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Comparative Analysis of Codes of Corporate Governance Implementation in the United Kingdom and South Korea Essay

The principal objective of this essay is to provide a comparative analysis of the application of codes of corporate governance in the United Kingdom (UK) and South Korea, with particular emphasis to the code of board balance and independence and the code of audit committee and auditors. The essay undertakes a comprehensive assessment of the compliance and limitations of the application of these particular codes of corporate governance in the UK and South Korea and how the codes impact on companies and investor confidence in these two countries.      

Introduction

Codes of corporate governance refers to the set regulations which guide the performance of all activities that board of directors undertake on behalf of a company with a view of ensuring beneficial actions geared towards safeguarding the interests of stakeholders of the company in terms of providing direction, exercising authority and implementing oversight over the management (Sobel, 2005). Codes of corporate governance provide local and international investors with the opportunity to derive important judgements about the commitment of companies and corporations in advancing the interests of shareholders (Shabbir & Padgett, 2005). The codes of corporate governance evidently impact on the performance of complying companies by regulating management and financial reporting activities of

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companies but also build investor confidence in the particular companies by providing accounting-based performance of the companies (Aguilera, 2005).

The continued significance of sound management policies in both publicly listed and privately owned companies has seen increased pressure for companies around the world to observe the codes of corporate governance. Sobel (2005) noted that although codes of corporate governance are generally designed to suit country specific needs, regional and international economic bodies such as the European Union (EU) and the Organisation Economic Cooperation and Development (OECD) have authored general guidelines which member countries may adopt voluntarily. It has previously been suggested that compliance to codes of corporate governance translates to a firm’s performance and companies which commit to total compliance perform well as a result of sound monetary and fiscal policies (Weir & Laing, 2001).

The codes of corporate governance is an umbrella component consisting of numerous other codes that include composition of board of directors, remuneration, relationship between shareholders and management, accountability issues and auditing regulations. This essay focuses on the analysis of formulation and implementation of the code of board balance and independence and the code of audit committee and auditors in UK and South Korea, two countries that have consistently supported the formulation and implementation of codes of corporate governance designed to ensure sound management of public investments.

Overview of Codes of Corporate Governance in the UK

The findings and recommendations of the Cadbury Committee that was set up in 1992 by the UK government have gone a long way in shaping the country’s policies that concern governance of corporate entities. Today, the Combined Code serves as the main reference for codes of corporate governance that relate to composition of board of directors, remuneration, relationship between shareholders and management, accountability issues and auditing regulations (Aguilera, 2005). In the UK, all listed companies are required to subscribe to code of corporate governance (Spira & Bender, 2004) Aguilera (2005) further noted the principles contained in the Combined Code further require companies to specify how they have succeeded in applying the codes of corporate governance and categorically identify the failure to comply with certain aspects within justifying explanations. Moreover, foreign companies are not spared because the principles of the Combined Code dictate to them to make disclosures of any significant differences between the codes corporate governance of their home countries and those of UK as their host country (Aguilera, 2005). Some of the key aspects of the 2006 Combined Code on Corporate Governance that concern the code of board balance and independence include the following:

·         The board must demonstrate balance in its constitution of non-executive and executive members, with the non-executive directors being accorded majority slots over executive board members. The board of directors should not be unnecessarily large so as to warrant an idle and unproductive board of directors.

·         Thorough vetting of the non-executive board members must be conducted to determine the independence of the non-executive directors with regard to the relationship with the executive management or shareholders with majority interests in the firm.

·         Non-executive directors must make disclosures confirming the non-existence of any interests or affiliations with the internal management and shareholders with controlling interests. This requirement of the code is designed to ensure impartiality in the actions of the non-executive directors in their oversight duties.

·         Non-executive directors should constitute at least half of the board membership in mid-sized to large companies, while small companies should employ a minimum of two non-executive directors.

·         The post of the senior most independent director should be allocated to one of the non-executive directors who should duly be accessible to shareholders so as to facilitate the channelling of any discontent about the performance of the executive team.

·         The outside directors must at all times be provided with the necessary information required in the performance of their duties in order to facilitate accuracy in the assessment of the management situation in the corporation.

·         The duties of the outside directors should include the careful collection and consideration of adequate information at all levels of decision-making processes to ensure informed approach in protecting and advancing the best interests of the company.

The key aspects of board balance were mainly adopted from the Cadbury Report of 1991 which sets the ratio of outside directors at 46 percent (Dahya et al., 2002).  (The Combined Code further spells out conditions that concern code of audit committee and auditors and they are summarised in the 2008 publication of Financial Reporting Council titled: ‘Guidance on Audit Committees’. The key recommendations on audit committee and auditors include the following:

·         Mandatory establishment of a three-member (or two-member for small firms) audit committee consisting of non-executive directors who are independent.

·         Clear definition of the responsibilities and roles of the set audit committee fully backed by terms of reference in writing.

·         The board should be responsible for the appointment of the auditors with reference to recommendations of the nominations committee.

·         Audit committee appointees should serve for maximum terms of three three-year periods as long as their independence is comprised.

·         Scheduled meetings should be as many as possible and planned to coincide with the important financial reporting dates.

·         The audit committee meetings should be strictly an affair of the members and the chairman, and the attendance of any non-members must be sanctioned by the committee.

·         Audit committee sessions should last as long as possible to enable members cover all aspects of planned discussions.

·         The audit committee should be facilitated to meet both the external and internal auditors without the participation of the management at least once a year, to facilitate free discussion of matters concerning audits.

·         The audit committee should be fully capacitated resource wise to fully undertake its duties.

Overview of Codes of Corporate Governance in South Korea

South Korea subscribed to the codes of corporate governance for OECD member countries before it finally drafted its own codes titled ‘Code of Best Practice for Corporate Governance’ in 1999 (Kang 2004). According to Kang (2004) the code was drafted with the objective of maximizing competitiveness in the corporate sector through the enhancement of management efficiency and transparency.

Code of Best Practice for Corporate Governance covers key aspects that concern the protection of shareholder interests, the composition of the board of directors, operational criteria for audit committees and auditors, evaluation and monitoring measures and the rights and limitations of stakeholders (Kang, 2004). Kang (2004) was emphatic that all Korean companies listed in both the Korea Stock Exchange (KSE) and KOSDAQ are subject to the requirements of the Code of Best Practice for Corporate Governance. Some of the key aspects of the Code of Best Practice for Corporate Governance that concern the code of board balance and independence include the following:

The appointment of adequate number of directors to the board to ensure effective management of the company’s internal activities and committees.
The composition of the board must include directors from outside the company who are independent from the influence of the internal management and shareholders with controlling interests. The code recognizes that the number of outside directors should be limited to levels where they can exert balanced influence but also recommends a ratio of more than half of the number of outside directors to the to the overall composition of directors in big corporations and financial institutions, in order to facilitate the board’s supervisory functions of ensuring transparency and accountability.
The fair and transparent nomination of directors through the establishment of independent nomination committees.
The outside directors should not have any conflict of interests that may interfere with their independence from the internal management and shareholders with controlling interests. As such, outside directors must make disclosures confirming the non-existence of any interests or affiliations with the internal management and shareholders with controlling interests. This requirement of the code is designed to ensure impartiality in the actions of the outside directors in the supervisory duties.
The outside directors must at all times be provided with the necessary information required in the performance of their duties in order to facilitate accuracy in the assessment of the management situation in the corporation.
The duties of the outside directors should include the careful collection and consideration of adequate information at all levels of decision-making processes to ensure informed approach in protecting and advancing the best interests of the company.

The Code of Best Practice for Corporate Governance also stipulates numerous requirements on audit committee and auditors of corporations. The code requires big corporations and institutions holding government supported investments to establish audit committees as internal committees. The audit should have three board members at minimum, of which two-thirds should be outside directors. Corporations that do not have audit committees are required to have at lest one regular auditor. The audit committee and the auditors bear the responsibility of monitoring and evaluating the entire financial activities of the organization, with particular emphasis to financial control systems applied internally and accuracy of financial reporting. The Code of Best Practice for Corporate Governance further states that internal audit function can be supported by external auditors and the audit committee holds the responsibility of recommending nominations of the external auditors.

Comparative Analysis

There exists much semblance in the code of board balance and independence of the two countries in terms of controls and supervisory functions. However, the UK and South Korea are characterized by significant economic disparities because the former is a developed economy while the latter is a developing economy. The UK observes absolutely home grown codes of corporate governance that have evolved over time from important publications such as policy papers and task force findings and reports on corporate governance (Aguilera, 2005). On the other hand OECD guidelines formed the benchmark against South Korea’s developed its codes of corporate governance (Kang, 2004). The significant economic similarities and differences between the UK and South Korea form the main variables for evaluating the implementation and effectiveness of the codes of corporate governance in the two countries.

Compliance to codes of conduct is a compulsory requirement for all companies listed in UK’s just as it is for all listed companies in Korea’s stock exchanges. Debate has been rife whether companies really do comply to their country’s stipulated codes of corporate governance (Spira & Bender, 2004). Shabbir & Padgett (2005) warned that despite suggestions that compliance to codes of corporate governance translates into a firm’s performance this assumption remains far from reality. In a study carried out to correct the assumptions set by previous studies which rule out any links between the performance of firms and their compliance to the codes of corporate governance, Shabbir and Padgett (2005) developed a non-compliance index for FTSE 350 companies for a period of four years running from 2000 to 2003. When they measured the performance of the firms with respect to total shareholder return, they found a negative correlation of the index to total shareholder return, a clear implication that those firms complying with the codes of corporate governance register higher profits. These findings by Shabbir & Padgett (2005) critically contradicted the long held assumptions of the endogenous status of governance in the management of organizations. The findings provide adequate testimony to the fact that investors can derive important judgements about a firm’s commitment to advancing shareholders’ interests from the firm’s compliance standards to the codes of corporate governance.

The derivation of perception from elements of the accounting values rather than basing perception entirely on market related fundamentals demonstrates just how important the codes of corporate governance are (Aguilera, 2005). Codes of corporate governance evidently impact on the performance of complying companies by regulating management and financial reporting activities of

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companies but also build investor confidence in the particular companies by providing accounting-based performance of the companies (Shabbir & Padget, 2005). However, unlike companies in UK which are well cushioned by the privileges associated the country’s advanced first world economy, the story is quite different for companies in South Korea which have to put up with the challenges of the developing economy. As an emerging market, Korea has to contend with numerous challenges associated with systemised corruption, poor governance, resistance to change, slow economic progress, and poor legal infrastructure. Despite these numerous challenges, Korea’s codes of corporate governance went a notch higher than those of the UK by proposing hefty fines for non-compliance and even transfers the liabilities of third party damages to accounting firms responsible for carrying out insufficient audits (Kang 2004).

Conclusion

So far, it is evident that the codes that govern the management of companies in the UK and South Korea are similar in many aspects considering the fact that both are designed to enforce transparency and efficiency in the domestic and international liberalized markets. For example, the adoption of the Cadbury Report of 1991 in UK brought with it high CEO turnover clearly indicating the significance of the codes of corporate governance in codes in promoting effective oversight, accountability and performance (Dahya et al., 2002). The prevalence of oversight bodies in listed companies ensures the protection of the interests of investors, because non-executive committees have the capacity to recommend the firing of irresponsible or inefficient executives. However, as Klapper & Love noted, there is urgent need for institutional reforms in emerging markets so as to ensure full compliance to stipulated codes of corporate governance. Klapper & Love (2003) identified judicial inefficiency and failure to protect shareholders as the biggest threats to the governance of corporate organization in emerging markets.

References

Aguilera, R. (2005). Corporate governance and director accountability: An institutional

      comparative perspective. British Journal of Management, 16, S41-S49.

Committee on Corporate Governance. (1999). Code of best practice for corporate

      governance.

Conyon, M. & Mullin, C. (1997). A review of compliance with Cadbury. Journal of

     General Management. 22(3), 27-36.

Dahya J., McConnell, J.J., & Travlos, N.G. The Cadbury committee, corporate

      performance and top management turnover. The Journal of Finance, LVII(1), 462-

        483.

Kang, M. (2004), Codes of corporate governance in Korea. Korea Development Institute.

Klapper, F., L. & Love I. (2003). Corporate governance, investor protection, and

      performance in emerging markets. Journal of Corporate Finance, 10(2004), 704-728.

Shabbir, A., & Padgett, C. (2005). The UK code of corporate governance: Link between

     compliance and firm performance. ICMA Centre of Finance Discussion, DP2005(17).

     Retrieved from: http://ssrn.com.

Sobel, P., J. (2005). Auditor’s risk management guide: Integrating auditing and erm.

Spira l., F. & Bender, R. (2004). Compare and contrast: Perspectives on audit

        committees. Blackwell Publishing, 12(4), 489-499.

The FRC guidance on audit committees. (2008). Retrieved from

        http://www.frc.org.uk/corporate/auditcommittees.cfm

Weir, C. & Laing, D. (2001). The performance-governance relationship: The effects of

       Cadbury compliance on UK quoted companies. Journal of Management and

       Governance, 4(2000), 266-281.

 

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