Company boardrooms face a wide and growing array of rules, codes of conduct and obligations. This has resulted in a complex series of committees, advisors, compliance departments, risk officers and other entities to which boards turn for assurance.
Despite this growth in regulation, there remains an increasing degree of public mistrust of the corporate boardroom and continuing public dissatisfaction with boardroom remuneration.
The response of many boards is to spend ever greater sums on compliance, governance and reporting whilst also attempting to demonstrate corporate social responsibility through good works. This has simply led to an excessive level of regulatory cost and burden which has produced little benefit in terms of restoring public trust in the boardroom and considerable weariness within the boardroom. It has also led to CSR activities which are now a mix of an offset tax and a papal indulgence in that there is no change to underlying corporate behaviour but regular payment is made to society by way of compensation and in the hope of pardon.
It is improbable that legislators and regulators will ever do anything other than increase the regulatory burden while the price of CSR inexorably rises. The backdrop will be growing public mistrust of the boardroom.
The only likely exit from this cycle of events will be one which is engineered from within the boardroom through leadership. This can be achieved by applying several simple principles to boardroom deliberations and by reaching a new consensus about a company’s legal purpose and powers.
There is currently no straightforward guidance for directors as to how they determine the purpose for which their company exists. All directors know they are fiduciaries and that they have duties. Many directors wrongly believe that their overriding duty is simply to maximise financial returns to shareholders. This is a safe error to make as it is only society which suffers from it: there is no direct legal consequence to getting this wrong.
The nature of directors’ duties was considered in a 2003 White Paper when two broad views were advanced: enlightened shareholder value and the pluralist approach. Enlightened shareholder value was the chosen route but it has done little to enhance public trust in the boardroom. The failure of boards to embed acceptable standards of behaviour in the everyday existence of their companies has in part been because corporate social responsibility has assumed an existence which runs parallel to and outside a company’s commercial affairs. This outcome would have been little different if the enlightened approach had made way to pluralism.
A solution will only be found if corporate responsibility ceases to be an offset mechanism and becomes a meaningful part of a company’s existence. This does not mean that companies become social enterprises. It means that the boards of companies understand the purpose for which their company exists. They can determine that purpose and reinvent it but it will not simply be to provide a vehicle for maximised short term profitability.
To build a case for a purposive approach, and to demonstrate that that such an approach requires no change to the law, it is necessary to look at the origins of limited liability. This will, in turn, throw some light on the nature of a director’s fiduciary duties and explain why those duties are owed primarily to the company itself and not crudely to its current shareholders’ financial interests.
Limited liability for companies in England and Wales was introduced by an Act of Parliament in 1855. The parliamentary debate which preceded the Act was split as to its desirability. Those who favoured limited liability did so because it allowed capital from ordinary people to be channeled into corporate entities whose actions would benefit society: “Individuals having small capital could effect nothing of themselves, but by a combination of these small sums a large capital might be created and great public service rendered.”
The opponents of the Bill feared that it would lead to ruinous speculation and that “all the mischief…. that attended the railway companies had emanated from the fact of the directors being masters of the company and not the company [master] of the directors.”
Limited liability was, therefore, an artificial construct designed to benefit society. That is one reason why fiduciary duties are owed to the company. The company is essentially a conduit through which benefit was intended to accrue to society. This was an important element of the underlying trusts imported by the idea of fiduciary duty in this context.
Limited liability is not, therefore a free good or a right. It is a privilege conferred on corporate entities in return for public benefit.
This view calls into question accepted contemporary ideas about directors’ duties and challenges the unthinking acceptance that shareholder value and shareholder interests carry all before them. It also leads rapidly to the conclusion that the success of a company can only be determined after the purpose of the company has been clearly articulated. This purpose will differ considerably from one company to another but no director can properly consider what his or her duties are without knowing why their company exists.
An investment trust and a healthcare company will produce very different answers to the question: “What is our company for?”
The basis on which limited liability was made available was an understanding that the answer to this question would satisfy the objective of creating some public benefit through the accumulation of capital investment.
The outline code suggested below takes a purposive approach as its starting point. It then adapts some of the principles identified by Lord Bingham in ‘The Rule of Law’ and suggests that these will provide a workable guide for directors as they discharge their duties.
The conclusions boards may reach will be varied and contingent upon many other factors. No-one should require a report as to how those principles have affected their thinking. No-one should be upbraided for failing to reach a conformist conclusion following consideration of those principles. The code is not prescriptive. Equally, this is not a code whose application should be delegated to a committee or to a compliance team or which should require expert advice as to its meaning. It is simply a sound starting point from which a modern board might embark.
Principle 1
A board should consider the purpose for which their company exists and should ensure that its purpose justifies the privilege of limited liability status.
This exercise should lead a board to consider:
-what is the project or series of projects which the company seeks to accomplish?
-what might be the benefits to society which will accrue form those projects?
-should the company seek to articulate these benefits in its public documents?
Principle 2
A board should ensure that its conclusions relating to its purpose are accessible and, so far as possible, intelligible, clear and predictable.
It is important that company employees can understand how they should take account of their company’s purpose and its consequent interactions with society. It is also important that counterparties should understand the standards which are being applied.Finally, it is important for business counterparts to assess the climate in which they are doing business.
Principle 3
A board should ensure that its interactions with society are undertaken in good faith and are governed by principles which apply equally to all, save to the extent that objective differences justify differentiation.
This principle should influence the ways in which companies recruit, develop and reward their people and the way in which they deal with counterparties. It does not mean that commercial judgment is replaced by philanthropic behavior. It might, for example, inform the way in which a board of directors approaches its tax planning and lead it to a conclusion which differs from that which is presently reached.
It might also inform the way in which a board approaches investment in a territory which itself has a poor rule of law reputation. An analysis of the interest of all counterparties might lead a board to be braver in investing in a territory with a poor record of human rights if they genuinely believed that their investment might lead to change over time.
It might also inform decisions relating to remuneration and reward and lead to a re-evaluation of the ways in which remuneration is approached.
It might also lead to a re-evaluation of the value of collaborative approaches in markets which have always been driven purely by competition. It might also lead to different approaches to customer services in industries which are balanced to service providers rather than customers.
It might be thought that these principles lack reference to commercial success as traditionally measured. It is, however, highly unlikely that any board will feel able to live up to these principles without a business model that is financially robust, sustainable and capable of being funded over time. The nature of that model and its consequences for all connected with it may, however, need to differ from current norms.
The principles outlined in this code are ones which apply some rule of law principles to the difficult area of personal fiduciary duties but set them in the context of a clearer understanding of purpose than currently exists. A board should not conclude that responsibility for this aspect of its existence should be delegated to a committee or an executive or an advisor. Neither, however, should a board have to report on compliance with the code or be held accountable by any regulator or external authority in relation to it. It is simply a means of defining the basis on which a company should interact with society. It could lead to much bolder decisions on the part of boards regarding investment and longer term planning as well as greater independence of thought on the part of business leaders.