Speech by Sir Adrian Cadbury at the FRC's 20th Anniversary of the Corporate Governance Code Event
News types: Speeches
Published: 6 November 2012
Find below the plain text version of Sir Adrian Cadbury's speech at the FRC's 20th Anniversary of the Corporate Governance Code Event on 6th November 2012.
First I must thank most warmly those who have organized this celebration of twenty years since the publication of the Committee’s Report and Code of Best Practice and I want equally to thank those who have so kindly written to commemorate this anniversary. I cannot think of a more festive and appropriate way of drawing to a close an unexpected and eventful chapter of my life. It opened early in 1991 when Sir Ron Dearing, on behalf of the Committee’s sponsors, invited me to chair the Committee, which had already been formed and whose terms of reference had already been agreed.
The Committee had been established in the wake of the collapse of two major quoted public companies, whose audited accounts gave no indication of the true state of their financial affairs. This led to a lack of confidence in the reliability of reports and accounts and by extension to London as a financial centre. The Committee saw as its causes, loose accounting standards, uncertainty over the control responsibilities of directors, and competitive pressures on companies and on auditors.
These concerns were heightened, soon after the Committee began its work, by the collapse of BCCI and of Robert Maxwell’s enterprises. Maxwell’s sensational and disastrous fraud went well beyond the issues of financial reporting and control, which were the Committee’s main focus. Maxwell, who had in earlier years been given a red card by the Department of Trade, dominated an entirely ineffective board of his own choosing and attempted to shore up his failing business by pillaging the company pension fund. This led the Committee unavoidably to widen its remit from the financial aspects of corporate governance to corporate governance itself, and the responsibilities of boards.
The Committee took evidence on the causes of weaknesses in the way in which boards discharged their responsibilities for financial reporting and controls and found, not unexpectedly, a wide spectrum of board effectiveness. There were fortunately enough well-regarded public companies, on whose experience and competence the Committee could draw, in order for it to be able to base its recommendations on best practice. Too many directors and boards however were unclear about their precise responsibilities and there was no guidance to be found in the Companies Acts on the role of boards.
The fundamental failure throughout was to distinguish between governance, which is the responsibility of the board, and management, which is the task of the executives, appointed and monitored by the board. The responsibilities of governance include determining the company’s purpose and the strategy for achieving that purpose, setting the tone of the enterprise and planning succession. It is for management to turn purpose into action. The strict sense of accountability of boards for their stewardship is diminished, if the line between governance and management is blurred. There is a temptation for boards to meddle in management, because managing is more engaging, in both senses of the word, than governing. This is incidentally as much of an issue for trustees, as it is for board directors.
The Committee found the distinction between governance and management was further weakened, because the posts of chairman and of chief executive were combined in over half of the top 1000 companies. In addition, twenty years ago, both the role and the effectiveness of non-executive directors were ambiguous. It was customary for chairmen to appoint non-executive directors from among the circle of those whom they knew. The weaknesses of this form of selection are obvious. A key recommendation of the Code to improve board effectiveness was therefore that: "Non-executive directors should be selected through a formal process and both this process and their appointment should be a matter for the board as a whole." Many boards at the time had too much of the flavour of a club, with collegiality taking precedence over constructive questioning and challenge.
Structurally, the governance role of boards was weakened by the absence of support from appropriate committees of the board. Only just over half of the top 250 UK industrial companies even had audit committees. Few had remuneration committees and even fewer nomination committees. This meant that boards were loaded with detailed managerial work at the expense of time for governance. Equally, opportunities were being missed to involve non-executive directors, through membership of board committees, thereby enabling them to gain a greater understanding of their companies and to work with senior staff.
The recommendations of the Code aimed to clarify the duties of directors and boards and to strengthen their governance role. They also drew the line between the respective responsibilities of directors and of auditors for the integrity of the report and accounts. The Committee’s objective was to make the existing system and structure of unitary board governance more effective, not to invent a new one. Implementation of the Code was to rely on market not statutory regulation.
The Committee’s first step in gaining support for the recommendations in its Report and Code was to issue a draft report, to encourage comment. This was to achieve two purposes. First it was to gain a mandate for the manner in which the Committee had interpreted its task. A Code of Best Practice for companies, supported by recommendations to investors, and guidance for auditors and the accountancy profession, went further than the corporate sector would have envisaged, when the Committee on the Financial Aspects of Corporate Governance was launched. Its implementation however depended on broad acceptance by the corporate sector. The second purpose was to test and to revise the Committee’s approach in the light of informed comment. The draft drew a wide and constructive response, of which the Committee took note and which encouraged the Committee to proceed on its existing path.
The Committee saw compliance with the Code of Best Practice as being in the self-interest of companies and of investors. The basis of the Code was disclosure. Openness by companies of their systems and processes of governance was the key to informed market regulation. Agreement by the London Stock Exchange to make it a condition of listing for quoted companies to report on how far they complied with the recommendations of the Code and to give reasons for areas of non-compliance was crucial. "Comply or explain" is perhaps the most enduring legacy of the Committee’s work and the one most widely adopted internationally.
The Committee fulfilled its remit with publication of its Report and Code in December 1992. It further published its Monitor on compliance with the Code in May 1995, when handing over to its successor body. What was striking was how quickly and how widely companies accepted the Code’s recommendations. The Monitor has not perhaps received the attention which it deserved.
I would like to draw attention to certain aspects of the Code. Although the Code was directed primarily to publicly-quoted companies, the Report encouraged as many other companies as possible to meet its requirements. Essentially the recommendations of the Code were not rules. They were principles or guidelines for companies to follow in ways which made sense in their particular circumstances. In terms of "comply or explain", both were equally valid responses. Explanation carried the same weight as compliance, with the market not the committee as judge of their validity. A central aspect of the Code’s recommendations, being guidelines, was that they were aspirational. They did not set a floor to governance standards, as statutory rules would have done, but they formed a starting point.
In the same way, the Code left it to boards to determine which non-executive directors were deemed to be independent, independence being broadly defined. Responsibility for such decisions and for those over the age and length of service of board members should in my view primarily rest with chairmen and their boards. External definitions of eligibility of board members may be useful as investor guidelines, but should not pre-empt the judgement of chairmen and boards.
While support for the Code was extremely heartening, there naturally were criticisms. Some considered that it would fetter enterprise, others that it had no teeth. There were complaints that auditors had been let off too lightly. The most fundamental concern appeared to arise from the Report’s emphasis on the importance of the role of non-executive directors and on the formation of committees of the board. They were feared by some as potentially dividing the board and thereby leading to a de facto two-tier board by the back door. This was a misunderstanding. As the Report made clear, all directors were equally responsible for the leadership of the company and while board committees made recommendations to the board, the decisions on those recommendations were those of the board as a whole. I saw it as my task after publication of the Report and Code to respond to all invitations to discuss the Committee’s findings. I wanted to explain how the Committee had arrived at its conclusions and the reasoning, which lay behind the recommendations of the Code.
For me, the last twenty years have been enormously rewarding in terms of the intellectual challenges they have presented and of the lasting friendships they have brought. I believe that in that short space of time boardroom effectiveness in this country has been transformed. The extent to which that is due to the work of our Committee is for others to judge. I look forward to the forthcoming publication of a history of the Committee by Professor Laura Spira and Judy Slinn, who have painstakingly pieced together all the information about the Committee which they can gather, in the absence of the official minutes which have mysteriously disappeared.
May I finish by once again thanking most warmly the Stock Exchange for their hospitality and those who have arranged this much appreciated celebratory event.