Theme: Political Economy | Content Type: Blog

A Lawyer’s Perspective on Corporate Governance Reform

Jay Cullen


Nicola Fioravanti

| 6 mins read

The ideas for corporate governance reform espoused in the final report of the IPPR Commission on Economic Justice make intuitive sense. But the question, from a legal perspective at least, remains: how feasible are such proposals likely to be in practice? Can they be operationalised via legal change, or will the spirit of these proposals be blunted by the implementation process and the inevitable tradeoffs that are inherent in legislative reform?

In its analysis of flaws in corporate governance, the IPPR’s report highlights the economic and legal confusions that surround how corporations or companies operate, and the significance of legal duties and powers enjoyed by directors, shareholders and other constituents.

Most business people at public companies would say that their overriding duty is something along the lines of the passages quoted in the report: “We, as directors or executives, have an overriding legal duty to shareholders to maximise their returns.”

Such a perspective – at least in legal terms – is completely false. The report is to be applauded for placing this falsehood front and centre. The problem is what to do about it?

The report recommends redefining directors’ duties to make it more explicit that companies are to be run in the interests of long-term success. This is a start, but is ultimately little more than tinkering with a model that needs more radical reform.

First, courts are not inclined to involve themselves in company affairs, save in cases of corporate insolvency or corporate criminality. So whilst we don’t have an explicit business judgement rule, as in the US or Canada, bringing directors before the court successfully remains difficult.

Second, although the Companies Act 2006 section 172 formalised the pursuit of shareholder value to an extent (ie. by adding a section providing that directors have a “duty to run their company for the benefit of its members”) the Act is not responsible for such primacy taking root. This was established long before 2006. In the absence of a separate mechanism, this type of legal reform would be unlikely to change behaviour, for the simple reason that company law, in most circumstances, requires shareholders to litigate against the directors if they are unhappy with their performance. This is unlikely to happen in circumstances where shareholder interests are being prioritised.

This is why the report’s suggestion to introduce a so-called ‘Companies Commission’ would be welcome. This could transform the conduct of large corporations. Moreover, it would not be as retrograde as it may first appear: there are historical precedents for such oversight. In earlier centuries, corporations could not exist unless created by the government under a Royal Charter or an Act of Parliament with the grant of a monopoly over a specified territory (such as the British East India Company, established in 1600).

There are also merits in ensuring that the UK’s takeover regime supports long-term value creation through the report’s suggestion of a new statutory public interest test which would be introduced for bids above a certain size. Again, this is an eminently sensible approach, and a member of the Sheffield Institute of Corporate and Commercial Law (SICCL), Andrew Johnston, has just co-authored a very thoughtful piece on this.

However, it may be less sensible to introduce limitations on shareholder voting rights to encourage long-termism. The report’s motivation is understandable. Yet if as the report claims, many shareholders are too short-termist, and are essentially ‘share traders’ rather than ‘share owners’, then such shareholders often have zero interest in playing a part in running the company. In the main, they are not invested to engage with company boards, managers, strategy and so on.

Many shareholders are investors for other reasons; for example, because they think those company’s shares will increase in value relative to others (either individually or across the market); for dividends; to free-ride on takeovers; or for regulatory purposes. So removing voting rights won’t incentivise them to do anything differently. What might instead incentivise them are restrictions on dividend payments, or restrictions on the premium received after a successful takeover, and restrictions on share buybacks.

In this age, which remains characterised by an existential struggle between capital and labour, worker representation on boards is another extremely important reform suggestion. This struggle, certainly in Western economies, is going to become ever more polarised. If we wish to avoid a long-term turn to populism which we have witnessed recently in Europe and elsewhere, the interests of labour have to be protected and, indeed, promoted. This is even more pressing considering the structural imbalances in the UK economy, which is migrating ever more towards financial services and high-tech, high-productivity sectors, and away from traditional industry.

Overall, the IPPR’s report offers some far-sighted and very welcome suggestions for economic reform. In particular, it recognises the need for a fundamental shift in the structure of the UK economy, and the key role of legislative reform in achieving this. With more lawyerly input, these may have been more likely to overcome the procedural problems inherent in law reform, which is necessary to implement some of the more radical changes envisaged. This is not to detract from the contribution made by the report to the debate: it has the potential to change the economy and economic prospects for the better, and I welcome its recommendations.

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    Jay Cullen

    Jay Cullen is Reader in Banking Law and Financial Regulation, Director of the Sheffield Institute of Corporate and Commercial Law (SICCL), University of Sheffield School of Law.

    Articles by Jay Cullen