Over the past few decades, the interventions in corporate governance, from Cadbury on, have been a monoculture of increasing shareholder empowerment. In Cadbury, this was expressed as: “The issue for corporate governance is how to strengthen the accountability of boards of directors to shareholders.” The fallacious belief in shareholder primacy is deeply embedded; it finds form in the concept of engagement.
The latest of these intercessions, the Stewardship Code 2012, continues this shareholder tradition and offers the following advice to investors: “Activities may include monitoring and engaging with companies on matters such as strategy, performance, risk, capital structure, and corporate governance, including culture and remuneration. Engagement is purposeful dialogue with companies on these matters as well as on issues that are the immediate subject of votes at general meetings.”
The results by any reckoning have been profoundly disappointing, but unsurprisingly so. Companies have been abusing their social license by avoiding taxes on an unprecedented scale since this serves the interests of shareholders more than any other stakeholder. Employees have suffered as the terms of their employment have disadvantaged them; bond-holders have suffered as leveraged buyouts have lowered the creditworthiness of the company’s outstanding obligations; even suppliers have suffered through adverse trading terms, such as ‘pay to stay’. When management incentives are seen to be well aligned to shareholder interests through stock price related remuneration, a management strategy that disadvantages these other stakeholder groups to the benefit of shareholders is obvious. A strategy that benefits both management and shareholders at the expense of others is a no-brainer.
The financial services industry took this to extreme; in pursuit of outlandish bonuses, risks of unprecedented proportion were taken, and shareholders were quiescent or supportive.
The Companies Act 2006 states the responsibilities of a director as: “A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (among other matters) to:
- a) the likely consequences of any decision in the long term;
(b) the interests of the company’s employees;
(c) the need to foster the company’s business relationships with suppliers, customers and others;
(d) the impact of the company’s operations on the community and the environment;
(e) the desirability of the company maintaining a reputation for high standards of business conduct; and
(f) the need to act fairly as between members of the company.”
The responsibility of the board is clear: promotion of the success of the company while maintaining an equitable balance between all stakeholder interest groups, internal and external. It is also clear that the board is not the agent of any of these groups, and is rather closer to holding a position of trusteeship to the company.
Some have advocated the promotion of different forms of company, mutuals and co-operatives, in pursuit of wider alignment of interests, with articles of association that reflect a more diverse, richer set of objectives. While the purpose of the company is a legitimate issue, and this approach would align more and different interest groups, this does not fully address the matter of equitable balance.
It is clear that the form of governance should indeed be determined by the purpose of the company. However, contrary to the beliefs of many financial analysts, this is not about the creation and maintenance of value or wealth, but rather about the production and distribution of the goods and services that we wish to consume in an effective, efficient and sustainable manner. The creation of value for stakeholders is incidental to this; it is a consequence and should not be an objective or purpose.
The question of control rights is central to this. For bondholders, these are the covenants and warranties in the securities issued; for employees, there is employment law. In conformity with the resolution of the problems of the tragedy of the commons, it usual to endow the most subordinate (in priority and time) stakeholders with control rights, and this is the justification for the rights accruing to shareholders. It is important to understand that these rights should be limited; left to pursue their own interests alone, with no moderating influence from the board, the full litany of other stakeholder abuse can be expected to emerge. Engagement and empowerment are close synonyms.
The question of shareholder rights is particularly interesting when the shares are listed and traded. In this situation, the shareholder is most unlikely to have supplied capital to the business – that was done by the original purchasers of the securities; the current shareholder bought their shares from some other previous shareholder. The company received committed capital at that time of initial issuance. In fact, the gyrations of subsequent market prices should be of little concern to the company, absent such things as share-price linked management remuneration, and the need to raise new investment capital. The empirical evidence is that companies that use their share price as a management guide perform worse than those that do not and that the market discipline of the share price, so beloved of regulators, does not work beneficially. Indeed, it appears that the primary flow of capital in stock markets is now from companies to shareholders rather than from investors to companies for new commercial investment; the market no longer serves the functions described by the models that endorse these approaches.
With the option to sell in a market and realise the shareholding value, can we continue to consider the shareholder to be the most remote claim in time or priority? The justification for control rights is far weaker. Other groups of stakeholders have claims that are far more remote in time. Notable among these are members of defined benefit pension schemes: particularly so, when the scheme is in deficit. In this regard, the German book-reserve system, where all contributions are invested in the firm, and employee participation in supervisory management boards is a right, seems an intriguing governance model.
The argument that shareholders have supplied risk capital is insubstantial; all other internal stakeholders have made company specific investments, in either or both human and tangible capital terms. These other stakeholders are more directly committed to the firm than shareholders, and it is commitment that is relevant for sustainable board planning. It is a commitment that is only too easily exploited by stock market influenced shareholders, in the absence of board moderation.
Con Keating is head of research at Brighton Rock Group
Comments