Company Law: Corporate Boards, Directors' Duties and the tension between Shareholder and Stakeholder theories.
What problems can you identify in relation to the structure of the corporate boards?
In line with international corporate governance trends, the UK has made use of the concept of the non-executive director. Their role is to make sure that abuse of process does not occur. Non-executive directors are directors from other companies (or organisations) who come and sit on the board of another company in order to ensure that there are appropriate checks and balances in terms of there being the possibility of dissenting, notionally independent voices. Having a certain number of independent non-executive directors is strongly recommended in influential but non-statutory publications like the Wates Corporate Governance Principles for Large Private Companies, the UK Corporate Governance Code and the LSE Listing Rules.
One prime area where this is said to occur is in ensuring that the executive directors in companies were not being overpaid (via the remuneration committee of the board). Theoretically, if these non-executive directors were not part of the company, the directors of that company would set their own pay and no-one would have a real say on whether this was correct.
However, the problem that exists in the structure of the corporate boards with the non-executives being on the board and remuneration committee is that, in reality, they are all friends of senior figures in such companies, and they know that if they give the directors a big salary other non-executive directors will do the same thing for them. There is an implicit element of mutual back-scratching.
Further, the non-executive directors are chosen by the companies’ boards, and the danger with this is that the non-executives know that if they do not provide a high salary they may not be reappointed or nominated for re-election to the board.
Outline some of the advantages and disadvantages of codifying directors duties?
The problem was that, before the duties were codified, they were all to be found in years and years of case law. This meant that if a company director wanted to know what he or she must do in order to ensure that he was not breaking the law, he would have to look through and understand the case law. However, directors do not have the time for this and they are not lawyers, so will find it difficult to understand that the case law is telling them without the benefit of extensive legal advice. This seemed unfair given that they could be voted off or disqualified if they were in breach. Clearly, the difficulty of understanding what the law in the area was made codification of directors’ duties very attractive. Directors would, following codification, (supposedly) have just one main point of reference. If that were the case, then directors would not have any excuse for being unaware of their legal duties.
However, the fear with codification was that company life changes very quickly as there are developments in society and business; however, the law and legislation takes a very long time to change because it has to pass through various political hurdles. The problem that comes about as a result is that full codification means that law can soon become out of date and this can slow business down and cause damage to the economy generally.
What the government has therefore decided to do instead is partial codification. What this means is that a director’s duties are principally found in sections 171 to 177 the Companies Act 2006, but the duties are also found in the case law as sections 170(3) and 170(4) specifically state that the old common law rules and equitable principles which formed the basis of these director’s duties must be used as guides to interpretation: hence, both case law and the statute applies. They may be able to print out and read sections 171 to 177 of the Companies Act 2006, but this is not enough for them to really understand their duties. This leaves the same problem that was talked about above in that directors do not have the time or skills to look at case law to make sure they are not acting in breach of the law.
What is the difference between the shareholder value theory and the stakeholder theory?
The two theories have an impact on the manner in which the directors are required to conduct their roles.
The shareholder value theory requires directors to act in the interests of the shareholders without considering the interests of any other parties. Essentially, it is about maximising profits and therefore maximising dividends. Therefore, the decisions directors make in this role must consider the impact on shareholders regardless of any negative impact that may be had upon the employees or suppliers or any other stakeholders. This approach has been regarded by some as being unsustainable because it causes problems for other stakeholders which can have a negative impact on the company in the longer-term – for example, if the employees are unhappy they are unlikely to perform as well. Ultimately, the shareholder value theory requires directors to act in the way that is more likely to increase the value of the shareholders’ interest in the company. Historically, this was considered the philosophy of Anglo-American capitalism.
The stakeholder value theory, on the other hand, requires shareholders to consider the interests of other interested parties within a company – these can include the shareholders, employees, creditors, suppliers and many others. The problem with this theory is that sometimes these parties can have conflicting interests and it becomes difficult for directors to balance these interests without causing injustice to one party. In broad terms, this approach tends to align more closely with continental European corporate law where companies’ corporate governance is more closely aligned to employee interests: for example, in Germany, certain companies have something known as a ‘supervisory board’ where nearly half of the members are employee-elected representatives.
The UK had for a long time adopted the shareholder value theory. However, following the enactment of the Companies Act 2006, directors are now required to make use of the enlightened shareholder value (‘ESV’) theory which requires directors to consider the interests of other stakeholders in so far as this is beneficial to the shareholders of the company. The problem that was present with the stakeholder value theory remains present in the ESV approach in that the different interests often means that directors are not able to satisfy all parties and there is no guidance as to how to balance these conflicting interests.
Furthermore, the ESV approach does not really empower other stakeholders as the only people that can bring an action should a director act contrary to his duties or contrary to the ESV are shareholders and it seems unlikely they will spend their money on an action that brings them no direct benefit.
What is the difference between subjective and objective duty of care?
The subjective duty of care was the historic approach taken in the older cases where, when deciding whether a director has breached his duty of care, the court would simply look at what someone with his knowledge and skill would have done – the idea here was that directors were hired by the company and its shareholders and if they did not do a good job this was not the directors’ fault but the shareholders’ fault because the directors had been hired by the shareholders. The objective duty of care considers what would have been reasonable for the director to do, this is a much stricter level of duty that was adopted in some of the newer cases.
However, it appears that the overall approach is that a subjective-objective approach should be adopted. For example, a director must exercise reasonable care, skill and diligence when acting for the company. Section 174(2) of the Companies Act 2006 clarifies that this means the ‘care, skill and diligence that would be exercised by a reasonably diligent person’ who exercises ‘the care, skill and diligence that would be exercised by a reasonably diligent person with the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company’. This is an objective standard. Additionally, this is to be assessed with reference to ‘the general knowledge, skill and experience that the director has’. This is a subjective test. Together, this means there is an objective minimum that all directors must satisfy, but if a director has any special skills or knowledge, then they may be held to a higher subjective standard.
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