On November 29, 2016, the Department for Business, Energy & Industrial Strategy (BEIS) published a Green Paper on Corporate Governance Reform, which sets out a series of options aimed at strengthening the UK corporate governance framework and ensuring that business behaviours are better controlled. This follows a series of regulatory reforms in the area of corporate governance since the 1990s. However, the nature of the perceived pressing problems has changed over time. While in the 1990s, corporate governance reforms mainly focused on the working of the board of directors, the role of shareholders, and on executive pay, after the financial crisis of 2007-8, the focus shifted towards long-term and sustainable corporate governance structures that would guarantee appropriate ‘risk management’ rather than encouraging managerial risk-taking. The new Government Green Paper now zeroes in on one of the key issues, namely, the appropriateness of executive pay not just in relation to firm performance, but also compared to worker pay. The Government also thinks that there is too much short-term thinking and proposes various alternatives to ensure that the voices of key stakeholders, including employees, are heard at the board level and that the corporate governance framework for the UK’s largest privately-held companies is strengthened.
In a detailed response to the Government’s consultation on the Green Paper, we propose an eight point reform agenda which includes recommendations on areas such as curbing excessive executive pay, reforming the remuneration committee, establishing advisory stakeholder panels, increasing the dialogue between company executives and stakeholders, and strengthening the corporate governance framework for the UK’s largest privately-held businesses. More fundamentally, we point out a certain discrepancy between the ambition of the corporate governance reform outlined in the Prime Minister’s and the Secretary of State’s introductions to the Green Paper, on the one hand, and the Government’s proposals, on the other.
The introductory sections to the Green Paper focus not just on the effectiveness of the corporate governance system per se, but also emphasise the importance of the public’s trust in ‘capitalism and free markets’ and the Government’s ambition to ‘build an economy that works for everyone’. On its face, therefore, the Green Paper can be seen as a move from a relatively limited focus on managers and shareholders alone – as posited by the still dominant agency theory of corporate governance – to a much more fundamental element, crucial to the legitimacy of the capitalist system. We do not think, however, that the proposed reforms are sufficient to achieve this broader objective. While some of the proposed reforms may certainly constitute an improvement on the current situation, eg in terms of stakeholder interests, they clearly fall short of what would be needed to achieve the Government’s more fundamental goal of restoring the public faith in the existing capitalist system. To achieve this, more fundamental reforms may have to be considered, which would also involve a shift in the market participants’ ethical and moral stance. We, therefore, contend that such reforms would have to go together with a reflection and a true dialogue about the moral and ethical underpinnings of our economy. Indeed, even some of the concrete reform proposals hinge on fundamental questions such as ‘what is the purpose of the corporation?’ and ‘who are corporations there for?’.
While the ‘enlightened shareholder approach’ enshrined in section 172 of the Companies Act 2006 suggests that a wider stakeholder community should be considered in board decisions, the related question of the purpose of the corporation, which would allow the Government to more precisely define the responsibilities of corporations and their directors towards different stakeholders, is not adequately addressed in the Green Paper. Although policy making in recent years has implicitly attempted to move away from a pure shareholder primacy view of stock corporations, it has not yet managed to set the terms for an honest debate about the purpose of the modern corporations and the formulation of a consistent stakeholder view that can inform and justify the direction of such reforms.
Without a more ambitious reform agenda, including a focus on the moral underpinnings of liberal capitalism, the proposals of the Green Paper (even if they may go some way in improving the current corporate governance system) will not in themselves be sufficient to address the fundamental problem of public trust in corporations and ‘build an economy that works for everyone’. Among others, a review of the main enforcement mechanisms of the UK code system (the UK Corporate Governance Code 2016 and its companion UK Stewardship Code 2012), which is largely based on the view that markets generally and shareholders specifically are responsible to evaluate the ‘comply or explain’ system, is necessary. In our view, a selective hardening of the tradition of the soft law and self-regulation approach for listed companies is needed to restore the public’s trust in ‘capitalism and free markets’ and give current – and even reformed – rules more ‘teeth’.
Dionysia Katelouzou is a Lecturer in Law at King's College London.
Aditi Gupta is a Lecturer in Accounting at King's College London.
Gerhard Schnyder is a Reader in Comparative Management at King's College London.