has emerged and, although this is not clearly defined from a legal point of view, companies are now reporting extensively on their CSR activities and agenda. Those CSR concepts are now undoubtedly part of the corporate governance landscape and, therefore, part of the Virtuous Circle; in fact, they are playing an ever increasing part in it. Redraw the Virtuous Circle in ten years’ time and the size of this segment, reflecting its relative influence on board behaviour, is likely to have increased significantly, and will certainly have done so if the current response to institutional ethical investment policies and focus on the impact of corporate activity on the global environment continues. Again, what is noticeable here is the lack of traditional sanctions compelling behaviour. For this reason, the need for, and influence of, the sanctions brought in with the enhanced Business Review for listed companies is open to question, given the history of voluntary compliance.

Consequently, this segment identifies the main source of pressure on boards as the need to be good corporate citizens, and the conclusion must be that, even without legal sanctions, that pressure appears to be working.

Conclusion

Looking at the constituent elements of the Virtuous Circle and the drivers for boards to adopt appropriate governance standards, the balance of sanctions and the system of accountability underpinning corporate governance in the UK seems about right.

The two largest segments of the Virtuous Circle – law and regulation, and shareholder and market pressure – represent dynamics which produce a balanced and meaningful corporate governance regime and, at present, these are appropriately supplemented by the other elements of the Virtuous Circle, namely the Courts and common law, and public opinion demanding good corporate citizenship.

The boundaries between the two largest and most influential segments are also about right. Extremes of behaviour and the fundamental tenets of the corporate reporting regime are appropriately matched by clear legal principles and policed by strong criminal and civil sanctions. For the most part, the legislature has resisted the temptation to try to control through legislation boardroom behaviour which, to paraphrase from the Cadbury Report, would impose

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What sanctions are necessary?

minimum standards allowing boards to comply with the letter and not the spirit of their requirements. This has allowed the middle ground in the Virtuous Circle to be populated by flexible codes of conduct which, on a day-to-day basis, allow shareholders (and key stakeholders) to be the arbiters of what does and does not constitute satisfactory compliance and behaviour.

However, this is not to say that the current system is perfect, that it could not be improved upon and, crucially, that there are not serious threats to it on the horizon.

There are potential problems associated with the implementation of the Audit Directive and, indeed, the 2006 Act appears to be paving the way for statutory provisions to replace Combined Code provisions by granting the FSA and the relevant Secretary of State a statutory power to produce corporate governance rules. It is this movement of voluntary codes into law and regulation that poses the greatest threat to the regime, as it moves us ever closer to the US model laid down by the 2002 Sarbanes-Oxley Act. This drift towards legislative measures has imposed on the US economy an estimated net cost of US$ 1.4 trillion40 and has meant that, whereas in 2000 ‘nine out of 10 dollars raised by foreign companies through new stock offerings were done in New York . . . in 2005, the reverse was true: Nine out of 10 dollars were raised through new company listings in London or Luxembourg’.41 The dangers of such a shift to legislation and regulation are very clear.

With the possible addition of the other sanctions proposed in the section ‘Proposals for reform’ (above), the comply-or-explain approach must surely be the way forward in relation to the mainstream areas of corporate governance. Clearly, to address those specific areas where excesses arise and where there are public interest concerns or a perceived need to protect wider stakeholders, the legislature may need to bring forward law or regulation. But the Combined Code has undoubtedly been a success in raising governance standards with a relatively light touch in those mainstream areas and ‘if it ain’t broke. . .’.

40American Enterprise Institute for Public Policy Research, 10 July 2006.

41Craig Karmin and Aaron Lucchetti, ‘New York loses edge in snagging foreign listings’, Wall Street Journal, 26 January 2006.

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