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began to overhaul their rules and regulations related to corporate govern-
ance. The repercussions of the Enron collapse have not come to a halt even
several years after its fall; such was the shock effect of the fall of the once
great Enron.
Chapter 21 “ UK corporate governance: reforms in the wake of corporate failures and the Enron case study 543

What caused Enron™s fall?
Despite extensive debate over what caused the fall of mighty Enron, it is
still relevant to clarify what led to the collapse, as well as to consider how
the governance shortcomings have been rectified in the US and the UK
and to consolidate the different reasons which were thought to be the
cause of failure of Enron by different scholars and analysts.
If the reason for the Enron collapse is to be given in one sentence
then it may be said that Enron™s inside monitors, directors and outside
monitors, auditors, stock analysts, credit agencies failed miserably in
being independent and objective while performing (or not performing)
their duty towards investors. Conflict of interest meant that they lost all

In the following paragraphs the major causes that were instrumental in the fall
of Enron are borne in mind while considering the UK corporate governance
background and framework. It may be recalled that:
The immediate cause for collapse was the revelation that creative accounting
helped Enron to hide its losses through the extensive use of SPEs (see also
below); and
The bankruptcy was the result of cumulative failure of its gatekeepers such
as directors, auditors, lawyers and analysts.
As indicated, in the next chapter the US reforms are considered by way of

The background and framework
In the UK the corporate governance regime is controlled by common law rules,
that is:
Case law largely relating to the fiduciary duties of directors; and
Statute, in particular the Companies Act 1985 and the Companies Act 1989,
which apply to both listed and unlisted companies.
In addition, listed companies must comply with the requirements of:
The Combined Code on Corporate Governance;
The Listing, Prospectus and Disclosure Rules issued by the Financial
Services Authority (FSA); and
The City Code on Takeovers and Mergers.
Accordingly there is no single source of law from which the rules governing
corporate governance emanate but a range of sources (e.g. Kay and Fowler 2005)
are available. In addition to these sources of law, the regulations and reports
Part E “ Case Studies of Business Risks

discussed below have a significant effect on the way in which corporate govern-
ance in the UK has been shaped into a self-regulatory form of governance (Law
and Wong 2005).
The equivalent corporate collapses in terms of well-documented cases of
corporate mismanagement of Enron in the UK “ the Maxwell and Polly Peck
debacles “ had already taken place in 1991. These debacles led to re-evaluations
of aspects of corporate governance frameworks such as:
Board and structure independence;
Financial reporting;
Executive compensation;
Shareholders™ rights; and
Company™s ethical, social and environmental responsibilities and reporting.
It is for this reason that it may be said that the UK government was in certain
ways more advanced in carrying out corporate governance reforms in compari-
son to the US.
Prior to the Enron collapse corporate governance reforms in the US were
more at state level, such as the reforms in the state of Delaware. In contrast
corporate governance reforms have been consolidated at national level in the
UK and have been systematic through a committee process. Unlike the US,
where corporate governance is focused on shareholders, in the UK the approach
has recently been in favour of combining shareholder and stakeholder
Companies in the UK and the US have been found to have differing
approaches to corporate governance in that in 90% of the UK™s largest com-
panies the CEO and chairman have distinct roles whereas in the US that is the
case in only 19% of companies. Executive compensation (referred to above) in
the US is twice that of their UK counterparts. Moreover long-term incentive
plans and stock options as a corporate governance measure to balance the inter-
ests of shareholders and executives equates to 161% of the average salary of
CEOs in the US whereas in the UK it is only 44% (Williams and Conley 2005).
A brief overview of the relevant UK reforms follows.

The Cadbury Report

UK corporate collapse
The early 1990s had witnessed a series of corporate failures and there were
government-supported systematic studies of corporate governance to
address the causes of collapse. However, with hindsight the recommenda-
tions made by government-supported committees did not prevent further
collapse though these were adopted by self-regulating businesses.
Chapter 21 “ UK corporate governance: reforms in the wake of corporate failures and the Enron case study 545

The fall of Robert Maxwell™s media empire led to the Cadbury Report which
addressed the role of directors and also reviewed the auditor™s role. The
Cadbury Report concluded that the most basic requirement for good corporate
governance is the accountability of the board to investors. The Cadbury
Committee was of the view that the foremost duty of the board is to provide
investors with all relevant information and recommended segregation in the
roles of CEO and chairman of the board.

The Greenbury Report
This report was published three years after the Cadbury Report. It was
the Greenbury Report which concentrated on compensation and recommended
the appointment of a remuneration committee consisting of nonexecutive
directors, as well as the participation of investors in decision making as to

The Hampel Review
The Hampel Review in 1998 reviewed both the previous report and endorsed
the recommendations of both the reports regarding:

The duty of the board to provide shareholders with all relevant information;
A separate role for CEO and chairman; and
The importance of the role of non-executive directors.

Since the recommendations made in all the three reports were not converted
into legislation they did not require legal obligation on the part of companies to
comply with them. The recommendations proposed by the Cadbury Report and
the Greenbury Report were included by the London Stock Exchange in its
Listing Rules as Best Practice Code and those of the Hampel Review into the
Combined Code.

Modern company law for a competitive economy
The fourth report, entitled Modern Company Law for a Competitive Economy,
focused on disclosure and called for legislative action. It differed from the pre-
vious reports which did not propose statutory reform.
Despite all these systematic studies and evaluations of corporate govern-
ance, collapses have not continued. Moreover, in spite of the controversy over
the role of non-executive directors in such collapses and risk management fail-
ures, the number of non-executive directors (NEDs) was not less in failed com-
panies than successful companies. This is best illustrated by the fall of Marconi
which is set out in the box below.
Part E “ Case Studies of Business Risks

The Marconi case study
Telecoms equipment group Marconi recorded a £5.1 billion loss before tax
for the six months to September. The loss occurred after the company
partly wrote off expensive acquisitions it made at the height of the tech-
nology boom. The company, which lost its top executives as its share price
sank from a high of £12 to around 30p, saw sales fall 19% from last year to
£2.58 billion.
With sales falling, the company™s debt “ a key source of concern for
investors already overburdened with bad news “ ballooned to £4.28 bil-
lion from £3.17 billion at the end of March. The losses prompted investors
to sell Marconi shares in early trading. The roles of CEO and chairman
were well separated.
The non-executive directors were not in any real sense independent
as the company influenced them bearing in mind their very high salaries
(as later recommended in reports of corporate governance).
The shareholders awoke only when the company was in financial dis-
tress and needed capital. The three issues that came to light with the fall
of Marconi were:

* The role of non-executive directors;
* Computation of termination compensation; and
* Executive stock options.

Therefore the conclusion is that the UK was not necessarily faring better than
the US although of course the magnitude of fraud by the management was not
as high as in the US (Dickerson 2003).
Meanwhile the conclusion of the study of UK companies by a professor of
Brauch College, Jay Dhaya, revealed that the separation of the CEO and the
chairman of the board did not bring significant improvement in functioning or
performance of the price of stock. In his view, although the split does not affect
the value of the stock, in particular circumstances the division may help. One
case in point is that of those companies that face heavy regulatory scrutiny.
They may have the chair focusing on government relations or having global
experience whereas the CEO concentrates on domestic business. Evidently the
split should be done if the specific circumstances of the company ask for and
support the separation (Pozen, Robert C. Harvard Business Review, April 2006).

The Enron case study: dimensions of risk management
and corporate governance
An important question that arises for consideration is whether the corporate
governance system regulating corporations in UK, if applied to Enron, would
have prevented the collapse of Enron. With this in mind, an attempt has been
Chapter 21 “ UK corporate governance: reforms in the wake of corporate failures and the Enron case study 547

made below to analyse the major causes of the fall of Enron bearing in mind the
UK corporate governance framework. It is also made bearing in mind the issues
of sustainable risk management in the context of this book.

Board oversight
One of the main causes of the fall of Enron was the close involvement of the
directors with the management or, put another way, their lack of supervision of
the malfeasance of the management on account of:
Conflict of interest;
Insufficient financial knowledge to understand the complex accounting of
Enron; and
The star status of the executives of Enron which gave them an aura of being
unable to do wrong.
In the UK while the board may have a non-executive chairman, insiders may be
in the majority on the board who will side with management. Moreover the
requirement of shareholders™ acquiescence in transactions involving conflict of
interest may not be effective due to the extensively dispersed ownership struc-
ture in the UK. This may lead to voting in favour of the management by default.
Therefore it is unlikely that the board structure in the UK could have prevented
the circumstances of Enron (Thorburn 2003).

Eversheds survey
It was reported in the Law Society Gazette that in a survey carried out by
the national firm Eversheds more than three-quarters of board directors
(78%) at public companies believed that increasing corporate regulation
had improved transparency. However, only 36% of those directors “ and
42% of equity analysts “ considered that the current regulatory environ-
ment reduced the risk of an Enron-style scandal in the UK.
Meanwhile they thought that the increased regulatory burden imposed
in recent years was damaging corporate profitability and growth. Almost
three-quarters of the analysts (73%) and four out of 10 directors believed
that an increase in red tape had a negative impact. Steven Francis, a regula-
tory partner at Eversheds, commented: ˜Given that much business regulation
introduced in the last few years has been designed to improve governance,
protect investors, employees and customers and prevent another Enron or
Worldcom, this lack of confidence among UK plc™s is very worrying.™

Lack of auditor independence
In the Enron case the auditors lacked independence since the provision of con-
sulting services to a corporation increases the influence of the executives over
Part E “ Case Studies of Business Risks

the auditors. In the UK, therefore, the principle-based accounting rules could
have prevented an Enron-like collapse as they put more pressure on the corpor-
ation to consolidate off balance sheet transactions. The mandatory requirement
of consolidation not only makes the financial condition of the corporation
transparent to investors and directors but also lessens the problems associated
with conflict of interest with auditors.

Executive compensation
Executives™ pay in the UK is not based on share price, unlike the US. This
means that the framework does not induce executives to go for short-term gains
by getting stock price moved for some time. Hence there is less risk of execu-
tives minting money by moving up the stock price for a short term and gaining
profit even when the corporation is on the verge of collapse (Thorburn 2003).
Although no corporate collapse of the magnitude of Enron and WorldCom
had occurred in the recent past, the Enron collapse did not leave the UK
unaffected. The UK embarked on its traditional systematic approach of
addressing the causes of the failures of the corporations by study and revalua-
tion by committees constituted of corporate experts.


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