Indeed, in these days when annual reports are replete with descriptions of a company’s sustainable and socially responsible activities, the company’s effective tax rate may be a good gauge of its sustainability. A low effective tax rate, unwarranted by investment or research and development expenditures, is an indicator of long-term unsustainability.
The interests of shareholders are not always well aligned with other stakeholders; often they are diametrically opposed. Maximising the returns of shareholders can be achieved at the expense of other stakeholders. It is obvious that this can be the expense of employees, through poor terms and conditions. It is no mere coincidence that the period when shareholder primacy has been dominant has seen the labour share of national income decline, and income and wealth inequality grow markedly. There is much employment law that governs the relations with employees, including some newer concepts such as their reasonable expectations.
Even the idea in take-over situations that the board must consider only the shareholders’ interests, which taken to be synonymous with the share price is suspect. Indeed, we have seen precautionary covenants introduced into bond and debt agreements precisely because many of the early leveraged buyouts specifically exploited the position of those creditors to the benefit of shareholders and the new “owners”.
The (false) idea that the board and management of a company are the agents of the shareholders leads to another misstep: managerial incentive remuneration based upon the share price. The alignment of managerial and shareholder interests through the share price leads to short-termism and even operates to the disadvantage of those shareholders who have long-term interests. It is clear that it drives the return of capital by share repurchase rather than special dividend. The argument that this is driven by differences in taxation does not hold water. The difference between income and capital gains is immaterial to many investors such as pension and sovereign wealth funds. Indeed, if a special dividend is a return of capital, it is not subject to taxation.
The argument that shareholders are morally the owners of a company, because they are “the suppliers of risk capital” is bizarre. Employees bring their human capital to the table, and it is very much at risk due to unemployment and redundancy, creditors have brought capital to the table and that may be lost in insolvency, and as we have seen in the egregious case of Premier Foods, even suppliers of goods can be suppliers of capital.
It appears that the one safeguard in the current position, auditing, is completely ineffectual in resolving these issues. Among the reasons for this are their limited reporting responsibility and an institutional organisation that almost ensures their capture.
The fundamental issue is that all of the interventions that we have seen have focussed upon the role of shareholders, with many changes to facilitate further “engagement” between shareholders and the management of a company. Historically, this began with the Cadbury report, which contains the sentence: “Thus the shareholders as owners of the company…” Among the more recent are the European Shareholders Directive, which was a response to: “identified shortcomings related mainly to two problems: insufficient engagement of shareholders and lack of adequate transparency” and the newly created Investors’ Forum in the UK, which has collective engagement at its heart.
This is all clearly misconceived. The board has responsibility for the company and should be concerned with balancing the interests of all of its stakeholder members; increasing the empowerment of any one of these groups will inevitably carry the possibility of harm to others. Indeed, in many cases such changes would likely be harmful within that group. What is clearly needed is a more explicit accountability of the board to these other groups.
In order to plan for the long term, the board needs shareholder commitment rather than engagement, just as it needs commitment from its employees and creditors.
Some observers have noted that there are forms of corporate organisation where this is already explicitly true, such as mutuals, co-operatives and community interest companies. Employee participation is well-known in many European countries. But organisation along these lines does not address the question of the responsibility of the company to society at large.
A limited liability company enjoys certain privileges and rights, which are granted by the state; some express this as a social license to operate. These rights and provileges are central; they give it its status as a legal person. Many of the issues of responsible and sustainable behaviour are of minor concern to direct stakeholders, but central in this broader context.
The question which should be taxing us is how best to make the board accountable to all of its stakeholders, internal and external. This is the situation for all of us, natural persons.
Con Keating is head of research at BrightonRock Group
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