UK: CRACKING THE CADBURY CODE. - The Cadbury Code of Practice on corporate governance has been described as ineffective and irrelevant. So will Cadbury Two be any different, or is statutory control now inevitable?

by Rupert Morris.
Last Updated: 29 Jan 2013

The Cadbury Code of Practice on corporate governance has been described as ineffective and irrelevant. So will Cadbury Two be any different, or is statutory control now inevitable?

The Cadbury committee may well be the subject of more knowing chuckles among the corporate dining classes than the Serious Fraud Office. Plenty of senior executives, fund managers and analysts will tell you privately that Sir Adrian Cadbury's Code of Practice on corporate governance is irrelevant and ineffective. A few will say it publicly, too.

They will say that anyone can sign up to the Cadbury Code and carry on ripping off their shareholders just the same. Some will say it is no more than window-dressing, others will curse it as an impertinence. And with a communal sigh, all these Cadbosceptics will bewail the impending emergence of 'Son of Cadbury' or 'Cadbury Two', the committee that will almost certainly be set up in June by the Financial Reporting Council to carry on the good work - or churn out more time-wasting strictures, according to your point of view.

Finally, there are those who say none of it matters, since the UK financial community is clearly incapable of putting a lid on greed and irresponsibility, and statutory controls are inevitable if Labour wins the next election - if the present Government's patience doesn't snap before then.

Messrs Major, Clarke and Heseltine do not want to be pressured into legislation on this vote-losing subject, despite the prime minister's surprise announcement on 28 February that he would 'consider' legislation on executive pay in the light of the report from the CBI committee chaired by Sir Richard Greenbury of Marks & Spencer. In the end, if the Government can avoid legislating, it will owe much to the public relations efforts of Cadbury, Greenbury, Tim Melville-Ross (IoD), and every other great and good member of the 'something must be done' chorus; at the very least, they have proved the City's willingness to respond to public anxiety and media criticism.

The question is: is Cadbury anything more than a PR gesture? Sir Owen Green, the former chairman of BTR, fears that however good its intentions, a mere code cannot inculcate self-discipline into a generation of high-earning go-getters who were caught up in the free-market euphoria of the Thatcher years but missed out on Adam Smith's moral teachings. 'Cadbury's non-executive directors were supposed to sit on remuneration committees and control executive pay,' says Sir Owen, 'and anyone can see that that hasn't worked. All it has meant is that your average non-executive director has three or four directorships instead of one or two.'

Sir Owen's old firm's fortunes seem to bear out his reservations, having performed far better in the pre-Cadbury days when he was chairman and chief executive and there was less non-executive boardroom ballast.

David Barber, chairman and chief executive of the Halma Group, is another sceptic. He starts from the happy position of representing one of the UK's most successful companies, the star, stock-market performer of the past 25 years, according to James Capel. He can afford to cock a snook at Cadbury - although he is more tactful than that. 'No one can disagree with what Cadbury is seeking,' he says. 'But just because Cadbury is approaching abuse of director power by advocating the appointment of non-executive directors doesn't mean that's the only solution.

'It so happens that we have run this company very successfully without non-executive directors. We have had a particular management style and it has worked very well for the shareholders. My principal interest is as a shareholder - my shareholdings being worth a lot more than my salary.

'As a full-time, committed manager, I think it's illogical to believe that a non-executive director can perform a useful function with a limited knowledge of the company. Part of my job is to act as a non-executive director, and when I sit in on a meeting that I'm not chairing, the more I understand about the business, the more I can contribute. The thing that always troubles me about non-executives is that they are not well enough briefed.'

It is good practice for non-executive directors not to have share options, says Cadbury. In that case, says Barber, how can they represent shareholders?

The Halma Group, with its remarkable record (kept up in 1994 with pre-tax profits up 20% to £25.1 million and earnings per share up 14%) and its modern management methods - share options from directors down to the lowliest employee - may be seen as the exemplar of the non-conforming company.

But the Cadbury conformists have their champions, too, none more plausible than ICI. 'I am in no doubt,' declared ICI chairman Sir Denys Henderson, accepting a corporate governance award in January of this year, 'that ICI over many years has benefited in its corporate decision-making processes from the presence of powerful, experienced and independent non-executive directors of proven business integrity ... They have both the muscle and the courage to exercise it if any excess of executive zeal in pursuing "the thrill of the chase"needs to be questioned.' The key, of course, is to choose the right people. As Henderson admits, Cadbury is no panacea, but 'it has concentrated minds wonderfully on board behaviour, its impact on corporate performance and values as well as on shareholder relationships'.

And sure enough, even David Barber is belatedly moving in Cadbury's direction. 'It suits me quite well to look at the possibility of splitting roles. That's why we've appointed a deputy chief executive, who may in due course take that job over from me - but our main interest is always the value of the shares, so we will not do anything in a hurry. Similarly, we're moving to appoint non-executive directors as our own internal management changes.'

The conclusion seems obvious. Following the Cadbury Code may well be irrelevant to a rapidly growing company, but when you aspire to blue-chip status, it can only help public confidence. But Cadbury always aimed for a broader application than that. So what has Cadbury One done, and what might Cadbury Two be able to do, for medium-sized and smaller companies?

In November 1993, Coopers & Lybrand produced a survey of medium-sized and smaller listed companies which showed that although 80% agreed with the general thrust of Cadbury, only 45% agreed that all listed companies should aim to comply in full with the Code. The smaller the company, the less the enthusiasm for the requisite three non-executive directors, separate chairman and chief executive, and separate remuneration and audit committees.

The general reaction was perhaps best summarised by two statistics: on the one hand, only 12% agreed with the Cadbury Committee's assertion that if its Code had been in existence, a number of business failures and fraud cases would have been spotted earlier; on the other, 80% said they were making changes in order to comply. In other words, people did not expect startling results but they were prepared to try to improve their own procedures.

Roger Davis, head of audit at Coopers & Lybrand, believes Cadbury can be uniquely valuable by setting a standard. The Cadbury Committee, he suggests, is not some sort of marshal, acting on behalf of the Stock Exchange to root out wrongdoers. But by championing what is widely seen as sensible and desirable, it can raise the tone of corporate governance. Similarly, the Code should be honoured in spirit, rather than obeyed to the letter. 'As auditors, we have been trying to lower expectations rather than meet them in full. The Cadbury Code wasn't written for reckless companies. It was trying to establish how good companies should be run, and it brought together the Bank of England, the Stock Exchange and the auditing profession to arrive at some sort of consensus. I think it has achieved that, and I've spent a lot of time in boardrooms where it is taken very seriously.'

Davis continues: 'I think it's very important that we do have Cadbury Mark Two. The main criticism of Cadbury One was that there was no prescription for carrying it forward. Without Cadbury Two, there certainly won't be any means of making any of these improvements stick.'

Before anyone can consider what form Cadbury Two should take, however, there has to be a broad consensus on the scope of Cadbury One - and no one is quite sure where the limits are. Should it be up to the auditors to interpret Cadbury as strictly as they reasonably can? Should they refuse to endorse a Report and Accounts that simply denies the need for non-executive directors, that provides no effective check on the power of the chief executive, or that refuses to establish audit or remuneration committees? Not if Roger Davis can help it. By and large, he accepts the traditional North of England view that an auditor is 'nought but scorekeeper', and should not try to be a referee as well.

So does the buck pass to the institutional shareholders and fund managers, those in the strongest position to put pressure on a wayward chief executive? This seems to be the way things are going, and here, perhaps, lies the future for Cadbury Two.

Tradition has it that UK shareholders are a docile, ignorant lot compared with their US counterparts. Jonathan Charkham, former adviser to the Bank of England and a member of the Cadbury committee, confirmed this in Keeping Good Company, his comparative study of international corporate governance, published last year. Relations between company boards and their shareholders were, he wrote, 'perhaps the weakest link in the UK system'.

Now things may be changing. Fund managers report that their clients are becoming increasingly critical of ineffectual non-executive directors and greedy executives. Cadbury can perhaps take some of the credit for slowing the directors' gravy train. 'More and more of our clients - particularly local authorities - are asking us to vote against the re-election of directors who have two-or three-year rolling contracts and/or salaries they see as unreasonably high,' says Nicola Horlick, MD of Morgan Grenfell Investment Management. She also suggests that companies should encourage non-executives to spend more time with them, finding out about their business - doing more, in other words, to earn their salaries.

As Gina Cole, secretary to the Cadbury committee, explains, gradualism was always the essence of the committee's approach. Asking for too much, too soon, would only have put backs up. So Cadbury proposed a maximum of three years for directors' contracts (two years less than the five-year maximum stipulated by the Companies Act). Two years later, the Institute of Directors is recommending a two-year maximum, while Marks & Spencer and the National Association of Pension Funds insist that one year is quite enough.

Now Cadbury One is starting to look outdated. In February, a report emerged from a joint City/industry working group chaired by Paul Myners, chairman of Gartmore, and sponsored by the DTI's Innovation Unit. Its remit was to find ways of improving the relationship of British industry and institutional shareholders, thereby aiming to stimulate investment and development. Even-handed as befits a committee in which finance directors were balanced by institutional investors, Myners demanded something from everyone.

Major institutional investors, Myners said, should be more open with managements about their investment strategy, should participate in the corporate governance debate - not least by attending annual general meetings - and should train their fund managers in commercial awareness. Corporate managements, in turn, should give an annual strategic presentation to investors and analysts, should upgrade their AGMs, train their people in investor relations, and openly discuss executive pay.

James Joll, finance director of Pearson and a member of the Myners committee, explains: 'We want to get away from the two-tier shareholder democracy in which institutional shareholders get privileged access to directors and regular strategic discussions, while everyone else has to make do with a Report and Accounts and an annual general meeting all too easily hijacked by special interest groups.'

Myners advocated AGMs in which operational management would deliver presentations, shareholders would submit questions in advance, and minority questions would be delegated for individual response.

Finally, Myners called for pension fund trustees to acquire sufficient expertise to set long-term goals for the fund, and targets for fund managers.

Lurking in the background is the spectre of a Labour government poised to legislate - an impression Stewart Bell, Labour's front-bench spokesman on corporate affairs, confirms. 'It is fair to say that the thrust of our work is towards legislation. We would like to introduce two-tier boards - an executive board and a supervisory board composed of non-executive directors. We want to make it voluntary, but we're looking at ways of giving fiscal incentives to companies to have two-tier boards.

'We always said we would give Cadbury a chance, and if it didn't work, we would legislate,' Bell continues. 'As far as executive pay is concerned, it clearly hasn't worked - but to be fair, that isn't why Cadbury was set up in the first place. As far as Cadbury Two is concerned, we'll see what it comes up with and how effective it is.'

So what form might Son of Cadbury take, and what should it seek to bring within its compass? All that is known at the moment is that the original sponsors - the Financial Reporting Council, the accounting profession, the Institute of Directors, the CBI and the Stock Exchange - have invited representatives of the major investment institutions to join in setting up the new body.

Given that one of the main thrusts of Cadbury One seems to be an invitation to shareholders to play a keener supervisory role in corporate governance, it would make sense to have at least one, and preferably two, shareholder representatives on the committee - one, say, from Proshare and one from the National Association of Pension Funds. For the rest of his committee, interim chairman Sir Sydney Lipworth will probably draw from a similar short list to Sir Adrian's.

As for its remit, Cadbury Two is bound to address the investor/company relationship. It could do worse than pursue some of the Myners recommendations, advising companies to make annual strategic presentations to investors and analysts, to keep them informed through quarterly trading updates, and to train managers in investor relations. Annual reports and annual general meetings could be radically improved to be of genuine value to shareholders - honest dialogue instead of soft soap.

Then there are the non-executive directors - by common consent still too narrowly drawn from among the chairman's friends and other clubbable fellows of minimal effectiveness. Pro-NED, set up by the Stock Exchange and Bank of England but now operating as an independent, profit-making, head-hunting agency, advocates hiring non-executive directors in just the same way as other top executives - assessing the strengths and weaknesses of the board, writing a job description for a non-executive director, then delegating a nomination committee(itself led by non-executive directors) to compose short lists and conduct interviews. It is hard to see how anyone who believes in the value of non-executive directors could object to such a procedure.

Another glaring issue is directors' remuneration, a subject on which Cadbury committee stalwart Jonathan Charkham has come up with a promising formula. Charkham advocates an executive remuneration advisory committee (ERAC) whose members would have no continuing relationship with the executives whose pay they were supervising, and would be elected by shareholders at the same time as they vote on the directors each year; previous directors or employees of the company, suppliers, customers, relatives or competitors would be barred. Unless Sir Richard Greenbury has a better idea Cadbury Two might well take Charkham's ERACs as their model.

Finally, no system of reporting or internal control can be seen to be effective unless auditors' duties are more clearly defined. No one wants to see a procession of hapless accountants through the courts, carrying the can for irresponsible, misguided or crooked managements, but nor should they be allowed to check figures and turn a blind eye to everything else.

A framework established, there remains the question of enforcement. Given the public mood for action, Cadbury Two needs to be seen to do more than Cadbury One. Andrew Baker, of solicitors Wedlake Bell, who served on the Corporate Governance Sub-Committee of the City Group for Smaller Companies (CISCO), says: 'Cadbury Two should be clearer so that people know what the rules are. The Stock Exchange should publicly censure boards that do not comply.'

'Public censure's too good for them!' the radicals will cry - and perhaps it is. But it would be another step in the right direction, and is the very least Cadbury/ Lipworth should do if it clings to the hope of avoiding legislation.

In one respect at least, the sceptics may well be right: whatever Cadbury Two does, it probably won't prevent legislation. George Goyder said it in The Just Enterprise in 1987, and seven years on, Charkham re-quotes him without demur: 'It is absurd that a law (The Companies Act) designed for a family business a century ago should continue to apply without substantial change to the whole of industry today, regardless of the size and purpose of the company. This represents the abdication of the state from its responsibility to create responsible institutions.'

The fact that Charkham, a former Bank of England man, can contemplate with equanimity such a widely drawn view of the state's responsibilities is an indication of how much the climate has changed. As the tide of Thatcherism retreats, it seems that more and more people are preparing for legislation, like it or not. And if there must be a new Companies Act, it will surely be a better one - or at least not such a bad one - if Cadbury Two has learned from Cadbury One and can point legislation in the right direction.


- Boards of directors, including three non-executives, must meet regularly and provide an effective lead and control of the business. Chairman and chief executive should be separate roles

- Non-executive directors (NXDs) should be independent, appointed for limited terms and selected through a formal process by the whole board

- Executive directors' contracts should not run for more than three years, and their pay, pension and stock options should be monitored by a remuneration committee (mainly NXDs)

- The board, monitored by an audit committee of at least three NXDs, must give a clear, balanced assessment of the company's position, establishing that it is a going concern and confirming the efficacy of internal controls


Sir Owen Green former chairman, BTR: 'Anyone can see that [the committee] hasn't worked'

David Barber chairman and CEO, Halma: 'Non-execs are not well enough briefed'

Sir Denys Henderson chairman, ICI: 'Cadbury has concentrated minds on board behaviour'

Stewart Bell Labour spokesman on corporate affairs: 'We want to introduce two-tier boards'


Jonathan Charkham ex-adviser, Bank of England: 'Board/shareholder relations are weak link in UK system'

Nicola Horlick MD, Morgan Grenfell Investment Mgt: NXDs should spend more time in companies

Paul Myners chairman, Gartmore: Major investors should be more open

James Joll finance director, Pearson: 'We don't want two-tier shareholder democracy'


Andrew Baker partner, Wedlake Bell: 'Stock Exchange should censor boards that don't comply'

Roger Davis head of audit, Coopers & Lybrand: 'It's very important we have Cadbury Mark Two'.

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