6 - The role of the regulator

Summary

Introduction

In this chapter I will briefly explain the rationale for the market-based approach to promoting good governance and why I believe the comply-or-explain approach to be the most effective means of achieving this objective, before going on to set out what I see as the proper role for the regulator and governments in encouraging the uptake of good practice. I will then illustrate how this role works in practice using two examples from my period as chairman of the Financial Reporting Council (FRC): the revisions to the Combined Code made in 2003 following the Higgs and Smith reports on non-executive directors and audit committees respectively, and the review of the Turnbull guidance on internal controls in the wake of the US Sarbanes-Oxley Act in 2004–5. The FRC is the body designated by the Government, with the support of the business, investor and professional communities, to be responsible for corporate governance. Finally, I will consider some of the challenges to the success of the market-based approach.

The market-based approach to promoting good governance

To set the context for a discussion of the market-based approach to promoting good governance I can do no better than start with two quotes. The first is the opening paragraph from the 1992 Cadbury Report, which put in place the basic elements of the framework that is still used in the UK, and the second is the first principle in the Combined Code on Corporate Governance:

The country's economy depends on the drive and efficiency of its companies. Thus the effectiveness with which their boards discharge their responsibilities determines Britain's competitive position. They must be free to drive their companies forward, but exercise that freedom within a framework of effective accountability. This is the essence of any system of good corporate governance.

The board's role is to provide entrepreneurial leadership of the company within a framework of prudent and effective controls which enables risk to be assessed and managed.