Watson (1997) argue that, partly because of its terms of reference, the Cadbury Report assumed

that accountability to shareholders was the primary objective of corporate governance,

Cadbury relied largely on improved information to shareholders, continued self-regulation,
more independent directors and a strengthening of auditor independence to improve account-
ability. The main recommendations of the Cadbury Report (as laid down in the Code of Best
Practice) can be summarised as follows and are detailed in Table 2.2:
• Ideally the role of chairman and CEO should be separated. However, if both posts are held by
one individual, there should be a strong independent element on the board (that is, a strong
and independent set of non-executive directors).
• The majority of NEDs should be independent of management and free from any business or
other relationships which could materially interfere with the exercise of their independent
judgement.
• Executive directors’ contracts should not exceed three years without shareholder approval.
• Full disclosure of the remuneration of the chairman and highest paid director should be
provided.
• Executive directors’ remuneration should be subject to the recommendations of a remuner-
ation committee comprised wholly or mainly of NEDs.
• Boards should establish an audit committee of at least three NEDs.
• Directors should report on the effectiveness of the company’s system of internal control and
confirm that the business is a going concern.
Essentially, the Cadbury Report required that a board of directors be comprised of at least
three NEDs of which at least two should be independent. In addition, Cadbury placed great
emphasis on the role of institutional shareholders in influencing corporate governance standards
at the individual firm level. The emphasis on the role of non-executive directors and institutional
shareholders reflects the fact that corporate governance in the UK at the individual firm level
acts through two bodies: the board of directors and the annual general meeting (AGM). The
system operating in the UK was described by Ezzamel and Watson (1997) as ‘accountability
through disclosure', whereby the board of directors is required to produce at the AGM externally
audited accounts to enable shareholders to assess the adequacy of the directors’ stewardship.
The Code of Best Practice was not mandatory but listed companies had to include a statement in
their Annual Report outlining their compliance with the Code. The compliance statement had
to identify and give reasons for any areas of non-compliance. Cadbury relied on self-regulation
to ensure compliance, where non-compliance (for example, having fewer than three NEDs)
should cause shareholders, particularly institutions, to question governance practices within
the non-complying company.
The Cadbury Report was successful in that its recommendations were generally adopted,
at least by the larger public companies. A 1995 survey commissioned by the Cadbury Com-
mittee which examined compliance with the Code reported that 97% of the top 100 quoted
companies had three or more NEDs and 82% had a separate chairman and CEO (Cadbury,
1995). In contrast, only 39% of the smallest quoted companies (with market capitalisation
between £1 million and £10 million) had three or more NEDs. Furthermore, while 90% of
the
top 100 companies issued compliance statements claiming full compliance, only 26% of the
smallest companies could claim full compliance. However, while compliance with the Code
is
of obvious interest, it is important to note that the disclosure requirements of the Code
them-
selves represented a significant departure from previous practice. Prior to Cadbury,
companies