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For many years executive remuneration has been one of the ‘hot topics’ in corporate governance. Each year there is a furore around executive remuneration with the remuneration of CEOs often being a particular area of contention. This year we have seen the spotlight focussed on the remuneration of CEOs at high profile companies such as BP and WPP resulting in much shareholder comment and media attention.

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Discussion on company law and corporate governance tends to focus on the role of the board of directors, the shareholders, the creditors, and the auditor, but surprisingly little attention is paid to company secretaries. Indeed, outside of the corporate sector, it is likely that many people would never have heard of the office of company secretary.

The post No “mere servant”: The evolving role of the company secretary appeared first on OUPblog.

What is Corporate Social Responsibility (CSR) all about? Companies appear to be adopting new attitudes and activities in the way they identify, evaluate and respond to social expectations. Society is no longer treated as a ‘given’, but as critical to business success. In some cases this is simply for the license to operate that social acceptability grants. In others, companies believe that favorable evaluations by consumers, employees and investors (who are, after all, members of society) will improve business performance.

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The limited liability company was one of the most significant inventions of the nineteenth century. The state permitted the incorporation of corporate entities, with many of the legal rights of a person, whilst limiting the liability of their owners for the companies’ debts. Elegantly simple, the limited liability company proved amazingly successful. Unfortunately, the idea was so successful that today the notion has become confused and immensely complex. The entire concept needs reinventing.

The post Wither independent audit? appeared first on OUPblog.

By William Lazonick and Tony Huzzard

In manufacturing plants all over the world, both managers and workers have discovered that when employees are involved in workplace decision-making, productivity rises. So in the United States, it made national news when on 14 February 2014 workers at the Volkswagen auto plant in Chattanooga, Tennessee rejected representation by the United Automobile Workers by a vote 712 to 626.

Unfortunately, the Chattanooga workers said no to just the type of employee involvement in productivity improvement that will be necessary to sustain their jobs going forward. To compete on the world stage, a strong employee voice in the workplace matters.

The UAW’s Chattanooga campaign would have made Volkswagen the very first foreign car company to a have a unionized plant in the United States. More importantly, a victory for the UAW was a precondition for the creation of a works council at the Chattanooga plant — a form of worker-management plant-level collaboration for improving manufacturing productivity that is a fixture of German industrial relations, but virtually unknown in the United States. Through information-sharing and problem-solving, the managers and employees on a works council improve product quality, speed up production processes, and reduce materials waste. It’s a win-win.

If American workers want to ensure the competitiveness of their manufacturing jobs, they should jump at the chance of instituting this type of forward-looking arrangement, one that enables their voice to influence the productivity of the work that they do. A large body of evidence shows that the involvement of workers in enhancing productivity increases both the earnings of workers and the competitiveness of the products that they produce. There is fresh evidence of the importance of worker involvement in the productivity improvements that contribute to making their own jobs, and the companies for which they work, competitive on a global scale.

In-depth case studies of automotive supply companies in Germany, Sweden, and the United States — comparing governance regimes and work organization at the plant level — have shown that the automotive supply industry requires creativity and learning from its workers to generate products that are competitive in terms of both quality and cost. The ability and incentive of workers to use their insights and intelligence to contribute to productivity improvements depends on the organization of work at the plant level. High-performance workplaces, characterized by “high road” jobs in which productivity improvements and pay increases go hand in hand, are critical to sustained competitive advantage.

Our research reveals the important role of employee voice mechanisms in high-road work designs, not just in German and Swedish automotive suppliers where worker involvement is formally recognized, but also in supplier firms in the United States where productivity is generally viewed as solely management’s concern. Employee representation in strategic decision-making substitutes a stakeholder approach for the one-sided emphasis on “maximizing shareholder value”—a flawed ideology embraced by business schools over the past 25 years in which all that matters is the company’ stock price. Our research confirms, and helps to explain, a larger body of industrial experience that shows that compromises between the financial interests of shareholders and the productive interests of employees have had considerable success in continental Europe. To succeed in global competition, the US automobile industry needs more, not less, employee voice.

Different nations favor different forms of employee voice. German firms have works councils at the plant level, and in companies with 2,000 or more employees, under the system known as co-determination, equal representation of workers and shareholders on the board of directors, plus one neutral seat. Whether at the plant level or the board level, change requires workers’ input and consent.

In Sweden, union representatives have the more prominent role. Since 1976, Swedish companies have been regulated by an act of parliament, the Co-determination Act, stipulating that company management must consult unions prior to taking decisions on major changes such as corporate reorganization, new work conditions, or the introduction of new technology. Although this requirement ultimately does not displace managerial prerogative, it does give time for unions to investigate the matters being decided and consult with members at central and plant levels prior to decisions being made. In practice, the co-determination regulations are codified in collective agreements across the companies concerned. Not only do these arrangements for employee voice allow for better road-tested decisions in firms; they also confer greater legitimacy on the management of change. For this reason, initial employer opposition to this form of employee voice has now given way to broad acceptance.

In the United States, in publicly listed companies, the ideology of maximizing shareholder value reigns supreme, even though, it is an ideology that enables top executives and corporate raiders to extract value from companies at the expense of value creation. Nevertheless, one of the US companies that we studied had a 100 percent Employee Owned Stock Plan (ESOP) in which the scope for self-dealing by top executives is much more constrained. And in two publicly listed US companies, plant managers had instituted programs for tapping workers’ knowledge, with UAW members involved in one of the cases. Indeed, the workers at the unionized plant had only recently elected to have the UAW represent them because of the protection that it afforded against their jobs being shipped overseas.

The UAW has been seeking to become more proactive in questions of labor’s voice in productivity improvement. UAW president Bob King assumed his position four years ago, coming off his work as UAW vice-president in structuring wage concessions to Ford Motor Company that helped to keep it solvent in the 2008-2010 automotive industry crisis, while General Motors and Chrysler went bankrupt and had to be bailed out by taxpayers. But as King made the cost-cutting bargains at Ford, he also placed worker-management productivity agreements on the agenda as a sustainable way to keep automobile plants competitive in the United States.

UAW rules hold that King, now age 67, cannot run for re-election as UAW president at the end of his term in June of this year. But the “high road” drive to improve the productivity of manufacturing jobs rather than pursue the “low-road” alternative of cutting workers’ wages needs to transcend his presidency. The evidence shows that to sustain high-road jobs while maintaining workers’ standards of living in advanced economies such as Germany, Sweden and the United States, workers’ voice in improving competitiveness needs to extend beyond the plant level to include restraints on corporate financial policies that enable rapacious company executives and Wall Street predators to appropriate corporate cash while leaving workers with low pay or out of work.

German-style works councils are by no means a complete solution to the problem of generating competitive products in high-wage nations. As a foundation for engaging workers in the process of productivity improvement, however, the “high road” alternative presented by the VW Chattanooga union election was a choice that American workers should have embraced.

A version of this article originally appeared on Alternet.

William Lazonick is professor of economics and director of the UMass Center for Industrial Competitiveness. He cofounded and is president of the Academic-Industry Research Network. His book, Sustainable Prosperity in the New Economy? Business Organization and High-Tech Employment in the United States (Upjohn Institute, 2009) won the 2010 Schumpeter Prize. Tony Huzzard is professor of organization studies at the Department of Business Administration, Lund University School of Economics and Management. Inge Lippert, Tony Huzzard, Ulrich Jürgens, and William Lazonick are the authors of Corporate Governance, Employee Voice, and Work Organization: Sustaining High-Road Jobs in the Automotive Supply Industry.

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Image credit: welding robots in a car manufactory. © RainerPlendl via iStockphoto.

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By Christine Mallin The disquiet over excessive executive remuneration packages and a lack of appropriate links with relevant performance measures has been a matter of concern in recent years. After the financial crisis, there is even more of a focus on this aspect with shareholders becoming increasingly frustrated with both the amount and the design of executive remuneration packages.

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By Christine Mallin

In late February, Lord Davies’ report on ‘Women on Boards’ was published.

The report was awaited with much speculation especially as to whether he would recommend quotas whereby listed companies would have to have a certain proportion of female board members.  Brian Groom reported that Lord Davies, had rejected quotas and that ‘only 11 per cent of submissions were in favour of quotas and the vast majority of women were vehemently opposed’ to quotas.  The report stated that ‘we have chosen not to recommend quotas because we believe that board appointments should be made on the basis of business needs, skills and ability’.

From their consultation, the report identified that ‘the informal networks influential in board appointments, the lack of transparency around selection criteria and the way in which executive search firms operate, were together considered to make up a significant barrier to women reaching boards.’ Aiming to improve the situation and increase the number of women on boards, the report has made ten recommendations including, inter alia, that FTSE 100 companies should aim for a minimum of 25% female representation by 2015 and that all Chairman of FTSE 350 companies should set out the percentage of women they aim to have on their boards in 2013 and 2015; quoted companies should be required to disclose each year the proportion of women on the board, women in senior executive positions and female employees in the whole organisation; the Financial Reporting Council (FRC) should amend the UK Corporate Governance Code to require listed companies to establish a policy concerning boardroom diversity, including measurable objectives for implementing the policy, and disclose annually a summary of the policy and the progress made in achieving the objectives; investors to pay attention to the report’s recommendations as part of their central role in engaging with companies; and executive search firms should draw up a Voluntary Code of Conduct addressing gender diversity and best practice which covers the relevant search criteria and processes relating to FTSE 350 board level appointments. Moreover this steering board led by Lord Davies will meet every six months to consider progress against these measures and will report annually with an assessment of whether sufficient progress is being made.

Companies themselves can provide support and encouragement through mentoring schemes.  Executive recruiters (or ‘headhunters’) also have a role to play as Gill Plimmer and Alison Smith report in their article ‘Agencies to help break glass ceiling’.  The pressure is on for headhunters to put forward more women candidates to companies for consideration for board positions.

Internationally, some countries have quotas, others do not.  As Joe Leahy reports, women executives may find it easier to climb up the corporate promotions ladder in Brazil but getting to the top rung can still be very difficult. For example, in Brazil the percentage of women board directors is only 8%, and to be appointed to the CEO position is even more difficult. In the European context, Daniel Schäfer and Peggy Hollinger point out that in 2010 only 2.2 per cent of executive board members at Germany’s 30 blue-chip DAX companies were women. They also highlight that in Germa

By Kirsty McHugh, OUP UK

One of the main areas in corporate governance that has caught the headlines recently is risk management. There is a widely held perception that in recent years many boards have not managed the risks associated with their businesses well – whether that was because they did not identify the risks fully or whether because having identified the risks, they did not take appropriate action to manage them. In the below post, Professor Chris Mallin explains more about this. She is Professor of Corporate Governance and Finance & Director of the Centre for Corporate Governance Research at the University of Birmingham, and blogs with fellow OUP author Bob Tricker at Corporate Governance. She is the author of Corporate Governance, the third edition of which has just been published. Her other blog posts can be found here.

The Financial Reporting Council (FRC)’s Review of the UK’s Combined Code published in December 2009  states that ‘One of the strongest themes to emerge from the review was the need for boards to take responsibility for assessing the major risks facing the company, agreeing the company’s risk profile and tolerance of risk, and overseeing the risk management systems. There was a view that not all boards had carried out this role adequately and in discussion with the chairmen of listed companies many agreed that the financial crisis had led their boards to devote more time to consideration of the major risks facing the company.’ The FRC therefore proposes to make the board’s responsibility for risk more explicit in the Code through a new principle and provision. Moreover it also intends to carry out a limited review of the Turnbull Guidance on internal control during 2010. Many companies, and especially those in the financial sector, have already established risk committees whilst other companies especially smaller companies, may combine the consideration of risk with the role and responsibilities of the audit committee.

The UK’s Alternative Investment Market (AIM) expanded rapidly during the 12 years following its inception in 1995. Then from 2007 onwards it went into decline. David Blackwell, in his article ‘Signs of recovery seen after years of famine’  states that ‘Hundreds of companies have left the market, the number of flotations has collapsed and fines for Regal Petroleum and others – albeit for regulatory infringements dating back years – have once again sullied the market’s reputation’. Nonetheless he points out that 2009 saw an improvement with the AIM index rising by 62 per cent over the year compared to a rise of 22 per cent in the FTSE 100.

The lighter regulatory touch on AIM has both attractions and drawbacks. On the one hand, companies find it easier to gain a London listing (albeit on AIM rather than the main market); on the other hand, this may bring concomitant risks for investors as they will be investing in companies which may well be riskier than their main market counterparts.

Family firms are the dominant form of business in many countries around the world and range from very small businesses to multinationa

Chris Mallin is Professor of Corporate Governance and Finance & Director of the Centre for Corporate Governance Research at the University of Birmingham. She is the author of Corporate Governance and she blogs with fellow OUP author Bob Tricker at Corporate Governance. The below post is an adapted version of one found on that blog, and is about whether companies should split the roles of Chair and CEO. Her previous OUP posts can be found here, here and here.

It is widely recognised that corporate scandals and collapses often occur when there is a single powerful individual in control of a company. This is exacerbated when there is a lack of independent non-executive directors on the board. Therefore it seems axiomatic that powerful individuals can be constrained, and the temptations they may face conquered, by having in place a sound corporate governance structure achieved through dividing the roles of Chair and CEO.

UK Context

Back in 1992, the much lauded Report of the Committee on the Financial Aspects of Corporate Governance, often referred to as the Cadbury Report after the Chair of the Committee, Sir Adrian Cadbury, identified the potential danger of combining the roles of Chair and CEO in one person. The Cadbury report recommended ‘there should be a clearly accepted division of responsibilities at the head of a company, which will ensure a balance of power and authority, such that no one individual has unfettered powers of decision’. This principle was embodied in corporate governance best practice in the UK, with the Combined Code on Corporate Governance (2008) stating ‘there should be a clear division of responsibilities at the head of the company between the running of the board and the executive responsibility for the running of the company’s business. No one individual should have unfettered powers of decision’, and furthermore the Combined Code explicitly states ‘the roles of chairman and chief executive should not be exercised by the same individual.’

Whilst combining the roles of Chair and CEO is rare in the UK’s largest companies, Marks and Spencer PLC is a notable exception. In May 2004 Sir Stuart Rose was appointed to the position of Chief Executive and subsequently in 2008 he became both chairman and CEO until July 2011. This combination of roles goes against the Combined Code’s recommendations of best practice. As a result in 2008 some 22 per cent of the shareholders did not support the appointment of Sir Stuart Rose as chairman. Nonetheless he remains in the combined role although there is still considerable shareholder unrest and 2009 has seen more dissent by shareholders on this issue.

US Context

In the US, the roles of Chair and CEO have often been combined but now more and more companies are appointing separate individuals to the two roles. A recent example of a US company which has decided to appoint an independent chairman is Sara Lee, the famous producer of gateaux, beverages and body care products. Sara Lee has decided to make this change as a response to investor pressure and also the growing trend in the US to split the two roles. Kate Burgess in her article ‘Sara Lee to separate executive roles’ explores this case in more detail.

Institutional Investor Pressure

In the UK there has long been pressure brought to bear by institutional investors on companies which have tried to combine these roles. This pressure, together with the long history in UK corporate governance codes against the combination of roles, means that few large companies seek to combine the roles (although as noted above, Marks and Spencer plc is an exception).

Recently Norges Bank Investment Management (NBIM), a separate part of the Norwegian central bank (Norges Bank) and responsible for investing the international assets of the Norwegian Government Pension Fund, has started a campaign to convince US companies to split the roles of Chair and CEO and appoint independent chairmen. Kate Burgess  in her article ‘Norwegian fund steps up campaign’ highlights how NBIM has submitted resolutions to four US companies calling on them to appoint independent chairmen. The four companies are Harris Corporation, Parker Hannifin, Cardinal Health Inc, and Clorox. In addition NBIM has also voted against combined Chair/CEOs at some 700 US companies. Interestingly Sara Lee had also been the focus of action by NBIM before agreeing to appoint separate individuals to the roles in future. Also in Kate Burgess’ article, Nell Minow of The Corporate Library states ‘NBIM can leverage a lot of shareholder frustration and a widespread sense that this is a sensible, meaningful but not disruptive initiative’.

It seems to be only a matter of time before the vast majority of companies will split the roles of Chair and CEO. Of course the individuals appointed to those roles must be both capable of fulfilling the tasks expected of them, and of ensuring that ultimately the two roles, carried out by separate individuals, unite the company under a common leadership approach. That may prove more difficult than many imagine and so the appointments process must consider fully the many traits needed to ensure success.

Chris Mallin is Professor of Corporate Governance and Finance & Director of the Centre for Corporate Governance Research at the University of Birmingham. She is the author of Corporate Governance and she blogs with fellow OUP author Bob Tricker at Corporate Governance. The below post is an adapted version of one found on that blog, and is about the important of votes in corporate governance. Her previous OUP posts can be found here and here.

Voting ones’ shares is seen as one of the main tools of corporate governance. In recent times, votes have been cast against adoption of the annual report and accounts, against the appointment, or re-appointment, of certain directors, and against certain proposed strategies. Votes can also be used via the ‘say on pay’ to signal displeasure at executive remuneration packages. Although the ‘say on pay’ is an advisory vote, it may nonetheless be quite effective at making boards think twice about the proposed pay packages for executive directors.

However companies do not always take as much notice of the votes cast as one would like. For example, the recent annual general meeting of Marks and Spencer is a case in point as regards the use of voting as a (vociferous) voice. Andrea Felsted and Samantha Pearson in their article ‘M&S chief defiant amid revolt by investors’ highlight that nearly 38% of votes cast backed a resolution seeking the appointment of an independent chairman within the next year. Sir Stuart Rose, who has been the centre of much criticism since taking on the roles of both chairman and chief executive, did not seem overly bothered by the investors’ views on this matter. There was also much shareholder dissent over the re-election of the chairman of the remuneration committee and over the adoption of the remuneration committee report.

Withheld votes
Whilst the importance of the vote is universally accepted, let us consider what happens in the UK when a vote is withheld. A withheld vote may signal that an investor has reservations about a resolution, or it may be a stronger expression that an investor is unhappy about a resolution, whilst falling short of actually voting against the resolution. However when the ‘vote withheld box’ is ticked on proxy forms in the UK, the withheld votes are not counted as part of the votes cast. For example, after its annual general meeting in May 2009, Shell published the voting results on its website. On Resolution 1 : Adoption of Annual Report & Accounts, there were: ‘votes for’ 3,301,631,965, ‘ votes against’ 3,394,595, and ‘votes withheld’ 16,026,721. However when indicating the percentage split of the votes, ‘votes for’ are shown as 99.90% and ‘votes against’ as 0.10%. The votes withheld were nearly 5 times that of the votes against but nowhere are they reflected in the percentage totals of votes cast. Similarly, on Resolution 4 : Re-appointment of Lord Kerr of Kinlochard as a Director of the Company, there were ‘votes for’ 3,161,974,849, ‘votes against’ 77,443,311, and ‘votes withheld’ 77,876,289. The percentage allocation indicated 97.61% ‘votes for’ and 2.39% ‘votes against’. The ‘votes withheld’ which again exceeded the ‘votes against’ were not reflected at all in the percentage totals. It should be said that Shell does clearly state that “a ‘vote withheld’ is not a vote under English Law and is not counted in the calculation of the proportion of the votes ‘for’ and ‘against’ a resolution.”

The Combined Code on Corporate Governance (2008) under Code provision D.2.1, states that ‘For each resolution, proxy appointment forms should provide shareholders with the option to direct their proxy to vote either for or against the resolution or to withhold their vote. The proxy form and any announcement of the results of a vote should make it clear that a ’vote withheld’ is not a vote in law and will not be counted in the calculation of the proportion of the votes for and against the resolution. However it’s interesting to note that a decade ago, the Report of the Committee of Inquiry into UK Vote Execution (1999), published by the National Association of Pension Funds, stated that whilst it was initially attracted to the idea of adding a third box (being an ‘abstention’ or ‘vote withheld’ box), it then decided that there were several arguments against the inclusion of such a third box. Firstly it might provide investors with an ‘easy option’ so that rather than voting against, they withheld their votes; and secondly since withheld votes are not counted, and have no legal effect, then it could drive down the level of recorded votes.

However as we have seen, the Combined Code does advocate the inclusion of a ‘vote withheld’ box on the proxy form. Therefore, it could be that in practice the addition of a third box which allows a withheld vote but which is not counted, may lead to the understatement of the level of dissatisfaction with some resolutions. Given that institutional investors are coming under more and more pressure to be seen to be active owners of shares, it may be that a ‘vote withheld’ will increasingly become seen as sitting on the fence, rather than taking a decision to vote against. In the US, it would seem that abstentions do have a legal effect under a majority voting system. For example, in a director election if there were more votes withheld than were voted for the candidate, then the candidate would not be elected, hence the abstentions (votes withheld) would have a legal effect.

Broker votes
Turning to US issues, the SEC has recently made some important changes to proxy voting. Weil, Gotshal and Manges (2009) report that ‘the SEC approved a change to NYSE Rule 452, eliminating broker discretionary voting of uninstructed shares in uncontested director elections, which will have the effect of reducing the number of votes cast in favor of the board’s nominees in the election of directors and strengthen the influence of institutional investors and activist shareholders.’

Blank votes
However James McRitchie has brought to our attention the problem of blank proxy votes which go to management. He highlights that fact that the broker vote issue that the SEC took care of is ‘where retail shareowners don’t submit a proxy (or voter information form) at all. When that happens, the broker or bank can vote within 10 days of the meeting. The “blank vote” issue arises when the shareowner votes at least one item on their proxy but leaves some other items blank……..[the voting] platform for institutional investors doesn’t allow submission of blank votes, [but the] platform for retail holders does and the SEC allows them to fill in the blanks as instructed by brokers and banks (always with management)’. Furthermore he states that ‘As shareowners who believe in democracy, we have filed suggested amendments to take away that discretionary authority to change blank votes, or non-votes, as they might be termed. We believe that when voting fields are left blank on the proxy by the shareowner, they should be counted as abstentions.’

Clearly the area of voting is a complex one and changes are being brought in over time to remove barriers to voting and to help ensure that votes are cast in a way which fairly reflects the owners’ intentions. A decade ago it would have seemed highly unlikely that many institutional shareholders would publish their voting levels in individual companies and on individual resolutions but many institutional shareholders now do this. In the US a number of institutional shareholders have gone a stage further and disclose their voting intentions prior to a company’s AGM. Hopefully institutional shareholders in other countries will adopt this approach in future.

Chris Mallin is Professor of Corporate Governance and Finance & Director of the Centre for Corporate Governance Research at the University of Birmingham. She is the author of Corporate Governance and she blogs with fellow OUP author Bob Tricker at Corporate Governance. The below post is an adapted version of one found on that blog, and is about the calls for wider adoption of a ’say on pay’ in the US. Her previous OUP post can be found here.

Widespread concern at the high levels of executive director remuneration has led to calls for wider adoption of a ‘say on pay’ in the US. Investors in the UK and Australia have, for many years, had the right to vote on the remuneration committee report of the companies in which they invest. The vote on the remuneration committee report is an advisory one meaning that it is not binding on the company. However in practice institutional investors have tended not to vote against the remuneration committee reports and on the – until recently – relatively rare occasions on which the remuneration committee report was voted against, it was seen as a strong signal of disapproval about some aspect of executive remuneration and one which the directors would be unwise to ignore.

Royal Bank of Scotland
It was no surprise to anyone that the Royal Bank of Scotland shareholders overwhelmingly rejected the banks remuneration committee report at the companies Annual General Meeting on 3rd April. Jane Croft and Andrew Bolger in their article ‘Thumbs down for RBS pay report’ stated that some 90.42% of votes cast rejected the report. UK Financial Investments Ltd (UKFI) the Government owned company which manages the taxpayers’ shareholding in RBS, and controls 58% of the RBS shares, voted against the report. Manifest, the proxy voting agency, stated that ‘the resolution on the remuneration report at Royal Bank of Scotland Group plc represents the highest ever “Total Dissent” vote on the remuneration report since the introduction of the requirement for the report to be put forward to a non-binding vote’.

Remuneration (compensation) committees
Remuneration committees have previously been criticised for having a ratcheting effect on executive directors’ remuneration. The composition of such committees is usually independent non-executive (outside) directors but nonetheless this has not stopped the increasing levels of executive remuneration. This is probably in part attributable to the fact that remuneration committees would tend to recommend remuneration for executive directors in the upper quartile of their peer group hence the ratcheting effect over time. The Corporate Library points out that, in the US, chief executives pay rose 24 percent in 2007 giving a median remuneration of $8.8 million.

Trade Unions Involvement
An interesting development is for trade unions calling for more worker involvement in setting top executive pay. Brian Groom in his article ‘TUC leader urges staff input over chiefs’ pay’ highlights that Brendan Barber, General Secretary of the Trade Union Congress (TUC), stated ‘there was “massive anger” among workers at paying the price for a recession made in the boardroom, not on the shop floor’. The directors of FTSE 100 companies came in for criticism as well as the directors of banks, with Mr Barber arguing for ‘workforce representation involved in remuneration committees of major companies’. The idea of representation of the workforce on the board or board committees has traditionally not been given much consideration by UK boards but maybe that might change in the future.

Shareholder proposals/resolutions
Another are where we may see change is in relation to shareholder proposals or resolutions. Although it is possible in the UK for shareholders to put forward shareholder proposals or resolutions, it is not that easy to do and hence dialogue has been the most frequently used tool of corporate governance with shareholder proposals maybe numbering just five or six a year.

In the US it is much easier to put forward a shareholder proposal and so we can see 800 or 900 of these each year in US companies. It is likely that in the future more of these shareholder proposals will be relating to executive remuneration and that they will achieve strong support from institutional investors who are increasingly being criticised for not having taken more action to help limit executive remuneration. Francesco Guerrera and Deborah Brewster in their article ‘Mutual funds helped to drive up executive pay’ highlight that mutual funds have tended to vote in favour of companies compensation plans and this has effectively sanctioned these spiralling executive remuneration packages. Kristin Gribben in ‘Pay proposals to dominate proxy season’ puts forward the view that, in future, mutual funds in the US will be more likely to support remuneration (compensation) related resolutions filed by shareholders.

Back-door pay
There is concern that some companies may seek to remuneration executive directors via the ‘back-door’ if, for example, bonus schemes do not pay out. Pauline Skypala in ‘Warning over “back-door” pay’ highlights that this is a concern to some investors including Co-operative Asset Management whose corporate governance manager, Paul Wade, states ‘If a company fails to create value for its shareholders, it is totally inappropriate to grant rewards to management that are disproportionate to shareholder returns’.

Future developments
With the continuing focus on executive directors’ remuneration packages, the forthcoming AGMs promise to give rise to many interesting debates, much emotive discussion, more shareholder proposals, and many more instances where ‘say on pay’ will result in an emphatic ‘no’ to excessive remuneration or remuneration which does not have appropriately stretching performance links.

Bob Tricker was the founder-editor of Corporate Governance: An International Review and is a retired Fellow of the Institutes of Chartered Accountants and Chartered Management Accountants. He is also the author of Corporate Governance: Principles, Policies and Practice. Bob Tricker blogs with fellow OUP author Chris Mallin at Corporate Governance. The below post is an adapted version of a post from that blog, and offers a controversial solution to the regulation of corporate entities and the role of auditors.

A crucial question
In the ongoing crisis facing financial institutions around the world, plenty of questions have been asked: did boards fail in their fiduciary duty to their shareholders; was creative accounting or fraud involved; did directors understand the business models their management was using or appreciate the risks involved; why did the independent outside directors (who are supposed to protect the interests of investors) not see the dangers; did the regulators fail or, worse, had they been taken over by the industry they were supposed to regulate; were the credit agencies at fault ; and, most frequently, did short-term performance bonuses paid to top management encourage greed and excessive risk taking?

But a crucial question remains that has not had much exposure: where were the auditors? Unqualified audit reports up to the collapse had concluded that the directors’ reports and accounts reasonably reflected reality. Yet, as we now know, the strategic model underlying the securitisation of mortgage debt and the expectation that financial markets would always be liquid was highly suspect, and could expose businesses to massive risk, even the possibility of trading when insolvent and ultimately failing.

The role of audit
The original 19th century model of the joint-stock limited-liability company was a brilliant invention. Incorporate a corporate entity with many of the legal attributes of individuals - contract, buy, sell, employ, sue - but without exposing the investors to financial risk beyond their original equity stake if the business failed. The idea enabled the creation of untold employment, personal wealth, and economic growth in the following century and a half.

But when states permitted the incorporation of limited-liability entities they demanded safeguards to protect society. The aims of the enterprise, its financial scope, a registered office, the names and addresses of its directors, and regular reporting were all required. Although the concept of the corporation called for directors to show a fiduciary duty to their shareholders, legislators were not naive. They knew that not all directors could be trusted. Auditors were required.

Initially, these auditors were appointed from amongst the shareholder members of the company. They reported to the other investors that the directors of their company had faithfully recorded the company’s financial situation. In 1872, for example, the audit committee of the Great Western Railway Company (GWR) in England reported to their colleague shareholders that “the various matters that concerned the finances … were highly satisfactory.” However, unlike today’s audit committees, which are made up of independent outside directors, the GWR’s committee was staffed by shareholders.

Interestingly, that GWR committee also reported that it had been supported in its work by Mr. Deloitte, a family name still familiar in today’s auditing business. Gradually, an auditing profession emerged. At first audit professional partnerships were small. But, as companies grew in scale and complexity, they grew larger. The relaxation of rules on the maximum number of partners and mergers enabled further growth. By the end of the twentieth century the world’s major listed companies were all audited by just five vast international accounting firms.

However, the auditors’ duty in essence had not changed from the founding years. It was still to report that the information given by the directors to the shareholders reasonably reflected the truth.

But the relationship of the auditors to the companies they audit had changed. As scale and complexity increased, the role of the auditors properly became more professional. Inevitably, their relationships with the directors of their client companies grew closer. Although in many jurisdictions the shareholders still voted on a resolution to appoint the auditors, it was the board of directors who really made the decisions. And although nominally the auditors’ reports were addressed to the shareholders, their detailed comments went to the directors.

Inevitably, a close relationship developed between the auditors and the staff of their client, particularly in the finance department. Issues that arose during the audit - questions about asset valuations, capital or revenue decisions, risk assessment or management control, for example - could be resolved without the board even being aware of them. So audit committees were introduced, first in the US and then, following the Cadbury Report, in the UK and around the world. Sub-committees of the main board, these audit committees relied on independent outside directors to provide a bridge between company and auditor, avoiding too close a relationship between executive directors and audit staff, and ensuring that all directors were fully aware of audit issues.

Following the Enron debacle, in which an energy company had effectively turned itself into a financial institution (also through securitisation), the requirements of the Securities and Exchange Commission in the US and subsequently the listing rules of stock exchanges around the world were changed. The rotation of managing audit partners, the prohibition of consultancy work by auditors for their clients, audit committees composed entirely of independent directors, and a cooling-off period before audit staff could join the finance department of a client were all demanded.

Audit: profession or business?
But I believe the issues go deeper. The real question is whether audit and accountancy is still a profession or has become a business. Do the auditors offer a service to management or are they still part of society’s regulatory function?

My early experience as an accountant was with a professional audit practice which provided service for a fee. The number of partners was small. The phrase corporate governance had yet to be coined. Of course, our partners were keen to be successful. In their community they were respected and well to do; but they were not rich. Neither would they compromise their principles. They would not sign an audit report, stating that the client’s account’s showed a true and fair view, unless the partner was personally convinced that they did. Better to lose a client than your integrity. This was a profession, after all. The audit process demanded absolute objectivity of thought and independence from the client

How different today. By the beginning of the 21st century, the five major accounting firms had become vast, international and concentrated. They were major businesses, offering products and solutions, with market share and profit performance as watchwords. Partners were judged by fee generation and growth. Partners’ expectations were inevitably influenced by the remuneration levels of their ‘fat cat’ clients. Then in 2002, one of the five, Arthur Andersen, collapsed, brought down by the Enron catastrophe. Then there were four.

But auditing is not astrophysics, even though recent government funding to bail out failing institutions may seem astronomical. True, the work demands detailed, intense and up-to-date work, but it is not actually difficult. Admittedly, too, these days the risks of litigation and forced resignation are higher. But the real challenge lies in determining standards and living up to them, as it always did.

So I have come to the conclusion that auditing has ceased to be a profession: it has become a business. Of course the business world has changed. Nostalgia has no place in strategic thinking. There is no going back to the profession of half a century ago. But I suspect that, unless auditing rediscovers what it means to be a profession and returns to its roots, state regulation of the audit process will have to be imposed to protect creditors, investors and the wider community.

Serious questions have to be asked about the auditors’ position. Where does the auditors’ loyalty lie: directors or shareholders? Who are their real clients: the board or the investors? The de jure response that the client is the company and that somehow this means the body of shareholders will no longer wash. The de facto reality is that the client is the board, working through the board’s audit committee. Is this satisfactory under current circumstances?

Ways ahead
Predictably, there have been calls for more regulation, introducing further rules to regulate auditors’ activities. Following Enron and the global collapse of Andersens, this was the approach adopted in many countries: the 2002 Sarbanes Oxley Act (SOX) in the US, the 2006 new Companies’ Act in the UK, and tighter regulation and stock exchanges’ listing rules everywhere.

But SOX has proved far more expensive, demanding, and bureaucratic than expected. Some argue that it has also proved less effective, as seen in its failure to identify the exposure underlying the financial institutions that have collapsed. Demands for rethinking the role of the SEC and the world’s other regulators, particularly over financial institutions, have been loud.

Another response has been a call to open the audit market, with second tier firms playing an increasing role in the audit of major listed companies. There has been some movement in this direction. But institutional investors like the assurance they believe they get from an audit opinion signed by one of the big four firms. Predictably, the partners of the firms in this global oligopoly do not favour this solution.

But there is a third alternative that has not been considered, Face reality, require auditors to be appointed by and report to the state, or society if you prefer. After all, it is the state that permits companies to incorporate and operate, and the state that is responsible for protecting the interests of investors, creditors and other stakeholders. That is why we have regulators.

Actually, this suggestion need not be quite as stark as it initially appears. In essence the regulatory structures already exist to manage such a relationship, although they would certainly need enhancing. The regulators, working with the shareholders, would appoint, re-appoint and if necessary replace the auditors, agree their fees and receive their reports. The company would, as now, bear the costs.

Reporting to the regulator, rather than the directors, would need auditors to develop a new mind set. Shareholders, particularly the institutional shareholders, would have a direct line to their auditors and the board’s audit committee. Comfortable relationships between directors and auditors would be at an end. Of course the partners of the big four would object, but society has to decide what is best in the long term.

A start could be made by focusing on the regulation of those companies that have just been massively funded by government. Surely, the auditors of companies that have been bailed out, and are now partly, and in a few cases wholly, owned by the state should no longer report solely to the directors. He who pays the piper…

Eventually, such an arrangement could be applied to all listed companies. Investors would know that their auditors worked for them, boards would rediscover that their primary fiduciary duty is to their shareholders not themselves, and trust would be restored, just as in the original 19th century model.