You are required to discuss the arguments for and against the introduction of statutory controls on corporate governance.

Advanced Financial Management Block Revision Mock Exams

Arguments for the introduction of statutory controls on corporate governance include the following:

(1) there already exist a raft of statutory controls on corporate governance, mainly in the Companies Act. For example companies must appoint auditors, directors can be removed according to standard procedures, and directors may not generally receive loans from their companies. What we are arguing here is whether the present statutory controls should be extended. It is fair to say that the existing controls have rather developed on a piecemeal basis, prohibiting specific acts when they have been observed in practice; thus the statute has lagged behind the reality. It would be more satisfactory if statutory controls could be developed at the same pace as developments in practice, though this ideal situation is impractical.

(2) the board of directors is supposed to act in the best interests of shareholders. However there may be situations where the interests of shareholders diverge from the managers‟ own interests; this conflict can be so strong that statutory controls are required to ensure that companies are run in the best interests of the shareholders. An example is directors‟ remuneration and service contracts. Directors

might want large remuneration and contracts offering large compensation if they are sacked. The Companies Act requires total remuneration paid to directors to be disclosed.

(3) a further conflict arises where auditors are appointed the directors, and the directors fix their remuneration, yet they report to the shareholders. There is a temptation for auditors to which to please the directors who have appointed them, rather than to act objectively in the shareholders‟ best interests. The independence of mind of auditors is guaranteed their professionalism required the Companies Act.

(4) the best way of ensuring good governance is likely to be the threat of further statutory controls. When directors see that a government is sincere in wishing to encourage good governance, the worst practices will be stopped for fear of attracting new legislation.

Arguments against the introduction of new statutory controls on corporate governance include the following:

(1) one cannot legislate against evil. If a bad man is determined to carry out a fraud, whether or not controls are enshrined in statute will be irrelevant.

(2) statutory controls may stifle individual entrepreneurship. Many companies have flourished in recent years because of the existence of one strong individual business person combining the roles of chairman and chief executive and pushing through their will, eg. Hanson in the UK. If the Cadbury recommendation to split the role of chairman and chief executive wherever possible had been enshrined in statute, such companies may not have enjoyed the success that they did.

(3) putting rules into statute encourages companies to obey the letter of the law rather than the spirit. The whole experience of the Securities and Investments Board in implementing the Financial Services Act regulations has proved that detailed rule books are an ineffective means of regulation. Statute should contain broad rules, backed up self-regulatory practice notes and points of interpretation. It is this latter approach that has been adopted the Accounting Standards Board in drawing up its new accounting standards, an approach that has proved successful to date. The Cadbury recommendations should follow this same successful course of action.

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