Shareholder Primacy in UK Corporate Law: An Exploration of the Rationale and Evidence
David Collisona*, Stuart Crossb, John Fergusonc, David Power d & Lorna Stevenson e
a *Corresponding Author: Professor of Accounting and Society, School of Business, University of Dundee, Dundee, DD1 4HN, Scotland, UK. Tel: + 44 (0)1382 384192, Fax: + 44 (0)1382 388421, e-mail:
b Senior Lecturer, School of Law, University of Dundee, Dundee, DD1 4HN, Scotland, UK. E-mail:
c Senior Lecturer in Accounting, Department of Accounting & Finance, University of Strathclyde, Curran Building,100 Cathedral Street,Glasgow,G4 0LN, Scotland, UK.E-mail:
d Professor of Business Finance, School of Business, University of Dundee, Scotland, DD1 4HN, UK. E-mail:
e Senior Lecturer in Accounting, School of Business, University of Dundee, Scotland, DD1 4HN, Scotland, UK. E-mail:
Contents page
Page
Executive Summary 3
Glossary 7
Chapter 1: Introduction 8
Chapter 2: Literature Review 12
Chapter 3: Review of CLR Documentation and Media Comment 37
Chapter 4: Perceptions of the Company Law Review 60
Chapter 5: Conclusions and Recommendations 86
Appendix 1: Changes in Directors’ Duties 95
Appendix 2: Research Methods 96
Appendix 3: A critical appraisal of the arguments made for and against
shareholder primacy in the CLR documentation 99
References105
Shareholder Primacy in UK Corporate Law: An Exploration of the Rationale and Evidence
Executive Summary
The aim of the research project described in this report was to examine the rationale for the traditional business objective in the UK which is the maximization of shareholder value (MSV). The project included an analysis of relevant aspects of the Company Law Review (CLR) process in the UK which ultimately led to the Companies Act 2006 (CA 2006) and which determined that shareholder primacy would be maintained as a key principle of UK company law. The CLR had raised the central question: ‘in whose interests should companies be run?’ and put forward two alternatives: one based on shareholder primacy, and the other based on balancing the interests of a range of stakeholders. The two alternatives were described as ‘enlightened shareholder value’ and ‘pluralism’.
Specific objectives of this research report included a review of the relevant literature; a study of the official documentation issued in connection with the CLR insofar as this related to the question ‘in whose interests should companies be run?’; an examination of contemporaneous views and debate about the CLR process by studying media coverage of the issues; and ascertaining the views of key individuals who carried out the CLR about how the central question of ‘interests’ was considered, and about the evidence that was used as the basis for its recommendations.
The main findings of the report are based on interviews held with 15 individuals, most of whom were directly involved in the CLR, as well as evidence from the literature. The CLR was generally seen as a useful tidying up and modernising exercise; it was also widely thought to have been very ably led. But one of the most striking findings from these interviews was the frustration and strength of feeling about the real value of the CLR exercise amongst some of those who were closely involved.
Regarding its consideration of the central debate between enlightened shareholder value and pluralism, the CLR was described as a ‘waste of time’ by one Steering Group member who thought that there was never any intention to have a ‘meaningful discussion of the issues’ while another Steering Group member said there was little interest in discussion of principles or ‘the bigger picture’. Other participants took a quite different view: it appeared to the researchers that those who supported the ‘enlightened shareholder value’ outcome were generally content about the quality of the examination which took place, while those who leaned to the ‘pluralist’ view, which was rejected, were very much less so. Having said that, a number of interviewees, even some who were supportive of its outcomes, felt that the breadth of expertise and opinion represented on the Review was rather narrow; and a more critical view was that it was set up to fail.
In response to a question about the evidence that was considered as part of the CLR we gathered that the process was ‘less a matter of evidence and more one of debate’ though it was also suggested that the knowledge and experience brought to the Review by the participants meant that evidence was not lacking. However a very specific criticism was the absence of discussion of comparative international evidence. A detailed consideration of differing types of capitalism, including the significance of legal traditions, is a feature of the literature review in this report. A key part of that review is the description of two competing approaches to capitalism which are widely acknowledged. One approach, the Anglo-American, is found in the developed English speaking countries, and is sometimes characterised as ‘stock market capitalism’, in contrast to what may be called ‘social market’ capitalism which can be found, in differing forms, in continental Europe and in Japan. Arguably the central feature which distinguishes these two approaches is the objective which companies pursue. In the Anglo-American countries this is typically MSV, while traditionally in the other group a balance is struck between the interests of different stakeholder groups. Thus the two approaches may be characterised as ‘shareholder value’ and ‘stakeholder’ capitalism respectively, corresponding to the alternatives presented by the CLR. It is also worth noting that, within the literature and in the business media, there have been calls for the ‘shareholder value’ model to be adopted in what have traditionally been ‘stakeholder’ countries; though such arguments have also been strongly challenged.
Interviewees were asked about the new wording for directors’ duties introduced by CA 2006. This wording requires directors to ‘promote the success of the company for the benefit of its members’ while having regard to the interests of others. This form of wording is regarded by some as giving more acknowledgment to the interests of stakeholders (other than shareholders) than the wording it replaced. However there is also a view that it does the opposite. Since the old wording referred to ‘the company’ rather than members, the new wording is seen by some as making shareholder primacy more explicit. The wording was summed up as ‘a fudge’ by one of our interviewees. What was made very clear to us was that shareholder primacy was the intended outcome – and this was the unequivocal understanding of all the interviewees.
Interviewees were asked whether directors’ duties amounted to a duty to maximise shareholder value and broadly speaking this was agreed. While there were differing views over whether this meant maximising share price in the short term, interviewees from the corporate sector thought that this was exactly what it meant. Some interviewees questioned the importance of the legal wording on directors’ duties and noted that shareholder value rhetoric in the US and UK was a result of pressure from the financial markets rather than legal requirements. But it was also thought that a ‘shareholder primacy legal framework’ readily lent itself to a shareholder value rhetoric whose emphasis on a single financial metric was implicated in the phenomenon of ‘financialisation’, and specifically in high levels of executive remuneration and the financial crisis.
In relation to differing forms of capitalism, interviewees did recognise MSV and shareholder primacy as identifying characteristics of Anglo-American capitalism though some interviewees were also quick to point out some differences between the US and UK. Evidence that poorer societal well-being is associated with the Anglo-American model of capitalism was presented to interviewees for their reaction. Such evidence is extensive and shows that a range of health and other “quality of life” indicators are highly correlated with income inequality. Amongst the developed OECD countries higher inequality is associated with countries which have traditionally followed a “shareholder value” rather than a “pluralist” approach to business objectives. In particular,interviewees were asked whether such evidence could be considered relevant to any review of the laws governing corporate conduct. Views varied a great deal; some were skeptical about the evidence and some were not, but most interviewees thought that the evidence merited serious consideration in any future review of the legal framework governing companies.
While it was not a main focus of the research, the critically important question of the compatibility of MSV with ecological sustainability was also addressed in the interviews. Some interviewees thought it could be compatible if a long term view were to be taken of MSV; others took the view that a maximising ethos could conflict with, and encourage resistance to, regulatory constraints.
Recommendations
The extensive literature that we have reviewed as part of this project, and the evidence provided by our empirical work, has led us to believe that the issues outlined above justify a re-examination of central aspects of company law in the UK. Our findings suggest that the question ‘in whose interests should companies be run’ was not seriously examined as part of the CLR, and this is certainly the view of a number of the participants. MSV as an established corporate objective, and the accompanying shareholder value rhetoric, have arguably contributed to the recent financial crisis through the pursuit of a single objective at the expense of long term prosperity and wider social considerations. In particular, there is evidence to suggest that Anglo-American countries have a ‘case to answer’ in regard to their consistently poor measures of social well being relative to those of other developed economies which typically pursue a ‘stakeholder’, rather than a ‘shareholder’ model of capitalism. This evidence was not considered as part of the CLR and, in accordance with the views of some, though not all, of the interviewees, we recommend that it should be considered in any reappraisal of company objectives.
In addition to the central focus of the research, other specific issues were raised by our interviewees as meriting re-examination in any such future review of company law. Four issues in particular received some emphasis. First was the need for greater corporate accountability, in particular the original proposals for the Operating and Financial Review were thought to merit reconsideration; another was a recommendation of the CLR (which had not been adopted by government) for a standing body to keep company law under review. The other two issues were linked to potentially perverse consequences of maximizing shareholder value; these were the regulations governing the market for corporate control in the UK, and also the level of directors’ remuneration.
Glossary
BIS: Department for Business, Innovation & Skills
CA 2006: Companies Act 2006
CLR: Company Law Review
CLRSG: Company Law Review Steering Group
ESV: Enlightened Shareholder Value
MSV: Maximization of Shareholder Value
OFR: Operating and Financial Review
Shareholder Primacy in UK Corporate Law: An Exploration of the Rationale and Evidence
Chapter One
Introduction
This report examines the rationale for what is arguably the central characteristic of the ‘Anglo-American’ business model. This central characteristic is the widespread acceptance of the maximization of shareholder value (MSV) as the fundamental objective of business activity.
This is a subject which, in the UK context, was explicitly considered during the process which culminated in the introduction of the Companies Act 2006 (CA 2006). That process included the Company Law Review (CLR) which began in March 1998 and whose Final Report was issued in June 2001, and continued through various parliamentary stages before the new act became law in November 2006[1].
The CLR explicitly addressed what it termed ‘the question of ‘scope’ – i.e. in whose interests should companies be run’ (Company Law Review Steering Group (CLRSG), 2001, p.41). The outcome of the Review was clear support for shareholder primacy with ‘the basic goal for directors’ being ‘the success of the company in the collective best interests of shareholders’ (CLRSG, 2001, p.41). The resultant CA 2006 requires a director to ‘act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole’ though directors must also ‘have regard to’ a range of other interests including employees, the community and the environment (Ch. 2, Pt 10, 172 (1))[2].
The scope of this research project included an examination of the process which led to this conclusion in the CA 2006, and also consideration of its outcomes. The methods used included a review of relevant documentation; an examination of the coverage of the CLR in the business media; and interviews with a range of interested parties including members of the CLR Steering Group (CLRSG), members of other CLR Working Groups, and individuals with board level experience of listed companies. A detailed outline of the research methods employed is given in Appendix 2. While the main empirical focus of this research was therefore the UK, a key aspect of this study is a consideration of the wider international context as a basis for evaluating alternative approaches to the conduct of business. This wider context is provided by a review of the relevant literature.
A very important implicit restriction in both the empirical and literature based components of this research should, for clarity, be made explicit here. Our interest is in ‘large companies with real economic power’ (to borrow a form of words from CLRSG, 2000, p.13) not in smaller private companies which happen to share a similar legal status but which are, in substance, very different entities. It should be noted that the CLR explicitly highlighted this difference and sought to recognise the needs of small companies separately in their deliberations.
The study was motivated by, firstly, interest in what have been termed different ‘varieties of capitalism’ and the evidence that the literature on that topic may provide in assessing the case for or against MSV; secondly, growing evidence amongst wealthy countries of systematic differences across a range of indicators which measure quality of life and which are correlated with income inequality - we wished to explore what links this evidence may have, or be perceived to have, with corporate law and culture; and, thirdly, the recent and ongoing financial crisis which has given a fresh impetus to questions concerning the way that business activity is financed and conducted in different parts of the world.
There is a conjecture implicit in the previous paragraph which is explored within the current study. It is that the fundamental objectives which guide business strategy and operations can have both economic and social impacts and that evidence about the latter in particular could play some role in assessing the regulatory framework within which business operates. This conjecture appeared to be uncontentious according to a ministerial statement made during the CLR process:
The key to shaping the market in ways that achieve our twin objectives of efficiency and social justice lie in the framework of rules within which companies do business and make a profit. So company law and corporate governance are at the heart of our debate about the kind of society we want and the nature of our economy. (Byers, 2000).
There is, of course, a lively debate about the interests which business should serve that arguably reflects the perceived significance of the issue for wider society. The central dispute concerns the right of one particular stakeholder group in business, the shareholder group, to have its interests maximized. This debate is of course deeply political although within the disciplines of accounting and finance it scarcely seems to take place at all, at least within the Anglo-American culture, possibly because the language of accounting precludes it. ‘Profit’ is the share of the cake allocated to shareholders while the slices going to all other participants are called ‘costs’.
While there are a number of different models of capitalism in developed economies a distinction is often made between two broad approaches: these may be characterized as the Anglo-American ‘stock market’ model in which MSV is the typical objective of companies, and the ‘social market’ model of capitalism in which, traditionally, a balance is struck between the interests of different stakeholders. The social market model, in differing forms, is associated with a number of continental European countries and Japan (Albert, 1993; Coates 2000; Dore, 2000; Hutton, 1995; 2003). This dichotomy is examined within the literature review and its relevance highlighted for the debate which occurred within the CLR.
The rest of this report is organised as follows. Chapter 2, which follows, reviews the literature concerning shareholder primacy and possible alternatives. The chapter initially examines different models of capitalism before rationales for and against shareholder primacy are discussed. Finally, aspects of law and legal traditions are considered in this chapter.
Chapter 3 presents a brief overview of relevant aspects of the CLR process and the subsequent events which led up to CA 2006. It also reviews how the central issue of directors’ duties was reported and discussed in the business media, specifically, the Financial Times.