The self-declared overall objective of the ‘Study on directors’ duties and sustainable corporate governance’ that Ernst and Young recently prepared for the European Commission DG Justice and Consumers (EY report) is to ‘assess the root causes of short termism in corporate governance’. Accordingly, most responses focus on the study’s initial examination as to whether the current rules are problematic, eg, whether company law, as it stands, gives management an incentive to favour shareholders’ value to the expense of other stakeholders and potential short-termism. To prove that there is a problem of this kind is difficult, if not impossible. By attempting to conclude that current company law promotes short-termism, the study has made itself prone to criticism. It started, so to say, on the wrong foot.
In our recent paper, we argue that this shortcoming should not induce the Commission to misjudge company law’s potential for sustainability. A more convincing starting point for the political discussion would be to acknowledge the climate challenge and to ask whether and how company law may be able to contribute to tackling it. In fact, most (if not all) will agree that we currently face a climate challenge. As a consequence, although the current Study may be criticized for its approach, the study’s potential shortcomings should not prevent a debate on the potential for company law to promote sustainability.
Company law can be designed in ways to address the climate change problem, as sustainability and company law interact closely with one other. Yet the inherent vagueness of the politically pre-defined target to avoid a climate crisis makes it difficult to tailor a suitable regulatory approach. If possible and likely to be effective, soft law should be preferred to hard law and Member States should enjoy discretion as to how best to adopt respective rules in light of their national context. On the other hand, an approach which relies exclusively on soft law is unlikely to reach its goal. For instance, various Member States may choose not to adopt any relevant measures in order to protect their own national economy. Since the climate challenge is global, the European rule-maker cannot rely on regulatory competition. Moreover, an obvious objection to soft law mechanisms is that they may not be sufficient and that the climate challenge requires more substantial, mandatory legal rules.
In short, company law needs to find a middle ground. While climate and environmental law may well make use of mandatory rules since they aim to achieve specific, well-defined outcomes, tailoring regulatory strategies in company law is more challenging. After all, requiring all companies to act as social enterprises would involve a fundamental shift in how business is conducted. Such a solution is likely to be too radical. What is possible and recommended, however, are so-called nudging approaches to company law. Nudging has in fact been successfully applied in many other areas of law. Yet its potential in company law is still largely underrated. Nudging strategies are not limited to soft law but can also include hard law, with a focus on procedural (rather than substantive) rules. Substantial interventions in company law risk missing the point or lacking precision, and at the same time the negative consequences are potentially huge as they are tinkering with the fundaments of company law. On the other hand, procedural rules have the advantage of being less intrusive by preserving freedom of choice, and if we get it wrong, the only consequences will be the imposition of additional costs on companies whereas substantive rules typically prohibit certain private choices.
The EY report outlines a range of measures in accordance with the negative ‘drivers’ they each aim to mitigate. Although the list is long, it is in no way complete, as evidenced by national laws that provide for additional measures. The report even fails to mention measures that have been discussed in other parts of the Commission, in particular the steps proposed in the Action Plan for Financing Sustainable Growth. While the scope of the report may well require the analysis to be focused, the report omits important measures that are more in line with the regulatory approach that has been outlined above. In our paper, we discuss some of these measures (such as duties of a more specific nature, reporting requirements, or also the improvement of shareholder decision-making) in detail and propose that in the work ahead, the Commission should consider a broader range of measures than those outlined in the EY report. We conclude that, in the face of climate change, sustainability matters and that company law is able to provide suitable regulatory instruments in order to create incentives for managers, shareholders and other stakeholders to take sustainability into account.
Florian Möslein is a professor of law at the University of Marburg, Germany.
Karsten Engsig Sørensen is a is a professor of law at the School of Business and Social Sciences, Aarhus University, Denmark.