Corprate
Corporate governance
1/26/2018
Corprate
Journal of Business Studies Quarterly
2010, Vol. 1, No. 2, pp. 32-55 ISSN 2152-1034
Corporate Governance in the U.K: Audit Committees and
disclosure Arrangements – A Web-Based Analysis
Mohamed Hegazy, American University in Cairo
Karim Hegazy, Partner, Crowe Dr. A.M.Hegazy & Co.
Abstract
The main objective of this research is to assess whether UK listed companies comply with
the U.K code of corporate governance regarding audit committees and disclosure
arrangements. The research also aims at testing whether the companies’ size and board
composition affect the management’s decision to comply with the requirements of the
U.K code. Data was collected from the U.K listed FTSE companies. Descriptive statistics
including frequency tables, mean, other central tendency measures and regression
analysis were used to test the research hypotheses. The findings of the descriptive
statistics show most of the listed companies comply with the U.K code. The results of the
regression analysis indicate a small association between the size of the companies
described by the number of employees and the degree of compliance with the code.
Future research should be more directed toward testing the other requirements of the
code.
Keywords: Corporate Governance, Audit committees, Disclosure arrangements, nonexecutive
directors, board composition.
Introduction
After a multitude of high profile business failures and accounting restatements (Enron,
WorldCom and Quest) in 2001 and early 2002, the U.S Congress attempted to regain the investor
confidence in the financial reporting process by issuing the Sarbanes-Oxley Act of 2002 (SOX).
This law has required auditors to increase their audit work on internal control systems and placed
pressures on audit firms to reconsider their audit process for publicly traded companies. In July
2003, a combined code of corporate governance replaced the combined code originally issued by
the Hampel Committee on corporate governance in the U.Kin June 1998. The replacement of the
1998 code followed the collapse of a large number of companies in the US and attempted to
protect shareholders and investors’ interests in the Financial Times London Stock Exchange
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2010, Vol. 1, No. 2, pp. 32-55
33 ©JBSQ 2010
(FTSE). The code’s main and supporting governance principles covered a number of important
issues related to the day to day operations of the company including the management of the
company by the board of directors, board members remunerations, management accountability,
and management relations with shareholders, internal control and audit committee guidelines.
As stated in the preamble of the code listed companies are expected to comply with the code
provisions most of the time and departure from the provisions of the code may be justified in
particular circumstances.
This research aims at determining whether listed companies in the U.K do comply with
the provisions of the combined code of corporate governance regarding audit committees and
disclosure arrangements. The area of corporate governance is an important topic especially with
the current financial crisis affecting many economies and related businesses. In such
circumstances, there is a need for better and more enhanced control over the operations of FTSE
listed companies. In addition, the research also aims at determining whether the characteristics of
some listed companies mainly the size of the companies and the composition of the board can
affect management’s decision to comply with the code. The size of the company can be
interpreted using the companies’ total turnover and number of employees while the number of
non-executive directors will be used to describe the composition of the board.
The research study is composed of four sections. The first section is an introductory
providing insight into the research question and related objectives. Section 2 reviews the
literature related to the evolution of corporate governance in the U.K Furthermore, this section
presents some of the literature that shows how companies’ performance has been enhanced by
issuing corporate governance principles and guidelines. The duality in roles by the chairman and
CEO, board composition & non-executive directors and the role of audit committee are analyzed
in this respect. Section 3 discusses the research methodology used including the design of a
checklist based on the provisions of the code especially regarding the audit committees and
disclosure practices. It also presents the statistical analysis and data collection methods. Section
4 presents the research conclusions, limitations and recommendations for future research.
Literature Review
Corporate governance was defined as ’a system by which companies are directed and
controlled’ (Cadbury report 1992, p.5). Corporate governance was also described as an ‘’internal
system encompassing policies, processes and people, which serve the needs of shareholders and
other stakeholders by directing and controlling management activities with good business sway,
objectivity accountability and integrity’’ (O’Donovan, 2008). Corporate governance is understood
as a set of relationships between a company, its management, its board, its shareholders and
other stakeholders. Corporate governance is highly rated as it not only provides the structure
through which companies objectives are set but also how they are monitored, maintained and
achieved. Figure (1) describes the classic the corporate governance structure.
© Mohamed Hegazy and Karim Hegazy
34
Figure 1. The classic corporate governance structure
(Boyd, 1996, p. 169)
Having a bad corporate governance structure may be disadvantageous as it can threaten
the integrity of governance professionals in terms of their public reputation and their professional
liability (Jones and Pollitt, 2001). Broadly speaking, corporate governance deals with external
aspects such as the relationships with stakeholders as well as internal aspects such as internal
controls and board structures. (Mallin et al, 2005). In fact, corporate governance is an essential
tool nowadays for any corporate success and affects many aspects of the organization and
business activities. In the U.K there were three major periods identified for the evolution of
corporate governance. The 1st period was characterized by the dominance of the funding family
and began from the industrial revolution to the 1920s. The 2nd period was mainly marked by the
rise of the professional manager concept and covered the time following the 1920s to the 1970s.
The 3rd period from the 1970s was characterized by the increased accountability to the society
(Gomez and Korine, 2005).
Board of Directors
Auditor
Chief Executive
& Management
Chair
Appoin
t
Report
Elect
Audit
Appoint
Report
Shareholders
Journal of Business Studies Quarterly
2010, Vol. 1, No. 2, pp. 32-55
35 ©JBSQ 2010
Table (1) presents more information about how corporate governance concept evolved through
the previous centuries.
Table 1: The evolution of corporate governance and the procedures of democracy
19th century-1920s 1920s-1970s 1970s-21st
century
Model of
reference for
corporate
governance
Familial Managerial Popular
Economic
enfranchisement
Implementation
Creation of rights to
ownership
independent of
social standing
Reinforcement
Strengthened by law
and corporate
practice. Public
general meetings
become standard
Reinforcement
Strengthened by
new rules on the
right to vote;
protection of
minority interests
Separation of
ownership/control
No Implementation
Generalization of the
limited liability form,
with boards and
disclosure
requirements
Reinforcement
Increasing board
supervision over
managers
Representation
with public debate
No No Implementation
Mass ownership;
stakeholder
activism
(Gomez and Korine, 2005, p. 747)
Following the prolonged period of economic growth in the 1980s the economy began to
show signs of overheating mainly through rises in GDP growth and asset prices. This led to
major scandals in the U.K in the late 1980s and early 1990s such as the collapses of BCCI,
Guinness, and Polly Beck as well as the controversy over directors pay and the lack of controls
and business conduct (Jones and Pollitt, 2001).The Cadbury report was issued in 1992 as a first
attempt to try and provide guidelines and foundations of a set of corporate governance codes so
that scandals and business collapses could be minimized in the future and was a product of the
Financial Reporting Council, the London Stock Exchange and the accountancy profession. Table
2 presents the main recommendations of the Cadbury report.
© Mohamed Hegazy and Karim Hegazy
36
Table 2: Main recommendations of the Cadbury Report
Governance issue Cadbury Code Recommendation
Separate CEO and chairperson Recommended but not compulsory
Nomination of Directors Formal board process via nomination committee
dominated by outside directors
Outside Directors Minimum of 3 non-executive directors
Independence of Directors Majority of non-executives to be independent
Rotation of Directors Directors to be appointed for specific terms with
non-automatic reappointment
Pay and Bonuses Annual Report to reveal disaggregated director’s
pay; remuneration committee of board to be
dominated by outside directors
Independence of the Auditor Audit committee of the board to be formed,
comprised exclusively of outside directors
Flow of information to the board Board to have a formal schedule of decisions;
directors to have paid access to outside advice
Greater Scope of Auditing Auditors to review compliance to the Code,
including directors’ statements on going-concern
and on internal audit effectiveness
(Boyd, 1996, p.170)
The main feature of Cadbury report was self regulation approach whereby reporting of
compliance to the code was part of the listing requirements for public companies in their annual
reports showing the extent of compliance with the code. However, the Cadbury report failed to
achieve its objectives due to the limitations of its mandate report as it was silent on non financial
aspects of governance and to the size of a firm (Boyd, 1996). There was no distinction made
between large and small listed firms in terms of compliance with the code. Furthermore, Cadbury
report had recommended the establishment of a remuneration committee consisting of non
executive directors but details of its policies had not been precluded or examined. Moreover,
Cadbury report did not go in detail about the level of executive pay (Conyon and Peck, 1998).
As a result of all such criticism, the Greenbury report was issued in 1995 covering the
level of executive pay and director’s remuneration (Greenbury, 1995). The report addressed the
functioning of the remuneration committee made up of non executives who would determine
both individual executive pay and pay policy. The remuneration committee was responsible for
issuing a statement of compliance or non compliance in the annual report. The report also
emphasized the importance of timely and accurate disclosure. In 1998, the Hampel report was
later issued to review the progress of companies in compliance status, promote high standards of
corporate governance in the interest of investors’ protection and to preserve and enhance the
standing of listed companies in corporate governance levels (Hampel, 1998). The main
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37 ©JBSQ 2010
recommendation was that companies should include in their annual reports a narrative statement
of how they apply the relevant principles of corporate governance to their particular
circumstances. However, the report can be seen as endorsing the Cadbury report but adding
nothing new to the main requirements of such report (Dahya et al, 2002).
To overcome application problems of the Hampel report, a Turnbull Report and revised
Combined Codes were issued in 1999, 2003 and 2008 respectively. The Turnbull Report focused
on how to implement best practice systems of internal control, the need for a board statement on
internal control and discussed the appropriateness of having an internal audit function (Turnbull,
1999). The report was short and generally perceived as completed the work left unfinished by the
Hempel report in this area. At the same time, the revised Combined Code issued in 2003 aimed
primarily to advance the best practice through revisions of the code and to focus more on the
behaviors and relationships of the best people available, their good qualifications and relevant
experience, which are essential for an effective board. Finally, the revised code issued in 2008
included guidelines of the audit committee that were separately published for listed companies
(FRC, 2008).
The issuance of the first Combined Code in 1998 was not mandatory confirming the
tradition characterizing the U.K regulating environment which is evident in voluntary disclosures
rather than legal enforcements. The philosophy of the ‘comply or explain’ principle offers
intelligent discretion and flexibility and allows for exceptions of the actual rules. As Higgs
(2003, p.3) stated in his research study: ‘The brightness and rigidity of legislation cannot dictate
the behaviour or strengthen the trust I believe is fundamental to the effective unitary board and
to superior corporate governance.’ U.K listed companies are also required to issue a statement
of compliance with the detailed principles of the combined code in their annual reports. The
main role of the combined code is to shift the balance of power held by the company’s board and
its subsequent subcommittees away from the company’s main executive directors and instead
give greater prominence to non executive directors’ independence and role in the decision
making process and different companies corporate governance structures. The code also
emphasizes the importance of the separation between both roles of the company’s chairman and
CEOs. Furthermore the code sets out provisions relating to the composition of the board of
directors and its main principles and duties as well as clearly setting out the functions of the three
main committees which are the remuneration, audit and nomination committees as well as
stressing the importance of the need for non executive directors in the boards. In the following
sections the researcher will discuss details associated with the main characteristics of the code of
corporate governance.
The U.K code of corporate governance regards duality as undesirable and recommends
the separation of the CEO and chairman positions i.e. no one person should hold both posts. This
is to avoid concentration in the decision making in only one individual and to maintain the
balance of power within the board of directors. Prior research on the impact of duality of CEOs
and chairman duties has given different results. Jensen (1993) points out that when one
individual holds both positions, internal control systems may fail as key functions of the board
cannot effectively perform their duties which also include evaluations and firing of the existent
CEO. Forker (1992) was of the opinion that duality was associated with poor disclosure which in
turn results in ineffective monitoring of managerial opportunistic behaviour. Moreover, Fama
and Jensen (1983) concluded that the concentration of all decisions (management and control) in
one person reduces the required effectiveness needed in monitoring top management. Another
study by Cosh et al (2006) found that duality has a negative impact on announcements and long
© Mohamed Hegazy and Karim Hegazy
38
run returns but a relatively positive effect on key operating performance measures. Brickely et al
(1997) also found that separate CEO and chairman may engender costs in monitoring the
chairman and information sharing costs between them.
On the other hand, Boyd (1995) found that combining both roles in one person is
associated with higher profitability. In contrast Rechner and Dalton (1991) found that combining
the roles of a chairman and CEO reduces profitability whereas Baliga et al (1996) found no
effect on performance. Based upon the findings of all the above studies, the researchers believe
that the separation of CEO and chairman positions is important for better management of the
company and possible control effectiveness over the business operations.
The board of directors is seen as an internal mechanism whose main duties are to take
some of the major decisions on behalf of shareholders and to align owners’ incentives with the
management by ensuring that the management behaviour is consistent with the owners’ interest.
In a research study by Butler (1985) he found that board of directors dominated by outside
directors are more likely to behave in shareholders’ interest. However this was not always the
case as Holl (1975) found insignificant differences. Other studies such as the one made by Faccio
and Lasfer (1999) found no specific relationship between board ownership and firm value in
general. This was also confirmed in US in a study by Hermalin and Weisback (2003) as they
found no association between firm performance and board composition.
However, the effects of board composition on voluntary disclosures were mixed as
Beasley (1996) found that non executive directors are positively related with the board’s ability
to influence voluntary disclosure decisions. Dahya et al (2007) found that board composition has
no meaningful impact on financial performance. It is also often believed that the smaller the
boards the more effective they are specially in taking specific and important decisions. This was
confirmed by Lipton and Lorsch (1992) and Jensen (1993) as they criticized the performance of
large boards’ problems in poor communication and decision making. According to Jensen (1993)
as groups increase in size they become less effective because the coordination and process
problems overwhelm the advantages from having more people to draw on. In addition to that
CEO performance incentives provided by the board through compensation and threat of
dismissal operate less strongly as board size increases and financial ratios related to profitability
and operating efficiency appear to decline as board size grows. Also, the effect of the board size
was found to have an insignificant effect on takeover by firms. This was confirmed in the U.K in
a study by Conyon and Peck (1998) who examined 481 listed companies from 1992 to 1995 and
found a negative effect of board size on both market and book value and profitability.
At the same time, non executive directors (NED) are defined as being independent of
executive management positions or other management functions of the company and free from
any relationships which may affect their judgment. Some of the advantages of having a large
number of non executive directors are the valuable business experience and views they offer
(Hanniffa and Cooke, 2002). In addition, non executive directors can also contribute to
objectivity, impartiality as they look at decisions and issues from a wider and broader
perspective than executive directors. Moreover, they are able under the new provisions of the
combined code to challenge policies of the executive directors which they feel are not in the
interest of the company’s shareholders. The reasons for the effective monitoring of companies’
board decisions by non executive directors are reputation concerns and fear of lawsuits.
Hermalin and Weisbach (1991) and Dahya et al (2007) found no relation between firm
performance and function of outside directors. This was not supported in a research by Baysinger
and Butler (1985) as they found that companies perform better if there are more outsiders in the
board. Rosenstein and Wyatt (1990) also found out that new appointments of non executive
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39 ©JBSQ 2010
directors are linked with company performance. Another study by Klein (2002) examines
whether audit committees and board characteristics are related to earnings management to the
firm. He found that firms with board committee of more than a majority of independent directors
are more likely to have abnormal accruals than others. Using a Cross sectional analysis he found
a negative association between abnormal accruals and the percentage of independent directors
but no evidence of a systematic association between having an independent audit committee and
abnormal accruals. Finally, it was tested that the proportion of non-executive directors is
associated with better specific decisions including acquisitions, CEO turnover and executive
compensation (Hermalin and Weisbach, 2003).
However having a large number of non executive directors may be disadvantageous as
they only meet a few times during a year and hence perform their duties on an irregular basis.
(Pass, 2006; Weir and Laing, 2000). Also, outside directors often lack the information necessary
for decision making as they do not fully understand the business or have little time to devote to
their duties. This fact was supported by Yermack (1996) as a negative relationship between the
proportion of outside directors and company’s performance was found. Another study by Weir
and Laing (2000) showed that the number of non executive directors in the U.S have an
insignificant impact on share price performance but a relatively negative impact on profitability.
The results of all the above studies confirm the notion that the board of directors and its
composition is an important issue in corporate governance and the success of any company is
significantly measured by the board effectiveness and independence.
From the above analysis, we can identify a number of research hypotheses interpreting
the decision of compliance with the U.K code. As shown in the hypotheses below, the decision
of compliance may be affected by the size of the company and/or the composition of the board.
The size of the company can be interpreted using the companies’ total turnover and number of
employees while the number of non-executive directors will be used to describe the composition
of the board.
H1: The listed companies in the U.K comply with the requirements of the code of corporate
governance regarding disclosure arrangements.
H2: There is a relationship between the size of the company and the level of compliance with
disclosure arrangements.
H3: There is a relationship between the composition of the board and the level of compliance
with disclosure arrangements.
Over the past years the role of audit committees has developed dramatically to meet the
challenges of changing economic, social and business environments and is seen as a powerful
device for improving value of relevant intellectual capital disclosure. The audit committee
should consist mainly of non executives. The audit committee’s memberships should not include
directors who are current employees, former employees within the last three years, employees
who have cross compensation committee links nor have immediate family members of an
executive officer.
Three key provisions were stated in the U.K Combined Code of 2003 and audit committee
guidelines in 2008 regarding the composition of audit committees.
© Mohamed Hegazy and Karim Hegazy
40
· At least one audit committee member should have relevant financial experience
· Three meetings should be held annually to coincide with duties within the audit and
financial reporting cycle
· only relevant members and the chairman should be present at the meetings
Different studies were carried out to test whether audit committees have a key role in the
success and performance of a company. Ho and Wong (2001) found out that effective audit
committees would certainly improve internal control mechanisms and act as means of
minimizing agency costs and the presence of an audit committee is closely associated with more
reliable financial reporting, enhanced quality and increased disclosure. This view was also shared
by Olson (1999) as he concluded that inactive audit committees would merely monitor
managements effectively and hence lead to a negative impact on the company. Again the issue of
independence and non executive directors are crucial for audit committees.
Other studies confirmed the fact that audit committees composed of less than a majority of
independent directors are more likely to have a high ratio of abnormal accruals than others. Klein
(2002) argued that board independence and audit committees are positively related to market to
book values past negative earnings and the size of a firm. However a different case study by
Mangena and Pike (2005) found no relationship between the size and independence of audit
committees and voluntary disclosure arrangements made by companies. To sum up, studies may
have provided different findings associated with the role of the audit committee in enhancing the
company's performance but all agreed that it is an important element of corporate governance.
The more independent and qualified the members of the audit committee, the better they serve
stakeholders and other users in ensuring proper control over the company's activities and
performance.
From the above analysis, a number of research hypotheses can be identified to interpret the
decision of compliance with the U.K code. As shown in the hypotheses below, the decision of
compliance may be affected by the size of the company and/or the composition of the board.
H4: The listed companies in the U.K comply with the requirements of the code of corporate
governance regarding audit committees.
H5: There is a relationship between the size of the company and the level of compliance with
audit committees.
H6: There is a relationship between the composition of the board and the level of compliance
with audit committees.
Research Methodology
Data was collected using a checklist constructed to test the level of compliance of U.K
listed companies with the combined code concerning mainly the audit committees and disclosure
arrangements. The audit committee part in the checklist included 14 sub elements discussing
guidelines related to the composition and function of the committee whereas the disclosure
arrangements included 15 sub elements for good disclosure practices and as a whole the checklist
is about 3 pages long. The 1st part of the data collection was done manually. The researchers
used the internet to access the most recent annual reports of the top (FTSE) 100 companies in the
U.K which was for the year 2008. The Financial Times London Stock Exchange (FTSE) is
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41 ©JBSQ 2010
known to be one of the most attractive stock markets in the world and an active market for IPO
(Initial Public Offering) for both local and foreign companies, a matter which will require
procedures or elements of corporate governance to protect the funds of those investors. The
checklist was then used to examine if each company would comply with the main requirements
of audit committees and disclosure arrangements. When compliance was evident a 1 was ticked
otherwise it was given a Zero. This process was repeated for each of the (FTSE) 100 U.K
companies. Most of the data collected was of qualitative nature.
The second part of the data was collected using the software Financial Analysis Made
Easy Database (FAME). Several aspects for the size of the company and the composition of the
board such as the company’s latest turnover figure, number of employees and the number of non
executive directors for all of the (FTSE) 100 U.K companies were collected in order to perform
the detailed descriptive statistics as well as regression analysis and to test whether any of the
characteristics of listed companies do have any effect on the degree of compliance with the code
of corporate governance. In cases where data required was not available in specific companies,
they were not replaced but instead treated as not available information and those companies with
missing aspects were totally ignored in the regression analysis performed thereafter. Therefore in
the regressions the number of observations were not 100 but varied between 82 and 87 according
to the variables chosen for testing purposes.
Data Analysis
Several central tendency measures such as the mean, mode, median were computed to
assess the average degree of compliance of all U.K companies in respect to the code of corporate
governance. However, estimating the mean values had some difficulties as they are sometimes
influenced by extreme values therefore other central tendency measures were also undertaken
and performed to strengthen and support the analysis findings. On the other hand, data variation
can be measured in three different ways: standard deviation, range (minimum and maximum
values) and percentiles. The researchers computed the above measures to show the spread of the
results more clearly and give a better picture of them. To be able to compare the spread of data
between the financial measures, which are of different magnitudes, the coefficient of variation
was also computed as its values can be easily compared and the larger the coefficient of variation
the larger the relative spread of the data (Saunders et al, 2006). The researchers analyzed these
variations and gave possible interpretations and explanations when evident.
Regression Analysis
The second part of the analysis covered a multiple regression analysis made in order to
test whether there is any association or relationship between the three independent variables
chosen: Number of non executive directors, latest turnover figure and finally the number of
employees in each firm and the degree of compliance by companies in relation to the audit
committees and disclosure arrangements. The researchers used the statistical software package
‘’Stata’’ which main capabilities include data management, statistical analysis and custom
programming. The researchers made several regressions of each individual variable on the
degree of compliance. The three main aspects which were looked at were: first, the coefficient
which mainly shows the magnitude and direction and the variation of the regression. The second
and most important aspect to be considered is the p-value which shows if the test is significant or
© Mohamed Hegazy and Karim Hegazy
42
not. Finally, the R2 which mainly explains how much of the dependant variable is explained by
the independent variable was calculated and the higher the percentage the better. Then, multiple
regressions were performed including all 3 independent variables in order to get clearer results as
each model alone was not that significant. Multiple regressions on each compliance aspect alone
were made: the audit committees and the disclosure arrangements in order to test whether there
might be any association between the independent variables chosen and each individual
compliance aspect.
Results of Descriptive Analysis of the Disclosure Arrangements
Table 3 presents the main elements of the disclosure arrangements under the U.K code of
corporate governance and the degree of compliance by listed U.K companies. The main
disclosure elements cover several aspects such as the composition of the board and its members
as well as the 3 main committees represented by the remuneration, audit and nomination and
their respective duties. It also covers elements such as the role, names and functions of the non
executive directors.
Table 3: Descriptive Analysis of the Disclosure Arrangements
Under the disclosure arrangements there were 15 elements selected for testing. Two
elements are complied with by all of the (FTSE) 100 companies. The elements are the disclosure
Elements of disclosure
Number
of
companies
complying
Percentage
of
compliance
Names of board/CEO/Chairman 100 100
Going concern assumption 100 100
Nomination committee and its responsibilities 96 96
Remuneration committee and description of its work 96 96
Directors report /audit report and their respective reporting
responsibilities 96
96
Nr of board and subcommittee meetings and attendance by
directors 95
95
Review of Internal controls 95 95
Separate section describing work of audit committees in
discharging responsibilities 88 88
Separation of duties management /board 87 87
Non executive directors names who are believed to be independent 79 79
Performance evaluation of the board its committees and directors 62 62
Understanding of company by Non-executive directors 30 30
Explanation that if non audit services are provided objectivity and
independence of the auditor is safeguarded 18 18
Absence of internal audit function and its reasons 0 0
Reasons given for no acceptance of audit committee
recommendation by the board and a statement by the audit
committee showing their position 0
0
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43 ©JBSQ 2010
of the names of the board, CEO and chairman and the second is the going concern element. This
is expected as every company is required to include such information in their annual reports
including the going concern assumption. There were 2 elements not complied with at all by the
whole group of listed companies. They cover reasons should be provided if no internal audit
function exist and situations where the audit committee recommendations are not accepted.
These disclosures were not adhered to by companies unless matters exist or occur. However
these aspects were included by the researchers in the design of the checklist to maintain the
originality and the same elements as shown in the U.K code.
Out of the 15 available elements seven are complied with by a percentage of 95% or
higher which is a significant figure and shows that half of the elements under the disclosure
arrangements are complied with by almost all of the companies. These elements include
disclosure about the nomination and remuneration committees and their responsibilities, the
number of board members and subcommittee meetings and attendance by directors, the review of
the internal control, a separate section describing the work of the audit committee and finally the
performance evaluation of the board, its committees and directors. In addition, two third of the
elements of disclosure arrangements are complied with by almost 80 companies showing
significant level of compliance of the code for disclosure arrangements. Table 4 shows a
summary of the descriptive statistics’ results in relation to disclosure arrangements elements. The
mean average compliance is almost 70% increases to 80% if we exclude the last 2 elements with
a compliance of 0%. This indicates that companies are complying with the majority of the
elements mentioned in the combined code and its related attachments in respect to disclosure
arrangements. The above results provide evidence for the acceptance of H1.
Table 4: Descriptive statistics results for disclosure arrangements
Descriptive Measure Results
Mean 69.4677
Median 88
Mode 96
Standard Deviation 37.73567
Coefficient of Variation 54.32196
Minimum 0
Maximum 100
25th Percentile 46
50th Percentile 88
75th Percentile 96
However, the researchers noticed the wide spread of data as shown by the minimum and
maximum results given by 0 and 100. Percentile statistics show that although the 25th percentile
rank is 46 which are due to the 2 elements not complied with by any company it only implies
that a minority of companies don’t comply with the majority of the code issues selected for
testing. Moreover looking at the 50th percentile rank it can be seen that about half of the elements
are complied with by a very high number of companies, namely 88. Finally, the coefficient of
variation is calculated and is found to be over 50% which means that there is a large spread of
data and the data are uniform i.e. less dispersed.
© Mohamed Hegazy and Karim Hegazy
44
From the results obtained we can state that the code of corporate governance is mainly
used by companies as a guideline and as a help to maintain good corporate governance structures
and norms but not as a strict code where all companies should comply with all its requirements.
Results of the analysis of audit committee elements
Table 5 provides the results of the descriptive analysis regarding elements of the audit
committees. The findings of the descriptive analysis show that the highest element of compliance
was the audit committee meetings with a minimum of 3 times a year. The majority of companies
had active audit committee with some of them having 6 or more meetings per year. The majority
of companies also disclosed the terms of reference of the audit committee besides giving the
names of the members of the committee and their qualifications. An average of around 95% was
found for all the above mentioned characteristics for the audit committee guidelines.
Table 5: Results of the Descriptive Analysis for Audit Committees
Moreover, 90 companies representing 90% of those listed in FTSE provided on their
website separate sections to describe the work of audit committee and its responsibilities. This
provides strong evidence about the willingness of the management to show an effective
monitoring role of the committee of the company's internal control system, audit function and
management risk models. The approval of the appointment of internal audit head by audit
committee represented only 16%, a low compliance percentage indicating continued struggles
between top management and the audit committee about such decision making. It is expected
that with the wide recognition of the role of the audit committee this element would be enhanced
and the audit committee will have a better say in the appointment of the Head of internal audit
department. At the same time, the low level of compliance (only 16%) of whether audit
Elements of audit
Number
of
companies
complying
Percentage
of
compliance
Audit committee meetings /assumption 3 times at least 97 97
Number of audit committee meetings 96 96
Terms of reference of audit committee 94 94
Members of audit committees names and qualifications 93 93
Separate section to describe work of audit committee and
responsibilities 90
90
Audit committee approval of risk management/internal control 88 88
Summary of the role of audit committee 84 84
Financial experience of at least one member of audit committee 82 82
Report on the way audit committee has discharged its
responsibilities(Audit) 79 79
Annual review of the audit committee by the board 45 45
Internal audit work and role 35 35
Approve appointment of internal audit head by audit committee 20 20
Non audit services provided or not 16 16
Disagreements between board and audit committee 1 1
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2010, Vol. 1, No. 2, pp. 32-55
45 ©JBSQ 2010
committee approves non audit services for external auditor may not reflect non-compliance with
the code in this matter but rather companies refuse to require such services from their external
auditors.
In addition, the existence of any disagreements between the board and audit committee
had a low percentage. This may be justified as no disputes might have occurred between the two
bodies or disputes may have occurred but quickly solved through discussion and appropriate
decision by both parties. Out of the 14 available elements there were 5 elements complied with
by a percentage of over 90% and 9 elements were complied with by 80% of the companies
which is a reasonably acceptable figures and shows that the majority of companies are
complying with the code regarding audit committee requirements.
Table 6 includes a summary of the descriptive statistics results for audit committees. The
mean average compliance is 65.71%, however excluding the last element which is only complied
with by 1 company the mean increases to 70% which is a reasonably good figure. Such results
show that companies are complying with the majority of elements in the code in respect to audit
committees. It is also evident that the mean and median are not far apart which may imply that
the measures can be approximated to a normal distribution. The mode value, however, shows no
elements complied with by the same number of companies. Also noticeable is the spread of data
as shown in the minimum and maximum values which are 1 and 97 respectively. The percentiles
are also calculated to support the fact that data are spread widely however it is clear from the 50th
percentile that over half of the elements are complied with by a percentage of 83% which is a
relatively high number.
Table 6: Results of Descriptive Statistics of Audit Committees
Descriptive Measure Results
Mean 65.71429
Median 83
Mode N/A
Standard Deviation 34.44601
Coefficient of Variation 52.41784%
Minimum 1
Maximum 97
25th Percentile 37.5
50th Percentile 83
75th Percentile 92.25
Finally the standard deviation is calculated and found to be 34.44601, showing the extent
to which the values differ from the mean. However to get clearer results the coefficient of
variation is calculated (52.41784 %) which is over 50% supporting the existence of a large
spread of data and only few elements are not complied with by some companies. The coefficient
of variation result of over 50% also shows that data are uniform i.e. less dispersed. The above
results provide evidence for the acceptance of H4.
© Mohamed Hegazy and Karim Hegazy
46
Results of the Regression Analysis
To test whether there is any association between the level of compliance for both audit
committees and disclosure arrangements figure and the three independent variables latest
turnover figure, the number of employees and the number of directors, a regression is performed
for each independent variable and the total degree of compliance. The results of these three
regressions obtained were that each model alone is not significant except for the regression
containing the number of employees with a p-value of .006 = 0.6% which is significant at the 5%
& 1% levels. The problem with such result is that the coefficient was very small. The p-values
for the other two regressed variables are 0.103 and 0.754 respectively which in turn are
insignificant.
Table 7: Reg. compliance turnover
Regression Measures Results
Number of observations 87
R-Squared 0.1310
Adj R-Squared 0.0196
Coef 1.24e-08
Std. Err. 7.53e-09
T 1.65
P-value (95% conf. interval) 0.103
Table 8: Reg. compliance employees
Regression Measures Results
Number of observations 96
R-Squared 0.0766
Adj-R-Squared 0.0668
Coef -0.000125
Std. Err. 4.49e-06
T -2.79
P-value (95% conf. interval) 0.006
Table 9: Reg. compliance directors
Regression Measures Results
Number of observations 89
R-Squared 0.0011
Adj-R-Squared 0.0104
Coef -.0444828
Std. Err. .1417932
T -0.31
P-value 0.754
Journal of Business Studies Quarterly
2010, Vol. 1, No. 2, pp. 32-55
47 ©JBSQ 2010
Regression results for all 3 individual variables combined with compliance figure
To investigate further, we specified our model better by controlling for the three variables in
the same model. The main results are as follows:
· For every 1 point increase in the latest turnover figure the percentage change in
compliance changes by an increase in 1.56 x 10-8. Its accompanied p-value is 0.048
which in turn is almost insignificant.
· For every 1 point increase in the number of employees the change in the compliance
figure is a decrease by 0.0000129 and a p-value of 0.012 which is significant however
with a small magnitude.
· For every 1 point increase in the number of non executive directors the change in the
compliance figure is an increase by 0.0960487 and a p-value of 0.531 which is
insignificant at the 5% level.
Table 10: Reg. compliance turnover employees’ directors
Measures
& Results
Turnover Employees Directors
Coef 1.56e-08 -.0000129 .0960487
Std. Err. 7.73e-09 5.02e-06 .1527762
T 2.01 -2.56 0.63
P-value 0.048 0.012 0.531
Number of observations 82
R-Squared 0.1094
Adj R-squared 0.0751
Also the R2 (0.1094) obtained suggests that 10% of the regression is explained by the specified
model chosen which is not a confirming figure but an acceptable one. Reasons for the low R2
obtained may be because compliance by firms with the code is discretionary and voluntary to the
management’s decision hence there is no obligation on firms to comply. Another reason for the
low R2 may be that the 3 variables looked upon in this research are not that sufficient to find any
relationship or association so there is a need for looking at other variables.
The most important finding of the regressions performed is that the variable of the
number of employees although with a very small magnitude is significant at the 5 % level hence
there is some association with the total compliance figure. The scientific interpretation from the
above results is that as the number of employees increases the average total compliance degree
decreases so it is preferable for companies to have a controlled number of employees to cover the
implementation of its operations.
Type
© Mohamed Hegazy and Karim Hegazy
48
Regression of all 3 variables and audit committees compliance figure
The results of the regression for all 3 variables and audit committees however were very
similar to the ones obtained previously with the total degree of compliance as the number of
employee variable was the only one found to be significant although with an extremely small
magnitude as well as the R2 figure which is approximately 10% hence both results are identical
to the ones found previously.
Table 11: Reg. comp1 turnover employee directors
Measures
& Results
Turnover Employees Directors
Coef 9.24e-09 -8.06e-06 .0165339
Std. Err. 4.91e-09 3.19e-06 .0971103
T 1.88 -2.53 0.17
P-value 0.064 0.013 0.865
Number of observations 82
R-Squared 0.0993
Adj R-squared 0.0647
Regression results for all 3 variables and disclosure compliance figure
In relation to the compliance figure of the disclosure arrangements the p-value of the
number of employees’ variable in the regression was the only figure with a significant result of
0.032 at the 95% confidence interval. This suggests that there is a reasonably fair association
between the number of employees and the compliance figure relating to disclosure arrangements
hence a 1 point change in the employee figure results in a change in compliance relating to
disclosure arrangements by a decrease of 4.8 x 10-6. Thus, the lower the number of employees
the better and more effective they can be monitored hence leading to more controlled work and
better level of compliance.
Table 12: Reg. comp2 turnover employees directors
Measures
& Results
Turnover Employees Directors
Coef 6.32e-09 -4.80e-06 0.795147
Std. Err. 3.38e-09 2.19e-06 .0668008
T 1.87 -2.19 1.19
P-value 0.065 0.032 0.238
Number of observations 82
R-Squared 0.1002
Adj R-squared 0.0656
Type
Type
Journal of Business Studies Quarterly
2010, Vol. 1, No. 2, pp. 32-55
49 ©JBSQ 2010
In summary it can be said that although there might be a small association between the
number of employees and the different compliance figures in total the 3 variables chosen have
not been found to have a good relationship to the compliance figures. Thus, the degree of
compliance by companies might be due to other factors or other explanations requiring further
research and analysis. The above results provide evidence for rejecting H3 and H6 as no
relationship was found between the composition of the board and the level of compliance with
the U.K code. Furthermore, the findings also rejected H2 and H5 as no relationship existed
between the size of company described by the total turnover and the level of compliance of the
U.K code with some significant relationship found between the number of employees and level
of compliance for both audit committees and disclosure arrangements.
Conclusion, Limitations and Recommendations
Corporate governance has become so important since 2002 as series of corporate frauds
and other catastrophes led to the destruction of billions of dollars of investments, the loss of
thousands of jobs, the criminal investigation and record–breaking bankruptcy filings. All these
conditions beside the need to restore the good reputation of the accounting profession and
protecting shareholders' interest created the need for tools and principles that increase
transparency. In 2003, a combined code of corporate governance was introduced in the U.K
covering several corporate governance structures and combining all main principles covered in
previously published codes and laws (Cadbury (1992), Greenbury (1995), and Turnbull (1999)).
Companies are required as a matter of best practice to fully comply with many of the aspects of
the code and its amendments issued in 2008 and if not explanations should be provided. The
current research was prepared to investigate and test the level of compliance by the (FTSE) 100
companies for two main aspects of the code mainly the audit committees and disclosure
arrangements.
The research methodology included the literature review covering issues and matters
relating to the nature of corporate governance with an overview of the evolution of corporate
governance codes in the U.K Moreover, the research analyzed the main characteristics of
corporate governance such as duality, board composition and non executive directors and audit
committees and reviewed previously made researches on whether these characteristics have any
effect on companies’ performance. Six hypotheses were developed. Two of these hypotheses, H1
and H4, tested whether U.K listed companies comply with the code of corporate governance
regarding audit committees and disclosure arrangements. The other four, H2, H3, H5 and H6,
tested whether relationships existed between the size of the companies and board composition
and the level of compliance with the U.K code. A detailed descriptive analysis was performed. A
regression analysis was also undertaken to test whether there might be any association between
the different levels of compliance and companies size and three independent variables namely
turnover figure, number of employees and number of non-executive directors
The results of the descriptive analysis indicate that the average degree of compliance
relating to both the audit committees and disclosure arrangements was found to be around 70%.
This is a significant result and confirms the acceptance of H1 and H4. The findings showed that
companies are nowadays using the code as a good base for their corporate governance structures
and performance assessment. There is a need, however, for companies to place more emphasis
© Mohamed Hegazy and Karim Hegazy
50
on different elements such as internal audit work and non audit services. Only a small number of
companies comply with those elements. The main findings of the regressions performed was that
except for a small association found between the number of employees and compliance figure
(total and for each requirement alone) there is no significant association found between the other
two variables (i.e. turnover-and the number of non executive directors).
There are a number of limitations associated with the current research. First, the testing of
the level of compliance by listed companies of the code of corporate governance was limited to
two main elements of corporate governance namely the audit committee and disclosure
arrangements. Other elements which have not been tested include the role of the board of
directors, the external auditors, nomination and remuneration committees etc. Second the study
examined elements of audit committee and disclosure arrangements for the FTSE 100 companies
without testing for other companies listed in the FTLSE. Thus, the results of the study cannot be
generalized. Third, a limited number of companies’ characteristics namely the number of non
executive directors, number of employees and latest turnover figure were used to assess their
effects on the level of compliance by companies. Other characteristics including the size of the
company, capital of the company, total assets, and type of industry have not been tested. Fourth,
the limited number of non complying listed companies did not allow the researchers to make
more detailed investigations about possible reasons for such non compliance using either
interviews or telephone calls with the investor relation officers of specific companies, a matter
which was planned to be undertaken if the results provided ways to investigate such noncompliance
status.
However, a number of important recommendations can be derived from the findings of
this research. First, other listed companies' characteristics mainly the type of industry,
profitability and the size of the company assessed either by owners' equity or capital must be
analyzed and studied to test whether there is a significant relationship between these elements
and the level of compliance with the U.K code. Second, a larger sample of companies listed in
the FTSE must be selected for testing compliance levels to ensure a good representation of the
operating environment in the U.K coupled with an assessment of companies’ characteristics to
provide some insights into the reasons behind a high level of compliance with the code. Third,
interviews should be made with the investor relation officers of some of these listed companies
to inquire about reasons of non compliance with some of the elements of the combined code and
to identify management objectives associated with high compliance with the combined code.
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Author Biography
Mohamed Hegazy is a Professor of Accounting and Auditing at the Department of
Accounting, School of Business, the American University in Cairo. Dr. Hegazy holds two
bachelor’s degrees from Cairo University in Accounting and in law. He also holds two masters
degrees; one in Accounting from Birmingham University, U.K and the other in Knowledge
Based Systems (i.e. Expert Systems) from Edinburgh University. He received his Ph.D in
Accounting and Finance from Birmingham University, U.K. His research and teaching interests
include: financial reporting, auditing and other assurance services, information systems,
corporate governance, financial and administrative restructuring, and valuation studies. Dr.
Hegazy can be reached at: mahegazy@aucegypt.edu.
.
Karim Hegazy is an executive partner in Crowe Dr.A.M.Hegazy & Co- a member of
Crowe Horwath International – Chartered Accountants and Consultants. Karim holds a
bachelor’s degree in Accounting and Finance from Middlessex University – U.K as well as a
Masters degree in Accounting and Finance from Brunel University – U.K. Karim speaks fluent
German, English, and French languages. His areas of interest for research are financial audit,
corporate governance, cost accounting and financial reporting. Karim can be reached at:
Karim.hegazy@dramhegazy.com.
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