Corporate governance in the financial

services sector
Morrison Handley-Schachler, Linda Juleff and Colin Paton

Morrison Handley-Schachler
is a Lecturer in Accounting,
Linda Juleff is a Senior
Lecturer in Economics, and
Colin Paton is a Research
Associate in Accounts and
Economics, all at School of
Accounting and
Economics, Napier
University Business School,
Edinburgh, UK.

Abstract
Purpose The purpose of this paper is to overview the goals of corporate governance in the financial
services sector from a theoretical perspective. This sector has experienced some high profile corporate
scandals, including BCCI, Barings Bank, and Equitable Life. Yet the UKs Combined Code on Corporate
Governance does not give any special prominence to the corporate governance issues involved in this
important and idiosyncratic business area.
Design/methodology/approach First, the broad parameters of corporate governance are discussed,
from a theoretical perspective. From this particular characteristics are derived applicable to the financial
services sector. These issues are examined and the extent to which they have been addressed by
contemporary academic or policy-related studies is considered, and also how they are related to the
activities of the main bodies responsible for external oversight.
Findings The main attention of this paper is banks and a key issue arising is that the typical structure
of their balance-sheets high leverage, and a mismatch in their assets and liabilities, mean that it is
imperative that they keep lenders confidence, and imply a wider duty of care for bank directors. External
regulators (FSA) and auditors have vital oversight functions, which should encourage sound
governance practices. One avenue of future research would be to assess the effectiveness of
compliance in the UK, given that financial companies have obligations concerning both FSA
requirements and Combined Code provisions.
Originality/value Some key issues pertaining to corporate governance in financial services are
addressed, highlighting their significance, to encourage further investigation by academics and
practitioners in the field.
Keywords Corporate governance, Financial services
Paper type Conceptual paper

1. Introduction
The purpose of this paper is to examine the goals of corporate governance in the financial
services sector, from a theoretical perspective, having regard to the purposes for which
financial institutions exist, the different sources from which those institutions derive their
funds, and the agency agreements under which those funds are held. Our primary interest is
corporate governance in the UK financial services sector, an area of increasing interest
(Mallin et al., 2005).
In this paper we examine the tensions which can be caused both by the existence of
different interest groups and by the need to balance responsible risk management
against the imperative of making an economic return as part of a successful and dynamic
economy. We consider the appropriateness of the approach to corporate governance
adopted in recent recommendations on corporate governance in the UK, which have
focused on a single agency agreement, that between shareholder and director, thereby
neglecting other agency agreements that exist in financial services, including mutual
ownership.

DOI 10.1108/14720700710827202

VOL. 7 NO. 5 2007, pp. 623-634, Q Emerald Group Publishing Limited, ISSN 1472-0701

CORPORATE GOVERNANCE

PAGE 623

The paper proceeds as follows. First, we address a few fundamental questions regarding
what corporate governance is, and the issues it is concerned with, in particular those
affecting the financial services sector. In the next section we examine corporate governance
issues in financial services. We explain why it merits particular attention, we outline the role of
the sector regulator, and then we discuss some academic and policy-related studies in this
area. The final two sections are conclusions, and pointers for future research, respectively.

2. What is corporate governance? Theoretical considerations

Corporate governance is a very general phrase, denoting, as the Cadbury Report (1992),
says, the system by which companies are directed and controlled. It is concerned with
structures and the allocation of responsibilities within companies.
More specifically, discussions on corporate governance have concentrated on the relations
between the directors and managers of the corporation and other parties. The parties
concerned have varied. Dimsdale and Prevezer (1994) noted in the opening of their preface:
Corporate governance is concerned with the way in which corporations are governed and in
particular in the United Kingdom the relationship between the management of a company and its
shareholders.

This focus in corporate governance has continued to underlie the provisions of subsequent
corporate governance reports in the UK, including Greenbury Report (1995), Hampel
Report (1998), Turnbull Report (1999), Higgs (2003), and Smith Report (2003).
The OECD (1999) hints at a wider network of relationships, while maintaining the emphasis
on the relationship between shareholder and director, defining corporate governance as:
A set of relationships between a companys management, its board, its shareholders and other
stakeholders. Corporate governance also provides the structure through which the objectives of
the company are set, and the means of attaining those objectives and monitoring performance
are determined. Good corporate governance should provide proper incentives for the board and
management to pursue objectives that are in the interests of the company and shareholders and
should facilitate effective monitoring, thereby encouraging firms to use resources more efficiently.

The introduction of other stakeholders raises the question of where exactly the shareholders
interests rank in terms of directors priorities, notwithstanding the emphasis subsequently
placed on the primacy of shareholders interests in what the OECD perceives as good
corporate governance. The OECD to some extent answers this question, in its remarks on
the role of stakeholders:
The corporate governance framework should recognise the rights of stakeholders as established
by law and encourage active co-operation between corporations and stakeholders in creating
wealth, jobs, and the sustainability of financially sound enterprises.

Two observations on the OECDs perception of the role of the corporation can be made here.
First, it is assumed that the corporation serves purely as an agency for wealth-maximization
for all concerned. The shareholders interests are assumed to be synonymous with those of
the company (objectives that are in the interests of the company and shareholders) and
the role and interests of stakeholders are narrowly defined in terms of economic activity
(wealth, jobs, and the sustainability of financially sound enterprises). Second,
stakeholders are carefully defined in close legal terms: only rights protected by law
whether through contract or by statute need be respected. Wider, non-statutory or
non-contractual relationships are not considered in this framework.
In the context of the financial services industry, the first observation above relating to the
OECDs conception of corporate governance has a great deal of merit. Financial institutions
do indeed exist to maximise wealth. The use of agency theory and legalism in the OECDs
Principles to define a range of stakeholders also has advantages over the very specific
agency approach adopted in the UKs corporate governance reports. The UK approach
privileges the shareholders interest to a degree not justified in classical agency theory, in
which an agency relationship is defined as:

PAGE 624 CORPORATE GOVERNANCE VOL. 7 NO. 5 2007

A contract under which one or more persons (the principals(s)) engage another person (the
agent) to perform some service on their behalf which involves delegating some decision making
authority to the agent (Jensen and Meckling, 1976, p.309).

As financial institutions usually act partly in the capacity of fund managers, it should be not
be assumed that agency relationships within the industry will be primarily defined in terms of
shareholdings. In fact, a number of financial institutions have no shareholders and fall within
other categories of organization in which Jensen and Meckling warned that agency
problems would arise (especially mutual companies, cooperatives, Jensen and Meckling,
1976, p. 309). However, even for companies in this field, there are usually numerous agency
relationships with providers of funds which arise from the companys activities as a fund
manager and which are encompassed by the OECDs principles but tend to be neglected by
the Cadbury report and its successors.
However, in stakeholder theory (Dodd, 1932; Evan and Freeman, 1993), no agency
relationship, indeed no legal relationship at all, is needed to establish moral rights to
influence a companys activities. All that is required is the ability to affect, or to be affected
by, the corporation. Financial services firms tend to have a number of such stakeholders,
especially among those who have no present contractual relationship with the institution but
may seek to enter into such a relationship in the future. These include businesses and
individuals who are applying for funds and who may be affected by decisions to accept or
reject applications or to impose higher or lower interest rates.
In this paper we give attention to conflicts which can arise in the financial services industry
between different groups of principals, principals and other stakeholders, as well as to
conventional principal agent conflicts.
According to Jensen and Mecklings definition, there a number of different groups of
principals who provide funds for management by the directors and other employees of
financial services companies. Ordinary shareholders are one group. Other groups include
preference shareholders, and non-shareholders such as bondholders and depositors
(see section 3). All of these groups funds are available for the directors to use for the general
purpose of generating financial returns to be distributed among the principals.
Other groups of principals provide funds which must be managed within a far narrower
remit. These principals primarily consist of contributors to managed funds. These funds do
not form part of the financial companys balance sheet, in financial accounting terms, and
the fund itself may be constituted as a separate company. However, what characterizes the
agency relationship is the management of one partys funds by another and such a
relationship clearly exists between contributors to managed funds and the fund managers,
who are generally employees of banks and other financial services companies.
In addition, there are a wide variety of organizations whose employees are responsible for
the management of these funds. Perhaps because of the extreme sensitivity of the
management of financial resources and the ability of financial services companies to obtain
capital from customer deposits instead of from shareholders funds, the financial services
industry, more than any other, has been characterized by the development of institutions
based on principles of mutuality, in which the owners are also customers, alongside those
incorporated as shareholding companies, in which the owners can be easily distinguished
from the customers. These institutions were initially created with the intention of providing in
one way or another for the social welfare of their members, through the provision of pensions,
loans and insurance. Membership was therefore based on a specific need for such
provision, the ability to contribute and a rough parity of risks between the members. In such
organizations, the task of the manager, as agent for the members of a mutual society, is not to
maximize the profits of the organization but to provide the specific financial service for which
the society was created at the lowest cost or to provide the maximum benefit for a specific
cost.
It is thus possible to provide a substantial list of the principals whose funds are managed in
the financial services industry, their relationships with their agents and their objectives in
engaging the agent. The list shown in Table I is by no means exhaustive.

VOL. 7 NO. 5 2007 CORPORATE GOVERNANCE PAGE 625

PAGE 626 CORPORATE GOVERNANCE VOL. 7 NO. 5 2007

Director, Manager

Director, Manager
Company

Company

Company

Company-fund
manager

2 Preference shareholder

3 Holder of irredeemable bonds or

debentures

4 Depositor

5 Current account holder

6 Contributor to a managed fund

Primary agent

1 Ordinary shareholder

Principal

Table I The main principals in financial services

Objectives of principal

To preserve a financial asset and, as far as possible, to

receive income paid by the company. If the amount of
interest is not laid down in contract, it may be partly
determined by the returns the corporation makes on its
investments, the fees it receives for fund management and
the profits it makes on insurance business

To receive a specified amount of income each year and the

repayment of the loan (redeemable instruments) or a
specified amount of income each year in perpetuity
(irredeemable)

Owner of a share of the assets of a fund managed by the

corporation as agent and by an employee of the
corporation as the corporations agent with the objective of
maximizing profits within the constraints agreed between
the principal and agent. The corporations management of
the fund is usually constrained by a requirement to invest or
not to invest in certain types of security, certain types of
company, industry or geographical area. This requirement
is usually part of an explicit contract between the
contributor and the corporation or implicit in the
representations made about the fund in advertising and
promotional material. The fund may be constituted as an
OEIC (Open-Ended Investment Company)

(Continued)

To maximize profit within constraints based on religious

prohibitions, secular ethics, the desire to diversify away
from areas or industries in which other investments are
already held, the level of risks and rewards sought by the
investor or any other reasoning

To obtain safe custody of funds and to disburse those funds

Unsecured creditor of a financial services company who
has a right to repayment of the loan on demand or after a efficiently to others
specified notice period. There is no legal distinction
between a current account holder and a deposit account
holder. However, a current account is characterized by the
prime importance of immediate access to the account
holders funds, with the receipt of interest being
unimportant. The corporation acts as custodian of the
account holders funds and as an agent for their
disbursement

Unsecured creditor of a financial services company who

has a right to repayment of the loan on demand or after a
specified notice period or on a specified date. In some
cases there is a contractual right to receive interest and in
other cases there may be an expectation that interest will be
paid

Creditor, usually unsecured, of a financial services

company run by its agents who has a contractual right to
interest and, if the bonds or debentures are redeemable, to
the repayment of the loan on a specified date

Member of a company which employs directors and

To generate profits for reinvestment or payment as
managers as agents to run a financial services business of dividends
a nature authorized in the companys memorandum and
articles of association and to maximize profits within the
constraints of those founding documents and public law
Member of the company
To receive a specified annual dividend on capital invested

Relationship with company

VOL. 7 NO. 5 2007 CORPORATE GOVERNANCE PAGE 627

Trustee, employer
or company

Company

8 Defined benefit pension scheme

member

9 Insurance policyholder

Company

Trustee, employer
or company

7 Defined contribution pension

scheme member

10 Stockbroking client

Primary agent

Principal

Table I
Objectives of principal

To be insured for a specified event at minimum cost, cost

being partly a function of the returns which the corporation
expects to make from investing the premium

To provide a specified benefit at minimum cost. Shortfalls

are usually met by the members themselves through higher
contributions at a later date or by the members employer,
at the expense of other employee benefits, and not by the
fund manager

Customer of a corporation which is contractually bound to To own a specific security and to receive income derived
buy specified shares or securities and deliver the
from it
certificates to the customer or to provide custodial services
for a specified fee. There may be a contractual duty to
receive and remit, disburse or hold in custody the interest or
dividends on the shares or securities

Customer of a corporation which is contractually bound to

provide money or services if a specified event occurs, in
return for the payment of an agreed sum (premium) on an
agreed date

The same as for defined contribution scheme members,

except that the annuity and lump sum are calculated in
accordance with a formula agreed before the first
contribution is made

Owner of a share of the assets of a fund managed by the To maximize future income by maximizing profit
corporation as agent and by an employee of the
corporation as the corporations agent with the objective of
maximizing profits over a specified time period in order to
fund the purchase of an annuity and the payment of a lump
sum. Constraints may be agreed on the type of investment
allowed. The scheme member sometimes has a direct
agency-contract relationship with the corporation. More
commonly, the pension scheme is managed by trustees,
who are the scheme members agents and employ the
corporation as their agent. In other cases, the scheme
members employer acts as the trustee

Relationship with company

As can be seen from Table I, there are a very wide variety of principals involved in the
financial services industry. To complicate matters further, a wide variety of organizational
structures is also involved.

3. Corporate governance in financial services

3.1. Why does it merit special attention?
All of the official UK pronouncements on corporate governance, from Cadbury to Higgs and
Smith, have been sector-wide, and so do not address the specific concerns of the financial
services sector. This in practice has meant that they have been concerned primarily with the
single agency relationship between company directors and shareholders, rather than
accounting for the broad range of principals that are features of financial services
companies. The distinctive characteristics of financial services companies imply the need
for distinctive corporate governance arrangements for this sector.
Financial services are a critical part of any economy, and are particularly significant in the
UK, the core being the historic City of London, one of the worlds leading international
financial services sectors, employing over 1 million people, and with net overseas earnings
of 31.2 billion or 5 percent of GDP (DTI, 2005). Banks are the most important component
within financial services, providing deposit and loan facilities for personal and corporate
customers, making credit and liquidity available in adverse market conditions, and providing
access to the nations payments systems. The other main areas are life assurance, and a
broad range of fund management activities.
Recent corporate collapses and malpractices within the sector suggest that, despite UK
financial markets being well-developed and relatively sophisticated, there have been
sufficient system weaknesses to enable episodes of financial company malfeasance. The
main cases are BCCI, Barings, Equitable Life, mortgage endowment mis-selling, split-cap
investment trust opacity, and a spate of money laundering failures[1].
In respect of the firm collapses, BCCI, as one of the worlds largest banks, was closed down
by the Bank of England in 1991. Based in London, it was licensed as a deposit-taker by the
Bank in 1980. Over the next eight years the bank increased its assets by engaging, it
subsequently emerged, in a number of fraudulent activities, leading to an official enquiry
(Bingham, 1992). A civil action brought by shareholders and creditors of BCCI against the
then regulator, the Bank of England, is still ongoing. The outcome could have important
implications for shareholders and creditors, especially of financial institutions.
Barings failure was due to the activities of a rogue trader, Nick Leeson, who transacted
derivatives on East Asian exchanges, which were, in some cases, unauthorised. All
unauthorised transactions were entered, and losses made on them were accumulated, in an
error account opened by Leeson. As a result of these losses, Barings was placed in
administration due to insolvency in February 1995 (Kornert, 2003). The crisis highlighted
weakness in internal and external controls, and the importance of maintaining a sufficient
level of capital on the balance sheet (at the time of Barings liquidation, accumulated losses
were 927m compared to capital of around 309m, as reported in 1993 (Kornert, 2003)).
Equitable Lifes problems centred around its Guaranteed Annuity Rates (GARs) policies sold
in the 1980s and 1990s, which guaranteed investors a minimum annuity rate on retirement.
These reflected the high interest rates of the period, but when rates began to fall, it became
increasingly expensive for the company to honour them. The company failed to set aside
reserves to cover the cost of meeting the guarantees, and did not alert investors, in their
published accounts, to the escalating contingent liability. (Dale, 2001). Unable to meet its
obligations to policyholders, the firm closed to new business in 2000, and remains so.
All of the above events were a shock to the capital markets, and dented investor
confidence. Each identifies the need to sharpen both risk management and internal control
procedures, and external oversight. These cases called into question the role of the
regulator. The Financial Services Authority (FSA) was set-up in 1998 to take over
responsibility for banking supervision.

PAGE 628 CORPORATE GOVERNANCE VOL. 7 NO. 5 2007

3.2. The FSA

Under the Financial Services and Markets Act (FSMA) 2000, the FSAs regulatory powers
were extended, assuming full responsibility for the regulation of financial services under this
Act in December 2001. The FSA has a number of rule-making, investigatory, and
enforcement powers in order to meet its four statutory (FSMA) objectives, which can be
summarised as:
1. to maintain market confidence in the financial system;
2. to promote public understanding of the financial system;
3. to secure an appropriate degree of consumer/investor protection; and
4. to reduce financial crime.
The above objectives, especially 1, 3 and 4 concern matters that are fundamentally relevant
to corporate governance. To illustrate the governance nature of the arrangements,
statements on high-level standards from the 2005 edition of the FSA Handbook of Rules and
Guidance (FSA, 2005) include a statement of Principles for businesses applicable to
authorised firms, and Statements of principle, applicable to approved persons. Moreover,
firms are required to divide responsibilities among directors and senior management and
maintain appropriate systems and controls (Dewing and Russell, 2004).
The various compliance requirements monitored and enforced by the FSA are likely to
complement official corporate governance provisions, as detailed in the (revised) Combined
Code. It is not the purpose of this paper to examine the extent of this in detail. The purpose of
this paper is to examine the goals of corporate governance in the financial services sector,
and we give particular attention to the largest component of that sector, banks, in section 3.3
below.
3.3. External audit
FSMA 2000 also gives statutory auditors additional responsibilities beyond those contained
in the 1985 Companies Act. Most importantly, they are required to report to the FSA
breaches of laws and regulations such as insider trading or breaches of solvency
requirements for banks or insurance companies. Audit firms may also be engaged as
skilled persons to report to the FSA on financial services firms activities under FSMA 2000.
The role is examined in depth by Dewing and Russell (2005).
Regulations such as the Open-Ended Investment Companies (Investment Companies with
Variable Capital) Regulations 1996 (SI 1996/2827) also require a separate audit of the
financial statements of these funds, with no exemptions for size. This is a classic application
of the auditors role in protecting the principals (contributors), because of the risk that
misappropriation of funds by agents (fund managers) would not be detected by any other
means. However, there is an enhanced agency risk in the auditors own contract with the
principals, because of the reduced danger of audit negligence coming to light if such
misappropriations do not result in the funds insolvency.

4. Recent studies
4.1. Federal Reserve Bank of New York
There is relatively little extant analysis of the field of corporate governance as it applies to the
financial services sector in the academic literature[2]. An important paper addressing this
issue is Macey and OHara (2003), part of a special study on corporate governance for the
Federal Reserve Bank of New York.
In their overview of the corporation as a contract, Macey and OHara (2003) suggest that
fiduciary duties should be owed by corporations and their directors not only to shareholders,
but also to nonshareholder constituencies, to redress an overemphasis in law and
economic theory on fiduciary duties owed to shareholders. They state that there are many
situations in which non-shareholder constituencies, such as uninsured depositors in banks,

VOL. 7 NO. 5 2007 CORPORATE GOVERNANCE PAGE 629

might value a contractual right more than shareholders value it. Moreover, they observe that
banks have, relative to other sectors, high gearing, or debt in proportion to equity, levels,
creating a public interest case for accountability to fixed claimants (including depositors) as
well as to equityholders.
Macey and OHara also comment on the potential for any bank failure to affect the wider
banking system and on the danger of liquidity crises at banks (bank runs) arising from the
banks role as providers of long-term liquidity through loans backed by short-term deposits.
This has given rise to the use of deposit insurance to give sufficient confidence to depositors
to prevent panic-led bank runs. However, Macey and OHara warn of the danger of moral
hazard, where this safety net encourages shareholders and managers of insured banks to
engage in excessive risk-taking, especially if insurance is subsidised by the taxpayer,
although they add that this can be mitigated by minimum capital requirements.
Finally, Macey and OHara suggest that market forces backed by effective accountability
mechanisms may be more effective than external regulations, as depositors with funds at
risk have an incentive to monitor bank activity and banks competing for deposits have an
incentive to gain competitive advantage through improved controls.
Macey and OHaras proposition that banks accountability should properly be to a wider
grouping (not just shareholders), due to their particular characteristics, is supported by
Adams and Mehran (2003), who provide statistical, non-econometric, analysis. This
compared corporate governance variables for a sample of bank holding companies with the
same variables for a sample of manufacturing firms. They find differences in some key
corporate governance variables: board size and composition, board activity, CEO
compensation, CEO ownership, and block (large, typically institutional) share ownership.
These differences are a result of different industry characteristics, including formal external
regulation of banking firms, such procedures not being applicable to manufacturing firms.
The policy implication is that banks require different, more extensive corporate governance
arrangements than manufacturing firms.
4.2. Basel Committee
In terms of formal pronouncements, the Basel Committee on Banking Supervision (1999) has
been active in drawing from the collective supervisory experience of its members in issuing
supervisory guidance to foster safe and sound banking practices. Reinforcing the
importance of the OECD (1999) Principles, for international corporate governance, it
produced Enhancing Corporate Governance for Banking Organisations. The Committee
recommended a number of sound corporate governance practices for banks, which are
consistent with UK corporate governance findings including: the need for clear lines of
responsibility and accountability throughout an organisation (e.g. Cadbury), ensuring board
members are properly qualified and not subject to undue influence from management
(Higgs), and effectively utilising the work of internal as well as external auditors (Turnbull).
In addition, they stress the importance of ensuring an environment supportive of sound
corporate governance; and the role of supervisors. The significance of other stakeholders is
emphasised, which is consistent with discussions above.
4.3. Reserve Bank of New Zealand
Mortlock (2003), in a study for the Reserve Bank of New Zealand discusses the need for
appropriate banking supervisory arrangements and specific financial disclosure and
external auditing arrangements. He identifies two particular features of banks that suggest
the need for a more intensive focus on corporate governance than some other industry
sectors:
B

reliance on debt funding; and

complexity of their risks.

Mortlock, like Macey and OHara (2003), argues that corporate governance in banking is a
crucial determinant of financial stability:

PAGE 630 CORPORATE GOVERNANCE VOL. 7 NO. 5 2007

. . . although poor quality macroeconomic policy and economic shocks often play a major part in
contributing to financial instability, it is fair to say that inadequate risk management within banks
and other financial institutions is the root cause of most episodes of financial system distress. And
a frequent cause of poor risk management is inadequate corporate governance.

Barings, as described in section 3.1, is a prominent example of precisely those corporate

governance weaknesses of which Mortlock warns, namely failures in risk management
systems and internal controls, risk-management training for staff, including directors and
senior managers, structures to encourage bank directors to take responsibility for risk
management and effective external periodic reviews of banks risk management systems
and internal controls (Mortlock, 2003). Mortlock also argues for frequent disclosures of the
market value of banks credit exposures and suggests the disclosure of directors and
managers conflicts of interest and the boards rules for handling them, as well as an
attestation that the directors are satisfied with the banks risk management.
Mortlock stresses the importance of effective market disciplines in promoting financial
stability and sound risk management/corporate governance practices. Market disciplines
can be strengthened by encouraging competition. It will be interesting to follow the
progression of the implementation of Basel II (Basel Committee on Banking Supervision,
2004) for likelihood of reducing competition through possible increased concentration of
banking firms.
Another potential competition issue is deposit insurance (Macey and OHara, 2003), as
deposit schemes must be designed to avoid allowing deposit-takers with
high-risk-high-return strategies insuring their depositors at the expense of customers of
lower-risk institutions.
4.4. Myners Review of the governance of life mutuals
Myners investigation into the governance of life mutuals was instigated following the
Penrose (2004) enquiry into events at Equitable Life. Myners reported in December 2004.
The terms of reference were to: Consider the governance framework for mutual life offices
in comparison with that for comparable companies. In particular the following were
examined:
B

the level of member involvement in the governance of life mutual offices;

board accountability for mutual life offices; and

the level of regulation by the FSA to which mutual life offices are subject.

Mutual companies tend to provide longer-term financial services, such as mortgages and
life insurance. The customer relationship is paramount, and, because they do not have to be
concerned with remunerating shareholders, they have a potentially lower cost of capital,
although the concomitant of this is an enhanced risk to policyholders, well illustrated by the
case of Equitable Life.
Myners notes that, as with proprietary companies, potential for conflict of interest exists for
life mutuals also between owner (members) and managers, which, in the case of poor
accountability, can lead to inefficiency. In the case of Equitable Life, corporate governance
weaknesses led Lord Penrose to conclude that . . .the Board was a self-perpetuating
oligarchy amenable to policyholder pressure only at its discretion (Penrose, 2004).
Myners perceived a gap in the formal rules to which life mutuals are subject. For example,
unlike proprietary listed companies, life mutuals are not subject to requirements of the
Companies Act and Listing Rules, and are not required to publish a statement on
compliance with the Combined Code. Similarly, life mutuals are not subject to uniform
obligations governing their relationships with their members.
The Myners Review (2004) recommends that:
. . . life mutuals should adhere to a version of the Combined Code that is annotated with guidance
that does not alter Code principles but aims rather to promote interpretations that best uphold
these principles in this sector.

VOL. 7 NO. 5 2007 CORPORATE GOVERNANCE PAGE 631

The principal guidance offered by the annotations is:

B

firms should make a governance statement in their annual report;

firms should publish a directors remuneration report;

for non-executive directors to receive appropriate information and pro-active support; and

boards should consider how dialogue with members can best be conducted.

5. Concluding remarks
Corporate governance developments in the UK have evolved in a rapid fashion from the
initial Cadbury report in 1992, and subsequent Code of Best Practice, to the revised
Combined Code of 2003. The Code has emerged partly as a response to corporate
misfeasance involving large companies within financial services, including BCCI and
Barings. These reports have failed, however, to give any special attention to banks, or other
financial firms. Moreover, their main concern has been the relationship between company
directors and their shareholders, thus largely ignoring the (often competing) interests of
other stakeholders, including bondholders and mutual customer/owners.
In this paper we have highlighted the distinctive attributes of financial services firms that
result in particular owner-manager relationships and distinctive corporate governance
arrangements, resulting in the following keypoints:
B

In the case of the banking sector, which was the main focus of this paper, the structure of
bank balance sheets especially banks highly leveraged condition and the mismatch in
their assets and liabilities means that it is imperative that banks maintain the confidence
of their creditors and implies a wider duty of care for bank directors. In particular, fiduciary
duties properly extend beyond shareholders to non-shareholder groups.

In financial services, the FSAs rule-making, investigatory and enforcement powers are vital.

External auditors also have additional responsibilities in connection with financial services
clients, including reporting breaches of laws and regulations, and assisting the FSA as
independent experts in their investigations. These externally-imposed compliance
requirements should support and complement effective internal corporate governance
structures.

6. Future research
This paper points to some key questions requiring future research:
B

Given the breadth and depth of the financial services sector, analysis of the corporate
governance features/requirements of specific sub-sectors is appropriate. Much attention
has been devoted to banks in this paper, but life mutuals for example, merit special
attention due to their particular agency characteristics.

Future research needs to consider carefully what corporate governance practices

financial companies may be expected to adopt in the UK in view of official
pronouncements on the subject, such as the Basel Committee on Banking Supervision,
or Myners Review of the Governance of Life Mutuals.

While listed financial companies in the UK have to meet FSA compliance, they also have
to disclose compliance or otherwise with the Combined Code. One avenue of future
research would be to assess, through survey, how financial companies viewed these
arrangements in practice, and the perceived effect on firm operations/performance. An
interesting issue to explore is to gauge to what extent the regulation and Code provisions
are regarded as a compliance hurdle, rather than a feature that can be effectively
integrated into a firms overall strategic management.

Notes
1. Recent money laundering cases have involved two of the largest banking groups retail operations:
Royal Bank of Scotland (2002) and Abbey National (2003).
2. Often (for example in the USA) more commonly referred to as the financial sector.

PAGE 632 CORPORATE GOVERNANCE VOL. 7 NO. 5 2007

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About the authors

Morrison Handley-Schachler is a Lecturer in Accounting at Napier University. He has
co-authored articles on public sector risk management, accounting history and trade in
emerging markets.
Linda Juleff is a Senior Lecturer in Economics at Napier University. She has co-authored a
number of works in the areas of managerial and industrial economics. She is the
corresponding author and can be contacted at: L.Juleff@napier.ac.uk
Colin Paton is a Research Associate in Accounting and Economics at Napier University.

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PAGE 634 CORPORATE GOVERNANCE VOL. 7 NO. 5 2007