opinion: best governance comes down to people

The real test is whether the code can alert shareholders when serious problems are emerging

Cadbury, Greenbury ... human nature being what it is, most of us prefer to focus on personalities rather than policies. Many more are aware of the existence of Cedric the pig than of the broader corporate governance policies of the company to whose AGM he was brought along. As the business community waits to hear who will assume the corporate governance mantle being laid down by Sir Adrian Cadbury, the time has come to begin discussion in earnest of the key issues to be addressed in the forthcoming review of the Code of Best Practice on corporate governance.

To ensure the durability and standing of the code, companies should only be able to declare full compliance with it when they have adopted the principles laid down as well as the formal requirements. Most boards wish to have an effective system of corporate governance; the real test is whether the code can quickly bring to the attention of shareholders the few situations in which serious problems are emerging. To achieve this goal, the new committee will need to strike a careful balance between strengthening the code in a few places and avoiding any drift towards a rule book approach.

On audit committees, for example, the code currently just requires that "the board should establish an audit committee of at least three non-executive directors with written terms of reference which deal clearly with its authority and duties". It would be helpful if the Cadbury Report's statement on the normal scope of the audit committee's work were additionally incorporated within the code.

If every listed company's non-executive directors (NEDs) are to be capable of bringing independent judgement to issues of strategy, performance and resources, a clearer distinction needs to be drawn between independent and other NEDs. Independent directors are independent of management and free from any business or other relationship that could interfere with their independent judgement.

The current requirement in the code that the board should include non- executive directors of sufficient calibre and number for their views to carry significant weight in the board's decisions would be buttressed if reference were made instead to its containing the appropriate number of independent NEDs. It would also make more sense for the audit committee to consist wholly of a given number of independent directors rather than, as at present, to have only three non-executives as a required minimum. Furthermore, listed companies should disclose which non-executive directors are considered independent, the definition of independence adopted and, in cases where the roles of chairman and chief executive remain combined, the identity of the senior independent director. Now that more than 80 per cent of the top 500 companies have split these roles, those continuing to combine them should set out their reasons. Larger companies should perhaps also be required to establish nomination committees for making board appointments.

Smaller listed companies, meanwhile, many with a capitalisation well below pounds 50m, must feel unfairly burdened by the Cadbury recommendations. To be in full compliance with the code, these companies must satisfy exactly the same requirements as top 100 companies with a market capitalisation of at least pounds 1.4bn. Given that their boards are usually small, serious thought should be given to recommending that they should be called on to have, as a minimum, only two independent NEDs in place of the present requirement for three, a majority of whom must be independent. This change would significantly increase compliance in this area. Of listed companies capitalised at between pounds 1m and pounds 10m, 47 per cent would then comply with the code, compared with 23 per cent at present. For those with a market value of pounds 10m to pounds 25m, the respective figures would be 71 per cent compared with 39 per cent.

Possible modifications to the Cadbury Code have been outlined. Ultimately, however, the effectiveness of every corporate governance system rests with the people involved - directors, shareholders and others - and their willingness and ability to discharge their responsibilities.

The author is secretary of the Corporate Governance Group of the Institute of Chartered Accountants in England and Wales. Views expressed are the author's own.