Corporate Governance in the Uk

Introduction

This essay aims to examine the history, meaning, practical function, legislation and development of corporate governance in the United Kingdom. Corporate governance is a subject that has become increasingly important over the last few decades and looks set to continue with continuing corporate failures pushing corporate governance to the forefront.

To fully understand the subject of corporate governance in the United Kingdom we must first define corporate governance and understand it's meaning. Schleifer and Vishny (1997) give a succinct, if rather narrow definition that "corporate governance deals with the way suppliers of finance assure themselves of getting a return on their investment". A broader and more functional definition is given by the OECD (1999).

"Corporate governance is the system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as the board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance."

Corporate governance is a wide and important subject that covers a range of issues from accountability and transparency and the relationship between shareholders, stakeholders and the company's management to the external and internal system of controls of companies to ensure that the best interests of the shareholders are being pursued and met.

The Wikipedia entry for corporate governance (2006) notes;

"Corporate governance is a multi-faceted subject. An important theme of corporate governance deals with issues of accountability and fiduciary duty, essentially advocating the implementation of guidelines and mechanisms to ensure good behaviour and protect shareholders. Another key focus is the economic efficiency view, through which the corporate governance system should aim to optimise economic results, with a strong emphasis on shareholders welfare."

In brief, corporate governance is the system of controls to ensure that investors can assure themselves that they will get their investment back.

Jensen and Meckling (1976) developed the agency theory of shareholder-manager relationships as a 'nexus of contracts' between the principle, i.e. the owners and the agent, i.e. the managers. The agent is delegated power to make decisions and spend the principle's money on behalf of the latter. With this arrangement there arises possible problems. The separation of ownership and control dictates that the managers have increased power and levels of information than the owners and could, without monitoring and regulation, not act in the best interests of the shareholders. These agency problems can happen in many ways too numerous to list here but Jensen and Meckling (1976) realised some problems such as Moral - Hazard problems particularly relevant to the UK and US because of the market based contracting economies.

Corporate governance is varied in almost every country depending on a number of factors such as the economic development of the country, the strength of the legal system, the stability of the government but despite this the U.K is decidedly different from that of it's neighbouring regions in the E.U. There is a unitary board of management and a broader shareholder bases as well as hardly any dual shares and no pyramid structures. (Franks et al. 2004) An examination of the history and development of corporate governance and legislation in the U.K may provide some answers to the considerable differences that have occurred in contrast to many other European countries and worldwide.

History

The current situation as already stated is very different to it's European counterparts. Many of the differences originate from the high protection of minority shareholder rights which stems from the common law system built on English medieval law. This law system's flexibility facilitated change throughout the 20th century.

Many years before the phrase 'corporate governance' was even coined, scholars such as Adam Smith (1838) and Berle and Means (1932) realised the potential problems involved between investors and management and the separation of ownership and control in industrialised countries such as the U.K. Like many of the U.K's European counterparts the U.K had many large and successful family owned companies such as Cadburys, Rowntree and Beechams in the 19th and early 20th century. The transition that occurred in Great Britain from family owned corporations to a dilution of large majority blocks of family owned shares happened fairly rapidly throughout the 20th century and leads us to the present situation of "institutional and widely dispersed ownership". (Monks 2001)

A strange situation has occurred in the United Kingdom in that there are few family owned companies and of them the family usually owns only a small share of the company. In most other countries family owned business's account for a large share of the concentration of ownership. Although the family owned company was commonplace in the U.K and in Europe in the 20th century, Chandler (1990) noted a difference between the types of ownership and control. Whereby in Europe family ownerships began to delegate managerial roles yet retained financial ownership the opposite trend was occurring in Britain as family owned firms had their ownership stakes diluted yet held a disproportionate number or seats on the management boards, quite often as Chairman. This type of "power without responsibility" may have been the cause of the criticism throughout the 20th century that the managers of Britain's large companies were "behind the times" and "plagued by stolid conservatism". (Aldcroft 1964).

Through acquisitions and the issuing of more shares, the power that many prominent families had on a company were simply diluted again and again to more resemble the diverse shareholder base apparent in the UK today.

Franks et al (2004) notice that there were trends of frequent takeovers and acquisitions in the 20th century and it was only the strengthening of the rights of minority shareholders that slowed these effects. Institutional investors started to become the major shareholders and a regulated market