The Cadbury Report

The origins of the report

The Committee on the Financial Aspects of Corporate Governance, forever after known as the Cadbury Committee, was established in May 1991 by the Financial Reporting Council, the London Stock Exchange, and the accountancy profession. The spur for the Committee’s creation was an increasing lack of investor confidence in the honesty and accountability of listed companies, occasioned in particular by the sudden financial collapses of 2 companies, wallpaper group Coloroll and Asil Nadir’s Polly Peck consortium: neither of these sudden failures was at all foreshadowed in their apparently healthy published accounts.

Even as the Committee was getting down to business, 2 further scandals shook the financial world: the collapse of the Bank of Credit and Commerce International and exposure of its widespread criminal practices, and the posthumous discovery of Robert Maxwell’s appropriation of £440m from his companies’ pension funds as the Maxwell Group filed for bankruptcy in 1992. The shockwaves from these two incidents only heightened the sense of urgency behind the Committee’s work, and ensured that all eyes would be on its eventual report.

The effect of these multiple blows to the perceived probity and integrity of UK financial institutions was such that many feared an overly heavy-handed response, perhaps even legislation mandating certain boardroom practices. This was not the strategy the Committee ultimately suggested, but even so the publication of their draft report in May 1992 met with a degree of criticism and hostility by institution which believed themselves to be under attack. Peter Morgan, Director General of the Institute of Directors, described their proposals as ‘divisive’, particularly language favouring a two-tier board structure, of executive directors on the one hand and of non-executives on the other.

The contents of the report

The suggestions which met with such disfavour were considerably toned down come the publication of the final Report in December 1992, as were proposals that shareholders have the right to directly question the Chairs of audit and remuneration committees at AGMs, and that there be a Senior Non-Executive Director to represent shareholders’ interests in the event that the positions of CEO and Chairman are combined. Nevertheless the broad substance of the Report remained intact, principally its belief that an approach ‘based on compliance with a voluntary code coupled with disclosure, will prove more effective than a statutory code’.

The central components of this voluntary code, the Cadbury Code, are:

• that there be a clear division of responsibilities at the top, primarily that the position of Chairman of the Board be separated from that of Chief Executive, or that there be a strong independent element on the board
• that the majority of the Board be comprised of outside directors
• that remuneration committees for Board members be made up in the majority of non-executive directors
• that the Board should appoint an Audit Committee including at least 3 non-executive directors

The provisions of the Code were given statutory authority to the extent that the London Stock Exchange required listed companies to ‘comply or explain’; that is, to enumerate to what extent they conform to the Code and, where they do not, state exactly to what degree and why. The detail of this explanation, and the level of implied censure on companies which do not adhere to the Code, have both varied over time, but the basic ‘comply or explain’ principle has endured over the intervening years and become the cornerstone of UK corporate governance practice.