Shareholders v Stakeholders: Managing Interests & Expectations on the Company Board
Sarah Jane Leake | Bloomberg Law
“Industry has come under pressure to consider the wider effects of the decisions it takes in pursuit of profitability, and companies now explicitly or implicitly accept that they have responsibilities not just to shareholders, but also to employees, customers, creditors, suppliers, the local community and to society at large.”1
The concept of corporate governance carries different connotations across the globe. The underlying idea is, however, the same in all countries. Essentially, it represents “the system by which companies are directed and controlled.”2 In a wider sense, it refers to a “set of principles between a company’s management, its board, its shareholders and other stakeholders.”3
Corporations in Anglo-Saxon jurisdictions, such as the UK and the U.S., conventionally focus on the agency relationship between the principals, the shareholders, and their agents, the directors of the company. In contrast, continental European and Asian systems tend to embrace the interests of others within the corporation.
In the UK and the U.S., a business corporation is typically “organized and carried on primarily for the profit of the stockholders [i.e., shareholders].”4 Profit maximisation, under the doctrine of shareholder primacy, is therefore the directors’ overriding objective.
It is increasingly being asked whether a director’s main focus should be to make money or if he should “encourage active co-operation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises.”5 This is all the more important given evidence that companies primarily driven by profit maximisation to satisfy shareholder interests usually only do so for short periods of time.6
Yet, where a wider stakeholder group is taken into account (stakeholder theory), the primary focus on shareholder value starts to disappear. Despite this, some companies, both in the UK and internationally, have proven that it is possible to continue to maximise shareholder value while also taking on board the interests of the wider stakeholder constituency.
The John Lewis Model
The John Lewis Partnership (JLP), one of the UK’s most successful companies, is an employee-owned partnership owned by trust on behalf of all of its employees, which, under its constitution, commits itself to successfully managing stakeholder relationships. Each employee, for example, has the opportunity to have a say in the way in which the business is run through branch forums, divisional councils, etc. and, moreover, are represented at board level.
The JLP model has proven consistently successful. In the year to 29 January 2011, the company’s post-tax profit amounted to £127.4 million,7 and in 2011 JLP was the country’s fourth largest private company by sales.8 Moreover, this system of internal governance has been strongly defended by the company’s employees. Although each and every one of them would have received a guaranteed £100,000 upon the company’s flotation, they overwhelmingly voted against the proposition.9
This model of governance has not been more widely accepted in the UK as it is traditionally perceived as antithetical to shareholder primacy. However, the Government is becoming more amenable to the idea of increased employee engagement, as reflected in its current proposals to turn the Post Office into a mutual-style company actively run by its members.10
There is been growing interest11 in adopting a stakeholder approach in the UK, in part because of the industrial and economic strength of those countries that have embraced this approach for many years.
The Japanese system has embraced the wider stakeholder constituency for centuries. Traditionally, Japanese corporations put the family first and view an employee who devotes his time to the business as having a larger stake in it than a shareholder. Moreover, directors of Japanese corporations have no fiduciary duty to shareholders. Yet, in view of the recent indictment of Olympus Corp.’s former chairman, former executive vice president, and ex-auditing officer for falsifying securities reports over a 13 year period, the lack of a fiduciary duty may not necessarily be so advantageous.12
While the board structure is akin to that in the UK, shareholders can not have much influence, as boards are typically larger in size and the majority of participants are from within the company. Moreover, it is widely accepted that the role of the employee is so important in Japanese corporate governance that employees are able to influence decision-making without actually being represented at board level.13
Co-determination, the idea that an employee plays a role in managing the company for which he works, is essential to the German corporate psyche. In Germany, companies with over 500 employees are required to have a management board (Vorstand) as well as a supervisory board (Aufsichtsrat), which oversees the activities of the Vorstand. In addition, where there are more than 2,000 employees, the workers have a legal right to elect nearly half of the Aufsichtsrat, which, in turn, gets to appoint members of the Vorstand.14 This system was developed on the premise that it develops more trust, co-operation, and collaboration between the workforce and the management.
Under the doctrine of shareholder primacy, directors have a relatively homogenous group of shareholders to relate to. Should they take on board the wider stakeholder interest, they would become accountable to a wide array of stakeholders on multiple, potentially conflicting, issues; employees would ask for higher salaries and better working conditions, consumers would ask for higher quality and cheaper products, and creditors would ask for low-risk and high returns.
The pursuit of profit is a straightforward concept. However, if all stakeholder interests are to be acknowledged, trade-offs and conflicts of interest are inevitable. This would undermine the duty of the agent to the principal, as shareholder interests would at times need to be jeopardised for the “greater good.”
There are, however, likely to be diversities in opinion within the shareholder group itself (e.g., high-risk versus low-risk, short-term versus long-term). Furthermore, for the stakeholder theory to be contrary to business, it must be agreed that the sole and ultimate goal of a corporation is profit maximisation, which in itself has short-term connotations.15
In the agency relationship, directors are accountable to the company’s shareholders. However, where all stakeholder interests are to be taken into account, lines of accountability become blurred. It could be argued that because there are so many interests to take on board, and as there is no longer a defined overriding objective, company directors would, ultimately, end up being accountable to no one.
With no single criterion for judging performance and balancing a multitude of interests, the directors could arguably end up exploiting the corporation for personal gain. Taking on board the wider stakeholder interest, directors would be permitted to act independent of the shareholders and could end up using the firm’s resources for their own interests, such as the arts, under the guise of corporate social responsibility, without needing to be accountable for the expense of such ventures.
Without the corporate performance measurement that comes with the profit maximisation goal, it appears that there is no methodical way to assess the performance of the directors or the company.
Enlightened Shareholder Value
While taking on board the interests of the wider stakeholder constituency may divert stakeholder wealth in the short-term, it could be good for the company, and therefore the shareholders, in the long-term. As the Royal Society for the encouragement of Arts, Manufactures and Commerce (RSA) reported some 12 years ago, “[o]nly through deepened relationships with, and between, employers, customers, suppliers, investors and the community will companies anticipate, innovate and adapt fast enough,” and so therefore “[o]nly by giving due weight to all key stakeholders can shareholder value be assured.”16
A solution may be to move away from the polar shareholder versus stakeholder concept and compromise, blending together the best of both shareholder and stakeholder theory. As such, the long-term value of the firm should represent the directors’ overriding objective and provide them with the primary criterion for making the relevant trade-offs amongst competing interests. This is otherwise known as “enlightened shareholder value” (ESV).
Hermes, one of the world’s largest institutional investors, recently adopted an ESV approach. In 2002, the company stated that its:
“overriding requirement is that companies will be run in the long term interest of shareholders. Companies adhering to this principle will not only benefit their shareholders, but also we would argue, the wider economy in which the company and its shareholders participate . . . . [A] company run in the long term interest of shareholders will need to manage effectively relationships with its employees, suppliers and customers, to behave ethically and have regard for the environment and society as a whole.”17
This concept has, to a limited extent, been introduced in the UK by virtue of section 172 of the Companies Act 2006, which requires companies to give due regard to the wider stakeholder interest, as well as the “likely consequences of any decision in the long term.”
Yet, for corporate governance to be implemented as successfully as possible, is more proactive involvement from a corporation’s stakeholders required?
The Importance of Employees
As JLP has proven for over a century, it is possible for directors to maximise shareholder value while at the same time taking on board the interests of the wider stakeholder group. Moreover, Germany, with its co-determination system, has proven itself to be one of the most resilient countries in Europe during the recent financial crisis and the current Eurozone debt crisis.
To maximise profit in the long-term for the benefit of the shareholders, stakeholders, in particular the workforce, cannot be mistreated or their voices ignored. Their input on key business decisions is necessary in order to develop trust and loyalty, which, in turn, promote productivity and, ultimately, profitability.
While ESV requires directors to give due regard to stakeholder interests, and the likely consequences of all decisions made in the long-term, it arguably does not go far enough. To have a material impact on business decisions, stakeholders must be listened to. For this, they need a platform on which to be heard. Having their views taken into account is not enough.
It has been argued that stakeholder representation on boards, or at least at committee-level, would give stakeholders a direct platform to air their views and to partake in key decision-making. It would also help to break down the “group think” so prevalent on boards in the UK today18 and give employees a pivotal role to play in opening up the boardroom to fresh ideas. It would also bring the UK in line with other EU Member States, the majority of which have already embraced employee representation at board level to varying degrees (including Austria, the Czech Republic, and Sweden).
Yet, given the continued commercial and political opposition to stakeholder representation on boards in the UK, it is unlikely that co-determination will be accepted in the current political climate.
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