This post summarises our submission made in response to the UK Parliament Inquiry into corporate governance. The Inquiry is set in the context of public distaste for the ‘unacceptable face of capitalism’ (see eg ‘Philip Green is not the only unacceptable face of capitalism’, Financial Times (28 July 2016)) which has manifested itself in several recent corporate scandals, such as those at BHS and SportsDirect. We believe that the capitalist model is still a sound basis for economic order as it can be supportive of individual development and freedom, economic growth, and aligned with our democratic values. However, modern capitalism is interposed by the corporation (eg Galbraith, 1976), now the predominant way of organising business and enterprise. For various reasons, the modern corporation can fall short as an effective vehicle through which to realise the optimistic capitalist vision.
In the UK, the legal construct of the modern corporation is a ‘separate legal person’ subject to internal control by the ‘Board of Directors’ and, to a greater latitude than in many jurisdictions, by shareholders. The dominant ‘contractarian’ ideology of the corporation (from Coase, 1937) which underlies shareholder primacy (notably, Easterbrook & Fischel, 1984) unabashedly supports the purpose of the modern corporation as maximising shareholder wealth. Neither the legal nor prevailing ideological construct of the modern corporation reflects the reality that (a) the economic organisation is made up of many more parts than its ‘Board’ or shareholders, and (b) the societal institution that is the corporation serves multifaceted purposes and carries out activities not narrowly confined to shareholder wealth maximisation. How can the modern corporation be reformulated in order to foster both ethical business behaviour and efficient/competitive economic organisation? We argue that reforms in company law and corporate governance are timely.
In particular we support the following reforms:
1. Corporate ethics can be improved through corporate governance reforms that redress the balance of power in a corporation and move away from shareholder primacy.
2. There should be a fundamental willingness to recognise the valuable and plural inputs of different categories of ‘capital’ for a corporation’s wealth creation beyond that of managerial talent and shareholders’ investment.
3. Corporate governance reforms should orient towards greater stakeholder engagement and protection, and these can be operationalised in corporate law reform.
4. Directors should have a duty to map and engage the key stakeholders of a company relevant to its long-term success as a whole.
5. Key stakeholders of a company should be protected by a constitutional document/s with the company setting out engagement frameworks and each other’s responsibilities and obligations.
6. Directors should owe their duties to promote the long-term success of the company to the company as a whole and not just to members (i.e. shareholders).
7. Directors should have a duty to ensure prevention of asset stripping or excessive corporate wealth transfers.
8. Controlling shareholders should owe fiduciary duties to the company, whether in a public or private company.
9. Enforcement of directors’ and controlling shareholders’ duties should be widened to enhance stakeholder accountability and to address current weaknesses in enforcement.
10. Best practices in corporate governance should extend to issues of firm-wide corporate culture, internal control, middle to lower levels of governance, firm-wide communications and scrutiny, and whistleblowing institutions.
11. Board composition should be reformed to include some measure of stakeholder and independent representation, subject to minimum criteria of directorial competence.
12. Board diversity should be encouraged in light of the composition reform proposed immediately above, but should still be determined by an independent nomination committee of the Board.
13. Executive pay should reflect a fair balance of power and wealth distribution in the company. It should encourage long-term business success and be seen as legitimate by wider society.
14. There is scope to consider if malus and clawback rights over a defined period of time against executive pay should be legislated in favour of companies.
15. There is a case for an independent Board committee for ethics and good culture in every publicly traded and significant private company.
Iris H-Y Chiu is Professor of Corporate Law and Financial Regulation, and co-Director at the Centre for Ethics and Law at University College London. Roger M. Barker is Honorary Associate at the Centre for Ethics and Law at University College London.