BAE Systems, Europe's largest defence contractor at the centre of corruption claims over its arms deals with Saudi Arabia, has been urged to review business practices and install tougher anti-corruption measures.

An independent report by Lord Woolf, the former Lord Chief Justice of England and Wales, recommended 23 measures which would improve transparency and raise ethical standards.

Lord Woolf warned in the report: "Despite the progress made, the company has a substantial task ahead if it is to meet higher standards."

"If reputational issues are not promptly addressed they are likely to fester," he said.

Lord Woolf said that BAE had admitted it had not focused enough on ethical practices: "Critically, both the chairman and chief executive, in discussions with us, acknowledged that the company did not in the past pay sufficient attention to ethical standards and avoid activities that had the potential to give rise to reputational damage."

Dick Olver, the BAE chairman, said: “The Committee’s publication of this report is an important step towards BAE Systems’ objective of achieving benchmark standards of governance in the conduct of its day-to-day business."

BAE said that it would provide more feedback and details of the measures it intends to undertake by the end of July.

The report also calls for BAE to commission an external audit of its ethical business conduct and its management of reputational risk within three years and further reports should be commissioned at regular intervals thereafter.

The group needs to develop a code of business ethics and the board's Corporate Responsibility Committee should take charge of ethical conduct and reputational risk.

Lord Woolf said that BAE should create a team, led by a senior executive reporting to the chief financial officer and responsible for ensuring there are high ethical standards across the group.

It should also set up central registers for the monitoring of gifts and corporate hospitality.

He called for both external and internal audits to form the basis of a public update to shareholders each year in its annual report.

Lord Woolf has recommended that the ability of senior executives and the heads of BAE's business units to demonstrate high ethical standards should be reflected in their performance appraisals and the variable element of their remuneration.

BAE has already revealed in its latest annual report that senior executives will be set higher targets in ethics and safety. These targets will make up 12 per cent of potential bonuses for 2008.

The commissioning of the Woolf report has been heavily criticised for the limitations of its scope.

It has examined BAE's current practices, but did not look at the Saudi contracts into which the Serious Fraud Office conducted a bribery and corruption investigation.

This investigation was ordered to be dropped by the Government on the grounds of national security.

The High Court ruled last month that the Serious Fraud Office acted unlawfully in its decision to drop the investigation. The SFO is set to take the matter before the House of Lords.

Last October, Mike Turner, BAE's chief executive, announced he would step down once his contract runs out in August this year. The announcement came just months after Mr Turner had announced his intention to run the company for another five years.

It is believed that Mr Olver wanted to bring in a new blood to help implement a new, less aggressive corporate culture.

The group may announce a successor to Mr Turner at tomorrow's annual meeting.

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