The Political Economy of the Company

THE POLITICAL ECONOMY OF THE COMPANY

The Political Economy of the Company

Edited by

JOHN PARKINSON, ANDREW GAMBLE and

GAVIN KELLY

OXFORD – PORTLAND 2000

Hart Publishing Oxford and Portland, Oregon Published in North America (US and Canada) by Hart Publishing c/o International Specialized Book Services 5804 NE Hassalo Street Portland, Oregon 97213-3644 USA Distributed in the Netherlands, Belgium and Luxembourg by Intersentia, Churchillaan 108 B2900 Schoten Antwerpen Belgium

© The Contributors severally 2000 The Contributors severally have asserted their rights under the Copyright, Designs and Patents Act 1988, to be identified as the authors of this work Hart Publishing is a specialist legal publisher based in Oxford, England. To order further copies of this book or to request a list of other publications please write to: Hart Publishing, Salter’s Boatyard, Folly Bridge, Abingdon Road, Oxford OX1 4LB Telephone: +44 (0)1865 245533 or Fax: +44 (0)1865 794882 e-mail: [email protected] WEBSITE: http//www.hartpub.co.uk British Library Cataloguing in Publication Data Data Available ISBN 1–84113–120–2 (paperback)

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Contents List of Contributors 1. Introduction: The Political Economy of the Company ANDREW GAMBLE, GAVIN KELLY, AND JOHN PARKINSON 2. The Politics of the Company

vii 1 21

ANDREW GAMBLE AND GAVIN KELLY

3. The Labour Party and the Company BEN CLIFT, ANDREW GAMBLE, AND MICHAEL HARRIS

51

4. The Public Interest and the Company in Germany

83

SHAWN DONNELLY

5. Worker Rights and Responsibilities in the Modern Company

101

ROBERT TAYLOR

6. The Conceptual Foundations of the Company: A Pluralist Approach

113

GAVIN KELLY AND JOHN PARKINSON

7. Defending the Rentier: Corporate Theory and the Reprivatization of the Public Company

141

PADDY IRELAND

8. Corporate Governance in a Political Climate: The Impact of Public Policy Regimes on Corporate Governance in the UK

175

SUE BOWDEN

9. Institutional Investors: What Are Their Responsibilities as Shareholders?

195

G P STAPLEDON

10. Evolution and Policy in Company Law: The Non-Executive Director

233

JOHN PARKINSON

11. Comparative Corporate Governance: Sociological Perspectives

265

GREGORY JACKSON

Index

289

List of Contributors SUE BOWDEN is a Reader in Economics at the University of Sheffield and jointorganiser of the corporate governance research initiative of the Political Economy Research Centre at Sheffield. Her recent research has focused on the historical evolution of corporate governance in the UK. BEN CLIFT is a Lecturer in French and Comparative Politics in the Department of Government, Brunel University. His book Where are National Capitalisms Now?, co-authored with Jonathan Perraton, is forthcoming in 2001. SHAWN DONNELLY is Assistant Professor in International and Comparative Political Economy at Koç University, Istanbul. He was formerly a Research Officer in the Political Economy Research Centre, University of Sheffield. ANDREW GAMBLE is a Professor of Politics at the University of Sheffield and Director of the Political Economy Research Centre. He is joint editor of The Political Quarterly and a Fellow of the British Academy. His publications include Hayek: The Iron Cage of Liberty and Politics and Fate. MICHAEL HARRIS was awarded his doctorate at the University of Sheffield in 1997 for a thesis entitled The Subversion of Citizenship—New Right Conceptions of Citizenship, Thatcherism and The New Politics. He is now working in educational and technology research. PADDY IRELAND is Head of the School of Law at the University of Kent at Canterbury. He has written extensively on the historical development of company law and corporate theory. GREGORY JACKSON is a Research Fellow at the Max Planck Institute for the Study of Societies in Cologne. He has been a Visiting Researcher at the Ministry of International Trade and Industry Research Institute in Tokyo and at the London School of Economics, Centre for Economic Performance. GAVIN KELLY is a Senior Research Fellow at the Institute for Public Policy Research. He is currently secretary of the IPPR’s Commission on Public Private Partnerships which will report in the Spring of 2001. JOHN PARKINSON is a Professor of Law at the University of Bristol and an Honorary Research Fellow of the Political Economy Research Centre, University of Sheffield. He is a member of the Company Law Review Steering Group.

viii List of Contributors GEOF STAPLEDON is an Associate Professor and Reader in Law at the University of Melbourne. He is also a director of the corporate governance research and advisory firm, Institutional Analysis. ROBERT TAYLOR is employment editor of the Financial Times. His latest book—The TUC: from the General Strike to the New Unionism was published in 2000. He is now working on a history of engineering workers and electricians in Britain.

1 Introduction: The Political Economy of the Company ANDREW GAMBLE, GAVIN KELLY and JOHN PARKINSON

I

N THE LAST hundred years the company has become a central institution of the modern capitalist economy, rivalling the market in its importance, but it does not have a single, universal form. Its institutional characteristics vary markedly between and even within national jurisdictions, but there are certain common features. At its simplest the modern company is an association which has a legal personality separate from its members, and has become the most effective means of organising and coordinating all the stages of the economic process—from finance through production to consumption. Economic production on the scale that is now commonplace would be unthinkable without the company. But there is no one best model on which the whole world is converging. Viewed comparatively indeed the company appears as a very complex phenomenon, the product of widely different legal rules and political assumptions. The meteoric rise of the company over the last century to the dominant position it occupies today might have been expected to have made it a major focus for social science and legal research. There is indeed a great deal of specialist literature on the company, particularly in economics, law, and sociology, but much of this has stayed within quite tight discipline boundaries, and there has been relatively little work which seeks to link together the different insights of these literatures and attempts to understand the company in its full economic, legal and political context. What has been lacking is a political economy of the company. This book originated from two linked projects1 funded by the Leverhulme Trust and the Anglo-German Foundation carried out at the Political Economy Research Centre (PERC) at the University of Sheffield between 1996 and 1999. The first project on corporate governance funded by the Leverhulme Trust explored different theoretical and historical perspectives on the nature of the 1 The research teams involved in these projects comprised Ben Clift, Shawn Donnelly, Andrew Gamble, Michael Harris, Gregory Jackson, Gavin Kelly, Sylvia McColm, and John Parkinson. The editors wish to thank the Leverhulme Trust and the Anglo-German Foundation for their support.

2 Andrew Gamble, Gavin Kelly and John Parkinson company. The theoretical literature in economics and law raises crucial questions about the nature of the company such as what do we mean by the company? What are its purposes and whose interests should it serve? Who, if anyone, owns the company, what does ownership entail? Are there “members” of the company other than owners, what do these different conceptions imply for the purposes of the company and the governance arrangements it assumes, and what are the implications for public policy towards the company? The historical literature on the company explores the way in which the company as an institutional form has evolved in different jurisdictions, and the reasons for the differences in the legal and political pattern between, for example, Britain, Germany, the USA, and Japan. The project funded by the Anglo-German Foundation was a joint collaboration between PERC and the Max-Planck-Institut für Gesellschaftsforschung, Cologne, and focused specifically on the question of how the public interest has been defined in relation to the company in Britain and Germany, comparing the different political and legal assumptions on which the company has been based in the two countries and linking this to different understandings of the public interest with regard to company behaviour and regulation. It analyses normative and empirical aspects of how the company is related to the public interest. How do legislators and administrators see the company’s objectives when they make regulatory decisions? What makes a company legitimate? Who has a right to participate in the company’s operation? How is power distributed within the company? The aim of this book, drawing on these projects and on the independent research of the other contributors, is to add to a developing political economy of the company. Political economy has many different meanings, and does not constitute a single approach but a field of study, in which there are many different perspectives. There are, however, certain common themes. Political economy is first of all interested in how political and economic systems work. Its starting point is that social orders and the institutions which make them up need to be studied as complex wholes rather than as analytically distinct parts. There may be many particular insights from analysing economic, political and legal aspects of institutions separately, but these institutions also need to be studied as a whole, first in order to understand the interrelationships between the different aspects, and secondly to understand the broader political and economic context in which the particular institution is embedded. Political economy is also concerned not just with how a particular social order works, but also with how it might work and how it should work, by identifying the most appropriate institutions and structures for the achievement of policy goals. In the past political economy has sometimes been seen as an enquiry into the iron economic laws which governed human societies independent of human will, but properly understood it is also about agency; its true character has always been prescriptive and policy-oriented. It is political economy because it is about improving government, the design of institutions, and

Introduction: The Political Economy of the Country 3 the conduct of public policy in the light of theories about the nature of economic and political order and its historical evolution. A political economy of the company needs to be historical, institutionalist, and comparative, drawing on the insights of the specialist literatures on the company where appropriate, but also always being interested in the big picture: the significance of the company as an institution, how it originated and how it has changed, and how it might be reformed. Political economy is a living tradition of ideas and argument about the organisation of the economy and the state, and the relations between them. Since the company has become a key form of association in the economy over the last hundred years, it is of especial interest to the different perspectives in political economy. It has been both celebrated and denounced. Three main organising concepts have dominated the debates on the political economy of the company: ownership, governance, and regulation. What unites all three is the concern with the public and the private and how the boundaries of these in respect of the company should be drawn. Different national jurisdictions and different perspectives in political economy have resolved these questions in a variety of ways. The debate has not been the same at all times and in all places. But certain broad themes and trends are evident. The concept of ownership has always been central to the political economy of the company. Many of the early liberal political economists were suspicious of the company because of its dilution of the principle of individual private ownership, and sought to restrain its growth as much as possible on the grounds that it was inimical to honest and moral enterprise, and was a stepping stone to a collectivist and bureaucratic economy. Socialist political economists did not disagree. Marx regarded the rise of the joint stock company as an expression of the increasing social character of production, and therefore a development that prepared the way for a transition from capitalism to socialism. The displacement of the individual capitalist by the collective capitalist made the achievement of socialism depend on effecting the political transfer of legal ownership from the capitalist class to the state, as the representative of the whole people. Nationalisation of the means of production, distribution and exchange became the solution to the problem of the company for generations of socialists. The growth of the corporate economy and the huge concentrations of economic and political power which the new corporate giants wielded were regarded as expressions of a system in decay, the concentration and centralisation of capital, the era of monopoly capitalism. The debate between liberal and socialist political economy, centred as it was on the question of the ownership of the means of production, came to focus increasingly on the nature of the company, since the means of production were increasingly controlled by companies rather than by individual entrepreneurs. The merits of public or private ownership were defined in relation to conceptions of economic efficiency on the one hand and social citizenship and democracy on the other. Liberal political economists defended the traditional case for private ownership and a competitive market economy as the best way

4 Andrew Gamble, Gavin Kelly and John Parkinson of ensuring economic efficiency, and in doing so were obliged to extend their arguments to include the company as a leading agency of private ownership. They sought to counter the arguments about monopoly by stressing competition, and the arguments about political authoritarianism by emphasising the contribution of companies to political pluralism. The rise of the giant firm was certainly troubling to all parts of the ideological spectrum and to the leading perspectives in political economy, but its reality and increasing dominance could not be denied. In the twentieth century capitalism was indisputably corporate capitalism—all the dynamic sectors of the economy came to be organised and dominated by companies, and the majority of workers became employees of companies. The modern company raised many more questions than simply the question of ownership, important though that remained for all schools of political economy. The new debate that developed was about governance, the recognition that the ubiquity of the company as a form of large-scale organisation in the modern industrial economy required a focus on how it should be governed, and how it might be justified in terms of the principles on which the economic and political order were based. This new focus was crystallised in the famous book by Berle and Means, The Modern Corporation and Private Property, published in 1932. It opened a new debate by drawing attention to the significance of the divorce between those who managed the corporations and those who owned them. They raised the central problem of what was later to become known as corporate governance— to whom should the directors of a company be accountable? Whose interests do they serve? And whose should they serve? Berle and Means raised a set of questions which have not gone away even if some elements of their analysis are now questioned, in particular the idea of a split between ownership and control itself, since that implies that control rights are not a form of ownership. The real change represented by the modern company to which Berle and Means drew attention was the fragmentation of ownership rights, and the increasing fiction of maintaining that the legal title of shareholders still conferred ownership, when many of the most important aspects of ownership were exercised by the directors and managers of the company. If managers in the modern company enjoy increasing autonomy, what mechanisms can be employed to ensure that the way in which they exercise their powers are in the interests of their shareholders, their creditors, their employees, their suppliers, their local community, or in the wider public interest? This is a problem which has existed since the beginning of the company, but different answers have been given to it. The problem exists whether or not the company is in public or private ownership. One set of solutions looks to companies’ own governance structures, the internal constitution of the company which lays down rules on, for example, how directors are chosen and remunerated, what their duties are, to whom they are accountable, how the board of the company is constituted, who is represented on it and what its powers are. The problem of accountability is made internal to the company; although there are legal require-

Introduction: The Political Economy of the Country 5 ments with which the company must comply, there is also a great deal of selfregulation through the culture and rules of the company itself. The other set of solutions looks to regulation of the company by external agencies, whether special regulatory agencies or the courts. In this case the company has legally to comply with certain standards which are imposed through legislation. The debate on regulation asks whether there are public interests or public goods which the company ought to serve, or whether the company is best treated as a private association with as little regulation as possible, or even no regulation at all. Recent debates on both governance and regulation have focused on the issue of shareholder value versus stakeholder value: the spectrum of views runs from those who argue that the public interest is best served if companies are accountable only to shareholders, through notions that companies should pursue shareholder value but in an enlightened way which formally takes account of other interests, to the range of stakeholder arguments that directors should be legally obliged to take into account interests other than those of shareholders either through these interests having formal representation on the boards of companies or through compliance with external standards. The protagonists of shareholder value give greatest weight to efficiency, arguing that efficiency will be maximised if companies are given the clear unambiguous target of maximising shareholder value. Public policy should insist that markets are competitive and that all obstacles to enterprise, including regulatory burdens, are reduced as much as possible. Competition is the best way of ensuring that economic activities serve the public interest. Stakeholding theories also see efficiency as important, but give priority to other values, such as social cohesion. They tend to reflect a more complex view of the public interest, which recognises that there is a public interest in certain outcomes such as equal opportunity and environmental protection. To achieve such objectives requires greater external regulation of companies through the legal system or their selfregulation through the institutions of corporate governance than the protagonists of shareholder value are prepared to concede. Political economy debates over the governance and regulation of companies have had an important comparative dimension, which has been part of the wider literature on models of capitalism. The different legal construction of the company in different national jurisdictions mean that there are very different understandings of the public interest in relation to the company.2 In the United Kingdom, the company is viewed as a private association, while in Germany the company is seen as a public body with a “constitutional” structure laid down by public authority. These different legal foundations for the company have created distinct historical paths of development which have shaped attitudes and institutions. In reality the company is both private association and public body, but the way in which the balance between the two is determined can be crucial. In every 2 This is documented in detail in Shawn Donnelly et al., The Public Interest and the Company in Britain and Germany (London, Anglo-German Foundation, 2000).

6 Andrew Gamble, Gavin Kelly and John Parkinson jurisdiction the company is a public institution constituted by legal rules and political decisions, but that still leaves a great deal of room in determining how public interest obligations are defined, how they have been adapted to meet economic and social changes, and the instruments of public policy which are used to enforce them. These public interest obligations refer in particular to three relationships: companies and investors; companies and employees; and companies and the community. Each of these relationships is problematic, but they have been dealt with very differently depending on whether it has been considered appropriate to address them through forms of external regulation of the company (as in the private association model), or through modification of the internal structure of the company (as in the constitutional model). In Germany, for example, the agency problems of the modern corporation, stemming from the incapacity of fragmented shareholders to monitor management effectively, led to the introduction of a two-tier board system after 1870 that made relations between the different parts of the company constitutional, as well as the relations between the company, civil society and the state. The aim was to find a means to embed the new organisational form of the company in ways which would strengthen rather than threaten social stability. This approach still guides legal developments in Germany, despite recent concessions to the strong pressures for more liquid capital markets and more effective protections for individual shareholders. In Britain, in contrast, because the company has been treated as a private association the relationship between the company and its investors and employees and wider community has been seen as relatively unproblematic. Even when ownership became more dispersed this attitude persisted, partly because more regulation was held to reduce the competitiveness of British business, and partly because there was confidence that change in personnel and policies in poorly managed companies could be brought about by the workings of the market for corporate control and the ability of investors to exit. There have been some efforts to increase transparency and the effectiveness of audit in order to allow investors to make informed decisions. Compared with Germany, however, mandatory interference in the internal constitution of the firm has been relatively limited. The same picture is evident in respect of employees. Germany has a longstanding tradition of worker participation in corporate governance, both to promote industrial democracy and to strengthen productive capacity, as well as checking the power of organised capital, and ensuring the political legitimacy of the capitalist system. Public interest issues such as equal opportunity and environmental protection were dealt with through internal negotiation and the appointment of an officer of the company to implement policy. In Britain, again in contrast, the internal structure of companies only once became a serious political issue, around the time of the Bullock Report. External regulation or public ownership were relied upon to control corporate power and legitimise capitalism. There was a widespread assumption on both right and left that the company was a private association that should either be left alone in accordance

Introduction: The Political Economy of the Country 7 with laissez-faire principles, or abolished altogether in the name of social justice. Missing from the British debate on the company was the idea of the company as an association whose internal structures might be altered in order to pursue pragmatic compromises between capital and labour. In the first chapter after this introduction, “The Politics of the Company”, Andrew Gamble and Gavin Kelly look at broad questions which have influenced the politics of the company in different national jurisdictions. They argue that the company is an organisational form which was initially created through politics and has to be sustained by politics, and they therefore argue against the idea that the company is best understood as a spontaneous and inevitable product of technological change. It is the different legal and political foundations for the company around the world which explain the diversity of the form of the company in capitalist economies. This means that the history of the company is inseparable from the political conflicts over how the powers and responsibilities of the company should be defined, what should be its licence to operate. What this licence is in any particular national jurisdiction depends on different conceptions of the public interest. Gamble and Kelly therefore examine the concept of the public interest, and discuss its different meanings and how it is related to the activity of politics. They then elaborate the notion of a politics of the public interest, the process by which the public interest is formulated and developed in particular political systems and political cultures. This leads on to an exploration of how the public interest was defined in relation to the company in Britain, first in the nineteenth century debates over limited liability and the joint stock company, and secondly in the twentieth century debates over how the company should be governed. What these debates reveal is that companies are both private associations and public bodies, and that it is the variety of ways in which these two aspects are combined which gives rise to different politics of the public interest in relation to the company in different national jurisdictions. In Britain it is shown how strong was the opposition to the creation of a general right of incorporation and still more to the principle of limited liability on the grounds that it would undermine individual responsibility, the foundation of both enterprise and prosperity. This was a position which received strong support from many liberal political economists, but it was eventually overcome by a coalition of supporters of laissez-faire and advocates of wider property ownership. But the successful removal of restrictions on the formation of companies and the granting of limited liability did not result in a constitutional form of the company becoming dominant. Instead the company was conceived primarily as a private association, and attempts to assert its public character were on the whole successfully resisted through the twentieth century. This theme is taken further by Ben Clift, Andrew Gamble and Michael Harris in their chapter on “The Labour Party and the Company”. They explore the curious absence of interest shown by the British Labour Party in the company and in company law reform in the twentieth century. Despite a long and

8 Andrew Gamble, Gavin Kelly and John Parkinson interesting tradition of reflection on the company and its constitutional basis by Labour Party intellectuals, and despite several opportunities to take action, very little was done. Although the Labour movement grew up in opposition to capitalism and was pledged to regulate the private sector in the public interest, in practice Labour governments upheld the dominant form of the British company as a private association, reflecting a view of the company as an arena of fundamentally opposed interests. This adversarial conception has always treated the company as a unitary interest which can accommodate but not incorporate the interests of labour. The reasons for this attitude are traced from 1918 through to 1979. The authors look at the writings of party intellectuals, the development of party policy, and the debates (or often lack of them) at the time of the Cohen Report in the 1940s, the Jenkins Report in the 1960s, and the Bullock Report in the 1970s. Attention is particularly focused on the Party’s beliefs in public ownership and the tradition of independent free collective bargaining in the trade union movement. The belief in public ownership meant that this was regarded as the solution to the problem of the company and the public interest. Once firms were nationalised they would become agents of the public interest. Although this position became more and more unrealistic, as it became clear that Labour governments had only very limited ambitions to nationalise private industry, it was not replaced by a concern with how to reform the internal structures of the company, and certainly very little interest was displayed in the constitutional conception of the company found in Germany. One of the main factors explaining this was the opposition of the trade unions to participation by their members in works councils or management boards, fearing that it would compromise their independence. This ambivalence was most clearly revealed in union attitudes to the Bullock Report. Commissioned by the Labour Government in 1974 following a long campaign for industrial democracy supported by different wings of the Party, the Report represented the high water mark of attempts within the Labour movement to change the internal constitution of companies. Its conclusions, however, were not only strongly opposed by the employers, but also by many leading trade unions, which meant that it stood little chance of being implemented. Policy after 1979 was to swing in a very different direction. The political opportunities which had existed in the twentieth century to undertake a fundamental reform of company law and redefining companies’ licence to operate were not taken. In Shawn Donnelly’s chapter on “The Public Interest and the Company in Germany”, the focus shifts to the very different conception of the public interest found in Germany where there is a greater willingness on the part of the state to regulate decision-making mechanisms and structure relationships within companies in order to protect both private and public interests. An early example of the German approach was the imposition in the late nineteenth century of the two-tier board in public companies. The aim was to improve the mechanisms for protecting investors in the face of increasing management power, a

Introduction: The Political Economy of the Country 9 result of widening shareholder dispersal. While similar developments in the United Kingdom did not produce a regulatory response, in Germany a public interest in securing “external” shareholder interests in order to facilitate the supply of capital to industry was recognised. Another distinctive feature of the German corporate economy, institutionalised employee consultation, and in relation to workplace issues, joint decision-making, was created during the course of the twentieth century. In addition to the inherent appeal of industrial democracy, participation was seen as contributing to industrial peace, and more generally as underpinning the legitimacy of the capitalist system. The main emphasis in Donnelly’s chapter is on exploring how public interest concerns relating to the company have changed in recent years, particularly since the challenges presented by reunification. A major issue has been the drive to increase the supply of investment funds to the corporate sector in order to promote growth and employment. This has led to a policy aimed at broadening and deepening capital markets. As well as the creation of new markets, measures have included legislation to improve the quality and quantity of financial information published by quoted companies, and to outlaw insider dealing. In this area Donnelly concludes that the German corporate economy is in a state of transition. Regulatory changes have made investment in German companies more attractive to outside investors from both home and abroad. However, inside shareholders, notably the banks and other industrial companies with large share stakes, characteristic of the German corporate scene, have not lost their dominant voice, nor have the distinctive institutional features regulating company-investor relations given way to a disintermediated market for corporate control. How long this will remain the case is unclear, with tax changes pending that will remove the fiscal penalties when disposing of large share blocks and the Vodafone take-over of Mannesmann showing that hostile bids are now feasible in Germany. Turning to employees and the company, Donnelly notes a broadened public interest agenda in relation to employee concerns in the workplace. Works councils are acquiring new functions, for example, in relation to health and safety, harassment, and discrimination. Their existence as localised mechanisms for the implementation of employment policy helps avoid the need for excessively detailed and inflexible prescription. At the same time as the role of works councils is expanding, however, structural changes in the German economy are causing the number of companies that have works councils to decline. Further, while there is no serious political challenge to co-determination at board level, many companies have taken steps to limit the participation of employee representatives in decisions by reorganising board committee structures in a way that reduces their involvement. Environmental protection provides another example of the “denser and more active institutional structures” that German companies have been required to develop in response to public interest concerns. Companies are, for instance, obliged to appoint an environmental officer who, among other things, will act

10 Andrew Gamble, Gavin Kelly and John Parkinson as a link with the relevant government agency and report on company performance. The intention is to induce a culture of corporate responsibility towards the environment leading to more favourable outcomes than can be achieved by “command and control” styles of regulation alone. At the same time, the costs to business of overly prescriptive regulation might be avoided. Donnelly expresses some scepticism, however, about how successful this policy has been to date. In his chapter “Worker Rights and Responsibilities in the Modern Company”, Robert Taylor argues that the United Kingdom should look to the German, and wider mainland European experience with employee democracy, in meeting the social and economic challenges presented by developments in technology and globalisation. He refers to recent evidence showing a positive link between productivity and profitability and the existence of vigorous institutions for employee representation. The presence of these institutions in continental Europe is attributable in part to legislative action from the end of the Second World War onwards designed to ensure employee security and social cohesion. He also points, however, to more recent organic developments related to the emergence of the IT and e-commerce economies. Here hierarchical control structures are inappropriate and new forms of employee involvement a practical necessity. The Gyllenhammar Report published by the European Union in 1998 provides further indications of the importance of social dialogue and also notes the adoption of progressive attitudes to corporate responsibility towards employees in an increasing number of European companies. An important factor is the recognition that workers must have trust in their employer if they are to be properly motivated. Representative institutions also play a crucial part in permitting the consensual negotiation of workplace change. As Taylor points out, the Gyllenhammar study commends an approach to consultation that is more ambitious than merely addressing the social consequences of corporate restructuring and technological innovation that are already a fait accompli. Rather, it should permit employee involvement in the formulation of broader and longerterm industrial and employment strategies. Taylor contrasts this approach with the “narrow, limited and timid” discussion of the subject from the centre-left in the United Kingdom, and calls for a revival of the debate that preceded the Bullock Report in the 1970s about the introduction of democratic values in the development of the modern company. There have been positive developments, such as the adoption of flatter, more participative decision-making structures as a rational response to changes in the economy, though Taylor cautions against exaggerating the amount of real employee involvement that these entail. Also encouraging is the growth of partnership agreements between employers and trade unions. If these are to be more than mere statements of good intent, however, they must be backed up by a strong commitment on the part of companies “to inform, consult, and listen to their employees in a systematic way”. At the same time, the democratic rights of

Introduction: The Political Economy of the Country 11 employees to security and fair treatment must be balanced by a willingness on their part to recognise the importance of flexibility to business success. Taylor doubts that the “representation gap” that currently exists in British companies will be closed without the introduction of minimum legislated standards. European Commission proposals for mandatory information and consultation arrangements through works councils, currently opposed by the British Government, are an obvious way forward. On a broader plane, Taylor regards embedding flexible provisions for employee participation as part of what should be a wider public policy agenda to create countervailing pressures to “modify, if not civilise” the forces of globalisation. The contribution of employees, and other non-shareholder stakeholders, to the success of the enterprise is taken up in “The Conceptual Foundations of the Company: A Pluralist Approach” by Gavin Kelly and John Parkinson.3 They argue that there is an economic rationale for departing from the traditional corporate objective which gives priority to the interests of shareholders over those of other groups and correspondingly, a case for investigating how company law might be adapted to reflect a more broadly based conception of the enterprise. In concentrating on the efficiency case for a pluralist model they do not suggest that this is the only basis for arguing that companies should be made more responsive to the interests of a wider range of groups. Such a change might be justified, for example, as bringing about a more equitable distribution of the risks and rewards of corporate activity or as recognising the importance of participative values. Kelly and Parkinson’s aim, however, is to challenge the economic rationale for shareholder supremacy in its own terms, by contending that an alternative model of the company might be more efficient than the current one and noting that reforms advocated in support of non-efficiency values need not necessarily result in the adverse economic consequences that are often predicted. The standard analyses of the company found in the law and economics literature assume that shareholders are the sole bearers of residual risk, and argue in consequence that they should be the exclusive beneficiaries of governance protection in the form of directors’ fiduciary duties and the right to appoint the board. Kelly and Parkinson, however, draw on an alternative strand in the literature which notes that employees, customers, and suppliers may make investments (for example, in training or physical or organisational capital) in the company which are “firm-specific” or “sunk” and which mean that they too are exposed to risk against which they cannot be fully protected by contract. The main economic significance of this is that such stakeholders may be deterred from making investments in the company at a socially efficient level, since their “stakes” cannot currently be adequately protected. This prompts a brief discussion of how stakeholder protection might be improved. 3 This is a slightly modified version of an article with the same title which appeared in [1998] 2 CfiLR 174.

12 Andrew Gamble, Gavin Kelly and John Parkinson The chapter concludes by confronting the argument that if companies organised on pluralist lines were more efficient than shareholder-exclusive ones, enterprises would have adapted accordingly without the need for external intervention. Kelly and Parkinson point to signs of increasing interest in pluralist arrangements, particularly in the new knowledge industries, but accept that their use is not widespread. They suggest that one explanation is that managers and shareholders in the conventional company derive benefits from control and privileged access to the firm’s residual income, respectively. These groups are unlikely to initiate changes that will reduce their private benefits even though they might be wealth-increasing overall. A second explanation is that the wider legal, economic, and political context in the United Kingdom is less conducive to the development of pluralist arrangements than it is in those countries commonly regarded as having stakeholder corporate systems. An active market in control, for example, and the absence of well-developed intermediate organisations such as trade associations may obstruct or inhibit pluralist experiments. This chapter was written before the Company Law Review Steering Group, undertaking a fundamental review of company law on behalf of the Department of Trade and Industry, canvassed “pluralist” and “enlightened shareholder value” models as alternative bases for the future development of company law in the United Kingdom.4 The Steering Group has subsequently endorsed an approach in which shareholder interests retain their overriding character, but in which directors’ duties and reporting requirements emphasise “inclusiveness”, that is, the importance of giving proper weight to the various interests that are constitutive of corporate success.5 While supporting a pluralist objective, in the sense of seeking a framework that maximises “wealth and welfare for all”, it doubts the desirability and practicability of pluralist governance structures. In “Defending the Rentier: Corporate Theory and the Reprivatisation of the Public Company”, Paddy Ireland calls for a more fundamental reappraisal than that discussed in the previous two chapters of the allocation of rights in and over the company. He argues that the overriding importance that company law attaches to the rights of shareholders is not an inevitable response to the economic role of shareholding, but the product of judicial and legislative choices. As over the past two hundred years the nature of the involvement of shareholders has changed from entrepreneurship and active participation in management to what Ireland regards as that of “functionless rentiers”, the law has reconceptualised the relationship between companies and shareholders in a way that has preserved the preeminence of shareholder interests over those of other affected groups. Corporate theory, which has sought variously to explain, legitimate, and criticise such developments is revealed to be “not a steadily advancing body of 4 Company Law Review Steering Group, Modern Company Law for a Competitive Economy: The Strategic Framework (DTI, London, 1999), 33–55. John Parkinson is a member of the Steering Group. He writes in this book in a personal capacity. 5 Company Law Review Steering Group, Modern Company Law for a Competitive Economy: Developing the Framework (DTI, London, 2000), chs 2, 3 and 5.

Introduction: The Political Economy of the Country 13 knowledge but a long-standing site of ideological struggle”. There have been a number of distinct phases in the dominant understanding of the relationship between a company and its shareholders. Initially a company was its shareholders; it was a “company of shareholders” and the shareholders were regarded as the beneficial owners of the assets used in the business. With the increase in size of companies in the nineteenth century, growing shareholder dispersal and separation of shareholding from management, there were accompanying reconceptualisations of the share and of the company itself. The share came to be regarded as an intangible form of property quite distinct from the underlying assets, and the company as an artificial body with its own legal personality. While the shareholders were no longer the owners of the assets, a new idea emerged that they were the owners of “the company” as a reified entity. While at least as far as the public company is concerned this had little basis in law (shareholders possess few of Honoré’s incidents of ownership), the “myth” of shareholder ownership persists today. Ireland regards it as serving a powerful justificatory purpose. The notion that shareholders own companies suggests that their retention of the rights to profit and to appoint and dismiss the directors are “underlain by the fundamental moral principles of natural right, liberty and moral desert”. These rights are independent of their impact on such things as productive efficiency and the distribution of wealth and preempt analysis of what the rights of shareholders should be. The idea of shareholder ownership was increasingly questioned from the 1920s onwards, however, particularly in the USA. As shareholders apparently became more irrelevant to the operation of companies, their status was reassessed and the wider social responsibilities of companies recognised. By the 1950s in Britain Gower felt able to ask whether shareholder democracy and the emphasis on profit did not have an old-fashioned ring. Crosland thought that managers now controlled companies independent of shareholders and balanced the interests of shareholders with those of employees, customers, and the community at large. Ireland argues that the rise of currently fashionable contractual theories of the company was a backlash against such challenges to the priority of shareholder interests and the proper functioning of the capitalist market economy. He traces in some detail how contract theory has been used to “reprivatise” the public company. It dispenses with the notion of the company as a substantial entity and with it shareholder ownership. Instead, the relationship between shareholders and managers is characterised as a pure agency relationship, and corporate governance is seen in consequence as involving not complex questions “of productive organisation, social wellbeing and social justice, but simply the difficulties facing shareholder-principals trying to negotiate sufficiently binding contracts with agent-managers”. The moral case for shareholder supremacy based on property rights is replaced by a consequentialist argument, which seeks to legitimate the position of shareholders by reference to efficiency.

14 Andrew Gamble, Gavin Kelly and John Parkinson No attempt is made within this framework, Ireland points out, to evaluate the relative importance of the goal of efficiency and competing goals. Nor is the argument that existing arrangements are efficient assessed by reference to wideranging empirical comparison. Rather, efficient outcomes are simply assumed, as being the product of market processes. More fundamentally, while contract theory has no place for the notion that the shareholders are the owners of the company, it is still dependent on the pre-defined rights of the shareholders as owners of corporate assets. These rights and the ensuing power relations are not, Ireland observes, “natural” or “pre-social” but depend on the exercise of public power. The company cannot, therefore, notwithstanding the attempts at “reprivatisation”, be regarded as a private phenomenon. He calls for a reconstitution and a reallocation of corporate rights in pursuit of “democratically agreed goals which take account of the complex issues of social and individual wellbeing and justice”. An important theme in several of the preceding chapters has been the very limited extent to which the state has attempted to shape corporate governance in the United Kingdom in accordance with a public policy agenda. While there has been little direct public involvement in the design of governance mechanisms, however, Sue Bowden in her chapter “Corporate Governance in a Political Climate: The Impact of Public Policy Regimes on Corporate Governance in the United Kingdom” makes the important point that government policy has nevertheless influenced the way in which corporate governance has operated in this country and the behaviour of the relevant actors. Although there is an extensive literature on the contribution of corporate governance systems to economic performance, little attention has been paid to the impact of public policy regimes on governance (in the United Kingdom, in contrast to some systems overseas). Bowden makes the point that it is the anticipation or fear of government policy, as much as policy itself, that has been important. Thus, she argues that for several decades of the twentieth century the possibility of the nationalisation of failing businesses exacerbated the tendency of institutional shareholders to refrain from active intervention in portfolio companies. The belief that shareholders in such companies would be bought out on favourable terms may also have reduced the level of shareholder exit, compromising the operation of the market for corporate control by artificially supporting share prices. The threat of nationalisation of shareholding institutions, in the shape of banks and insurance companies, may similarly have increased the reluctance of these organisations to engage in exit, for fear of drawing attention to their position of power in the economy. Juxtaposed with periods in which a significant extension of public ownership seemed a realistic possibility, have been periods of active encouragement of the take-over market as a means of addressing the United Kingdom’s industrial ills. Bowden notes, for example, the creation of the Industrial Reorganisation Corporation in the 1960s and the emphasis in the 1980s on the “survival of the

Introduction: The Political Economy of the Country 15 fittest”. Problems, real or perceived, thrown up by an active take-over market, such as short-termism, asset-stripping and various forms of financial abuse have in their turn, however, prompted countervailing calls for public ownership and/or greater regulation of financial institutions. The take-over boom of the 1980s was important in reviving interest in corporate governance in political and academic circles and one of the factors that led to the development of governance codes of best practice. The underlying point is that public policy in the United Kingdom has engaged with, but never fully worked through, “whether corporate governance should be left to the market or be the rightful domain for government intervention and regulation”. Later in the chapter Bowden illustrates how a number of issues that are of current interest in governance, particularly the role of shareholders, monitoring by non-executive directors, and relations between different stakeholder groups in the firm were all under active discussion by the Wilson Government of the 1960s. Practical measures aimed at improving corporate performance and intended to fill the breach created by shareholder passivity included initiatives by the IRC to place expert managers on company boards, subsequent engagement by the DTI in individual companies’ affairs, and exploitation of the leverage obtained from government shareholdings. As far as reforming the legal framework within which companies operate was concerned, however, for example, to promote involvement in governance on the part of the institutions, little progress was made. The government came increasingly to recognise the difficulties of using the law to persuade “the right people to do the right thing”. Similarly, broadening the responsibilities of companies to include groups additional to shareholders gave rise to seemingly intractable problems of defining what those responsibilities were and designing legal provisions to put them into effect. Bowden speculates about whether the present government’s enthusiasm for “modernising” company law will fade as did that of its Labour predecessor in the face of such obstacles. One of the messages of Bowden’s chapter is that public policy in the United Kingdom has not only failed in the past to increase shareholder supervision of management, but has actually made the situation worse. Measures to address shareholder passivity, for example, by making it compulsory for institutions to vote, are now again the subject of public policy debate. In “Institutional Investors: What are their Responsibilities as Shareholders?”, Geof Stapledon brings useful clarity to this area by examining what the legal obligations of institutional shareholders in relation to governance currently are, and considers whether steps such as the introduction of mandatory voting would be desirable. The proposition that institutions, which control around 70 per cent of the shares of UK listed companies, should play an active governance role, not unnaturally, is in large part premised on the belief that by so doing corporate performance will be improved. Stapledon notes that the empirical evidence regarding this proposition is equivocal, though there is certainly some that supports it. There is also a tendency for studies to underestimate the total impact of activism, since

16 Andrew Gamble, Gavin Kelly and John Parkinson there appears to be a significant level of behind-the-scenes involvement which is inevitably difficult to evaluate. The chapter maps the lines of accountability within the different types of institution (pension funds, insurance companies, unit trusts, investment trusts, and open-ended investment companies and relationships with external fund managers, indicating who has the legal entitlement to vote the institution’s shares and who has practical control over voting. Insofar as institutions or actors within them have legal obligations in relation to the way they exercise their rights as shareholders these obligations are, of course, owed not to the company in which the investment is held but to the beneficial owners of the shares whose interests might be affected accordingly. In essence, a failure to vote (or exercise governance functions more generally) will not normally constitute a breach of duty so long as active and genuine consideration has been given to the issue. In principle, liability could therefore arise if proper consideration were not given. As, however, this duty is difficult to enforce (for example, because of the problems of establishing a causative link between voting behaviour and losses suffered by beneficiaries), Stapledon concludes that there is a lack of practical legal incentives for institutional investors to be active in governance in the United Kingdom. He does not argue on the strength of this that it would be desirable to introduce mandatory voting (it would be impracticable to impose obligations in other areas, for example, requiring institutions to engage in active dialogue with management). Among other reasons, the effect of compulsory voting would be to reduce the proportionate influence of those institutions that currently vote willingly. Further, the evidence from the USA, where private sector pension funds are legally obliged to vote, does not encourage the belief that such a requirement is of value, since it often leads merely to window-dressing and does not necessarily promote an appropriately considered use of voting rights. This being the case, the costs appear to outweigh the benefits. Stapledon also argues against a requirement for institutions publicly to disclose how they have voted, not least because this might result in less rather than more monitoring, since a fund manager, which is often a financial conglomerate, that acquired an activist reputation might lose business in other areas of its activity. He does, however, suggest that there is a case for strengthening the requirement in the Pensions Act 1995 that if pension fund trustees have formulated a policy on voting, they must include it in the statement of investment principles that the Act mandates. He argues that the Act might usefully go further, and make it compulsory for trustees to have a voting policy. It should also be changed to increase the obligations of external fund managers as regards putting the policy into effect, from the current requirement to do so “so far as reasonably practicable”, to one to use best endeavours. Otherwise, however, Stapledon notes the existing ability of institutions to arrange through contract for external fund managers to vote in accordance with the institution’s voting guidelines, and also market developments which help overcome the agency problems between an institution com-

Introduction: The Political Economy of the Country 17 mitted to an active governance policy and external managers. Thus, the growth of proxy advisory services should lower the costs of involvement and the arrival of specialist “active investors” enables funds to select managers who share their commitment. An alternative, or at least a supplement to monitoring of managers by shareholders is monitoring by non-executive directors. The codes of best practice devised by the Cadbury and Hampel Committees over the past decade have had the effect of increasing the numbers of non-executives in post and raising the profile of their monitoring role. In “Evolution and Policy in Company Law: the Non-Executive Director”, John Parkinson observes that while Cadbury was triggered by a number of high-profile collapses of major companies in which there had been managerial impropriety and financial reporting failures, there is a more general problem of accountability that the use of non-executives might address. This has been recognised in the United Kingdom since at least the early 1970s. The Bank of England, for example, was at that time concerned that the poor performance of large sections of British industry was partly attributable to the difficulties of removing weak management, and that a powerful nonexecutive element might help overcome this problem. If recent research is anything to go by, replacing inadequate management is still a problem today. Viewing the role of non-executives in this light suggests that there is not, as sometime argued, a conflict between monitoring and economic performance. Monitoring is not merely about “hygiene”, but rather it contributes to performance by ensuring that the company is effectively led. The rise of the non-executive (in the USA, the “independent” director) is regarded by exponents of contractualist, evolutionary theories of the company as an example of the successful operation of market forces in the governance arena: it shows that corporate governance arrangements evolve, without external intervention, to meet current-day requirements. Parkinson’s account suggests, however, that companies in the United Kingdom have actually been fairly unresponsive to the need to modify board composition and functions. Over the past thirty years there have been a variety of initiatives aimed at promoting the use of non-executives. Their limited success has necessitated a form of, private sector, regulation, in the shape of the Cadbury Code and its successor the Combined Code. If it is true that non-executive monitoring can improve corporate performance (the chapter reviews the evidence) the evolutionary process would seem to have worked rather poorly. It may be that competitive forces are not of sufficient strength to overcome managerial self-interest in avoiding close scrutiny. Against this background Parkinson questions whether the Combined Code yet goes far enough in specifying board responsibilities. The active involvement of management in selecting non-executives and the minority position of the latter in particular seem likely to reduce the effectiveness of board monitoring. To what extent, if any, the Code should be replaced by law and whether the contents of the Code should be strengthened are issues on which the Company Law

18 Andrew Gamble, Gavin Kelly and John Parkinson Review has consulted, though at the time of writing what the outcome will be is unclear. The chapter draws on the experience with the development of board monitoring to question contractual approaches to the company more generally. It accepts the value of the contract model as a device for analysing the allocation of risks, returns, and control rights in companies, but in so far as the model purports to provide a realistic account of the processes by which governance controls are designed and adopted it regards “contract” as a serious distortion. Evolutionary theory is relied on by its supporters to raise a strong presumption in favour of the efficiency of current arrangements. Those arrangements depend, however, directly or indirectly, on regulatory interventions that respond, not least, to failures in private ordering. Given these failures, we should be more open-minded than contract theory allows about the desirability of further intervention. In the final chapter in this collection, “Comparative Corporate Governance: Sociological Perspectives”, Gregory Jackson also draws attention to the distorting influence of contractual, and particularly agency theory approaches to the company. He broadens the critique, arguing that the dominance of agency theory in corporate governance research has, as a result of its narrow focus, hampered efforts to explain the international diversity of governance systems. He argues for a broader view of governance that takes account of the wide range of relations and institutional arrangements that shape who has control in large companies, the interests that these companies serve, and how risks and rewards are allocated among different stakeholders. The focus of the agency costs literature is on how effective assurances can be provided to shareholders that once they have invested their funds, managers will act in the shareholders’ and not their own interests. The approach adopted tends to be reductionist: it is concerned with isolated bilateral contracts between management and shareholders, viewed from the standpoint of their efficiency in reducing the costs of the divergence of interests between managers and shareholders. As such, it fails to recognise that governance structures are shaped not just by the quest to minimise agency costs but also by “many dimensions of interdependence between firms and their market, technical, cultural, social, political, and institutional environments”. A further set of problems arises from the assumption that institutions are the efficient outcomes of market processes. Because it sees governance arrangements as purely market-driven phenomena and neglects the role of politics in their formation, the agency cost analysis has difficulty in explaining the origins of differences between governance systems internationally. What is needed is an analysis of the company that takes seriously its embeddedness in social structures, that is, sociological perspectives on the company that have been marginalised by comparative research in the law and economics tradition. To that end, Jackson explores the issues of ownership and control, the role of employees in corporate governance, and the role of management, in the light of a richer understanding of social context than found in agency theory.

Introduction: The Political Economy of the Country 19 In relation to the first of these issues, he notes that agency theory assumes shareholders to be homogeneous, whereas they may in reality have different interests, those of individuals and pension funds, for example, being purely financial, while others, such as other companies and banks have strategic organisational interests which may take precedence over financial returns. More broadly, the nature and extent of shareholder influence over management is shaped by the identities and interests of shareholders and the channels of control that are available to them. Both these factors invite an examination of the role of politics and not just markets in the creation of different patterns of ownership internationally. As Jackson explains, different strands of research in this area have considered the role of regulation of the financial system, differences in the legal rights of shareholders and minority protection, and the influence of political alliances of managers and workers in limiting the prerogatives of shareholders. Turning to employees, from an agency perspective they are simply providers of a factor of production. Since employees do not bear residual risk, they have no role in governance. As Jackson points out, however, the employment relationship is a hierarchical one. The radical incompleteness of labour contracts means that the successful operation of the enterprise depends on employee goodwill, which in turn requires legitimacy. The legitimation and limits set to bureaucratic authority of management involve “a complex intersection of economic, political, and social forces” and imply that employees are central to an understanding of governance. He substantiates this position and sketches the modes of involvement of employees in governance in Germany, Japan, and the USA, noting also related inter-dependencies, for example, the connection between long-term, committed shareholders in Japan and the tradition of “lifetime employment”. In his discussion of management, Jackson explains the importance of a richer understanding of managerial interests, the conditions under which managers are likely to be influenced by shareholders and other groups, and how they attend to the multiple and conflicting goals of organisations and their members, and in so doing moves beyond the stylised assumptions about “managerial opportunism” found in the agency literature. Following Cyert and March and Aoki he regards organisational goals and decision-making as dependent on coalition-building, and notes national differences in typical managerial backgrounds and the institutional structures in which decision-making takes place. Pulling these threads together, Jackson discusses how the efficiency properties of institutions depend on their “fit” with other institutions, positively or negatively. This provides a basis for looking at national systems not only in terms of the conventional division found in agency cost analyses between market- and bank-based systems, but also in terms of how governance coalitions of capital, labour, and management relate to each other. Institutional complementarities give national regimes their coherence, but may also be sources of weakness. From this viewpoint, no system is likely to be superior in absolute terms, but

20 Andrew Gamble, Gavin Kelly and John Parkinson rather to possess comparative advantages in dealing with particular aspects of the operating environment of the company. The chapters in this book are derived from a number of different perspectives, but they all contribute to a political economy of the company in the broadest sense: an understanding of the different political and legal contexts which have shaped the development of the company and of the considerations that should determine its future development. What is certain is that the company is not about to disappear, and the way the public interest is defined in relation to it will continue to be a subject of intense political, legal, and academic interest. The future of the company is central to the wider question of the legitimacy of the modern economic order. This book hopes to make a contribution to that debate.

2 The Politics of the Company ANDREW GAMBLE and GAVIN KELLY

I

N CONTEMPORARY CAPITALISM, companies have become ubiquitous, dominating most sectors of the economy and overshadowing individual ownership and enterprise, once the foundation of capitalist economies. Some companies have become giants, straddling continents, and dwarfing in size many national economies. The rise of the corporate economy has often been seen as marking a new phase of capitalist development, or even a new kind of economy altogether.1 At its heart is the modern company, an association that has a legal personality separate from its members, which enables it to raise finance, to contract for various kinds of services, and to organise production.2 This dominance of the company was first created and has since been sustained by politics. Two questions have been crucial. First, should companies be allowed to exist at all, by being granted a “licence to operate”? And secondly, if they are given a licence to operate, whose interests should they serve? These questions are political because they presume that there are alternatives both to the company itself as an organisational form and to the way in which the company might be governed. The focus of much writing on the company as on the economy generally is anti-political in the sense that it denies there are any significant collective choices and seeks to explain the company as an inevitable product of technological change. The increasing scale of economic production in leading sectors of the economy required new organisational forms both to raise the vast sums of capital that were needed to finance it and to coordinate an increasingly complex production process. On this view corporate forms of organisation are simply the most rational and efficient means for carrying on economic activity in contemporary capitalist economies.3 Politics can facilitate the process of natural corporate evolution; more often it just gets in the way. 1 J K Galbraith, The New Industrial State (Hamilton, 1967); Paul Baran and Paul Sweezy, Monopoly Capitalism (New York, 1966). 2 Leonard Tivey, The Politics of the Firm (Oxford, 1978). 3 See Frank Easterbrook and Daniel Fischel, The Economic Structure of Corporate Law (Cambridge, Mass, 1991); Oliver Williamson, The Economic Institutions of Capitalism (New York, 1985). Easterbrook and Fischel describe the distinctive features of corporate law as a series of adaptations with substantial value in the evolutionary struggle for corporate survival.

22 Andrew Gamble and Gavin Kelly Such accounts of the rise of the modern company leave many things unexplained, such as the precise transmission mechanism between the appearance of new technology and the invention of new organisational forms. They cannot explain why there is such diversity in the form of the company in capitalist economies. Over a period of one hundred years should not one best practice form have evolved and driven out all the others? This clearly has not happened, as the literature on the differences between corporate governance in North America, Britain, Germany, France, and East Asia abundantly testifies.4 The degree of concentration of ownership, the patterns of corporate governance, and the way in which the purpose of the company is defined all differ markedly. Although technological conditions are important in explaining the rise of corporate organisational forms, they are therefore not sufficient. Legal and political conditions have also been crucial. The idea that the company evolved smoothly in response to technical requirements of economic development should be rejected. Instead the company needs to be understood as an institution which had in part to be deliberately constructed through political and legal agency. The company from this perspective is a contrivance which bears the imprint of the various historical contexts and social and political systems in which it was fashioned.5 The company is not just a product of private interest but also of public interest. Its various forms derive from different legal and political assumptions. The history of the company is therefore inseparable from political conflicts over how the company should be defined, its powers and responsibilities, its purposes and its members. Politics matters because it shapes particular outcomes and is often responsible for the widely divergent features of corporate organisation found in different national jurisdictions. This has led some to suggest that if the baleful influence of politics were removed, all systems of corporate governance would be rational and efficient, and convergent on the same basic principles dictated by technical needs. But this dream of a politics-free world is a mirage. Politics is an aspect of human experience which cannot be eradicated, because it is constitutive of that experience, determining the collective choices which must be made in any society. The company has become a key focus in political debate on how the public interest should be defined, both as an agent and as an institution. In this chapter we consider the meaning of the concept of the public interest, and how the company has been conceived in terms of it. Two key political issues are explored, illustrated through examples from the British case. The first concerns the establishment of the legal foundations of the company, the “licence to 4 A Shleifer and RVishny, “A Survey of Corporate Governance”, NBER Working Paper 5554 (Cambridge, Mass, 1996); Jonathan Charkham, Keeping Good Company: A Study of Corporate Governance in Five Countries (Oxford ,1994); Ronald Dore, Stock Market Capitalism: Welfare Capitalism: Japan and Germany versus the Anglo-Saxons (Oxford, 2000). 5 One of the strongest defenders of this thesis has been Mark Roe. See Strong Managers and Weak Owners: The Political Roots of American Corporate Finance (Princeton, 1994).

The Politics of the Company 23 operate” which created the rules which shaped the development of the company. In Britain this was achieved by the mid-nineteenth century legal reforms which both enabled the huge expansion of the company as an organisational form and ensured that the company in Britain would be treated predominantly as a private association rather than as a public body with defined public responsibilities. The second issue is the legitimacy of corporate power and the purposes for which it is used, given the rapid concentration of economic power in the company, and the centralisation of control over that power in the hands of its managers. To whom are managers accountable, and whose interests do they serve? Are managers trustees for the assets of their companies, and if so on whose behalf do they exercise stewardship? How are the public responsibilities of companies best defined and realised? These questions direct attention to the internal governance arrangements of companies and to external regulation.

THE PUBLIC INTEREST

The idea of the public interest is one of the most pervasive as well as one of the most disputed concepts in western political thought. The very linking of the two terms “public” and “interest” has been questioned, since interest has often been conceived as belonging to the private sphere because it is an attribute of individuals. If it is individuals who have interests and who pursue them, what does it mean to talk of a public interest which is separate from the private interest of individuals? Yet the phrase is ubiquitous. New laws are recommended as being “in the public interest”. Institutions, including companies, are judged as to whether they conform to the public interest. Politicians, judges, civil servants, and other office holders seek to act “in the public interest”. If a politician announced that if elected she intended acting in her private interest it would cause consternation. That is not what office holders are supposed to do. But does acting in the public interest have any meaning? Many political scientists and political economists have concluded that it does not, and that the concept should therefore be dispensed with.6 One strong line of attack upon the concept has argued that the public interest is a normative not an empirical concept, and that wherever it is used it refers only to personal or group preferences, and does not denote anything separate from those preferences. Public interest is simply a cloak for private interest. It suits every individual and group to claim that they are acting for the public good and that they are considering the general welfare rather than just their own, but according to the sceptics all such claims are bogus and do not stand up to analysis. In politics there are only individuals and groups of individuals, and their interests and preferences. The struggle between groups determines who comes out on top, and therefore which group is able to define its own interest as the public interest. 6

David Truman, The Governmental Process (New York, 1951).

24 Andrew Gamble and Gavin Kelly This realist view of politics is not a new one. It has been voiced for as long as politics has been studied. Cynical views of politicians’ use of the public interest has been echoed many times since,7 and resurfaces more recently in the desire of public choice analysts to unmask “enlightened” government, by showing that politicians and bureaucrats are as self-interested as any other actors. On this view altruistic behaviour does not exist; there is only self interest and different ways of describing self interest.8 The classical notion of a public or common good does not depend on private interest at all, but is the product of knowledge which is universal and unchanging. The public good is objective and can be grasped only by those who are able to develop their powers of reason. This conception has cast a long spell over western thought, and still has resonance in the authority held to reside in particular forms of expertise, such as science and medicine. The notion of one objective public good has been on the defensive against the dominant modern western conception of politics as the pursuit and satisfaction of individual interests, rather than the establishment of the good society. This modern concept of interest is held by some to be inherently individualist and subjective, which means that there is no place within it for an objective conception of the public good. If a public interest exists at all it can only be the aggregate of all individual interests in a society. Since only the individual can judge what is in his or her interest, all forms of paternalism are both illegitimate and illusory, because they suggest that someone else can know better than the individual what their interest is. In this modern liberal conception the state should be organised so as to ensure that individuals are left free to define their interests in their own way and to pursue and satisfy them with the least possible interference from anyone else. The public interest is therefore simply the aggregate of all individual interests. But the matter has only to be stated in this way for the problems to be obvious. Achieving the framework in which all individuals are free to the greatest possible extent is by no means straightforward, since inevitably it requires judgements about the degree of interference that is necessary to secure it. For this reason Hayek amongst others acknowledged that there was a public interest separable from individual interest. The constitution of liberty, the general rules providing the framework in which individuals might exercise their liberty, was the essence of the public interest.9 There was a strong public interest in ensuring that spontaneous orders such as the market were protected, since they were not able to protect themselves. Yet their existence was the precondition for the pos7 See, e.g., Bertrand de Jouvenel, The Pure Theory of Politics (Cambridge, 1963) where he describes the public interest as nothing more than a propaganda device. See also Walter Lippmann, Public Opinion (New York, 1922) and The Phantom Public (New York, 1925). 8 Gordon Tulloch, “Public Choice in Practice” in Clifford S Russell (ed), Collective Decision Making (Baltimore, 1979), 31 at 33. See also James Buchanan and Gordon Tulloch, The Calculus of Consent (Ann Arbor, 1962). 9 F A Hayek, The Constitution of Liberty (London, 1960). See also Andrew Gamble, Hayek: The Iron Cage of Liberty (Cambridge, 1996).

The Politics of the Company 25 sibility of freedom, and this creates a conundrum for liberal politics. If individuals behave according to the dictates of self interest rather than of altruism, how will the rules which safeguard the market order be preserved, since to preserve them would require that individuals act altruistically? It cannot be in any one’s self interest to provide them for if it were they would arise spontaneously. Apart from some anarcho-capitalist theories which dispense with the state altogether, neo-liberal and libertarian theories of politics therefore still depend on a notion of the public good or public interest, which cannot be derived from their individualist assumptions. Virginia School public choice theory which scorns the notion of the public interest, and treats all public actions as the manifestation of private interest, still puts forward an elaborate set of constitutional principles, such as obliging governments always to maintain a balanced budget, which require the same self-seeking politicians and bureaucrats to act altruistically if they are to be put into effect. But if their empirical theory is correct, there are no good grounds for thinking that this is possible. There is a way out of this dilemma, but it involves dispensing both with the idea that the public good could be objective and knowable, and with the idea that the public interest is nothing more than the aggregate of private interests which only individuals can define. The essential step which has to be taken is to develop the notion that the public interest arises through politics. Even if we accept that individuals and their interests are the driving force of modern politics, there is no reason to treat those interests as only definable and knowable by the individuals themselves. Individuals are part of communities, and the roles, identities and characteristics they acquire and choose are the product of the history of those communities. Within the framework of particular communities there are conventional and commonsensical ways of defining the interests of individuals additional to those by which individuals define them for themselves. From such materials a politics of the public interest can be fashioned.10 It does not require the public interest to be determined by an elite and imposed on the people regardless of what the people desire. It can arise through a sustained negotiation and interaction between all groups in the society to establish the principles and the institutions through which the society should be governed. This process is political; it involves organising and defining communities of interest and attempting to project those interests as a public interest, rather than as a narrower sectional interest. This process is never complete, but it leads to the creation of different conceptions of the public interest which need to have certain characteristics if they are to be acceptable as legitimate contributions to discourse about public policy. Narrow expressions of self interest can be made but will generally fail unless they can also be turned into public interest arguments.11 Public discourse on the public interest creates a space in which 10 The idea of a politics of the public interest is developed by Richard Flathman in The Public Interest (New York, 1966). 11 This is strongly argued by Flathman, ibid. See also John Dewey, “The Public and its Problems” in The Later Works (Carbondale and Edwardsville, 1984), vol 2.

26 Andrew Gamble and Gavin Kelly arguments can be put about the constitutional principles on which social order is based. Out of this kind of discourse have come the institutions and principles which are the embodiments of the public interest and determine the quality of the polity and the degree to which it can provide a framework in which the key values of the society can be realised. The key debate is therefore not over whether there is a public interest or not, but over what kind of first principles should be employed in defining the public interest. If the political process is conceived not simply as a means of aggregating private interests but as an activity of deliberation to find the principles that best promote the common good,12 then the way is open for a contest between laissez-faire arguments that the public interest is best served by always respecting market outcomes and interfering as little as possible, and interventionist arguments that public action to regulate markets and determine the rules under which they operate is necessary and desirable.

THE MORAL BASIS OF THE COMPANY

A politics of the public interest in this sense has always been central to the company as an institution. There have been many political conflicts over how best to define the principles on which the organisation of the company should be based. The diversity in the form of the company in capitalist economies reflects different conceptions of the public interest, different ideologies, and different political, legal and economic systems.13 Although companies have become ubiquitous there has always been ambivalence about them, on both left and right. They do not easily fit into the categories of the main ideologies of the past century, whether liberal or socialist, because it has never been clear on which side of the line between the public and the private they fall. They are much more than the sturdy self-reliant individuals of liberal discourse, but neither are they unambiguous collective instruments of the popular will. They are agents of the market and subject through competition to the disciplines of the market, but their internal organisation is not governed by the market. They are hierarchies with a complex internal pattern of authority relationships. Each company is a little empire, a miniature socialist state, where rational planning and bureaucratic hierarchies of control hold sway. Companies are both private associations and public bodies, recognised in law as having their own will and personality, and expected to be responsible and accountable for their actions. But the balance between the public and the private aspect of the company vary between different regimes. Companies have often 12 Cass Sunstein, After the Rights Revolution: Reconceiving the Regulatory State (Cambridge, Mass, 1990); Sheldon Wolin, Politics and Vision (London, 1960). 13 For an application of this approach see Gavin Kelly, Regional Finance: History, Theory, Policy (Sheffield, 1998).

The Politics of the Company 27 appeared, and perhaps especially in the Anglo-Saxon world, as impersonal bureaucratic organisations which are impenetrable not just to citizens and consumers but also to their employees and shareholders. Finding out who will take responsibility in a company for decisions and outcomes is seldom easy, and this has always been one of the spurs behind calls to reform corporate governance, to provide greater transparency and disclosure of information as to how companies operate, and to enable shareholders and employees to have a voice in the affairs of the company. In every national jurisdiction the granting of a “licence to operate” to companies inevitably raises questions as to what they should give in return. What public responsibilities should they acknowledge in recognition of their public status and public privileges? One of the main differences in approach of national regimes, explored in several chapters in this volume, is between considering the company as a private association, which requires some external regulation to satisfy the public interest, and considering it as a public body which has clearly defined public responsibilities and purposes. In the latter case the company is “constitutionalised” through the detailed specification of its internal governance structure. This became the preferred model in many European countries but not in Britain,14 where the conception of the company as a private association prevailed. This had not always been so. Before the reforms of the nineteenth century, companies were regarded as deliberately created by government for a public purpose, which justified giving them a privileged position in the market, often a monopoly. When the opportunity to form companies became a general right, however, the character of the company as a private association of property holders was given more weight than its character as a public body with public responsibilities. Determining what the relationship of the company to the public interest should be posed particular problems for classical political economists because of the enormous moral and practical weight which they placed upon individual private ownership as the foundation of capitalism as a distinctive economic system. The classical political economists assumed a world of individual producers, and individual ownership of assets and resources. Where production was cooperative, the individual or group of individuals who put up the capital would own the assets and contract with other individuals to provide specific services, including labour services. The owner of the assets also controlled the enterprise by directing production, allocating resources, and determining how the income generated by the enterprise was distributed. This conception was the essence of the ideal of entrepreneurial capitalism, and was defended primarily on normative grounds—the rights of individual ownership. All individuals had a 14 George Goyder argues that British company law fails to state what a company is; gives directors as agents of the shareholders de facto control of the company’s policy, while conferring no corresponding rights on other interests. He also states that the limited liability company in British law is not constitutionally concerned with quality or value or the public interest. George Goyder, The Just Enterprise (London, 1987).

28 Andrew Gamble and Gavin Kelly fundamental right to possess and control their property, which could only be infringed, if at all, in very special circumstances. The growth of a corporate economy after 1860 posed a number of problems for the classical conception of the firm, both normative and analytical. Firstly it appeared to take away the pivot on which the whole edifice of market capitalism was built by driving a wedge between the legal owners of the assets of the firm and the controllers and managers of those assets.15 This raised public interest questions of efficiency and legitimacy. By what right did managers usurp the position of owners, and how could owners be sure that managers would act in their interests? But it also raised another set of issues. By permitting an enormous increase in the scale of economic organisation the rise of the corporate economy appeared to be replacing market coordination between firms by administrative coordination within firms as the main means by which resources were allocated and economic outcomes determined.16 Many of these questions came to a head in England in the nineteenth century controversy over limited liability. The joint stock principle had previously been confined to special undertakings like the East India Company. The reason it began to be extended much more broadly in the nineteenth century was the political pressure which developed as a result of the changing scale of production and the growing complexity of markets. The voracious financial needs of new sectors such as the railways in the 1840s made joint stock organisation (the pooling of funds to finance new ventures) necessary if the new developments were to go ahead. At the same time the potential of joint stock companies was enormously expanded by changes in company law between 1844 and 1862 which extended the privilege of incorporation, formerly granted only in very special cases, to all businesses desiring it. From 1856 they were able to incorporate with limited liability, which protected smaller investors and opened the way to an unlimited growth in the size of firms. The advantages of the new joint stock companies were rapidly demonstrated and in terms of assets, output and employment they quickly became dominant in the leading sectors of the economy. These developments posed difficult problems for the classical conception of the firm. To some it appeared to undermine the moral and practical basis of capitalism. Is capitalism still properly described as capitalism if the main productive enterprises are not owned and managed by individual entrepreneurs but by reified entities, the companies, which are accorded the status of individuals in law, and in which the functions of ownership have been divided between absentee shareholders and salaried managers? In a world of giant corporate bureaucracies how can those who direct them be made responsible and accountable, and how can competitive efficiency and entrepreneurial vitality be assured? Another issue was employment. Once self-employed individuals turned busi15 16

A Berle and G C Means, The Modern Corporation and Private Property (New York, 1932). A Chandler, Scale and Scope: The Dynamics of Industrial Capitalism (Cambridge, 1990).

The Politics of the Company 29 nesses into cooperative enterprises and hired workers, they became not only owner-managers, but also masters. Contracts of employment developed from the law on masters and servants, and conferred on employers the right to control their employees.17 This made nineteenth century capitalists already very different from independent producers, but powers that were allowed to be exercised by individual owners with little legal interference became more questionable when these same powers were transferred to the company. These questions focused attention upon ownership and what was happening to it. In the entrepreneurial economy responsibility for efficiency belonged to those who owned the assets. But in the corporate economy ownership is much harder to locate. Ownership in respect of physical assets is not one right but a complex bundle of rights, which includes the right to possess, the right to use, the right to control, and the right to alienate.18 These rights are in principle separable; it was their concentration in the hands of a single individual which inspired the ideal of an economic order based on individual ownership. But there was nothing in principle to stop these rights being dispersed, and this is precisely what the invention of the joint stock company with limited liability facilitated. In early forms of the company, the company was the shareholders, and they united in their persons the different rights of ownership. But in the modern company this is no longer possible.

LIMITED LIABILITY

Political hostility to the joint stock company was very deeply rooted in England in the eighteenth and early nineteenth centuries, largely as a result of the experience of financial scandals and company failures, particularly at the time of the South Sea Bubble in 1720. This scandal led to the passing of the Bubble Act which halted the development of joint stock enterprise for more than a hundred years. According to one observer the joint stock system was taken as “the sole and sufficient explanation of the miseries of the country. No words were too strong to condemn what was then considered to be a malign perversion of industry, destruction of commercial probity, and of a well-ordered social life”. 19 There always were exceptions, however, mainly because with the expansion of industry and commerce, there was a need for new organisational forms which would facilitate the carrying on of large-scale businesses. The exceptions included the canal companies, banking, insurance. But these were exceptions in the sense that they required legislation to set up them up. Between 1766 and 1800 17

Tivey, The Politics of the Firm, above n. 2. A Honore, “Ownership” in A Guest (ed), Oxford Essays in Jursiprudence (Oxford, 1961), 107; Andrew Reeve, Property (London, 1986). 19 W R Scott, quoted in Bishop Carleton Hunt, The Development of the Business Corporation in England, 1800–1867 (Cambridge, Mass,1936), at 8. See also Paddy Ireland, “Capitalism Without the Capitalist: the Joint Stock Company Share and the Emergence of the Modern Doctrine of Separate Corporate Personality”, (1996) 17 Legal History 40. 18

30 Andrew Gamble and Gavin Kelly more than one hundred separate canal Acts were passed. Adam Smith acknowledged the practical argument for companies to be licensed in certain areas, but he did so without enthusiasm. He wanted them to remain exceptions to the standard, which was individual ownership.20 Smith argued that only if ownership and control were united in the hands of an individual would economic efficiency be maximised and the public interest secured. He was a persistent critic of other forms of economic organisation, such as the joint stock companies created by Royal Charter and given special legal privileges to trade because of their importance to the public interest as it was defined by the Crown. Smith regarded such companies as inferior to ownermanaged firms, because managers who were not owners of the enterprise in which they worked would not have the same incentive as owners to take care of the business and ensure its success. Smith claimed for example that in joint stock companies like the South Sea Company or the East India Company the energy and zeal of the managers would be much lower than in a company where the owner was also the manager.21 Joint stock companies could only sustain themselves against the competition of more efficient owner-managed firms if they were granted legal privileges which either suppressed competition or provided them with a permanent subsidy. Smith’s misgivings were widely shared. Evidence that opposition to joint stock companies was not simply a matter of rhetoric was shown in the number of requests which were turned down. The Privy Council frequently rejected applications for charters, and instead recommended to aspirant companies that they set up as partnerships instead. Partnerships involved the voluntary association of wealthy and respectable individuals and many insurance companies did turn to this route. They were able to operate as corporations and maintain a continuous existence, even though they were denied the legal benefits of incorporation. The root of the opposition to the joint stock company was the idea that such companies were monopolies and if licensed would drive out individual enterprise. There was a sharp contrast with Scotland where the separate legal personality of an unincorporated trading company was recognised in Scottish law with the result that by the early nineteenth century there were many joint stock banking companies operating. Pressure grew in England to relax the law and in 1825 the Bubble Act was repealed, leaving the common law to deal with fraudulent promotions.22 The repeal led to a rapid expansion of company organisation in the insurance industry, but general incorporation was still denied. The established legal view remained that to act as a corporation without in fact being a corporation, i.e. sanctioned by a specific Act of Parliament, was an offence at common law. A strong strand of public opinion, represented in par20

Adam Smith, Wealth of Nations (London, 1961), vol II at 279, 280–1. Ibid., at 264–5. 22 Ron Harris, “Political Economy, Interest Groups, Legal Institutions, and the Repeal of the Bubble Act in 1825”, (1997) 4 Economic History Review 675. 21

The Politics of the Company 31 ticular by the Times newspaper continued to uphold the doctrine of unlimited liability as the foundation of commercial success and probity. Periodic speculative booms and financial crises were cited as evidence of the danger of departing from the principle. Pressure for change continued to build, not least from the evidence of successful experiments with limited partnerships elsewhere in Europe. In 1826 joint stock banks were finally authorised, but limited liability was still withheld from them, due to opposition from the Bank of England.23 Public utilities were proving more successful than other kinds of corporate promotion in gaining legislative approval, but there was still widespread and influential opposition. Many political economists such as McCulloch continued to insist that individual ownership was the bedrock of morally sound enterprise and that any larger scale of operation could be handled perfectly well by partnerships. A review held into the law on partnerships by the Board of Trade looked into the position in France and the advantages of the société en commandite,24 but rejected change. Limited liability continued to be regularly denounced. Lord Brougham in 1838 told the House of Lords that limited liability was “contrary to the whole genius and spirit of English law, contrary to the genius and spirit of the Constitution”. If enacted it would “relax that care and vigilance which every partner ought to keep over his association and give a license to every species of fraud”.25 The Circular to Bankers on 14 February 1840 stated:26 “Nothing should be done by the legislature to weaken the motives for personal industry, economy and thrift. The moral effect of all joint stock associations for mercantile objects which are properly within the compass of individual exertion is bad; they introduce in the place of patient labour and moderate expectations ambitious hopes and the habit of gambling in shares.”

The forces of reform were beginning to strengthen however. The same Circular to Bankers was forced to note that the amount of capital now invested in public proprietary companies was becoming unmanageable; new laws were needed to regulate their constitution and obligations properly. The main battering ram for change was the need to finance the railways. The scale of this finance was so huge that limited liability had to be conceded from the outset in the Acts of Parliament which set up the railway companies, and it exposed the anomalous position of other branches of trade where the same legal status could not be obtained. There were strong laissez-faire arguments for regularising the position, and during the 1840s a significant reform movement began to take hold in Parliament under Peel’s Conservative Government. A Parliamentary Committee was appointed in 1841 to inquire into the state of the laws on joint stock companies, and this was reconstituted in 1844 under the chairmanship of 23

Hunt, The Development of the Business Corporation in England, above n. 19, at 50. The société en commandite had existed in France since Louis XIV, had been codified under Napoleon and legalised in Ireland in the eighteenth century. 25 Quoted in Hunt, The Development of the Business Corporation in England, above n. 19, at 84. 26 Ibid., at 86. 24

32 Andrew Gamble and Gavin Kelly Gladstone and its remit widened. The Committee’s report led directly to the Joint Stock Companies Registration and Regulation Act 1844. This Act for the first time recognised the principle of the joint stock company as a beneficial and normal instrument for organising capital. The principle of universal limited liability was still resisted, but by the 1850s the laissez-faire argument had gained considerable ground against the older individualism. As Robert Lowe told the Royal Commission on Mercantile Law in 1854: “If people are willing to contract on terms of relieving the party embarking his capital from loss beyond a certain amount, there is nothing in natural justice to prevent it . . . the received principle in commercial legislation is to leave people to act for themselves”.27 Such arguments came to be increasingly influential and facilitated the acceptance of limited liability as a normal part of commercial arrangements. The railways had another effect, however. Railway speculation was an expression of the rapid accumulation of capital in England and the diversification of wealth in the middle of the nineteenth century. It led directly to the broadening of the stock exchange and an increase in the opportunities for small investors. Small investors had an obvious interest in limited liability to protect their investments, so too it was suggested did the working class. Giving evidence to the 1850 Committee John Stuart Mill, for example, argued that allowing partnerships to be limited was an effective means to implement social betterment: “the great value of limitation of responsibility as related to the working classes would not be so much to facilitate the investment of their savings, not so much to enable the poor to lend to the rich, as to enable the rich to lend to the poor”.28 Richard Cobden became active in promoting the idea that limited liability was the best means of allowing members of the working classes to set up in business for themselves. Cobden compared the existing company laws to the Navigation Acts and the Corn Laws which needed to be swept away to promote a free economy. Mill’s endorsement, however, of the principle of limited liability, was qualified. He agreed with Smith about its disadvantages, both on efficiency and moral grounds. However, he was much more aware than Smith of its positive advantages, particularly the benefits of professional management to the conduct of business.29 But Mill’s most important legacy for future debate on the company was his way of thinking about institutions. By focusing on the particular laws and customs of a society he showed how they could be subjected to rational appraisal and if necessary changed. The company does not have a single character given to it by the nature of ownership. Instead it is a bundle of rights, practices, and customs, which although linked can be disentangled and reformed separately.30 27 Ibid., at 118. See also his speech to Parliament in 1856 (at 134) when he was President of the Board of Trade. 28 Ibid., at 122. 29 John Stuart Mill, Principles of Political Economy (London, 1965), vols I–III. 30 An approach to the company later developed by Jim Tomlinson. See The Unequal Struggle? British Socialism and the Enterprise (London, 1982).

The Politics of the Company 33 Mill carefully analysed the advantages and disadvantages of the joint stock principle. He noted that many undertakings needed an amount of capital which was beyond the means of any but the richest individual or a sizeable private partnership. The only alternative to joint stock companies was government. There were many undertakings, particularly in transport and communications, which individuals could manage but not on the scale and with the continuity required for success. Joint stock companies were also likely to be transparent in their operations; losses were much harder to conceal than in private companies. Mill also, however, recognised many disadvantages in the joint stock principle. The first arose from administration of the affairs of the company by hired servants rather than by the owners themselves. Private firms, he argued, are better managed because individuals have a keener interest. In a joint stock firm the business is no-one’s principal concern except those who are hired to carry it on. For Mill there were two characteristics which a successful enterprise required: fidelity and zeal. Fidelity, Mill believed, could generally be secured, but zeal was much harder, because human beings were labour averse. He observed that neglect by domestic servants of their employer’s interests was practically universal except where long service or “reciprocal good offices” had produced either a personal attachment or some feeling of common interest. Mill thought likewise that the managers of a joint stock company would tend to disregard small gains and small savings, and would never have the incentive to introduce a truly economical system. Mental indolence would normally prove stronger than any inducements that were provided. Even so, Mill disagreed with Adam Smith that joint stock companies could never be expected to maintain themselves without the grant of an exclusive privilege. He believed they could, even if it was unlikely that they would ever be as efficient as individually owned firms.31 He came to believe, however, that the principle of limited liability had other justifications and that there was a public interest in pursuing it. Opponents of reform continued to use the arguments of the old individualist political economy, warning that if the principle of unlimited liability were to be relaxed the consequence would be an orgy of speculation, leading to a proliferation of unsound schemes which would eventually collapse, ruining all those who had invested in them. It would encourage fraud and destroy trust, separate ownership and control and undermine individual enterprise. But by the middle of the nineteenth century the combination of laissez-faire arguments and the campaign on behalf of small investors was sufficient to deliver change,32 and what was hailed as the Magna Carta of English company law was passed in a series of Acts between 1856 and 1862. What is apparent from the subsequent evolution of English company law, however, is that the laissez-faire faction in the coalition proved to have greater influence in shaping the constitution of the company than did the small investors 31

Mill, Principles of Political Economy, above n. 29, at 135–40. John Savile, “Sleeping Partners and Limited Liability”, (1955–56) 8 Economic History Review, Second Series, no 3, 418. 32

34 Andrew Gamble and Gavin Kelly and the working class. Robert Lowe, after he became President of the Board of Trade, enunciated the attitude which has been reflected in the way the British state has defined the public interest in relation to the company ever since. Having given companies a basic framework he argued, the state needed to leave them to manage their own affairs. It had no desire or business to force on “these little republics” any particular constitution or internal democracy.33 Although the huge legal privilege of limited liability had been granted, the exponents of laissez-faire were very unwilling that anything substantial should be conceded in return for it, in the shape of accountability, disclosure provisions or particular governance structures to ensure that companies acted in the public interest. Unlike Germany for example34 there was no attempt to entrench public interest provisions in the constitution of companies. They were still treated as private associations of property holders, which happened to have been granted public privileges. In this way the rights and legitimacy of individual property holders as owners of assets and employers of workers were transferred to the new legal personality of the company. The company became first and foremost a bearer of private property rights rather than the upholder of wider public responsibilities.

OWNERSHIP AND CONTROL

The corporate economy took time to develop and reveal its full potential, especially in England. In the last decades of the nineteenth century the rise of giant firms was much more marked in Germany and the USA. But the question of the economic power of these firms, who controlled them and who should control them, became key public interest issues in all countries. A basic divide came over the rights of shareholders and whether the public interest was best served if companies were run in the interests of shareholders rather than any other group. One argument was that the company should be treated as a little republic, a miniature political system in which all its members, the shareholders, have rights to representation, information, and ultimate decision-making through the annual general meeting. The shareholders are the company and the directors have to be accountable to them. But this simple model of shareholder power swiftly ran up against the problem that shareholders, unless they retain very large stakes, tend to become marginalised in the modern company, and the costs of exercising voice become too heavy. Limited liability makes possible large-scale enterprise and sites of economic power which are independent of the state, as well as high degrees of managerial autonomy. If the company is regarded as primarily a private association of property owners, a key public interest question is whether the rights of these property owners, the shareholders, are properly protected. This has been a persistent issue in 33 34

Hunt, The Development of the Business Corporation in England, above n. 19, at 135. See Shawn Donnelly, Chapter 4 below and Gregory Jackson, Chapter 11 below.

The Politics of the Company 35 the politics of the company in Britain, often to the exclusion of much else. After the passage of the nineteenth century reforms few still contested the joint stock principle, although there remained an unease about how the new companies would operate. Alfred Marshall willingly acknowledged the potential of the joint stock company and its marked superiority over other forms of business organisation, while drawing attention to some of the problems associated with it, particularly the danger that the shareholders would not have the time or energy to monitor the way in which the company was being run. He was optimistic however that the problem of fraud and wrongdoing by managers could be contained by “the progress of trade morality . . . aided in the future as it has been in the past, by a diminution of trade secrecy and by increased publicity in every form”. By this means “collective and democratic forms of business management may be able to extend themselves safely”.35 The issues raised by the extension of corporate organisation, however, were not confined to the relationships between shareholders and directors. One influential approach derived from Marx, who had followed Adam Smith in treating private ownership of the means of production, including labour, as central to understanding what made capitalism distinctive as an economic system. Marx regarded the rise of the joint stock company and the displacement of the individual independent owner as signalling a profound transformation in the way the economy was organised, and an expression of the increasingly social and collective character of the production process. It could no longer be owned and managed by individuals and families, but instead required cooperation on an ever-increasing scale. Marx expected that as production became more socialised it would come into conflict with individual titles of ownership to productive assets. The conflict could only be overcome by recognising the social character of production and transferring ownership rights to the whole community. Marx did not regard joint stock companies as socialist, rather he saw them as a stage towards the replacement of capitalism by socialism because they removed individual ownership of the means of production, and with it the conventional justification for individual appropriation and individual property rights.36 The joint stock company represented an institutional split between money capital and industrial capital. As the personification of industrial capital the company remained the agent of capital accumulation and subject to its imperatives, and therefore profoundly and unavoidably opposed to the interests of labour.37 This attitude to the capitalist corporation influenced generations of socialists in the twentieth century. The public interest required recognition that the company was not a private association but socialised property, which should be managed not by private and unaccountable individuals, but by professional managers appointed by the state. 35

Alfred Marshall, Principles of Economics (Cambridge, 1946), 304, 305. Karl Marx, Capital III (London, 1981), 567–72. 37 Paddy Ireland, “Corporate Governance, Stakeholding and the Company: Towards a Less Degenerate Capitalism”, (1996) 23 Journal of Law and Society 287. 36

36 Andrew Gamble and Gavin Kelly A different approach derived from Joseph Schumpeter. Like Marx he recognised the new stage of capitalist development that the extension of the corporate organisational form represented. The rise of the joint stock company was displacing the individual capitalist from control of the enterprise and creating a new corporate economy, dominated by vast corporate bureaucracies which blurred the sharp distinction between public and private property and made terms like capitalism redundant. The individual capitalist owner-managers had vanished, and it was a matter of indifference whether corporate property was publicly or privately owned. Schumpeter saw this shift as inevitable, if regrettable, and concentrated on highlighting some of the implications of the new order.38 He particularly emphasised the risks that attenuated forms of ownership posed for the legitimacy of the company: “Dematerialised, defunctionalised and absentee ownership does not impress and call forth moral allegiance as the vital form of ownership did. Eventually there will be nobody left who really cares to stand for it—nobody within and nobody without the precincts of the big concerns”.39 The decline of the owner-manager pushed the company increasingly into the public realm and raised new issues of accountability and the relationship of the company to the public interest. The boundaries between the public and the private had been decisively shifted. Individual ownership had lost its function and its rationale. State ownership was not inevitable, but Schumpeter thought it increasingly likely, unless some other way could be found of making legitimate the huge concentrations of corporate power which the joint stock principle facilitated. This approach has been particularly influential in defining the modern political debate on the company, supplanting the older conception of the shareholder republic. It received a classic statement in the analysis by Berle and Means of how the family-owned entrepreneurial firm had been displaced by the modern managerial firm, and ownership and control separated.40 Berle and Means focused attention on the constitution of the modern company, in which issues of representativeness and accountability come to the fore. If ownership and control are separated does this make companies less efficient? And if it does what type of corporate governance arrangements can overcome or mitigate it? It was the old problem recognised by Adam Smith and John Stuart Mill. If the shareholders were still regarded as in some sense the owners of the enterprise but became separated from the directors and managers who actually ran the company, how could the owners ensure that the company was being run in their interests, and how should the rights and responsibilities of each group be defined?41 The legal changes in the second half of the nineteenth century had 38

Joseph Schumpeter, Capitalism, Socialism and Democracy (London, 1949). Ibid., at 142. 40 Berle and Means, The Modern Corporation and Private Property, above n. 15. The concept of the separation of ownership and control has, however, been strongly criticised. See, e.g., Tomlinson, The Unequal Struggle, above n. 30, and Paddy Ireland, “Capitalism Without the Capitalist”, above n. 19. 41 Louis Putterman and Randall S Kroszner (eds), The Economic Nature of the Firm (Cambridge, 1996); Robert Monks and Nell Minow, Corporate Governance (Oxford, 1995). 39

The Politics of the Company 37 made possible the rise of the corporate economy in the twentieth,42 but there were significant divergences in the form of the company in different countries. Power was distributed differently between managers, shareholders and directors, and there were as a result marked variations both in the degree to which ownership was dispersed, and in the extent to which companies acknowledged obligations to stakeholders other than shareholders. In Britain, despite the attachment to the idea of shareholder democracy, the triumph of the laissez-faire principle severely limited the development of an active shareholder democracy in practice, while the UK financial system, by helping to prevent the kind of concentrated share ownership seen elsewhere,43 also encouraged a fragmentation of ownership, and a dispersal of shareholdings, which afforded a large measure of autonomy to the new class of managers in running the corporate economy. They based their legitimacy on the claim that the company was a private association. What is remarkable in the British case is the absence of any significant political challenge to this political outcome as the corporate economy developed. One reason for this, as already discussed, was that laissez-faire principles triumphed over individualist, libertarian principles in British political economy in the last decades of the nineteenth century. Laissez-faire arguments were not based on individual rights and were often employed to sanction noninterference with existing economic interests, and in particular were used to justify and underpin the emerging corporate economy. The traditional property rights doctrine was employed to legitimate the new forms of corporate property, which came to be seen as in principle no different from individual ownermanaged assets. This allowed corporate property to be treated as a private association, which should have the minimum of government regulation and interference, despite the legal privilege of incorporation having been granted. The doctrine of shareholder value is a much later crystallisation of this view of the company. The individual private owners are the people in whose name the managers of the company act and whose interest they have a fiduciary duty to serve, but this interest is defined very narrowly in terms of maximising the financial returns on shareholders’ investments, and in practice because of the difficulties of exercising voice by shareholders, managers enjoy significant autonomy.44 In the absence of a strong shareholder democracy or concentrated shareholding in Britain to hold managers to account, the emergence of an effective market for corporate control was ultimately to become the principal mechanism to 42

L Hannah, The Rise of the Corporate Economy (London, 1983). Although some recent research has shown that banks have exercised supervisory and monitoring functions over some British companies more than is sometimes thought. See S Bowden, “Corporate Governance in a Political Climate: The City, Government and British Leyland Motor Corporation”, Journal of Industrial History (forthcoming, April 2001), and “Corporate Governance, Ownership Rights and Responsibilities” (Sheffield, mimeo, 1999). 44 See Thorstein Veblen, Absentee Ownership and Business Enterprise in Recent Times (New York, 1923). 43

38 Andrew Gamble and Gavin Kelly ensure that the divergence between the interests of managers and the interests of shareholders did not become too extreme. But it took a very long time to develop, and needed the spur provided by the monopolies and mergers legislation in 1948. An effective market for corporate control permits hostile as well as voluntary take-overs. If managers underperform, the assets under their charge become underpriced, and this opens the way for a corporate raider to make a bid for the firm by offering existing shareholders substantially more than the existing value of their shares. Contemporary advocates of laissez-faire towards the company see an active market for corporate control as a better guarantor of shareholder interests than assigning shareholders strong political rights over the board,45 because it gives all shareholders the option of exit if the shares become underpriced, while the exercise of shareholder rights relies on the option of voice, which however can only be effective if the collective action problem in getting sufficient shareholders to mobilise and turn up to vote can be overcome.46

POLITICAL PARTIES AND THE COMPANY

Another reason why the politics of the public interest in relation to the company in Britain treated the company as a private association stemmed from the attitudes of the political parties. The Conservative Party, which was the dominant governing party in the United Kingdom for two-thirds of the twentieth century, accepted the assimilation of corporate property with private individual property, and became in practice a staunch defender of the corporate economy. It saw no need for a reform programme: the “Gladstonian company” remained as relevant to the late twentieth century as it was to the mid-nineteenth century. The Conservatives had traditionally been thought of as the party of property, championing the rights of property against state interference and against the claims of those without property. Originally the party of the land, the Conservatives in the nineteenth century were at times keener to protect the property rights of landowners than those of the new industrialists, occasionally sponsoring legislation such as the Factory Acts in the 1840s to curtail the freedom of industrialists to run their companies as they chose. Old property and new property, however, found more that united than divided them when threatened by the rise of democracy and the Labour movement and the growth of collectivist legislation. Conservatives came to treat property and its defence as one of the cornerstones of their politics and of the constitution. Conservatives played a leading role in the Property Defence League and other anti-socialist pressure groups and organisations at the turn of the century which attempted to stem the rise of the Labour movement and the 45 See Elaine Sternberg, “Stakeholder Theory Exposed”, (1996) 2(1) Corporate Governance Quarterly 4. 46 Albert Hirschman, Exit, Voice and Loyalty (Cambridge, Mass, 1970).

The Politics of the Company 39 tide of collectivist opinion. Their instinct was to resist legislation which encroached on the sphere of private property and the rights of owners. In the period before 1914 Conservatives tended to treat the company primarily as a form of private property, in which the rights of the owner were paramount. Their ideal remained the family/entrepreneurial firm, in which one individual owned and managed the company and commanded authority over his employees. Conservative views of the company were more influenced by a traditional view of social order than by free market ideas. Owners were masters who were owed obedience. The importance of authority within the company as a bulwark of authority within the wider society was what Conservatives emphasised. The joint stock company threatened this world of masters and men, by substituting impersonal authority for personal command and obligation. It also represented a move from individualism to collectivism. A V Dicey reiterated the point of view of the opponents of limited liability, arguing that the joint stock company, although promoted by Liberals, was a profoundly illiberal institution because it had “shaken that confidence in the omnipotence of individual effort and self-help which was the very essence of the liberalism that ruled England during the existence of the middle class Parliament created by the first Reform Act . . . One trade after another has passed from the management of private persons into the hands of corporate bodies created by the State”.47 Dicey believed that the tendency of this legislation was to diminish the importance of individual action and to justify arguments for a much more extensive state intervention in business, because it “accustomed the public to constant interference, for the real or supposed benefit of the country, with the property rights of private persons”.48 Despite this attachment to the owner-manager ideal another strand of thought developed in the Conservative Party in the twentieth century as the new corporate economy became more firmly established. The joint stock company came to be treated as an extension of the family/entrepreneurial firm which allowed the defence of managerial prerogatives to be assimilated into the overall defence of the rights of property.49 An increasing number of Conservatives in the twentieth century also recognised the significance of the managerial revolution and the rise of the joint stock company. They became advocates within the Party of the new managerial doctrines of inclusion and partnership. These were seen quite consciously as a way of meeting the legitimate concerns of organised labour about the way in which companies were run. Accepting that companies were public institutions which should be run in the interests of employees as well as shareholders, and that it was a duty of management to ensure this, was increasingly seen as a way of restoring legitimacy to property rights. These Conservatives accepted the obsolescence in practice of the old conception 47 A V Dicey, Lectures on the Relation between Law and Public Opinion in England during the Nineteenth Century (London,1926), 245. 48 Ibid., at 246. 49 Nigel Harris, Competition and the Corporate Society (London, 1972).

40 Andrew Gamble and Gavin Kelly of ownership and the firm and the need to put industrial relations on a new basis.50 An early example of this thinking can be seen in Industry and the State, written by a group of Conservatives in the 1920s, among them Robert Boothby, Harold Macmillan, and Oliver Stanley. They argued that “the real demand of the working classes today is not for the collective ownership of industry by the State but for a workable system by which industry shall be carried on with due regard to the interests and wishes of those engaged in it, whether as shareholders, managers or workers”.51 In discussing the organisation of the joint stock company they recognised the distinctive relationship which existed between directors and shareholders, which they likened to that between government and electorate. The legal control of a trading company rests in the hands of those who supply a particular form of the capital—the ordinary shares. Managers, they argued, carried out a similar function to civil servants, with the directors acting as ministers. The real problem however was labour: “the problem of the economic status of labour can in the long run only be solved by an association of labour with the government of the business—not in ordinary executive and commercial management, but in the larger sense by a share in the decisions of general policy and the creation of a feeling of real community of interest between the various parties in industry”.52 They also explored ideas of co-partnership and the need to spread ownership, acknowledging that a fundamental change was taking place in the organisation of the business unit. Personal management where ownership and management are one interest was, they concluded, largely disappearing. They accepted the argument of Berle and Means that the dispersion of shares had separated ownership from management. The beneficial side of this was that it allowed the wage-earner to become an owner of capital which would potentially heal the rift between capital and labour, but they remained nostalgic also about the disappearance of the owner-manager. A great deal had been lost. The older direct and traditional relationship between master and man was the “time-honoured organisation of society”. They were realistic enough, however, to recognise that the change could not be reversed. The managers of the modern joint stock companies were trustees not owners. They were trustees for shareholders, wage-earners and the general public. The great industrialists—the captains of industry—were not just private individuals or representatives of shareholders. They held great positions of national trust. The public corporation signalled a new era in economic life, in which production was increasingly for use rather than profit: “even in the case of strictly competitive enterprises, the growing dissociation of ownership and management is gradually leading to new and wider conception of the duties and 50 51 52

Andrew Gamble, The Conservative Nation (London, 1974). R Boothby, Industry and the State (London, 1927), 150. Ibid., at 152.

The Politics of the Company 41 responsibilities of each of the component parts of any industrial concern”.53 This One Nation Conservatism was developed by Macmillan in later books such as The Middle Way54 and became influential in the thinking of the party leadership after 1945 when the Party was adjusting to the expansion of the welfare state and the increased scope and responsibilities of government. But the Conservatives have not initiated major changes in company law and regulation. Instead they have supported self-regulation of companies, and the gradual emergence of new corporate cultures, such as that represented by Tomorrow’s Company.55 They have been content to trust managers to do the right thing and to run their companies in the right way. It was left to other parties to propose reforms. But while the Liberal Party did become interested in many aspects of corporate organisation and produced many new ideas on employee share ownership, profit-sharing and industrial democracy,56 the Liberals were a minority third party force after the 1920s and for most of the time had no influence on government. Perhaps most importantly of all the Labour Party, which might have been expected to push through corporate law reform, always gave it a low priority and achieved relatively little.57 It favoured securing its conception of the public interest either directly through public ownership, or through a mixture of external regulation, legislation on monopolies and mergers, and legal support for trade unionism. It had much less enthusiasm for changing the constitutional structure of companies by transforming them into public bodies, although these ideas and the German example were much discussed.58 Its three major opportunities for change in 1945–51, 1964–70, and 1974–79 were all missed although for different reasons. There was partial implementation of the recommendations of the 1945 Cohen Committee and of the 1962 Jenkins Committee. But no major reform of corporate governance or the internal structure of companies was attempted. In the 1964–70 Government there were wide-ranging discussions held within the Department of Economic Affairs, but these ultimately came to nought.59 One of the chief reasons for the lack of interest in the Labour movement was the strong commitment to the voluntarist tradition in industrial relations, which meant maintaining the ability of trade unions to bargain freely, treating them as private voluntary associations with some legal immunities from the provisions 53

Ibid., at 158. Harold Macmillan, The Middle Way (London, 1936). 55 See E Monkhouse and T Clarke (eds), Rethinking the Company (London, 1994). For an earlier view see Goyder, The Just Enterprise, above n. 14. 56 The classic document was the Yellow Book published in 1928. See for a general overview of Liberal Party economic thinking Andrew Gamble, “Liberals and the Economy” in V Bogdanor (ed), Liberal Party Politics (Oxford, 1983). 57 This is explored in Ben Clift, Andrew Gamble and Michael Harris, Chapter 3 below. See also Ben Clift, The Labour Movement and Company Law Reform 1918–45 (Sheffield, 1999). 58 See Clift et al., Chapter 3 below. Typical of the attitudes of the reform wing of the party are comments by Tony Crosland on company law. He rehearsed all the reasons for change, but then wondered if it was worth the effort. See A Crosland, The Conservative Enemy (London, 1962). 59 See Sue Bowden, Chapter 8 below. 54

42 Andrew Gamble and Gavin Kelly of the common law, counterbalancing the treatment of companies as in effect private voluntary associations.60 Underlying this view of industrial relations was an adversarial conception of the company which assumed that there was a fundamental and unresolvable conflict of interest between labour and capital. The main departure from this tradition was the pressure which built up in the Labour movement in the 1960s and 1970s for greater industrial democracy and which led to a commitment in the 1974 manifesto and the subsequent appointment of the Bullock Committee in 1976. The political strength of this committee was, however, undermined by the division of opinion within the British trade unions and the Labour Party as to the desirability of having worker directors on company boards.61 The employers’ organisations were implacably opposed.62

SHARES AND STAKES

The regulatory framework for companies in Britain has shown remarkably little change since it was set in place between 1844 and 1865.63 The main changes have concerned closer definition of the powers of the AGM and the conditions of audit, as well as the adoption of a mild regulatory regime to oversee monopolies and mergers policy. Within this framework the transformation of the British economy from an economy based on small scale individual enterprise to one dominated by large public companies proceeded. The essentials of the British system of company law have survived largely unscathed the challenge of the movement for industrial democracy, the rise of institutional investors, and concern over the social obligations of companies. The Thatcher Government elected in 1979 was committed to increasing competition but was not interested in reorganising the way in which companies were run. Starting from the late 1970s, however, there was a pronounced shift in mood, and a growing debate over the desirability of reforms in the legal framework for 60 K Wedderburn, “Companies and Employees: Common Law or Social Dimension?”, (1993) 109 LQR 220. 61 Colin Crouch, The Politics of Industrial Relations (London, 1979). 62 The debate on Bullock is explored in detail in Clift et al., Chapter 3 below and also in Michael Harris, The Labour Movement and Company Law Reform (Sheffield, 1999). There is an interesting contrast in historical development between Britain and the USA, the two supposed citadels of shareholder value. In the USA the rise of the corporate economy was politically contested much more than it was in Britain, and regulatory measures to break up trusts and to prevent concentrated share ownership of companies by financial institutions were introduced. Share ownership became as a result highly dispersed, but some commentators have argued that this was a direct result of the imposition of regulation (M Roe, Strong Managers and Weak Owners: the Political Roots of American Corporate Finance (Princeton ,1994) ). Although this prevented concentration of ownership it did not prevent concentration of production or the rise of the corporate economy. The invocation of shareholder value in this case as with Britain meant ceding a large degree of autonomy to managers, since if shareholdings are highly dispersed the collective action problems in making shareholder power a reality are formidable; the initiative tends to lie with the management, whatever the formal procedures may be. 63 J E Parkinson, Corporate Power and Responsibility (Oxford, 1993).

The Politics of the Company 43 companies. This has come to be known as the stakeholder debate.64 One central aspect of this debate focused on whether the notion of shareholder value ignored the claims of other stakeholders to be represented in the company; whether the scope of legal controls, such as directors duties, should be widened to include the interests of all stakeholders not just those of shareholders; and whether there were viable alternatives to the dominant model of shareholder value. It drew on models of good practice of corporate governance from within the UnitedKingdom, and the USA, as well as from European and Japanese models. Three particular trends contributed to this new mood. First, there were increasing anxieties about whether the market for corporate control in the Anglo-American model was operating in a way which not only punished weak and inefficient companies, but also penalised companies with long run growth potential, thereby contributing to a pervasive short-termism in attitudes towards investment in companies throughout the financial markets.65 Allied to this was the observation that German and Japanese companies were not only more successful in many sectors at sustaining long-term investment programmes; they were also more successful in using their human capital, through devices which rewarded loyalty and long-term commitment. Anglo-American companies by contrast were perceived as relying heavily on flexible labour markets and hire and fire policies for large parts of their workforce.66 Secondly, there was increasing pressure from the European Union. Once Britain joined the EU in 1973 the pressure for deeper integration and for harmonisation of many of the institutional features of the different national economies has become an important factor in domestic politics of Member States. Attempts to harmonise company legislation have been slow, and strongly resisted. Nevertheless the European Commission has sought to impose common standards for external regulation in areas such as environmental protection, as well as issuing several directives on company law, including a draft European Company statute.67 Britain has blocked further discussion of this, but the pressures for change introduced by recent developments such as moves to agree common accounting standards and negotiations to merge stock exchanges are mounting.68 Thirdly, support has developed for new forms of self-regulation. One of the consequences of the defeat of the Bullock proposals and the election of the 64 See Will Hutton, The Stakeholding Society (Cambridge, 1999) and The State We’re In (London, 1995); John Plender, A Stake in the Future: the Stakeholder Solution (London, 1997); Gavin Kelly, Dominic Kelly and Andrew Gamble (eds), Stakeholder Capitalism (London, 1997). 65 A Shleifer and R Vishny, “Breach of Trust in Hostile Take-overs”, in A Auerbach (ed), Corporate Takeovers, Causes and Consequences (Chicago, 1988). 66 The State We’re in and The Stakeholding Society, above n. 64. 67 E Berglof, “Reforming Corporate Governance: Redirecting the European Agenda”, (1997) Economic Policy 93. 68 See Shawn Donnelly et al., The Public Interest and the Company in Britain and Germany (London, 2000) for a fuller discussion.

44 Andrew Gamble and Gavin Kelly Thatcher Government was that it lifted the threat of government intervention from companies. At the same time many companies, adopting the language of stakeholding, sought to improve self-regulation of the corporate sector, partly in order to ward off any future plans for statutory regulation.69 The series of Codes of the 1990s—Cadbury, Greenbury, and Hampel, culminating in the Combined Code—was the main fruit of this activity.70 A number of positions in this debate can be identified. The first position is the defence of property rights, still strongly represented in the Conservative Party, Centre-Right think tanks, and elements of the financial press. It expresses a laissez-faire attitude to the company, arguing that there is nothing wrong with the traditional British view of the company, and that the stakeholding agenda would destroy the clear objectives which the concept of shareholder value provides for the managers of a company. If current legal arrangements are amended in any way to take into account interests other than those of shareholders, there will be potential confusion between objectives. The entrenchment of an unambiguous position of the exclusive rights of shareholders to control the company is the primary concern. The gulf between shareholders as principals and managers as agents is not held to be large, and where discrepancies do emerge, they are corrected through the market for corporate control. This view maintains that companies are still best understood as private associations, freely contracting with their employees, their customers, their suppliers and their bankers. So long as the state enforces competition the public interest will be secured simply by each company seeking to maximise the returns to its shareholders, because to achieve that each company will have to search out new ways to cut costs and improve service.71 Any interference by the government or any external interest in the way in which the company is run is judged illegitimate as well as threatening economic efficiency.72 In modern versions of this doctrine the fiduciary duty of directors to maximise shareholder value is regarded as a contractual matter, which depends on shareholders bearing the residual risks of the enterprise. The exclusive rights of shareholders here flows from an efficiency rather than from a moral imperative. But the result is much the same. Shareholders alone have a right to choose directors and to receive information which enables them to monitor their performance.73 A second position in the debate is enlightened managerialism, espoused particularly by those companies which have endorsed voluntary codes to improve 69 The corporate use of the term was pioneered by the Stanford Research Institute, in particular Robert F Stewart and Otis J Benepe, and by the Swedish management theorist Eric Rhenman. 70 J Parkinson and G Kelly, “The Combined Code on Corporate Governance”, (1999) 70 Political Quarterly 101. 71 D Willetts, “The Poverty of Stakeholding” in Kelly, Kelly and Gamble, Stakeholder Capitalism, above n. 64. 72 F Hayek, “The Corporation in a Democratic Society: In Whose Interest Ought It and Will It Be Run?” in H Ansoff (ed), Business Strategy (Harmondsworth, 1969), reprinted from Hayek, Studies in Philosophy, Politics and Economics (London, 1967), ch 22. 73 Easterbrook and Fischel, The Economic Structure of Corporate Law, above n. 3.

The Politics of the Company 45 self-regulation by companies. The language of stakeholding was adopted quite early by such companies to describe their approach, which recognised that companies had wider public obligations and could not be considered simply as private associations. These wider public obligations were defined through the claims of different stakeholders in the company—including employees, suppliers, creditors, customers, shareholders, and local communities. Directors and managers were regarded as trustees for the interests of these groups. The Codes were drawn up to promulgate good practice for corporate governance. The Cadbury Committee was the first, the most wide-ranging, and the most relevant to this view. It was followed by the Greenbury Committee which focused on executive remuneration, and the Hampel Committee on corporate governance.74 The Codes have been criticised for offering little more than an enlightened shareholder value perspective and for being a smokescreen for the continuation of unchecked managerial power.75 The resistance to statutory regulation by the large companies, and the relative weakness of the trade unions since the 1980s, does mean that the Codes are entirely voluntary, although most of the largest companies do seek to comply, at least in their mission statements, and the London Stock Exchange in its listing requirements after 1992 obliged Companies to state how they applied the Code’s principles.76 Enlightened managerialism believes that companies are best run by their executive boards and professional managers, and while they accept that there should be proper procedures for accountability, the long-run health of the business is best secured if managers are given sufficient autonomy and flexibility to manage the business.77 Seeing managers as trustees ensures that their duty is to serve all stakeholders rather than just shareholders. Their role becomes balancing the different claims on the company and making sure all stakeholders are taken into account and that the company acts in accordance with the public interest, but without the formal constraints which the German supervisory board and works council would impose. 78 A third position—active shareholders—gives primary attention to shareholder rights, but differs from the laissez-faire property rights position by seeing an important role for government in helping to make the company once again a republic of shareholders. Greater shareholder democracy and greater accountability of companies to their shareholders require government action to ensure that shareholders get more information and that the law is changed to 74 Cadbury, Report of the Committee on the Financial Aspects of Corporate Governance (London, 1992); Greenbury, Directors’ Remuneration: Report of A Study Group (London, 1995); Hampel, Committee on Corporate Governance: Final Report (London, 1998); The Combined Code: Principles of Good Governance and Code of Best Practice (London, 1998). See Parkinson and Kelly, “The Combined Code on Corporate Governance”, above n. 70, for a review. 75 Ireland, “Corporate Governance, Stakeholding and the Company”, above n. 37. 76 One of the tasks of the Company Law Review set up by the Labour Government in 1998 is to recommend who should take responsibility for monitoring the Combined Code in future. 77 John Kay, “The Stakeholder Corporation” in Kelly et al., Stakeholder Capitalism, above n. 64. 78 CBI, Boards Without Tiers: A CBI Contribution to the Debate (London, 1996).

46 Andrew Gamble and Gavin Kelly make it easier for them to hold directors accountable for their actions. The emphasis is on finding ways to increase disclosure in order to empower shareholders. Another role for government is to help spread ownership more widely by encouraging more individuals to hold shares; through schemes for employee share ownership (such as Employees Share Ownership Plans, ESOPs),79 and by changing the governance arrangements for pensions funds—altering the provisions of trustee law to make the benefactors of the funds feel more like owners.80 The aim of spreading ownership so that every citizen becomes a shareholder has been widely advocated across the political spectrum.81 Conservatives were especially keen on the opportunities presented by the big privatisation flotations of the 1980s to sell shares to many people who had not held shares individually before. The number of individual shareholders came to exceed the number of trade unionists. But many individuals did not hold on to their shares, and a wider share-owning culture proved hard to establish. Conservatives have also been attracted to ESOPs. These have been a considerable success in the USA but have had a much more limited application in the United Kingdom. On the Left there has been particular interest in pension funds and the enormous financial power which they now exercise in the UK market.82 Their existence means that most workers are indirectly owners of shares, but the pension funds tend to be even less accountable than the companies in which they invest. Stronger shareholder rights have also been advocated as part of a wider campaign to make companies more accountable both to their shareholders and to non-shareholder groups. It is argued that there is no necessary contradiction in trying to protect the rights of both groups simultaneously, for example by backing measures to improve the flow of information to shareholders so that they can act more effectively in monitoring company performance, as well as supporting the establishment of works councils. Shareholder adviser groups like PIRC83 monitor company performance and act as advisers and representatives for large institutional shareholders. In the USA large public pension funds such as CalPers84 have made a considerable impact on the way companies are run. Such activities reflect the growing importance of pension funds and other large financial companies in the ownership of shares, as well as pointing to the opportunities for organisations of small shareholders to become more active in holding managers to account. What these groups seek politically is new legislation which will enforce greater transparency and make the task of monitoring companies easier, and the dominance of shareholder meetings by executive boards harder. 79 Andrew Pendleton, “Stakeholders as Shareholders: the Role of Employee Share Ownership” in Kelly et al., Stakeholder Capitalism, above n. 64. 80 John Plender, A Stake in the Future: the Stakeholder Solution, above n. 64. 81 Jeff Gates, The Ownership Solution (London, 1998). 82 Robin Blackburn, “The New Collectivism: Pension Reform, Grey Capitalism and Complex Socialism”, (1999) 233 New Left Review (January/February) 3. 83 Pensions Investment Research Consultants (www.pirc.co.uk). 84 Californian Public Employees’ Retirement System (www.calpers.ca.gov).

The Politics of the Company 47 A fourth position—active stakeholders—treats shareholders as only one of the stakeholders in the company, not as the sole stakeholder, but it differs from enlightened managerialism in arguing for real empowerment of the other stakeholders, rather than trusting managers to be enlightened. Advocates of this position draw on pluralist models of the company and experience in other countries, particularly Germany, to argue that there needs to be a fundamental reform of the constitution of the British company. Reforms that have been suggested include changing directors duties to give directors a legal responsibility to manage the company in the interests of all stakeholders; and the creation of a twotier board structure, to create a supervisory board like the German Aufsichtsrat on which all stakeholders would be represented.85 Constitutional models of the company treat the company as a public association constituted through political and legal means.86 More recently they have drawn upon the developing pluralist literature on the company,87 which although it takes seriously the argument that the governance of the company should be rooted in ownership rights, disputes that such rights should be exclusively concentrated in the hands of shareholders. Instead it argues that other groups, particularly employees, make firm specific investments and incur risks in the way in which shareholders do, and therefore need to be represented in the governance of the company if efficiency is to be maximised.88 The legal framework needs to acknowledge the pluralistic structure of the modern company in order to make the company both more efficient and more legitimate.89

CONCLUSION

Politics has shaped the company in Britain in distinctive ways as it has in every other country. The public interest in relation to the company has never been finally settled, and is still evolving. This chapter has focused on how the legal foundations of the company were put in place in the nineteenth century and how 85 See John Parkinson, Chapter 10 below, for a discussion of reform proposals; also Hutton, The State We’re In, above n. 64. 86 R A Dahl, A Preface to Economic Democracy (Cambridge, 1985). 87 Margaret Blair argues that the objective of maximising the wealth potential of the enterprise should replace profit maximisation as the criterion by which corporate performance should be judged: M Blair, Ownership and Control: Rethinking Corporate Governance for the Twenty-First Century (Washington, 1995); J Kay and A Silberston, “Corporate Governance”, (1995) National Institute Economic Review 84. 88 Gavin Kelly and John Parkinson, Chapter 6 below and Parkinson, “Evolution and Policy in Company Law”, above n. 85, which discusses the view taken on these issues by the Company Law Review established by the Labour Government in 1998. 89 The TUC, which in contrast to some of the positions it once held about voluntarism and noninterference by government, has become a strong advocate of moderate corporate pluralism, and of government intervention to provide a legal framework to govern both companies and industrial relations. See TUC, Your Stake at Work: TUC Proposals for a Stakeholding Economy (London, 1996).

48 Andrew Gamble and Gavin Kelly these reflected a particular political choice—a view of the company as a private association. Very different paths of development were followed in Germany, in the USA and in Japan.90 In each case the impact of constitutional and legal arrangements, political ideologies and political parties, and interest groups and coalitions were crucial in determining how the public interest was eventually defined and how it was then embodied in the arrangements for corporate governance and external regulation of the company. The British case shows also that although the development path created by the decisions taken in the mid-nineteenth century became deeply embedded in British institutions and attitudes, and was not seriously challenged during the twentieth century, there was still considerable debate on the nature of the company and the most appropriate legal framework for it, as well as growing awareness of practice in other countries. By the end of the twentieth century the old idea of the company as a private association was under increasing pressure. The growth in external regulation of the company and the acknowledgement of its wider public responsibilities meant that the public character of the company was increasingly recognised, not least by the employers’ organisation and by leading companies themselves, even if there was still powerful resistance to this being incorporated in legislation. Another key shift has been the overhaul of the legislation on monopolies and mergers, resulting in the creation of the new Competition Commission, and the abandonment of the traditional UK informal and gradualist policy.91 The legal framework in the United Kingdom is being changed quite radically now in a number of areas, in part in response to a climate created by membership of the EU, which is encouraging a move away from the traditional forms of self-regulation and their style of “negotiated compliance” still so prevalent in Britain to stricter enforcement of performance standards and to the acceptance of the idea of a regulatory state long accepted in the rest of Europe.92 How far these changes will go is uncertain. The process is a political one. There remains great opposition to the development of a comprehensive regulatory regime for the company, and considerable efforts are being made to redefine the company in ways that maintain it as a private association,93 and to encourage other jurisdictions to follow suit. Conceptions of the public interest will continue to be contested and will continue to develop. As the boundaries 90 For Germany see Shawn Donnelly, Chapter 4 below and Jackson , “Comparative Corporate Governance”, above n. 34. For the USA see Roe, Strong Managers and Weak Owners, above n. 5; for Japan see Ronald Dore, Stock Market Capitalism: Welfare Capitalism: Japan and German versus the Anglo-Saxons (Oxford, 2000). See also David Coates, Models of Capitalism (Cambridge, 2000). 91 Stephen Wilks, In the Public Interest: Competition Policy and the Monopolies and Mergers Commission (Manchester, 1999). 92 Wyn Grant, The Political Economy of Industrial Policy (London, 1982); Martin Loughlin and Colin Scott, “The Regulatory State” in P Dunleavy et al. (eds), Developments in British Politics (London, 1997), vol 5. See also Donnelly et al., The Public Interest and the Company in Britain and Germany, above n. 68. 93 See Paddy Ireland, Chapter 7 below.

The Politics of the Company 49 between national jurisdictions become more fluid, so the arena within which the public interest is defined will be forced to expand, and the politics of the company will become more complex. But there will still be choices to be made and ultimately it will be politics that will decide.

3 The Labour Party and the Company BEN CLIFT, ANDREW GAMBLE and MICHAEL HARRIS

T

HE MARKET AND the company are key institutions of modern capitalism, and as such have been central to social democratic programmes which seek to govern the capitalist economy in accordance with principles of social justice. In Britain, however, while the market has indeed always featured strongly in Labour Party thinking, there has been a curious neglect of the company. The dominance of large public companies in the British economy has become ever more marked in the last hundred years,1 yet in Britain the legal form of the company has rarely been a priority for legislation or the subject of political conflict. There have been numerous Company Acts, but most of these have concerned technical legal issues. Few broad issues of principle have been addressed through legislation since the middle of the nineteenth century. The creation of the modern corporate economy in Britain was highly political,2 and required some major legal changes which were fiercely fought. The foundations of modern company law were established in the middle of the nineteenth century, before the establishment of democracy and the rise of the labour movement. The legislation between 1844 and 1862 established the right of incorporation, the legal doctrines of limited liability and separate legal personality.3 The political question that the grant of these legal privileges raised both at the time and ever since is what legal obligations should be demanded in return?4 The new laws brought into being the public company with limited liability as a general organisational form through which business could be carried on. It raised new normative questions: what are the appropriate boundaries of the public company, to whom should those directing it be accountable, who should 1

Leslie Hannah, The Rise of the Corporate Economy (London, Methuen, 1983). See Andrew Gamble and Gavin Kelly, Chapter 2 above. More detail on the themes addressed in this chapter is provided in two PERC Research Papers: Ben Clift, The Labour Movement and Company Law Reform 1918–1945 (Sheffield, PERC, 1999) and Michael Harris, The Labour Movement and Company Law Reform 1945–1979 (Sheffield, PERC, 1999). 3 B C Hunt, The Development of the Business Corporation in England 1800–1867 (Cambridge, Mass, Harvard University Press, 1936). 4 As Kenneth Wedderburn put it in the 1960s: “The fundamental question should be: What are the modern conditions appropriate in our society on which private capital in a mixed economy can be allowed the privilege of incorporation with limited liability”: Company Law Reform (London, Fabian Society Tract 363, 1965), 19. 2

52 Ben Clift, Andrew Gamble and Michael Harris be counted as members of it, how should power be distributed within it, and what private and public purposes should it serve? These questions might have been expected to be priorities of the programme of the Labour movement in its bid to reform capitalism, leading to a major review and reform of company law in the course of the twentieth century. Yet despite forming governments eight times before 1997, and on two occasions with substantial majorities, Labour never made company law reform a substantial priority of its legislative programme and when it did legislate introduced only minor amendments to company law. The puzzle which this chapter addresses is therefore the relative absence of proposals from the Labour Party until the 1970s debate on industrial democracy for changing the framework within which the public company should operate, the social responsibilities it should assume, and the “public” functions it should execute.5 Why was there so little interest in Labour in constitutional conceptions of the company and the nature of corporate governance—the internal organisation of public companies and company boards, and the regulatory framework within which they operate? Labour made a very substantial impact on many different areas of policy, advancing public interest agendas and legitimating an active role for the state. Its programmes helped reshape Britain in the twentieth century. Yet in company law there is very little to report. One explanation is that after 1918 the party was committed to public ownership of the means of production, distribution and exchange. Nationalisation became the means by which public companies were to be subjected to the public interest. Company law reform was therefore unnecessary, because all public companies owned by shareholders would be taken over by the state. But although this position was deep-seated in the Labour Party, it was hardly a realistic one. It soon became clear that at best the commitment to nationalisation was a very long term one, and the Party accepted that in government for the foreseeable future it would have to manage an economy in which the majority of firms and enterprises were privately owned. The revisionist generation in the 1950s went further, rejecting any general commitment to extending public ownership, and accepting the reality of the mixed economy as the framework within which to pursue social justice.6 But this made the lack of interest of Labour in the public company still more peculiar. If the mixed economy was now the horizon of Labour ambitions, Labour could hardly ignore the importance of the public company as the dominant organisational form of that mixed economy. Yet until the Bullock Commission in the 1970s no major change to the legal form of the public company was ever seriously proposed, and the Bullock Report was 5 An exception to this were the substantial discussions in the 1964–70 Labour Government within the Department of Economic Affairs and the Industrial Reorganisation Corporation about the need for reforming corporate governance in order to improve economic efficiency. A wide-ranging examination of the principles on which corporate law was based was launched within government. But when the DEA was abolished the momentum for reform was lost. See Sue Bowden’s discussion of this episode in Chapter 8 below. 6 Anthony Crosland, The Future of Socialism (London, Cape, 1956).

The Labour Party and the Company 53 never converted into legislation. We are left with a paradox. The party of the Labour movement which was set up to defend and advance the interests of working people appears to have been uninterested in the legal form of the institution which controlled and shaped so much of their lives. As will be shown in this chapter, the Labour Party did not lack a tradition of writing about the public company which raised questions about its constitutional basis, the distribution of power within it, and its relation to the public interest. What was lacking was the political will to make reform of company law a priority for legislative programmes. On the Centre-Left as a whole there was a good deal of interest in alternative organisational forms, some of them canvassed in the writings of the Guild Socialists, others in the Liberal Yellow Book. There were also moments in the course of the century, particularly in the 1940s following the Cohen Commission, which were politically opportune for the reform of company law. But nothing was done. This chapter seeks to understand this neglect by exploring the main assumptions which have determined the way in which the company has been treated in Labour’s thinking. Most important of these has been an adversarial rather than a constitutional conception of the company. The adversarial conception treats the company as an arena of fundamentally opposed interests. It is especially concerned with ownership and a particular understanding of the private/public divide. The distribution of power is asymmetrical, favouring owners and managers at the expense of employees. The consequence is that the company is perceived as a battleground between the representatives of labour and the representatives of capital. Labour and its allies have to fight politically and industrially to impose laws that constrain what the owners of capital and their agents can do. The company is a unitary interest that can accommodate but not incorporate the interest of labour. The conflict can be managed, but can only be finally overcome by the abolition of private ownership of the means of production. The adversarial conception of the company goes very deep in Labour thinking. Even among revisionist currents which rejected the need to transfer ownership, and accepted that managers could act in the public good, elements of the adversarial conception remained, revealed in particular in the support still given to the principle of independent trade unions and free collective bargaining. Most did not do so, preferring to treat the public company as an institution that could be rendered benign through strengthening collective bargaining as a countervailing force to it, and by encouraging corporate executives to embrace a doctrine of social responsibility. For many British social democrats the public company remained peripheral to their main concerns and still is. Social justice was to be achieved at the macro level, through state programmes of redistribution, rather than through changing institutional frameworks. Seeing the company in adversarial rather than constitutional terms meant that British socialists and social democrats were generally not keen on company law reform, because if taken seriously it required rejection of the adversarial notions

54 Ben Clift, Andrew Gamble and Michael Harris of the company to which they were so attached. This chapter will argue that this is the real explanation for the neglect of company law reform, particularly in the 1920s, 1930s and 1940s. In the 1940s the report of the Cohen Committee and the first majority Labour Government provided an exceptional opportunity for reform, which was not taken. The faith in nationalisation as the solution to problems of ownership and control intersected with the desire to preserve trade union independence. By the 1960s there was a serious movement of opinion in favour of transforming the corporate governance of public companies and nationalised industries, which eventually bore fruit in the proposals on industrial democracy made by the Bullock Committee in 1977. But these proposals were never implemented, and one of the main reasons was the division over their merits within the ranks of the Labour movement itself.

LABOUR THINKING ON THE COMPANY

It is not true that there was no interest in a constitutional framework for the company. On the contrary, there were several key thinkers in the early Labour Party, including R H Tawney, Harold Laski, G D H Cole, and Sidney Webb who did explicitly discuss the institutional framework of industry and the nature of the public interest in relation to the company. Tawney in particular devoted much attention to the structures and mechanisms by which privately owned industrial capital, and forms of industrial organisation, could be reconciled to the public interest. He argued that the workers should “form part of the government of industry . . . [because] the cause [of industry’s problem] is the government of industry, which means the government of all who work in it, by agents of the shareholders for the pecuniary gain of shareholders”.7 One of Tawney’s key ideas was the need to relate property to function. He lamented “the disappearance of the idea that social institutions and economic activities were related to common ends, which gave them their significance and served as their criterion”.8 In its place the idea of the absolute nature of property rights had resisted “every attempt to impose obligations as a condition of the tenure of property or of the exercise of economic activity”.9 Industrial ownership and direction of industry were regarded as requiring no justification, because they were held to be “rights which stand by their own virtue, not functions to be judged by the success with which they contribute to a social purpose”.10 Tawney argued that all rights of industrial ownership were contingent upon their success in discharging a social purpose which might be revoked if the func7 8 9 10

R H Tawney, The Nationalisation of the Coal Industry (Labour Party, 1919), 29–30. R H Tawney, The Acquisitive Society (London, Collins, 1961 [1921]), 17. Ibid., at 26. Ibid., at 28.

The Labour Party and the Company 55 tions were not performed.11 Limited liability should therefore be conceived as a contingent privilege, granted to companies only in return for, and for so long as, they performed certain “social” functions. The weakness of the company legislation of the nineteenth century was that it had intensified the divorce of property from function.12 Reformers should consider the end for which economic activity is carried on, and then adapt economic organisation to it. The responsibility for organising industry should be placed “on the shoulders of those who work and use, not those who own”.13 What is interesting about Tawney in relation to the wider debate on companies is that he explicitly addressed the problem of the constitution of economic organisations. Forms of property for which no function is performed should be abolished.14 Industry should be conducted along the lines of a profession, with the aim of serving the public and should be subject to rigorous public supervision, with the responsibility for maintenance of service resting with all those by whom the work is carried out. Capital should carry no right either to residuary dividends or to the control of industry, and be obtained at the lowest possible cost.15 Tawney wanted companies in the private sector to assume public responsibilities. The development of company law in Britain in the nineteenth century was the major impediment to the success of reconciling the organisation of industry to the public interest: “Had the movement against control of production by property taken place before the rise of limited companies, in which ownership is separated from management, the transition to the organisation of industry as a profession might also have taken place, as the employers and workmen in the building trade propose that it should, by limiting the rights of private ownership without abolishing it”.16

Harold Laski agreed with many of Tawney’s ideas, particularly the linking of rights of ownership to performance of service,17 and limiting the rights of the owners of capital to control over the enterprise: “We can erect institutions upon which workers are represented for the governance of industry . . . we can transform the power of industrial capital from that in which it becomes a residuary legatee of the industrial process to one in which it receives a fixed remuneration determined by agreement for the service it contributes”.18

11

Ibid., at 29. Ibid., at 61–4. 13 Ibid., at 81. Applying this principle did not necessarily mean wholesale public ownership, because what was corrupting to the principle of industry was not private ownership as such, but private ownership divorced from work. 14 Ibid., at 88 and 83. 15 Ibid., at 96. 16 Ibid., at 109. 17 Harold Laski, The State in The New Social Order, Fabian Pamphlet no 200 (London, Fabian Society, 1922). 18 Harold Laski, The Grammar of Politics (London, Pichering & Chatto, 1996 [1925]), 113. 12

56 Ben Clift, Andrew Gamble and Michael Harris Laski also wanted to see industry reorganised as a profession, informed by a “principle of public service”.19 He advocated the removal of the “functionless” owner to change the character of the control of industry, with the “rules drawn up for its governance upon the basis of functions performed”. Laski, like Tawney, accepted a continuing role for the private sector, and advocated the introduction of a constitution “both in the socialised industries, and in the industries retained under private management”.20 This constitution should include provisions for maximum working hours, minimum rates of pay, “more democratic methods” of control in industry, and increased provisions for publicity regarding rates of profit and production. The overall aim was to “infuse the process of production with the sense of responsibility it now lacks. We can make the community as a whole a partner in that process”.21 Laski also identified the source of the problem as the nineteenth century company law framework: “Under the modern company laws, any body of men may secure capital from its owners, with no sufficient guarantee either of a genuine service to be rendered or of a possible return on the investment. The company may be dishonest in its operation or inefficient, without the public being able at any point to have knowledge. Its proceedings are wrapped in secrecy”.22

He set out a new set of principles for company law, aimed at changing the attitude of investors, by banning proxy voting, and instituting one vote per shareholder (regardless of size of holding). These changes were designed to “end the autocracy of the directorate. The shares would carry with them a limited and preferred rate of dividend like the preference share in the ordinary company”.23 Any surplus after the paying out of such dividends would, in Laski’s scheme, be distributed slightly differently, with one-third going to the total of investors, one-third going to labour and management, and the final third going to the public. Laski recommended a reorganisation of the board of directors, insisting that, “it is necessary to associate [labour and management] with the direction of industry. To that end, on any company’s Board of Directors, one-half of the seats should be reserved for the elected representatives of management and labour, in equal proportion. They should have equal power with the representatives of invested capital”.24 Laski also wanted reforms to accounting practice: “Public regulation of the company is essential. Every company must be compelled to keep its accounts in the prescribed manner . . . required to submit annually to central government a report upon its working, together with a full balance sheet which displays both its total assets and the total liabilities and does not serve as a screen for secret reserves 19 20 21 22 23 24

Harold Laski, The Grammar of Politics (London, Pichering & Chatto, 1996 [1925]), at 202. Ibid., at 204. Ibid., at 209. Ibid., at 477–8. Ibid., at 479. Ibid., at 481.

The Labour Party and the Company 57 . . . the government must retain at all times the right . . . to inspect the company, to audit its accounts and to measure its efficiency”.25

The end result would be to bring the operations of all public companies firmly within the public realm: “The life history of a company would be, in the nature of things, a public adventure. Its profits would be known; its costs would be published; its wages and salaries could be scrutinised as though they were the wages and salaries of a minister and his officials”. By these means would be instituted “ a system built upon the principle that the controlling factor in industry must be the will of the community and the standards imposed by that will”.26

Sydney Webb shared the same view that what counted was making private economic power subject to the public interest. In a speech in Parliament in 1928 on the Company Act he criticised the Greene Committee for not examining the general point of what the public interest required, but only devising amendments for company law which had been called for by various cases which had arisen under that law. The Committee declined to consider whether that law was framed in the public interest generally. He argued that “the House ought to consider before parting with the Bill how much publicity should be required of a company to which the privileges of limited liability and of a good deal of anonymity are given”.27 Webb agreed with Tawney that: “the whole object [of business] is service . . . there is no justification for business unless it promotes the public interest, or serves the public in some way or other. . .let public companies have just that amount of secrecy which can be justified on the ground that less of that secrecy would militate against the service rendered by the public company to the community”.

Profit, he thought, “is not a valid reason for secrecy and there is no public interest in profit. The public interest is in the service rendered by the company”. Many of these themes are also to be found in the writings of G D H Cole in the 1930s. He noted how states which for so long had obstructed the rise of joint stock enterprise now do all they can to help it.28 He also argued that while in theory the joint stock company is: “a polity in which all shareholders have a voice proportionate to their holdings, in practice it is nothing of the sort; for the main body of shareholders are far too scattered, too shifting, and too little acquainted with the working of the businesses in which their holdings lie to make any effective use of their nominal voting power”.29

25 26 27 28 29

Ibid. Ibid., at 481 and 484. This, and the following extracts are reported in Hansard, 21 February 1928, cols. 1514–1523. G D H Cole, Modern Theories of Industrial Organisation (London, Gollanz, 1932). Ibid., at 21–2.

58 Ben Clift, Andrew Gamble and Michael Harris The problem with this arrangement, Cole argued, in terms very similar to Berle and Means, was that: “the impotence of the main body of shareholders in such a company may in practice give the directors a free hand in the direction of policy, including the fixing of dividends, the allocation of sums to reserve, and the entire expenditure of the company’s available resources”.30

Cole charted the advancing concentration and consolidation of control through combines and cartels. Limited liability was a clear recognition by the state of the purely passive part which the ordinary investor now played.31 This provided an opportunity. Since the shareholder no longer controlled his or her investment, rights should be redefined in accordance with their changed status. Profits should be shared as of right by the administrators and labourers who do the actual work of industry, while shareholders should have only a fixed or limited claim.32 Cole compared British arrangements unfavourably with Germany. In Britain, he observed, large-scale capitalist combines had grown up “almost wholly apart from any element of public regulation or control such as exists in the German Reich”. He attributed this to the “strongly individualistic temper” of British industrialists and to their reluctance to “surrender their powers to the hands of any general regulating body”.33 He called for the control of joint stock company abuses to remain in the hands of the Board of Trade, but armed with larger powers under an amended Companies Act.34

COMPANY LAW REFORM IN THE 1920S AND 1930S

Despite this evidence, however, of constitutional thinking about the company in the writings of many leading Labour thinkers, reform of company law never figured highly on Labour’s agenda in the 1920s and 1930s. There was an overwhelming preference for socialisation as the solution to the problem of reconciling private economic power with the public interest. Even Hugh Dalton, one of the principal architects of Labour’s economic policy in the 1930s, who recognised that there was likely to be a private sector for a considerable time to come,35 had little to say on company law reform. He accepted the need for some share by the workers in the control of industry and rights to consultation,36 even advocating that this should be put on a statutory basis, but at the same time

30 31 32 33 34 35 36

G D H Cole, Modern Theories of Industrial Organisation (London, Gollanz, 1932), at 49. Ibid., at 27. Ibid., at 29. Ibid., at 77 and 81. G D H Cole, The Machinery of Socialist Planning (London, Hogarth Press, 1938), 31–2. Hugh Dalton, Practical Socialism for Britain (London, Routledge, 1935), 262. Ibid., at 161.

The Labour Party and the Company 59 argued that in the non-socialised sector these were questions to be decided primarily between trade unions and employers’ associations: “Parliament might, indeed, assist by requiring employers to constitute works councils, with defined minimum functions, and by enforcing greater publicity regarding costs and the results of trading. But it is clear that, within the framework of capitalist industry, workers’ control, though it can make substantial progress . . . is subject to strict limits. In socialised enterprises, on the other hand, these limit are shifted outwards”.37

The dominant Labour view, articulated forcibly by G D H Cole, was that the shortcomings of company organisation should be remedied by the transfer to public ownership of the vast majority of private enterprise. The actual management of such concerns would be entrusted to “salaried experts”. This would be different from the private sector, because whereas the Board of Directors issued orders in the shareholder’s interest, the board of a socialised concern would represent the interests of the public in general.38 Managers would be recruited no differently from under capitalism, but their responsibility would be not to a scattered group of private shareholders, but to Parliament and to the public as a whole.39 In Labour Party policy documents in the 1920s and 1930s, company law reform gets few mentions, apart from calls for greater disclosure of information. There is no attempt to constitutionalise the company. The overriding aim is to socialise it, and then to deal with the questions of accountability and participation in that framework. Although Tawney and Laski had key roles in drawing up Labour policy documents in 1927 and 1928 including Labour and the Nation40 there is no mention of their ideas for a new constitution for the company. In its place is a relatively crude dichotomy between “the conduct of industry as a public service, democratically owned and responsibly administered, and the private economic sovereignty of the combine, the syndicate and the trust. It is, in short, between public ownership and control and one form or another of industrial feudalism”.41 Proposals for the private sector, described as “those industries which continue to remain in the hands of private capitalists”, involve various forms of external regulation—price control, regulation of monopolies, and measures to ensure the greatest possible publicity as to costs and profits. In Parliament, when legislation on companies was debated, as in 1928, the Labour Party confined itself to calling for greater publicity in the way companies were run, a “full public audit” and more powers of inspection.42 During the 1930s the development of Labour Party economic policy was centred upon the Finance and Trade Committee (FTC), a standing policy 37

Ibid., at 161–2, emphasis added. G D H Cole, Modern Theories of Industrial Organisation, above n. 28, at 48. 39 Ibid., at 59. 40 David Reisman, in his introduction to the 1996 edition of A Grammar of Politics (London, Pickering & Chatto, 1996), xiii. 41 Labour and the Nation (London, Labour Party, 1928), 23–5. 42 Hansard 21 February 1928, cols. 1455–1462. 38

60 Ben Clift, Andrew Gamble and Michael Harris subcommittee of the NEC. It identified company law as one of eight policy areas for study,43 but within three weeks this had already disappeared from NEC minutes outlining the FTC’s duties.44 The surviving minutes of later meetings make no mention of company law.45 Similarly the minutes and papers of the Legal Advisory Panel, which was asked to consider company law at the first meeting of the FTC, make no mention of company law or the need for its reform. Dalton and the FTC proved to be much more interested in macro-economic questions such as aggregate levels of investment. The work of the FTC was brought together in a pamphlet entitled Currency, Banking and Finance, which became an important document of reference for Labour economic policy in the 1930s. Its emphasis is heavily macro-economic. The need for reform to methods of industrial finance are dealt with not through reform to the joint stock enterprise or the regulatory framework within which it operated, but rather through the creation of a National Investment Board.46 One of the few proposed Bills contained in the FTC archive, and dated 1939, concerns the creation of the NIB.47 No similar plans were ever drawn up for reforming company law.

THE COHEN COMMITTEE

During the 1930s the shortcomings of the Companies Act 1929 became increasingly apparent and the need for a major review of company law was increasingly recognised.48 By 1943, with Dalton installed as the President of the Board of Trade, circumstances were propitious. The main instigator of the review was a senior Board of Trade civil servant, Sir Edward Hodgson.49 Because of the war a full-scale inquiry was thought inappropriate, so Hodgson proposed “a more limited inquiry” into “whether the fundamental principles underlying the company law are consonant with modern needs”.50 Hodgson outlined the proposed direction of reform as follows: “the law should be strengthened to provide greater publicity in regard to the formation and affairs of a limited liability company and of better safeguards for investors and shareholders . . . The small investor, whose numbers are now legion, is virtually a sleeping partner with neither the wish nor the opportunity to undertake any of the manage43

FTC minutes, 26 February 1932. NEC minutes, March 1932. 45 FTC minutes, 29 April 1932. 46 Currency, Banking, and Finance (Labour Party, 1934). 47 FTC archive, “Labour Party Financial Policy, Number 6”, February 1939, 4. 48 Paul Bircher, “Company Law Reform and the Board of Trade, 1929–1943”, (1988) 18 Accounting and Business Research (no 70) 107. Impetus for reform came primarily from the accounting profession, from the likes of Henry Morgan, President of the Society of Incorporated Accountants and Auditors, and was resisted by officials at the Board of Trade throughout the 1930s. Thus no action was take in the 1930s. 49 Dalton to Viscount Simon, 6 May 1943, PRO Board of Trade Papers BT 58/356. 50 Ibid. 44

The Labour Party and the Company 61 ment responsibilities which underlie the present legal conception of a shareholder, and he therefore needs special protection. There has also been a growing claim that the interests of the community as distinct from those of shareholders should have more recognition in the formation and conduct of a corporation to which the considerable benefits of limited liability have been given, especially in those quasi-monopolistic companies whose activities at home and abroad so seriously affect the country’s welfare. It is suggested that what is wanted now is a broad inquiry into the basic principles underlying the company law, so that in the difficult years following the war we may be assured that we are building on a basis erected to modern needs. Detailed improvements can be left for consideration at greater leisure”.51

In this memo Hodgson clearly conceived limited liability as a privilege, and accepted that, as a quid pro quo for the granting of that privilege, certain “public interest” requirements might legitimately be imposed on private companies. A review of this kind would have provided a considerable opportunity for Labour to have pushed for a fundamental reform of company law, and the establishment of a new constitutional framework for the company. Hodgson’s initial position statement, however, did not hold. Dalton’s memorandum on the subject was considerably more cautious.52 He concluded: “I propose therefore to set up a small committee, under a strong independent chairman, to examine the principles of company law and to consider whether any major reforms are necessary to provide better safeguards for the investor, the shareholder and the public interest, and greater publicity in regard to the formation and affairs of a limited liability company; and, if so, to suggest what they should be, so that a measure may be prepared for introduction at the appropriate moment”.53

The Committee was set up with Lord Justice Cohen as Chairman. Civil servants tried to make the inquiry purely technical, proposing that MPs and trade unionists be excluded,54 but Dalton resisted this: “It all depends on who the MPs are! . . . I want a few knowledgeable laymen to lessen the expert grip . . . I must also ask Mr. Citrine to suggest a Trade Union leader. It would be a grave political error not to do so. A man on the commission, looking at the problem from a Trade Union angle, would be definitely helpful”.55

Advice was sought from a number of sources. In November 1943, some German lawyers56 submitted a series of documents on the financial relations between companies and directors, and the relations between holding and subsidiary companies. Their evidence went into some detail about two-tier board arrangements, managing and supervisory boards, and on the advantages of limiting the number of board members. On 7 July 1944, they gave oral evidence to 51 52 53 54 55 56

Ibid. Dalton, Draft Memo on Company Law, 23 February 1943, PRO 58/356. Ibid. Memo by G E Preston, 17 April 1943, PRO 58/356. Ibid. (These are Dalton’s hand-written notes on an internal memo.) Board of Trade Memorandum, PRO BT 146/5 (CL 56).

62 Ben Clift, Andrew Gamble and Michael Harris the Committee. The eventual recommendations of the Committee, however, at no point sought to advance a case for the institution of such a framework for British companies, and it was never part of Labour Party thinking. But this was the moment that a significant change of direction for the British company might have been proposed. The vast majority of evidence submitted to the Committee was of a technical nature, from accountants, auditors, lawyers, and stockbrokers, addressing particular shortcomings of the Companies Act. Despite the declared intention to deal with “fundamental principles underpinning” company law, few submissions addressed such wide issues. Bodies which could have been expected to, such as the Co-operative Movement, the Labour Research Department, and the TUC, did not. Thus there was no radical “pole” to shift the deliberations of the Committee on to a reformist track. The Labour movement bodies submitted evidence which did not differ greatly from that of the accountants, and focused mainly on the need for greater openness and publicity.57 The submission from the Economic Committee of the TUC was typical of the Labour movement response. It did not address the issues of legal requirements regarding the internal organisation of companies. No mention is made, for example, of works councils, or worker representatives on boards. The memorandum notes that: “The TUC is not so much concerned with the financial relationship between the companies and their directors and shareholders, as with the desirability of strengthening the provisions of the Companies Act, 1929, so as to elicit more comprehensive information than is at present the case with regard to the business affairs of undertakings enjoying limited liability. In putting forward that view the TUC have in mind their policy of encouraging good industrial relations based upon mutual confidence which can be achieved only by the disclosure of adequate information”.58

A series of recommendations was then presented regarding nominee shareholders, the withdrawal of concessions to “private” companies, disaggregated profit and loss accounting, tighter regulation of subsidiaries and the presentation of consolidated accounts, and increased Board of Trade powers of investigation. The one proposal contained in the TUC document not found in many of the other submissions calls for a “standing consultative committee” on company law, “to provide for the Board of Trade a continuous examination of the working of the Act in order that any amendments which may be required can be suggested and put into effect with the minimum delay”.59 Although the declared intention of the Committee was to examine the “fundamental principles” underpinning company law, there is no mention in the TUC document of the need to 57 Labour Research Department Memorandum of Evidence, PRO BT 146/5 (CL 141); Submission of the Parliamentary Committee of the Co-operative Congress to the C.L.A.C., 31 October 1944, PRO BT 146/5 (CL 169A); TUC Proposed Evidence for Submission to the C.L.A.C., 16 May 1944, BT 146/5 (CL 131). 58 TUC Proposed Evidence, ibid. 59 Ibid.

The Labour Party and the Company 63 ensure the representation of the public interest within companies, or for their more stringent regulation in the interests of the community. Despite the recognition in other TUC documents of the importance of Industrial Boards with representation of employees, their creation was not deemed a matter for legislation or legal obligation. The continental model whereby their creation is a constitutional requirement of incorporation was not entertained. The furthest the TUC Report goes is to assert that, “whilst recognising therefore that the industry must itself develop those forms of organisation which meet its needs, there seems no reason why the Government should not require the formation of an Industrial Board, after a full examination of the conditions prevailing in the industry”.60 In terms of explicit treatment of the private sector, there were only two paragraphs, which stated: “private undertakings must necessarily operate by reference to the interests of their owners. It is essential, however, that the operations of private industry as a whole should be subject to a control representative of the public interest; and in the framing of that control not only has the viewpoint of workpeople a special right to consideration, but such a control can be made fully effective only if it makes proper provision for participation by organisations representative of the workers in industry in its operation”.61

But the Report also added: “It will be essential . . . that the trade unions shall maintain their complete independence. They can hardly do so if they are compromised in regard to Board decisions which are not considered to be in their members’ interests by the fact of their representatives’ participation in them”.62 At no point therefore was company law, or the Cohen Committee, seen by the TUC as a key arena for pursuing its objectives of making companies subject to the public interest. Overall, trade union engagement with Cohen was halfhearted, and centred solely on accounting issues and the need for greater disclosure to improve the quality of information available to trade union negotiators in free collective bargaining.63 Issues of worker participation and changes in the internal organisation of companies, although of great concern to the TUC, were not considered in the context of company law reform. The Cohen Report (the Report of the Committee on Company Law Amendment) led to the Companies Acts of 1947 and 1948. Many of its proposals were enacted, for example on nominee shareholders, on the concealment of accounts by public companies using “private” subsidiary companies, on the use of the “hidden reserve” in company reports, on the liability of directors for making misleading statements and omissions in civil law. Companies were now to be compelled to give full disclosure of directors’ interests at board meetings and annual general meetings, and the position of shareholders against directors was 60

Ibid., at 18. Ibid., at 19. 62 Ibid., at 21. 63 This was also the overriding focus of a memorandum submitted by the General Federation of Trade Unions, PRO BT 146/5 (CL 53C, 1943). 61

64 Ben Clift, Andrew Gamble and Michael Harris strengthened: via longer notice for AGMs; single reelections for directors and their removability from office by ordinary resolutions; circulation with the annual report of intended resolutions from shareholders with 5 per cent or more of the votes (or one hundred shareholders holding more than £100 each); and the right to send proxies to attend meetings and speak on their behalf. Little of this interested the Labour Party. Company law reform was not referred to at Labour Conferences between 1943 and 1948 (the only mention of the subsequent 1948 Companies Act comes in the report of legislation introduced during that year’s parliamentary session). Much more attention was devoted to monopoly,64 which was linked to the broader question of why a socialist economic policy was needed. The opportunity to reform company law went unrecognised.

THE JENKINS COMMITTEE

The next major opportunity for company law reform was the Jenkins Committee, established at the end of 195965 in response to a number of scandals in the City of London.66 The TUC’s memorandum to the Committee, and their oral evidence, emphasised the importance of company disclosure in the “interests of the public at large” as well as the workers in a particular company and good industrial relations. There were too many exemptions to the filing of proper accounts. Companies had become increasingly complex in organisation and adept at avoiding proper levels of disclosure, and the TUC was not convinced that the full disclosure of nominee shareholdings would present “insurmountable” problems. There was a lack of “voice” for non-voting shareholders. Cohen had been concerned with this development, but the tendency of the average shareholder to show a diminishing interest in company affairs had not been rectified. The TUC “doubted” whether non-voting shares should be abolished, given that the popularity of unit trusts was an indication of the “small regard” which many investors paid to the importance of voting rights, and that if an investor wished to buy shares carrying less than full rights he should be allowed to do so. The key issue on this matter was thought to be whether it was ade64 e.g, C A R Crosland, “Legislating Against Monopoly”, Socialist Commentary (January 1951), 4–6, 12. 65 See Minutes of Evidence Taken Before the Company Law Committee (HMSO, 1961). 66 See, e.g., New Statesman, 26 September 1959, 1. The members of the Committee were: Lord Jenkins (Chairman), Frederick Althaus, Eric Bingen, Leslie Brown, Sir George Erskine, Professor Laurence Gower, William Lawson, James Lumsden, Kenneth Mackinnon QC, Margot Naylor, Gordon Richardson, Charles Scott, Ron Smith, and William Watson. Its specific remit was “to review and report upon the provisions and working of the Companies Act, 1948, the Prevention of Fraud (Investments) Act, 1958, except in so far as it relates to industrial and provident societies and building societies, and the Registration of Business Names Act, 1916, as amended; to consider in the light of modern conditions and practices, including the practice of take-over bids, what should be the duties of directors and the rights of shareholders; and generally to recommend what changes in the law are desirable”.

The Labour Party and the Company 65 quately clear; there should be a “duty of companies to describe clearly the nature and defects of non-voting shares” offered for sale (similarly the risks of unit trusts themselves). Further, it argued against political donations (and furthering political objectives) by companies. The TUC might have submitted much more given the remit of the Committee, especially in the areas of directors’ duties and the rights of shareholders, but as with Cohen they failed to do so. Both the Cohen and the Jenkins Committees ultimately produced very conservative reports, and did not fully examine, let alone propose, other more radical reform possibilities, on the basis that there was “no great demand” for them. Their emphasis was regulatory and reactive, responding to recent scandals and problems, rather than seeking to deal with new phenomena by going back to first principles, as company law reform in the nineteenth century had done.67 There were other perspectives. The New Statesman suggested at the time of the establishment of the Committee that “We have reached a point, in fact, where theory and practice have parted: practice can be forced to adapt itself to the old theory, though the result is bound to be unsatisfactory, but what we really need is a fresh theory of the company and of the rights of shareholders, directors, managers, workers and consumers”.68 When the Jenkins Committee Report appeared in 1962, there were in fact two minority reports as well as the majority report. The majority report did not support a change in company law on two important issues—non-voting shares and the exemption of banks from normal accounting requirements, but it did sanction no-par-value shares, took away the accounting exemption from shipping companies, and also recommended some improvements in company voting procedure, important improvements in company accounts (covering turnover, depreciation, and subsidiaries), and compulsory disclosure of ownership by people owning 10 per cent or more of a company’s shares. Even these innocuous recommendations, however, did not become law immediately. Parliament did not make the time. There was also a marked lack of interest in the Jenkins Committee at both the Labour Party Conference and the TUC Congress.69

INDUSTRIAL DEMOCRACY

In the 1970s company law reform did belatedly become a hot issue in the Labour movement by becoming linked with the question of industrial democracy. Fundamental issues were debated, and major legislative change was proposed. Yet in the end nothing was achieved. One major reason for this was the continuing importance of an adversarial conception of the company in Labour 67 See, e.g. L S Sealy, Company Law and Commercial Reality (London, Centre for Commercial Law Studies, Queen Mary College/Sweet and Maxwell, 1984). 68 “City Lights”, New Statesman, 7 November 1959, 639–40. 69 TUC Report (1960), 276–82.

66 Ben Clift, Andrew Gamble and Michael Harris thinking and the priority as a result still given to nationalisation and trade union independence. Many on the left advocated industrial democracy because they saw it as means of securing nationalisation by another and better route. Many who opposed it did so because they suspected it would undermine free collective bargaining. These two positions dovetailed neatly with the counterpart adversarial conceptions of the company in the Conservative Party. What they made very difficult was the articulation and pursuit of an alternative constitutional conception which accepted both the legitimacy of the public company and the need for its regulation in the public interest. Industrial democracy in all its forms (such as workers’ control, workers’ participation, co-partnership) had a long history in the British Labour movement, but it had always been controversial because it threatened to undermine the role of trade unions by blurring the line between workers and management. There was also disagreement as to whether industrial democracy should be confined to industries that were nationalised, or whether as in Germany it should be extended to public companies in the private sector as well. Those who wanted to see participation of workers in the management of companies tended to see merit in the German system of works councils and two-tier boards,70 while others saw all such constitutional arrangements as compromising the ability of trade unions to defend the interests of their members. In the 1930s there was sporadic interest in industrial democracy and workers’ control, particularly in relation to the question of the administration of nationalised industries. The TUC’s Economic Committee in its 1932 Report on Trade Unionism and the Control of Industry sought to “redefine the aims of the movement in connection with socialisation of industry in the light of modern conditions”.71 Its focus was primarily on the role that workers should play in the running of public corporations, but it also paid considerable attention to the role of workers’ control in private companies. The means of control included operation by government department, financial participation by government in private enterprise, regulation by the establishment of legislative standards governing such matters as prices and quality, as well as by compulsory publicity for accounts; and finally the establishment of supervisory bodies.72 The TUC Economic Committee was, however, reluctant to endorse proposals for statutory or “constitutional” worker representation on boards of directors along the lines suggested by Laski and others, even for nationalised companies.73 It favoured instead unions airing their views on consultative bodies below the boards. This position was reaffirmed in memorandums prepared in 1933.74 But this was by no means a universal position. The Committee acknowledged that within the movement there was a strong desire that, at least 70 71 72 73 74

Cole, Modern Theories of Industrial Organisation, above n. 38, at 67–8. TUC Congress Report (1932), 132. Ibid., at 135. Ibid., at 136. NEC Minutes, 22 March 1933.

The Labour Party and the Company 67 as far as nationalised industries were concerned, trade unions should be given an adequate place on the board of management responsible for the general control and direction of each industry or service.75 The explanation for the reluctance to endorse industrial democracy was due to deep-rooted ideas of trade union independence. A distinction was drawn between “day-to-day” and “general” management. While the TUC was keen for involvement in the latter, excessive collusion in the former would, it was felt, lead to unions becoming implicated in management decision-making processes which could compromise their rights to free collective bargaining. As the Labour Party’s Reorganisation of Industry subcommittee put it: “a considerable part of the activities of industrial managements at present is concerned with the settlement of wages, hours and all other working conditions that most nearly affect the worker day by day. These matters are at present adjusted by negotiation between employers and Trade Unions. In our view, this method must continue to apply in the case of socialised undertakings. The adjustment of wages and working conditions must be undertaken by direct negotiation between the Trade Union and the Managements of these concerns, and Trade Union rights, including the right to strike, must be fully maintained”.76

Yet there was always a powerful undercurrent of opinion that this was not enough. At the 1933 TUC Congress, an amendment was moved which stated that: “wage earners of all grades and occupations have a right, which ought to be acknowledged by law, to an effective share in the control and direction of the industries which their labour sustains . . . that this right should be exercised by adequate representation upon the Central Board of Management and other administrative bodies, such as Area Councils and Works Councils . . . as a statutory right, that 50% of the representation on Managerial Committees shall be accorded to workers’ nominees”.77

The amendment was not carried. Such views were denounced as a new form of co-partnership which would “lead to the destruction of trade union organisation . . . [because] once a scheme of co-partnership becomes operative, the elected or selected workers’ nominees who, in turn, reflect the spirit and intention of trade union organisation, are held exclusively responsible by those whom they represent for the conditions prevailing in that particular undertaking”.78 The issue of workers control, after a long period of relative quiescence, resurfaced in a major way in the 1960s. One spur for this was the state of industrial relations and how it might be remedied. Another was the dissatisfaction with the forms of consultation established for the industries nationalised by Labour in the 1940s. In 1965, for example, in a debate on the steel industry at the Labour Party Conference, Clive Jenkins, General Secretary of ASTMS, criticised the 75 76 77 78

Ibid. Ibid. TUC Report (1933), 370. Ibid., at 373.

68 Ben Clift, Andrew Gamble and Michael Harris new plans for nationalisation as based upon an “outdated, unsatisfactory and stultifying form of control which excludes both participation of the workers and adequate ministerial control”.79 Following this conference the Labour Party Research Department established a Working Party on Industrial Democracy,80 but most unions remained cool.81 The 1968 Labour Party Conference debated an NEC statement on “Industrial Democracy”. It supported a single channel of communication between workers’ representatives and management, as well as company disclosure, and sought to develop the “existing machinery” of industrial democracy rather than “new and complex (and perhaps alien) structures”. It urged legislation on disclosure (on manpower, remuneration, management structure, directors’ shareholdings, production and profit issues), but although this would necessarily demand a reform of company law there was no debate on more radical or fundamental alternatives for reform in private sector company legislation. Experiments in worker-directors were encouraged in the public sector, though it was argued that these should not stop worker representatives being involved “at every level in an industry”. It was introduced to Conference by Ian Mikardo for the NEC, who argued it was not a substitute for “proper, overall economic control and for the public ownership of the commanding heights”, nor “strong and effective trades unions”; neither did it consist of “so-called joint consultation” or “appointing a retired trade union official . . . to a board of directors on condition that he then cuts himself off from all accountability to, or even contact with, the men he is supposed to represent”.82 The statement received considerable union backing,83 with Jack Jones (TGWU) arguing that industrial democracy was “not some sort of academic theory, to be applied in the dim and distant future”, but a “natural extension of trade unionism” via a single channel of negotiation and consultation. But the idea remained controversial, and many traditionalists remained unconvinced. The classic traditionalist view was stated by Eric Hammond (General Secretary of the EETPU): “If workers representatives have control of an enterprise they will require, require properly, to take into consideration the views of a wide range of interests in the process of decision-making and such matters as rationalisation, re-deployment, as well as apportionment of profits. There are three different interests to be taken into account: the consumer, the shareholders and the workers. If workers’ representatives are involved too deeply in management and are performing the task of management properly they will inevitably be inhibited in their activities as trade unionists: in other words, if they act as managers they will no longer be acting as trade unionists. If, on the other hand, the work79

Labour Party Conference Report (1965), 252–6. Its members were: Jack Jones (chairman), Professor K Alexander, D Delay, G Goodman, Dr A Hart, J Hughes, W McCarthy, E Moonman (MP), W Simpson, C Smith, and Professor K Wedderburn. 81 See John Horner, Studies in Industrial Democracy (London, Gollancz, 1974). 82 Labour Party Conference Report (1968), 344–7, 154–61. 83 TUC Report (1968), 531–7. 80

The Labour Party and the Company 69 ers’ representatives on a board of management are in the minority, their position may be even worse. They will have no control over decision-making but due to their membership of the decision-making body they could be limited in the use of their countervailing force as trade unionists. Their involvement in the decision-making process would commit them in some degree to the decision arrived at, and their capabilities as workers’ representatives would suffer accordingly. As I have said, we do not object to a trade union official being on a board of management. The proviso must be, however, that he is not a representative of the workpeople in that industry”.

But the TUC’s position was changing, and this was demonstrated by its submissions to the Donovan Commission in 1967. It proposed discretionary legislation which would allow experiments in workers’ participation by the removal of the legal inhibitions to representatives on boards. The majority report of the Donovan Commission, however, rejected the proposal for trade union representatives on company boards on the grounds of possible conflicts of interest which could arise for worker directors. They argued that it would be difficult to define the personal responsibilities of worker directors for the conduct of a company’s affairs, and their appointment might be a pretext for avoiding reform of collective bargaining, and because the appointment of a small number of them would not “change the real share in control of the majority of workpeople”. Five members of the Commission disagreed. They did not think that company boards could be made free of the pressures of special interest groups, and workers had little protection against them via collective bargaining machinery. Lord Collison, Professor Kahn-Freund, and George Woodcock thought that the point concerning legal responsibility could be met by appropriate legislation, and that progress could be made by voluntary agreement between unions and individual companies. Andrew Shonfield and Eric Wigham wanted compulsory participation, which would require changes to company law. They proposed that worker directors (no less than two for companies with 5,000 or more employees) should participate as other directors in board meetings, with the status of non-executive directors, appointed by relevant unions after consultation with the TUC. They would not be able to engage in collective bargaining with the company while serving on the board, and should share the general duties of directors to ensure the overall prosperity of the concern. They would serve a fixed term, report to their “constituency” but not be controlled by them nor be recallable by them. The TUC’s proposals to Donovan, however limited, were significant in that they represented the beginnings of a change in approach.84 They marked the abandonment of its former rigid line that participation in industrial democracy should be limited so as not to endanger trade union “independence”. In the private sector it did not specify the details (even in the broadest form) of the “legislation of a discretionary character” for trade union representation on boards, but had began at least to advance the arguments as to why this move might be 84

See John Hughes, “The Plans of the TUC”, (1968) 1 Workers’ Control Bulletin 36.

70 Ben Clift, Andrew Gamble and Michael Harris desirable (such as efficiency, the protection of workers, consent and social accountability). The radical position in the debate on industrial democracy was represented by the Institute for Workers’ Control, established in 1968, which argued consistently not for parity for employee representatives on the decision-making body of the company or enterprise, but that workers should themselves determine the overall policy decisions (subordinate to government, but with control over management). They wanted a reversal of the roles of class-divided society, not workers’ checks on still powerful (or powerfully-placed) existing management, but developments leading to self-management and democratic self-regulation.85 They rejected joint consultation as a concessionary management device, canalising labour aspirations away from real control and democracy. But they also rejected pure reliance on collective bargaining, which, however useful, was not enough to secure workers’ control.86 Prominent Labour figures associated with the IWC included Tony Benn, Michael Meacher, Audrey Wise, Joan Maynard, Eric Heffer and Stuart Holland. Holland argued that there should be majority workers’ control of supervisory boards at both the head company and subsidiary level, and that workers in all companies should have the power to hire and fire executive management on a basis of majority control, subject to conditions of tenure and dismissal for executive management.87 In this way demands for workers’ control were seen as an alternative way of achieving the socialisation of capital. Opposition from the left to the IWC, represented by Arthur Scargill and Bert Ramelson, argued that its proposals would lead to isolated struggles for workers’ control in different industries, and hence sectionalism. Scargill thought that so long as private ownership of capital determined the working of the national economy, workers should concentrate on the struggle to increase “real control” within capitalist society and to create socialism through collective bargaining and political activity. The IWC and its ideas were seen as guilty of diverting workers from the class struggle and encouraging them to participate in management.88 When it was in government between 1964 and 1970 Labour did not bring forward any major changes to company law, but the interest in industrial democracy gathered momentum, spurred by the far-reaching changes to employment law which the Heath Government introduced and the successful negotiation of entry to the European Community. The TUC established an Industrial Democracy Working Party, while the Labour Party’s Company Law Working 85 See the first issue of the IWC’s journal, Workers’ Control Bulletin, ibid, and its statement of aims (1968) 1 Worker’s Control Bulletin. 86 For further details on the IWC see Harris, The Labour Movement and Company Law Reform 1945–1979, above n. 2. 87 Stuart Holland, “How to Carry Out Labour’s Programme”, (1975) 8 Workers’ Control Bulletin 13. 88 Arthur Scargill, Audrey Wise and Mike Cooley, A Debate on Workers’ Control (IWC, 1978).

The Labour Party and the Company 71 Group met regularly from late spring 1973.89 In July 1970, the European Commission presented a draft statute for a “European company”: two-tier boards (executive and supervisory), with the latter consisting of one-third employees and two-thirds shareholders; an “employees council” entitled to information on the affairs of the company, participation and the right to give advice to management on certain decisions. This was followed by the draft fifth directive on company law in October 1972 which proposed that companies employing more than five hundred people should have two-tier boards. The TUC response to the European initiatives was predictably lukewarm. It feared that the creation of “European companies” might only facilitate the creation of a new form of multinational company under fewer legal and financial restraints, and thought that “the proposals for workers’ representation on Works Councils and on the supervisory board of the European company would in any event only be acceptable if trade union machinery at company-plant level were fully involved”.90 The TUC Working Party’s first report on “Industrial Democracy”91 came out in favour of employee-membership of management boards for companies employing over two hundred people in the private sector, but wanted representatives appointed via trade union machinery, not on the basis of “works councils” or similar European machinery separate from or independent of trade unions. It argued that company-based schemes of coownership and profit-sharing were “discredited”; they did not provide any real control over managerial decisions, or involve any common ownership principles as a result, and did little or nothing to reduce inequality since they did not involve the public sector. Even if shares with voting rights were distributed this would have to be “on a fairly massive scale” before any real control were vested in the workers as shareholders. With regard to European experiments in two-tier boards it thought they were “probably a desirable development in that the structure gives workers’ representatives a degree of joint control over all the major decisions of the company”, but appointments to supervisory boards are “acceptable and desirable only if made through trade union machinery at company level (the precise manner might vary), and retaining a representative character and links with the trade union machinery”. It thought there was “some merit” in introducing into UK company law the division of the present powers of the management board into a management board and a supervisory board, thereby giving worker representatives on the latter “a degree” (in fact, parity) of trade union and “social control” over major management decisions. The responsibility of worker representatives would be to trade union members employed in the firm rather than to the annual general assembly of shareholders. But the latter, “under European systems”, could, “arising from the right of ownership, 89 Its membership was: Bruce Millan, MP (as Chairman), Geoffrey Bing QC, John Gilbert, MP, Basil Jeuda, Professor Otto Kahn-Freund, David Lea, Harold Lever, MP, Tony Benn, MP, Sigmund Sternberg, and Professor Wedderburn. 90 TUC Report (1972), 227. 91 See TUC Report (1973), 384–422.

72 Ben Clift, Andrew Gamble and Michael Harris overrule the decisions of the other organs of the enterprise”; the Report suggested that “UK company law should extend the co-determination principle further to give rights of veto over AGM decisions as well as those of the Management Board”. This would mean supervisory boards with trade union representation for all companies separately incorporated under company law, whether or not partly or wholly owned subsidiaries. Collective bargaining, regarded as a major component of industrial democracy should be “broadened” by strengthening trade union organisation, restoring trade union rights (as eroded by the Industrial Relations Act 1971), and extending it into other areas (recruitment, training, manning, dismissals). A statutory obligation on companies to have regard to the interests of its workpeople as well as its shareholders, alongside greater company disclosure, was also supported. What underlay the TUC’s shift in position, as Patrick Wintour noted,92 was the realisation that the widening of the shop steward’s role beyond wages and immediate conditions into areas such as manpower planning, disclosure of information and job and income security meant that if shop stewards were to do anything other than react to strategic decisions of management, then they had to participate continuously in corporate planning issues such as investment, mergers, the appointment of top managers, product mix and pricing policy. The distinction between consultative and negotiating machinery was breaking down. In the wider Labour movement, many had concluded that the pressure for various forms of industrial democracy—from joint consultation, to participation and works councils—was bound to increase widely over the next ten years. Harold Wilson argued that “unless radical changes are made in relations between management and the shop-floor it will become increasingly difficult for modern industry to function effectively. It is no longer a question of whether workers should play a greater part in their day-to-day factory life—but how this is to be done”.93 Amongst other reforms Wilson advocated a compulsory system of works committees: “These committees should be elected from the shop floor in elections organised and administered by the trade unions. All factories with 100 employees or more ought to be legally obliged to establish such committees. The committees would need to be part of the trade union machinery in the factories and not separate from the normal range of trade union functions”.94

In private industry, he suggested that: “there should be wider experimentation, on the lines begun by the Labour Government in steel, for placing representatives of the workers directly connected on the relevant 92

Patrick Wintour, “The Social Contract’s Last Stand”, New Statesman, 7 January 1977, 3. Harold Wilson, “Democracy in Industry”, speech delivered at the North West Regional Conference of the Labour Party, 17 March 1973, 11. 94 Ibid., at 12. 93

The Labour Party and the Company 73 boards, including regional boards. This does not mean confining such opportunities to trade union officials, still less to trade union officers drawn from other industries”.

On the Left of the Party, Benn and others advocated industrial democracy as a new and more radical form of nationalisation. At the 1973 Conference he declared: “What I am saying is that industrial democracy begins now. We do not have to wait for the legislation we intend to introduce to begin the process of debate and dialogue within industry about how the firms should be run and which of them should be acquired . . . We reject as a party and as a movement the idea that one worker on the board is industrial democracy. [Applause]. We reject co-ownership. We reject the phoney works councils not rooted in the strength and structure and traditions of the trade union movement. [Applause]. All these are window dressing, designed to divert the demand for democratic control into utterly harmless channels. We are talking about the transfer of power within industry and we will not accept the existing pattern of nationalisation as a form for the future”.95

In 1974 the Labour Party Working Group on company law reform published its Green Paper, The Community and the Company Green Paper.96 It suggested that neither the 1948 or 1967 Companies Acts were “socialist in tone” and that both were “rather technical in content”. Shareholders had failed to control managements, directors and their companies. It made proposals to strengthen through company law both the public interest and the employees’ interest, and rejected the self-regulation approach inherent in Conservative plans for reform. A “Socialist Companies Act” would establish a new structure for the relationship between the company and its workers, regulate companies and financial institutions by a Companies Commission, and widen the scope of disclosure in the public interest and in the interest of employees. The “outmoded view” of company law, that the “interests of the company” are the interests of its shareholders, should be changed. Trade union participation at board level must be a supplement to and not detract from the trade unions’ position in collective bargaining, and given this a new legal structure should be “supported in principle”. But it also stated that “Collective bargaining is and will remain the predominant method by which workers acquire a share of power in the private sector”. Twotier boards would not be a necessity, that is legally obligatory, for worker representation on boards, but it was the Committee’s preference. Anything less than parity (with election of worker representatives through trade union machinery) would be unacceptable. The supervisory board would have regard to the “fundamental nature of the company’s operations”. Suggestions for greater disclosure followed the Labour Party’s 1968 NEC Statement (in such areas as manpower and remuneration, production and investment data, and profit and pricing policy). The issue of non-voting shares should be prohibited 95

Labour Party Conference Report (1973), 164–5. Working Group of the Labour Party Industrial Policy Sub-Committee (Company Law) Green Paper, The Community and the Company (Labour Party, 1974). 96

74 Ben Clift, Andrew Gamble and Michael Harris and existing non-voting shares should be enfranchised over a period of five years with the Companies Commission having powers and sanctions of enforcement. There was now a flurry of proposals for reform of company law, some of them openly espousing a constitutional model of the company, while being careful to ensure it was compatible with collective bargaining.97 Particularly notable was the Fabian Society Working Party on Industrial Democracy, which produced a pamphlet edited by Giles Radice advocating parity representation in the private (for companies with 2,000 workers) and public sectors, two-tier boards, and a new Companies Act.98 This was virtually identical to the Bill which Radice later introduced in the House of Commons. Radice argued that the Labour Party should commit itself to a programme of promoting industrial democracy based on the principles of single channel representation and strengthening and extending collective bargaining, via an increase in trade union membership by repealing Conservative legislation, the extension of shop floor bargaining, the development of company and group bargaining, employee representation on boards, and the recognition of trade union responsibility for a “major recruitment and educational effort”. The 1974 October Labour Party General Election Manifesto stated: “we will introduce new legislation to help forward our plans for a radical extension of industrial democracy in both the private and public sectors. This will involve major changes in company law and in the statutes which govern the nationalised industries and in the public services”. It was also part of the Social Contract. The TUC, however, remained divided on the issue. At the 1974 Congress some unions such as the AUEW continued to press for free collective bargaining and opposed anything which might compromise the traditional role of trade unions. They opposed the mandatory imposition of supervisory boards with worker directors. Others such as NUPE countered by arguing that the AUEW resolution was dangerously close to accepting the employers’ philosophy to restrict the role of trade unions to the pure collective bargaining process and

97 For a true constitutional model of the company it is necessary to turn to the Liberal Party. Its pamphlet on industrial democracy reiterated the Liberal policy of “workplace councils” and an Employee Voting Rights Bill to enable employees to “take part in the election of directors to the company on an equal basis with shareholders”. Company law would have to be reformed to confer “membership” on employees as well as shareholders; boards should have a statutory obligation to “respect the interests of the employees”; there should be greater disclosure, as well as the voting right concerning directors. The councils could review company objectives and performance, strategy and effect on employees, and “contribute views” on the running of the company: Stephen Abel and John Pick, Democracy at Work (Liberal Publication Deptartment, 1976). Another Liberal pamphlet on the “Democratic Enterprise” proposed employee share ownership, public representatives on company boards and “public interest” legislation for companies to broaden their social obligations. See Neil Martin-Kaye, Democratic Enterprise (Liberal Publication Department, 1976). 98 Giles Radice (ed), Working Power: Policies for Industrial Democracy (Fabian Working Party on Industrial Democracy, Fabian Society Tract 431, 1974). Radice was head of the Research Department of the General and Municipal Workers Union (later Labour MP for Chester-le-Street, Vice-Chairman of the Parliamentary Labour Party’s Industry Group, and Parliamentary Private Secretary to Shirley Williams).

The Labour Party and the Company 75 nothing else: “if you pass [it] you will be the toast of every board of directors in the City of London tonight”.99 Giles Radice introduced a ten-minute rule Bill in the House of Commons on 15 January 1975: “A Bill to Amend the Companies Act 1967 and to make further provision, in regard to companies and nationalised industries, for trade union representation on supervisory boards”.100 It proposed that companies with 2,000 workers or more and which recognised trade unions, at the trade union(s) request, would establish a two-tier board structure (management and supervisory), with parity representation, elected through trade union machinery, for three years (or a shorter period specified at the time of their election), which would be concerned with company strategy on investment and expenditure, employment, closures, shares and dividends, and company disclosure. The Secretary of State for Employment would have the power by order to reduce the 2,000 workers figure to a minimum of two hundred. Two hundred and fifty MPs voted for the Bill, a record then for a ten-minute rule Bill. It was given a formal second reading and went to Standing Committee for consideration. At the seventh sitting (Standing Committee C 9 July 1975), the Minister of State at the Department of Employment said: “I am now in a position to inform the Committee that it is the Government’s firm intention to introduce legislation on industrial democracy in the 1976–77 Session of Parliament”. In the light of this statement the Committee decided to suspend its consideration of the Bill.101 Strong supporters of early legislation like Jack Jones were disappointed by the Government’s response, because they saw the setting up of yet another committee as a way of evading action on the Radice Bill.102 In May 1975, the European Commission published a revised version of the European Company Statute, accepting the amendments made by the European Parliament (it proposed now that the supervisory board should consist of onethird employees’ representatives, one-third shareholders’ representatives and one-third members coopted by the employee and shareholder representatives to represent independently general interests). A European company with establishments in more than one Member State must establish a works council (national law could achieve representation of employees in companies established in only one country).103 The movement on company law by the European 99 TUC Report (1974), 557. See also, to represent the differences between the two most prominent trade union leaders on the issue, the contributions from Jones and Scanlon, in Charles Levinson (ed), Industry’s Democratic Revolution (London, Allen and Unwin, 1974), 231. 100 Industrial Democracy Bill, Giles Radice, Parliamentary Papers, Bill 60 (HMSO, 1975). It was also signed by Jack Ashley, Tom Unwin, Neil Kinnock, John Horam, Phillip Whitehead, Jim Sillars, John Cunningham, David Watkins, A Duffy, Jeff Rooker and Michael English. 101 Standing Committee C, Minutes of Proceedings on the Industrial Democracy Bill (HMSO, 1975). 102 Jack Jones, Union Man: The Autobiography of Jack Jones (London, Collins, 1986), 313. 103 See Finn Gundelach (European Commissioner for the Internal Market), “The Reform of European Company Laws” and press release, in F Sauzey and F Basagni (eds), Employee Participation and Company Reform (conference report) (Paris, Atlantic Institute for International Affairs, 1976), 51 and 70.

76 Ben Clift, Andrew Gamble and Michael Harris Commission, albeit slow and seriously hampered, helped spur the attempts by the more “progressive” sections of management (and some of the less progressive ones) to preempt what must have appeared an inevitable tide towards some form of increased industrial democracy.104

THE BULLOCK COMMITTEE

In July 1975 the Government announced a “commitment” to legislation on industrial democracy in the 1976–77 parliamentary session; and in August 1975 it established the Bullock Committee to “prepare the ground for legislation”. Its terms of reference were as follows: “Accepting the need for a radical extension of industrial democracy in the control of companies by means of representation on boards of directors, and accepting the essential role of trade union organisations in this process, to consider how such an extension can be best achieved, taking into account in particular the proposals of the Trades Union Congress report on industrial democracy as well as experience in Britain, the EEC and other countries. Having regard to the interests of the national economy, employees, investors and consumers, to analyse the implications of such representation for the efficient management of companies and for company law”.105

The Committee was to report during James Callaghan’s premiership. In his biography of Callaghan, Kenneth Morgan notes that: “Callaghan . . . was strongly influenced by Helmut Schmidt’s passionate endorsement of German co-determination . . . Callaghan’s natural stance was to try to move on from a purely adversarial system of industrial relations to what would in the 1990s be called by ‘new Labour’ a system of stakeholding with mutual rights and obligations. He arranged and attended a meeting held in Germany between the members of the Bullock Committee and Helmut Schmidt and other key German figures. The German Chancellor argued strongly that Britain’s confrontational system . . . was fundamentally harmful to the United Kingdom’s industrial performance . . . He attached much hope, as he was to affirm to the present writer eighteen years later, to creating an industrial transformation in Britain which would strengthen its international standing also. Callaghan, as a former 104 See John Jenning, “Will British Management Strike First on Workers’ Participation?”, Workers’ Control Bulletin (May 1974) 4. 105 It was chaired by Alan Bullock. Members were Jack Jones (General Secretary, TGWU), as noted, a strong advocate of worker participation and greater decentralisation in industrial management and labour relations, an outlook that reflected his quasi-syndicalist background in Merseyside industry; David Lea (head of the TUC Economic Department); Clive Jenkins (General Secretary, ASTMS); Labour law academic Lord Wedderburn (Professor of Commercial Law at the LSE and legal advisor to the TUC); Professor George Bain (Director of Warwick University Industrial Relations Unit); Sir Jack Callard (ex-Chairman of ICI, Chairman of British Homes Stores, and President of the Industrial Participation Association); Barrie Heath (Chairman of GKN, a director of Pilkington Brothers and Smiths Industries); Norman Biggs (Chairman of Williams and Glyn’s Bank, ex-Chairman of Esso); John Methven (Director General designate of the CBI); and Nicholas Wilson (senior partner in a city firm of solicitors, member of the Capital Markets Committee of the Bank of England, and of the Department of Trade’s Companies Consultative Group which advised on company law reform).

The Labour Party and the Company 77 trade union official who understood the problems and psychology of industrial relations at first hand, was the man to achieve it”.106

Many traditional socialists still remained opposed in principle. Eric Heffer, for example, argued against “workers’ control” and “democratic management”. Trade unions: “must remain independent, protecting the workers even from the very people they have elected, and certainly from the state. In a truly democratic socialist society, power must be diffuse. It is essential that there are a number of power centres, each one balancing itself against the other. That is why unions in a planned socialist society must be free to negotiate wages and conditions. I am sure that this suggestion will be regarded by some as anarchistic. Yet how else can workers protect their interests?”.107

He thought the TUC position on worker representatives was the “wrong way” to go about industrial democracy: “The old-fashioned idea that management is one thing, and trade union responsibility for safeguarding the workers’ rights etc. is another, is correct. Unless this is accepted confusion will reign and no real advances will be made towards democratic management”. The Bullock Report was published in January 1977. The majority report (signed by the Chairman, the three trade union members, Professor George Bain and Professor Kenneth Wedderburn) recommended that workers should have equal rights with shareholders to representation on boards of private companies (including holding companies) employing 2,000 or more people, and that this representation should take place through trade union machinery. This right would be triggered by an application from a recognised trade union, confirmed by a ballot of all employees. It emphasised that equal representation was essential if worker representatives were to be expected to accept equal responsibility, but that in addition to the equal numbers of elected worker and shareholder representatives, there should also be a third smaller group on the board: an odd number, more than one, of coopted directors jointly agreed by the two other groups (the so-called “2x+y” formula), who would safeguard against deadlock and help ensure that company policy was viewed in a wider context. The exact size of the “x” and “y” elements would be a matter for agreement between the unions and the existing board. All directors would have the same duties and responsibilities. The majority report took the view that it would be both impractical and undesirable to introduce into the United Kingdom the kind of two-tier board system adopted in some European countries, because they tended in practice to limit the power of the worker representatives in relation to the management board (giving them a negative power of veto over decisions already taken). Representation should therefore be on the existing company board. It would have reserved to it by law the main powers of initiative in company policy, hence 106 Morgan, below n. 117, at 560–1, referring to Jones’s book, Union Man, above n. 102, and an interview between Schmidt and Morgan. 107 Eric Heffer, “The Trade Unions and Socialism”, New Statesman, 7 November 1975, 564–5.

78 Ben Clift, Andrew Gamble and Michael Harris limiting both the (then) current shareholder right to initiate action in certain key areas and the ability of senior management to introduce new policies in strategic areas without reference to the board. The minority report, signed by three members of the committee, advocated that if a statutory right were to be accorded it should entail minority employee representation only on a supervisory board which would have no powers of initiative in terms of policy-making. It also favoured the development of participation below board level. The minority report criticised the terms of reference of the Committee, which presupposed a commitment to employee representation on company boards. The majority report described their legislative proposals as a halfway house between universally mandatory legislation (as in Germany) and purely enabling legislation. As the TUC Report (1977) noted: “In this respect the recommendations followed what might be termed the Scandinavian approach of giving a statutory right of representation to a company’s employees; the process of implementing this right to board representation could be triggered only by recognised trade unions, and would subsequently be subject to a ballot of the whole workforce. Following an affirmative ballot it would be up to the unions involved to arrive at an agreed procedure for electing worker representatives. Worker representatives would normally be employees of the company”.108

The reaction to the Bullock Report was predictable. The employers’ organisations and the Conservative Party were implacably opposed,109 while the trade unions remained deeply divided. Some, like the GMWU, thought the proposals did not give enough flexibility in the machinery for achieving joint control.110 The TGWU supported legislation for parity representation on boards but only if “linked with trade union representative machinery”. It opposed supervision of elections to boards by an Industrial Democracy Commission as “impractical” and an attack on trade unionism.111 It also opposed the setting up of supervisory boards because they would be “rubber stamps” for the management board, and representation on them would “severely curtail the influence of any worker representatives”. Jack Jones, however, the former General Secretary of the TGWU, and one of the strongest advocates of industrial democracy in the trade union movement, regarded the Report as an “historic document” and challenged the Government to implement it.112 But he too was critical of German-style supervisory boards and argued for a form of industrial democracy that built upon 108

TUC Report (1977), 244. The TUC also produced a Guide to the Bullock Report. The City Company Law Committee for example argued that the implementation of the proposals would damage efficiency and disrupt every major company in the country: City Company Law Committee, A Reply to Bullock (1977). In the Commons, John Nott opposed the Report as “unrealistic and destructive”, because it involved the imposition of legislation rather than “an evolutionary process”, and because of the “patronage” it would grant trade unions which would undermine the authority of middle management: (House of Commons Debates, cols 1493–1511). 110 GMWU, Industrial Democracy in the Light of Bullock (1977). 111 TWGU (General Executive Council), Industrial Democracy (1978). 112 Jack Jones, “In Defence of Bullock”, New Statesman, 4 February 1977, 143–4. 109

The Labour Party and the Company 79 existing shop floor organisation. He denied that this would increase trade union patronage. Many observers were unconvinced, arguing that the Bullock proposals would disenfranchise millions of workers (because of the 2000 employees limit and the single channel of representation).113 Also unconvinced were the supporters of free collective bargaining. Hugh Scanlon declared: “We think that industrial democracy can best be strengthened by an extension of collective bargaining, to which we know no limit”.114 The EETPU stated: “The conclusions of the Bullock Committee are not in line with the policy of this union, nor indeed with that of the TUC as expressed at Congress. The Terms of Reference and the composition of the committee made it inevitable that this predetermined result would occur. It will not solve the deep and underlying problems of Britain, nor will it advance the cause of genuine industrial democracy. We do not align ourselves with those whose objections are based on opposition to any advance of workers’ influence in decision making, nor those whose main concern appears to be the possible redundancy of 6,000 directors. The real extension of democracy in industry will come through the natural extension of collective bargaining and not through the elevation of a few individuals to boards of management”.115

On 26 January 1977, Edmund Dell, Secretary of State for Trade reaffirmed that: “the Government are committed, as we were when we set up the Committee, to a radical extension of industrial democracy by representation of the work force on company boards and to the essential role of trade unions in this process”, an “essential ingredient of the social contract”.116 Consultation would begin, with parallel consultations concerning industrial democracy in the nationalised industries. Dell stressed that a joint representation committee could decide that the appropriate method of selecting worker directors would be through all employees. Dell also suggested that he was not certain that the trade union movement was “unanimous” on wanting single-tier boards, but that they were an option alongside two-tier boards. Dell’s position was a difficult one; according to Callaghan’s biographer, Dell “strongly resisted change, and Shirley Williams disliked the elements of union power enshrined in Bullock”.117 Williams as Paymaster General chaired the Cabinet Committee, Dell was a member of it. The divisions within the Labour movement and misgivings about the role Bullock gave to trade unions in the representative machinery, allowed the opponents of Bullock within the Cabinet to sideline it. Although Albert Booth, the Secretary of State for Employment, fought manfully for the Report, there was 113 e.g, Eric Jacobs, Labour Editor of the Sunday Times. See his letter, New Statesman, 11 February 1977, 188. 114 Morning Star, 27 January 1977. 115 EETPU Circular, 31 January 1977. 116 House of Commons Debates, cols 1493–1511. 117 According to Kenneth Morgan, Dell behind the scenes fiercely resisted change: Morgan, Callaghan: A Life (Oxford, Oxford University Press, 1997), 562. See also Jack Jones’s book, Union Man, above n. 102, at 584.

80 Ben Clift, Andrew Gamble and Michael Harris little enthusiasm in the rest of the Cabinet. After consultations, a White Paper on Industrial Democracy finally appeared in May 1978. It emphasised that as far as possible the detailed arrangement should be worked out in each company on a voluntary basis, but put forward two major statutory “fall back” rights for workers, giving firms employing more than five hundred employees a legal obligation to discuss all major proposals affecting the workplace with employees’ representatives, and giving employees in companies employing more than 2,000 a legal right to representation on the board. It supported a two-tier board structure, demanding a change in company law, but where there was agreement the right to board representation could be on existing unitary boards. This White Paper was a much diluted form of the Bullock Report, and even this failed to get to the legislative stage. Callaghan announced further consultations would be necessary.118 He emphasised the need for the broadest basis of agreement between managements and those demanding participation in order to achieve progress. The White Paper proposals represented “first steps” in an “evolutionary process”. He was “not sure” whether a new Companies Act would be necessary or whether the responsibilities of directors should be broadened beyond the interests of shareholders. The consultations inevitably produced wide disagreement between the TUC and employers’ organisations.119 The Government’s lack of a majority and the end of the “Lib-Lab pact” also hampered early action. At the 1978 Labour Conference the issue of industrial democracy was swamped by other matters. As Jack Jones noted ruefully, “what was left of the Bullock Report then sank in the disaster of the winter of discontent”.120 The proposals relating to industrial democracy were not mentioned in the 1979 Election Manifesto. In opposition “industrial democracy” lived on in Conference resolutions. In 1980 Benn argued that an Industry Bill containing provision for industrial democracy must be “on the Statute Book within a matter of days after the election of a Labour government”, to applause.121 Similar rhetorical commitment to industrial democracy was given at the 1981, 1982 and 1983 Conferences, where resolutions which included demands for industrial democracy were regularly carried.122 After that it disappeared. CONCLUSION

The reason both for the relative neglect of company law reform in the British Labour movement before the 1970s, and the failure of the reform proposals put 118

House of Commons Debates, cols 1335–1355. A large number of companies had been involved in representation on the White Paper. See answer to question to the Secretary of State for Trade, House of Commons Debates, 15 November 1978, cols 285–286. 120 Jones, Union Man, above n. 102, at 315–16. 121 Labour Party Conference Report (1980), 30–1. 122 See Labour Party Conference Report (1981), 66; Conference Report (1982), 93–5, 184–7; Conference Report (1983), 193–5. 119

The Labour Party and the Company 81 forward by Bullock, is best understood as reflecting deep-rooted adversarial conceptions of the company within the Labour movement, which were expressed in the commitment to nationalisation to secure the public interest and the commitment to trade union independence as the basis for any viable industrial democracy. The weakness of constitutional thinking about the company meant that attempts by Labour to reform the institutional framework of the company were always severely handicapped. As a result, the Party, failed to seize the opportunities presented in the 1940s and again in the 1970s for a farreaching reconstruction of company law. In the 1940s it never registered as a significant priority; in the 1970s, when it did, the Party was too divided internally and too politically weak to find a way to implement it.

4 The Public Interest and the Company in Germany SHAWN DONNELLY

INTRODUCTION AND SUMMARY

I

N THE DECADE following reunification, public interest ideas relating to the company in Germany have undergone a significant transformation, both in favour of promoting greater shareholder activity in the affairs of the corporation, and in pursuit of greater corporate responsibility to employees and the broader community. This chapter reviews the more important developments, the reasons for their introduction, and draws conclusions about the future of corporate governance in Germany. It shows that contemporary German firms are subject to an increasingly broad palate of public interest requirements, some with long legal traditions, and some responding to recent changes in public interest agendas. However, the corresponding mechanisms of corporate governance vary more by issue area and firm than they once did. The typical German firm is changing in three ways. First, the German corporate economy has developed new, and improved the existing, institutions that serve the interests of outside shareholders. Less emphasis is now placed on the universal banks and insurance companies which have acted as their surrogates since the 1870s. However, the distinctive institutional features regulating company-investor relations have remained intact and been strengthened rather than giving way to a disintermediated market for corporate control. The supervisory board in particular has acquired a new importance that distinguishes the representation of shareholder interests in Germany from that in other corporate economies. Secondly, the representation of employee interests through works councils is simultaneously becoming more important and less common. The public interest agenda with regard to legitimate employee concerns in the workplace has deepened considerably, meaning that works councils now have a right to participate in the development and implementation of a broader range of company policies. At the same time, structural changes in the German economy coincide with a substantial decline in the percentage of firms that have works councils. If

84 Shawn Donnelly present trends continue, the shift from industrial to service sector activity and economic revival in the new states will reduce the percentage of firms with councils to less than half, which is the current state of affairs. Eventually, then, we should expect that the fully constitutionalised firm will become the minority model in Germany. In its place, German firms are increasingly bound by regulations and court decisions without direct participation from employees. Thirdly, various levels of government in Germany are promoting a new form of corporate governance to deal with postmodern public interest concerns, particularly environmental protection and equal treatment of men and women in the workplace. Companies are either encouraged or required to appoint contact persons responsible for the issue in question, who then interact with a government agency or an appointed surrogate to report on company practice. This method is considered by both the corporate and government sectors to be an alternative to direct and extensive regulation. This has the advantage of allowing for flexibility to match the needs of individual firms, and the introduction of an ongoing, dynamic treatment of company policy for the issue in question. The method also lends itself well to voluntary measures where there is a public interest in greater corporate responsibility, but unwillingness to saddle companies with obligatory costs, as is the case with some environmental protection goals.

THE PUBLIC INTEREST AND MANAGEMENT CONTROL

Shareholder interest representation in joint stock corporations has a long but ambiguous tradition in Germany. German company law in 1870 acknowledged the legitimate interests of shareholders in the security of their investments and provided for mechanisms to enable supervision on behalf of those not personally attending shareholder meetings. In contrast to British company law, this meant that a dispersed group of shareholders could expect some control over the activities of company directors without personally attending general meetings or otherwise devoting their time to the affairs of a single company. Assuming that the mechanism of the supervisory board functioned as intended, wealthy Germans could be encouraged to invest their capital extensively throughout the economy, thereby stimulating economic development at a crucial point in the country’s history. The disappointment of the 1873 wave of bankruptcies, known as the Gründerkrise, strengthened the conviction that the supervisory board had to be used systematically if shareholder interests in the proper management of the company were to be protected and promoted. The introduction of mandatory supervisory boards for all public limited companies in 1884 along with more extensive reporting requirements underlined the right of outside shareholders, those without an active role in the company’s operation, to have their interests represented to the management board. The public interest in shareholder protection stands in contrast to the British preference to view the company as a pri-

The Public Interest and the Company in Germany 85 vate association, in which no external intervention to strengthen the position of outside shareholders is warranted. At the same time, banking law allowed the country’s universal banks to monopolise representation of outside shareholders to the management board. While politicians acknowledged that this qualified the capacity of small shareholders to exercise their rights independently, they gave priority to ensuring that company managers were confronted with aggregated shareholder interests.1 In addition, accounting law ensured that companies could manage their books and report on their activities in such a way as to minimise the pressure for quarterly dividends and maximise their own resources. Consequently, the cost of providing security for shareholder investments is the lower dividend that companies pay to investors, than would be paid in Britain, for example. From the 1930s to the present day, company and banking law has built on this qualified protection of shareholder interests, although individual rights to vote independently at shareholder meetings have been increased significantly (see below). While the German conception of the public interest allowed universal banks to represent shareholder concerns, it also sought to contain the influence that stock markets and other capital markets could wield over the productive economy. Secondary capital markets were banned in the 1890s and were relegalised, incrementally, only between the 1970s and the late 1980s. Changes to accounting law to ensure the transparency of current business and financial holdings desired by outside institutional investors appeared for the first time in the mid-1990s. At the beginning of 2000, changes to the tax code to encourage outside institutional investors (such as pension funds) to compete with typical insiders (the life insurance companies and universal banks) in funding and placing demands on the corporate economy were still under discussion. Consequently, it is appropriate to think of Germany’s corporate economy as being in a state of transition from accepting the dominance of inside investors with their own sources of information on company activities, to one in which outside investors, personal and institutional, may participate without intermediation through universal banks and insurance companies. This constitutes a significant break with the past, but also an incomplete one. To date, outside investors have more opportunities to participate in investment, but the established institutions are not losing their dominant voice. The restriction on capital market influence was more than a preference for the traditional methods of corporate financing and control through banks and insurance companies. The collapse of 1873 introduced a distrust of unfettered capital markets that was bound up with a wider-ranging rejection of “Manchester Liberalism”, leading to their institutional containment, which has persisted ever since.2 In the Federal Republic, the containment and subordination of capital 1 E Wenger, “Universalbankensystem und Depotstimmrecht” in Helmut Gröner (ed), Der Markt für Untenehmenskontrollen (Berlin, Duncker und Humblot, 1992). 2 G Heeb, Börsentermingeschäftsfähigkeit und Aufklärungspflichten nach der Börsengesetznovelle (Stuttgart, Copy Druck Ziegler, New York, Commerce Clearing House, 1993) and Thomas Nipperdey, Deutsche Geschichte 1866–1918 Vol.1 (Munich, C.H. Beck, 1992) vol 1, 279.

86 Shawn Donnelly markets to the needs of the productive economy remained a central component of the country’s perception of its economic success, as the Bundesbank continued to emphasise well into the 1990s. Modern company law established in 1937 that outside shareholders were entitled to have an independent influence over how banks represented them, and most importantly, used their votes in the general meeting.3 Up to the present day, periodic revisions of the Aktiengesetz, or Joint Stock Corporations Act (AktG) have strengthened this right to the point where individuals may instruct their banking institution to exercise their proxy rights in a particular manner. Other provisions of the AktG continued to allow material disadvantages to outside shareholders by refusing to acknowledge a broader public interest imperative in a legal right to equal treatment in take-over bids. This means that corporate take-overs—meaning here the acquisition of a controlling stake in the company—could be arranged with the consent of universal banks and insurance companies that sit on the supervisory board, without involving other investors in any tendered offer. The first consideration taken of shareholder concerns in take-over bids was introduced through the 1971 (voluntary) Takeover Guidelines (Übernahme-richtlinien), and updated in 1989 (discussed below).

REUNIFICATION, ECONOMIC RENEWAL AND THE SHAREHOLDER

More than anything, the persistent unemployment following reunification and growing scepticism about economic recovery prompted the Kohl Government to increase the importance of “outside” shareholding in the German corporate economy.4 The CDU/CSU/FDP coalition won the first all-German elections in 1990 on the promise that integration of the new states into the Federal Republic would spark a new economic miracle, thereby minimising the economic and social consequences of reunification. For Easterners, this meant that unemployment would be a transitional concern that would not significantly overshadow the effects of reunification. For Westerners, concerned about the tax burden required to pay for increased social transfers to the new states, the prospect of an economic miracle could be expected to contain the costs of integration. Over the course of the 1990s, however, unemployment not only persisted in the new states but rose in the old states as well, jeopardising public morale, government finances, and not least, support for the sitting government. In order to tackle the country’s unemployment and public finance problems, the political demand for ensuring new investment into the German economy was high. One problem, however, was that investors, both domestic and 3 L Quassowski and G Schröder, Bankdepotgesetz: Gesetz über die Vervahwrung und Anschaffung von Wertpapieren vom 4. Februar 1937 (Berlin, Verlag Franz Vahlen, 1937). 4 Deutscher Bundestag, Wortprotokoll der öffentlichen Anhörung zum Thema “Stärkung des Kapitalmarktes Deutschland, Förderung des Aktiensparens und Verbesserung der Risikokapitalversorgung,” des Ausschusses für Wirtschaft (Bonn, 4 June 1997).

The Public Interest and the Company in Germany 87 foreign, viewed the German market as an unattractive investment opportunity. Another problem was that too few companies derived their funding through capital markets to allow investors an easy overview of what the economy had to offer, or to incite institutional investors to set up operations in the country. As late as 1997, public policy hearings on the state of the economy stressed that the situation would remain less than promising unless more venture capital could be attracted to the German economy—which in turn required broader and deeper capital markets.5 This realisation formed the basis of 1994 legislation promoting shareholding, but serves as a useful illustration of the central importance that shareholding was accepted to have for the future of the German economy. Key changes to German financial law made it possible for small and mediumsized enterprises to seek their fortune on the German stock exchanges, through the New Market (Neuer Markt) and through the Regulated Market (Geregelter Markt), both of which were established in 1994, having been provided for in the Second Financial Market Promotion Act (Finanzmarktförderungsgesetz) of the same year. The New Market is the jewel of the system, focusing on high technology companies, and represents a new importance for shareholding in sectors in which the value of companies relies principally on the inventiveness of their employees, and for which there is little collateral that the company can offer as security. The First Financial Market Promotion Law of 1989 was the first body of legislation that explicitly embraced the development of investor-friendly financial markets as part of a healthy national economy. Rather than focusing on the risk of speculative price manipulation, the law was promulgated in the belief that a developed financial market would provide additional liquidity for the German economy. Furthermore, the legislators worked from the assumption that the financial market would only fulfil its desired function if it were set up in such a way as to attract the average investor. Consequently, the 1989 Act set the conditions for establishing the first futures and options exchange, the Deutsche Terminbörse, to serve as the arena for such a development. At the same time, the law required dealers to provide comprehensive information about the financial instruments being considered for purchase, and to ask about the investor’s knowledge of investments, to ensure that consultations would fulfil their informative purpose.6 The 1989 Act also introduced the first measures to increase the breadth of activity and the depth of investment on regular German stock exchanges. The 1986 Stock Market Admittance Law (Börsenzulassungsgesetz (BörsenZulG) ) altered the Stock Exchange Law to improve the quantity and quality of information required from companies for official trading on German stock exchanges. It also sought to bring unlisted companies into the so-called regulated market parallel to official trading, which could serve as a halfway house 5 6

Ibid. Heeb, Börsentermingeschäftsfähigkeit und Aufklärungspflichten, above n. 2, 13–14, 129.

88 Shawn Donnelly for companies considering listing on the official markets, and where they would be more visible for interested investors. However, a tax on stock trading was not removed until 1989.7 In the same year, the Kohl Government also attempted to promote shareholding among employees with the 1989 Vermögensbildungsgesetz.8 The Sales Prospectus Act of 1990 (revised in 1994 and 1997) sought to promote small shareholding through better and more complete information, while holding prospectus publishers accountable for the validity and completeness of the information contained in the document. At the same time, it reduced the period of time for which liability rules applied. Instead of being liable for a period of thirty years from the date of publication for inaccuracies (a measure which led to conservatism in releasing information), liability was capped at three years. With the establishment of the Securities Trading Commission (below), listed companies were required to deposit copies of the prospectus with the oversight body for free public access. The next revolution in German attitudes toward the stock market came with the passage of the 1993 Securities Trading Act (Wertpapierhandelsgesetz (WpHG) ). For the first time, legislation introduced the premise that insider trading hurt the public interest, since small shareholders would not have the opportunity to make decisions in light of important information about the company’s business fortunes. In doing so, the law placed principal emphasis on the constitution’s guarantees of equal opportunities for all in the market economy.9 The WpHG required companies and informed “insiders” to publicise information that could influence the price of company shares, and to refrain from trading while the information remained inaccessible to the public. In addition, it established a federal oversight body, the Securities Trading Commission (Bundesaufsichtsamt für den Wertpapierhandel (BAWe) ), to which all trading in securities must be reported, and which is responsible for alerting prosecutors to offences. The Second Financial Market Promotion Law of 1994 was designed in part to fine tune reporting and supervision procedures.10 The interesting aspect of the WpHG is that the European Community had inspired and promoted the development against German wishes. The Kohl Government actively fought a European Community initiative to issue a directive to coordinate and upgrade insider trading laws. It wanted to retain the voluntary guidelines on insider trading that had been in place. It only relented in 1989 when it became apparent that refusing to agree to and implement the directive could do irreparable damage to the German economy through underdevelopment of a German capital market. Even then, the complexity of negotiating 7 U Koch, W Jensen, and S Steinhoff, Going Public: Recht und Praxis der Börseneinführung Unternehmen (Cologne, Velag Kommunikationsforum, 1999), 274–5. 8 V Dickersbach, Das neue Insiderrecht der Bundesrepublik Deutschland vor dem Hintergrund des europäischen Gemeinschaftsrechtes, Dissertation (Freie Universität Berlin, 1995), 31. 9 Ibid., 30. 10 Bundesaufsichtsamt für den Wertpapierhandel, Jahresbericht (Frankfurt, 1995).

The Public Interest and the Company in Germany 89 insider trading regulation with the Länder delayed implementation past the 1992 deadline, until 1994.11 In 1997, the Kohl Government’s legislative agenda moved more decisively toward reliance on stock market investment for economic growth and development, and accordingly, greater attention to shareholder interests. Discussions surrounding the Third and Fourth FmFG focused on possibilities for increasing the presence of institutional investors in the German capital market as a source of venture capital, and in encouraging small and medium-sized enterprises to enter the stock market rather than remaining private limited companies.12 In all of these cases, the Kohl Government sought ways of pursuing higher levels of economic growth and employment through the development of a deeper and wider capital market, meaning a capital market with more investment funds and more stock corporations respectively.13 Finally, the 1998 Control and Transparency Act (Gesetz über Kontrolle und Transparenz im Unternehmensbereich (KonTraG) ) introduced a comprehensive set of organisational requirements designed to improve the quality of information about company performance, supervisory board control of management reporting, and to ensure the right of shareholder groups with a quorum to demand an independent audit of company activity.14 Given the developments in favour of small shareholders since 1989, it is somewhat surprising that the Kohl Government did not introduce measures to ensure that small shareholders would be treated equally in the event of a take-over bid, or to prevent company managers from fighting off take-over bids. Germany updated its Take-over Guidelines to a Take-over Code (Übernahmekodex) in 1989, which recommended that investors attempting to acquire a controlling interest in a company offer the same terms to all shareholders. However, legislation to make the recommendations mandatory was not introduced on the grounds that compulsion was unnecessary. The Code was broadly accepted by the business community by 1995. However, even companies which commit themselves to the Code are not committing themselves concretely to refrain from introducing “poison pills” or other defensive measures in the event of a take-over bid, nor does the Code cover “private” offers that do not lead to a shareholder acquiring 50 per cent of the voting shares.15 In 1999, the Schröder Government began considering legislation to codify the terms contained in the Take-over Code. Upcoming research will seek to shed light on the Government’s public interest considerations in making the changes, and in particular, the extent to which take-over rules will resemble British 11

Dickersbach, Das neue Insiderrect, above n. 8, 25–6. Bundesministerium der Finanzen, Drittes Finanzmarktförderungsgesetz: Diskussionsentwurf eines Gesetzes zur weiteren Fortentwicklung des Finanzplatzes Deutschland (Bonn, 3 April 1997). 13 Bundesministerium der Finanzen, Zweiter Bericht für das Bundeskabinett zu dem Konzept der Koalitionsfraktionen “Globale Kapitalmarktpolitik für mehr Beschäftigung” (Bonn, 1998). 14 Bundesministerium für Justiz, Mitteilungen (Bonn, 28 April 1998). 15 G Thoma, Der neue Übernahmekodex der Börsensachverständigenkommission (Institut für Handels-und Wirtschaftsrecht, Arbeitspapier 9/96, 1996). 12

90 Shawn Donnelly protection of minority shareholder rights. In February 1999, an expert committee (Börsensachverständigenkommission) recommended that the Übernahmekodex be replaced by a law to ensure a “level playing field” for all investors, on account of poor corporate adherence, and a continuing dominance of insider interests in the market for corporate control.16 On balance, German governments seem to have adopted the assumption that the benefits of a shareholder-oriented financial market outweigh the disadvantages. Consequently, legislation has imposed a series of new measures that compel corporations to provide more information to the broad shareholding public, and that identify insider trading for the first time as an offence and enforce restrictions. These measures were taken under the Kohl Government with the hope that a deeper and wider financial market would finance a more robust corporate economy, and in turn, lead to better economic growth and employment. It remains to be seen, however, whether the Schröder Government shares its predecessor’s desire to place its weight fully behind shareholder interests by legislating the voluntary take-over rules that have been largely ignored since 1995. Another unknown factor for the future of shareholding in the German corporate economy concerns the development of German private pension funds that are not connected to an employee’s place of work. Although both SPD and CDU approve of such a change, promotion of private pension funds would require changes to the German tax code that would make life insurance policies relatively less attractive than they are at present. In early 2000, this problem had not been solved, nor was a legislative response in sight.

CORPORATE RESPONSIBILITY

Over the course of the twentieth century, German companies acquired responsibilities toward employees that affected not only their behaviour, but also their internal structures and standard operating procedures. The most important development was and remains the constitutionalisation of the firm,17 through which employees gained the right to consultation on, and in some cases, participation in setting company policy with regard to working conditions. The earliest councils were imposed by the state to force cooperative behaviour by unions and management that would facilitate maximum production of coal—a goal of immense public importance in the first years of the twentieth century—and then production for the war economy in 1916. In the Weimar Republic, the Social Democrats elevated the importance of cooperation through the councils, and a corresponding sense of company responsibility to a recognised public interest in its own right, while the National Socialist 16

Handelsblatt, “Gesetz soll Übernahmekodex ersetzen” (2 February 1999). See S Donnelly et al., The Public Interest and the Company in Britain and Germany (London, Anglo-German Foundation, 2000). 17

The Public Interest and the Company in Germany 91 dictatorship banned the councils as an affront to the leadership principle, or Führerprinzip.18 The Federal Republic followed the example of the Weimar Republic by relegitimating cooperation through the councils, and strengthened its impact on the company through co-determination. Employee representation on the supervisory board was firmly constitutionalised for large firms in the 1950s and for medium-sized firms in the 1970s, with the strongest power-sharing in the coal and steel industries. Although business generally met both councils and codetermination with scepticism and even hostility when they were first introduced, employer organisations have long since recognised the legitimacy of both forms of employee representation.19 An important change to the governance of company-employee relations in the last two decades lies in the accrual of additional responsibilities to works councils. The increasing workload is bound up with the heightened public interest in protecting and promoting workplace safety through national and European regulation. Since works councils must participate in developing and implementing company policy with regard to working conditions, they are increasingly called on to help manage new workplace issues that are made pressing because of the changing nature of work. The increasing reliance on electronics and computers in the workplace, for example, has led to European regulations on display screen exposure that works councils must participate in implementing. Just as easily, the proliferation of laptop computers could involve works councils if employers expect employees to take computer work home or on business trips. As the workplace changes, so are the responsibilities of works councils likely to change and grow accordingly. Works councils may also acquire new responsibilities because of changed perceptions of what issues may legitimately be addressed in the workplace. In the 1990s, works councils fought for and were granted by the country’s labour courts the right to deal with so-called mobbing incidents. Mobbing, which undoubtedly existed beforehand but was not considered a pressing issue in the German workplace, refers to the practice of driving employees out of the firm through sabotage of work and psychological warfare. In some cases, co-workers afraid for their own jobs were considered to be at fault, but more often, supervisors were accused of using mobbing to force employees out who would otherwise have been difficult to fire under the country’s lay-off protection laws (Kündigungsschutz). Either way, increased pressure from management to realise productivity gains with fewer employees, coupled with stronger fears of unemployment, combined in the 1990s to put a new public concern on to the corporate governance agenda. 18 W Fischer, “Labor-Management and Industrial Relations in Germany, 1870–1930,” in Keiichiro Nakagawa (ed), Labor and Management (Tokyo, University of Tokyo Press, 1979). 19 H Kotthoff, Betriebsräte und Bürgerstatus: Wandel und Kontinuität betrieblicher Mitbestimmung (Munich, Rainer Hampp Verlag, 1994).

92 Shawn Donnelly A second change in the management of employer-employee relations at the macro level is the decreasing share of companies in the economy that have works councils in the first place. Employees in smaller companies and in highgrowth sectors such as information technology and media are unlikely to have works councils. In addition, companies in the new states of the reunified Germany are much less likely to have works councils than their counterparts situated in the old states. This does not mean that companies are freed from the responsibilities that other firms have toward their employees, but rather that regulations are brought to bear through cases brought by individual employees before an industrial tribunal. Turning to co-determination at the executive level, there are two trends that tend to qualify the influence of employees in the supervisory boards of German companies. The first is the fact that German corporations have discovered that they can reduce the influence of employee representatives on the supervisory board by reorganising its committee structure. The current legislation, the Codetermination Act of 1976, mandates that employees constitute one-third of the supervisory board in medium-sized companies (from five hundred employees) and one-half of the board in large companies (from 2,000 employees), in which the employer holds a tie-breaking vote. In exercising its freedom to organise the committee structure as it pleases, boards increasingly delegate supervisory functions to subcommittees in which the balance of participation may not reflect that of the entire board. So, for example, particular issues may be delegated in a large corporation to subcommittees of three persons in which employee representatives have only one vote. The second trend, as in other countries, is that small and medium-sized enterprises are gaining in importance for employment in the German economy, with a corresponding impact on co-determination activity at the executive level. The impact is small, and perhaps temporary, but worth noting nevertheless. The 1970s were also the period in which legislation began to reflect a concern for the treatment of women in the workplace, beginning with, but not limited to, the issue of equal pay for equal work and work of equal value. However, pay remained unequal for reasons of wage law. The right to equal pay depended on how unions and employers agreed to evaluate the contribution of a particular position in the company—a right granted to them and protected constitutionally by virtue of their autonomy in setting wage levels. For a long time, unions and employers’ organisations colluded to value jobs carried out principally by women at a lower rate. Often, they justified higher rates of pay for strenuous manual labour and skilled shop labour than for office work on grounds of their inherently greater value. In the 1990s, both the Federal Labour Court and the European Court of Justice directed unions and employers’ organisations to change this method of calculation to reflect the real contribution that employees make with office skills.20 Consequently, new jurisprudence ensured that 20 For information on the German and European legal situation, see Bundesministerium für Familie, Senioren, Frauen und Jugend, Frauen in der Bundesrepublik Deutschland (Bonn, 1998) and

The Public Interest and the Company in Germany 93 anti-discrimination measures developed a much higher profile on the corporate governance agenda in the 1990 without a change in the applicable statutes. Greater company responsibilities and cooperative decision-making were also introduced in the 1990s in the areas of job protection and workplace safety for employees who are expectant mothers, and workplace harassment. In particular, the Kohl Government dealt with measures designed to help make parenthood more compatible with the workplace. Some provisions are external to the firm, such as the right to day care. As quality of life issues, in-firm measures are naturally handled by works councils. The principal in-firm measure is the right to an extended leave of up to five years with a guarantee of reemployment under the 1995 Mothers’ Protection Act (Mutterschutzgesetz). In addition, the Government encourages businesses to allow for flexible working arrangements to accommodate expectant mothers, extending to the context of collective bargaining in the works council.21 In doing so, the Government hoped to improve the quality and stability of relations between firms and their employees, and that firms would realise gains in productivity and corporate image as a result of their commitment. A broad spectrum of policy patterns and precedents has not been set with regard to the compatibility of family and work, however. This suggests that it is likely that it will be some time before an accepted body of practice is adopted on family-friendly policies, but that adoption will proceed much more quickly and thoroughly in companies that have works councils. Outside the firm, the 1994 Women’s Promotion Act (Frauenförderungsgesetz) set up women’s affairs officers at every level of government, who then are responsible for promoting equality in their communities. Companies, in turn, are responsible for ensuring that women’s affairs officers can speak with a designated officer in the company.22 This is, in theory, a considerable step forward in altering the governance in German companies with regard to women’s issues in the workplace, although it is not known how extensively the model is exercised. The establishment of external and internal officers provides an opportunity for the company to develop an overview of relevant policies, and to engage in dialogue with the works council, if present, with the advocacy of a government agency in the background. Although unions take equality issues in the workplace more seriously than they once did, the existence of a separate advocate provides a degree of insurance that public interest pressure can be brought to bear on the company. A Krämer, Die Gleichberechtigung im europäischen Arbeitsrecht (Aachen, Shaker Verlag, 1997). For analysis of the situation in wage negotiations and contracts, see Deutscher Gewerkschaftsbund, Gleichstellung in Tarifsverträgen und Betriebsvereinbarungen (Düsseldorf, 1998), and Tarifpolitik gegen Entgeltdiskriminierung (Düsseldorf, 1996). 21 Bundesministerium Frauen, Senioren, Familien und Jugend, Frauen in der Bundesrepublik Deutschland, above n. 20. 22 Deutscher Bundestag, Wortprotokoll der öffentlichen Anhörung zum Thema “Stärkung des Kapitalmarktes Deutschland, Förderung des Aktiensparens und Verbesserung der Risikokapitalversorgung,” des Ausschusses für Wirtschaft (Bonn, 4 June 1998).

94 Shawn Donnelly Environmental protection is a public concern that touches German companies extensively. Article 1 of the Constitution requires the state to intervene to protect the environment for the good of humankind, and to repair damage.23 The Federal Ministry for Environment, Conservation and Reactor Security and the Federal Environmental Office (Umweltbundesamt (UBA) ) see themselves as guardians of the public interest as they apply to corporate behaviour, and impose both external and internal requirements on companies. In addition to protecting current public interests, the federal ministry views itself as the guardian of future interests as well. Neither of these bodies work alone. They set the framework within which state authorities regulate company behaviour, and within which regional chambers of industry and commerce cultivate a culture of environmental management. This means not only that concrete environmental goals are brought into the decision-making process, but also that businesses are encouraged continually to improve the impact of business procedures on the environment. Regulation follows three main principles: the precautionary principle, or Vorsichtsprinzip, which requires businesses to alter products and processes to prevent environmental damage; the causal principle, or Verursacherprinzip for assigning liability for environmental damage, and the cooperation principle, or Kooperationsprinzip, in which state and business should dynamically improve knowledge of and capacity to handle environmental challenges.24 Environmental regulations are spread among several laws. A comprehensive Environmental Code was in preparation during the last Kohl administration, but has since been stalled by the Schröder Government. In the 1970s, public interest agendas forced German companies to step up their responsibilities for environmental protection. The earliest legislation, dating from the 1970s, required companies to provide and regularly update information on the environmental impact of their operations, to secure approval from state regulatory authorities working under federal and state guidelines, and to submit to inspections in case of complaint. In addition, the legislation required companies to appoint an environmental officer, who would be responsible for ensuring the availability of information, and who would guarantee that oversight bodies had a concrete dialogue partner for investigations. The introduction of environmental officers was seen as the best means of ensuring improved corporate governance in environmental issues without directly regulating companies, which at the time the Government saw as increasingly problematic.25 23 M Sträter and G Mandak, “Germany”, in Dennis Campbell (ed), Environmental Hazards and Duties of Disclosure (London, Graham and Trotman, 1994), 217, at 220. 24 Ibid., at 218. 25 M Blecher, “Environmental Officers: Management in an Ecological Quality Organization” in G Teubner, L Farmer and D Murphy (eds), Environmental Law and Ecological Responsibility: the Concept and Practice of Ecological Self-organization (Chichester, John Wiley and Sons, 1994), 238.

The Public Interest and the Company in Germany 95 The environmental officer is responsible for ensuring corporate compliance with legal requirements, innovating procedures with regard to their environmental impact, and communicating with agencies, government, environmental organisations and employees through works councils. According to Blecher, there is evidence that corporate management structures have accepted the officer’s role and absorbed its functions into management culture.26 However, there is some evidence (discussed below) that many companies did not take the role of the environmental officer seriously enough to make a full-time, qualified appointment. The 1974 Federal Emissions Prevention Act (Bundesimissionsschutzgesetz (BImSchG) ) requires companies fully to disclose plans to establish enterprises, including relevant details of the production process, with the exception of justifiable business secrets. The information must be sufficient to allow oversight bodies to fulfil their functions and include all material available to the environmental officer. Until 1996, the firm had to provide updates at least every two years, highlighting changes from the last report, with enough information to allow the authorities to check. In addition, certain operations must provide an annual emissions report.27 The 1976 Water Management Act (Wasserhaushaltsgesetz (WHG) ) works from the premise that the public interest demands prevention of water pollution in all forms, and that water use requires permission from state authorities. The only restriction on the duty to provide information is the protection from selfincrimination in the Constitution. The 1976 Waste Disposal Act (Abfallgesetz (AbfG) ) requires companies to draw up waste disposal plans, and does not have specific prescriptions, other than that reports must be clear and complete for state supervision. Hazardous materials are covered by the Chemicals Act (Chemikaliengesetz (ChemG)), which identifies reporting and responsible parties in only a general way, but which also follows the same principle of obligatory, clear and complete information to the appropriate authorities.28 Environmental responsibilities are buttressed by prosecution under the Criminal Code (Strafgesetzbuch (StGB) ), rather than general environmental law. About 35,000 cases are handled yearly involving various sorts of pollution and endangerment. Information and proof is a state responsibility.29 Since 1990, the federal government has taken several measures that impose stricter responsibilities and higher expectations on German companies, reflecting the higher public interest profile of environmental protection. The 1990 Environmental Liability Act (Unwelthaftungsgesetz (UmweltHG) ) tightened the responsibility of companies for the effects of their production processes. Sträter and Mandak describe the rules as a general no-fault liability regime for environmental effects caused by particular complexes and which additionally 26 27 28 29

Ibid. Sträter and Mandak, “Germany”, above n. 23, at 224–33. Ibid., at 235–46. Ibid., at 252–4.

96 Shawn Donnelly obligate a small circle of complex owners to insure against liability risk.30 Exceptions from liability are allowed for damage considered reasonable in the region, but not damage to persons.31 In the case of claims, the injured party has a right to information from the plant from its operators, with the exception of business secrets. Unlike other laws, the UmweltHG provides managers with no protection against withholding information on the grounds of self-incrimination.32 Also innovative were the introduction of liability for damages that occurred unintentionally, the first use of the Ursachevermutungsprinzip principle, which allowed authorities to assume that a particular site had cause the damage if it was capable of doing so, and the right of the authorities to examine production processes and spill sites in the course of an investigation. Liability was capped at DM 160 million for damage to third parties, but unlimited for damage to the environment for all but the most hazardous industries.33 Taken together, these measures allowed both government and the general public (through the courts) to impose a degree of responsibility and transparency in environmental management that had not existed beforehand. In 1993, companies were also compelled to contribute to reduction and/or recycling of packaging, principally through participation in the Green Point System. Companies were charged a membership fee that varies with the amount of packaging generated to finance recycling programmes. This cost has led German companies to factor packaging reduction into their production and marketing strategies. But the story of corporate responsibility toward the environment is not only about control and liability, but is also mixed with government concern about the cost of environmental protection. In 1996, the Kohl Government introduced new measures that relaxed control on German enterprises, with the explicit intent to simplify and lighten the burden on new investment. Businesses gained the right to a response from state authorities within three months of submitting an objection to a ruling, the right to waive a permit for changes to processes with minimal impact on the environment, and the requirement to submit updates every four years rather than every two.34 The real test for German companies, however, is whether they accept and cultivate the need to take environmental impact concerns seriously in all of their business practices. This would require building up the environmental officer’s role within the corporation into a position that undertakes reform independent of government guidelines. During the 1990s, government initiatives to mandate 30 Facilities devoted to “heat or energy production, mining operations, chemical production, and refining and processing of mineral oils, as well as refuse incinerators, landfills, and facilities for storing and disposal of hazardous materials”: ibid., at 248. 31 The “local conditions” rule would allow less stringent environmental protection for industrial areas in the new Länder, which were heavily polluted in 1990, and slowly improving. 32 Sträter and Mandak, “Germany”, above n. 23, at 249–51. 33 Die Wirtschaft, Police für den Störfall ist ein muß (31 August 1995). 34 Deutscher Bundestag, Gesetz zur Beschleunigung und Vereinfachung immissionsschutzrechtlicher Genehmigungsverfahren (Drucksachen 13/5643, 1996).

The Public Interest and the Company in Germany 97 the expanded activity of environmental officers and their co-determination of business decisions launched a debate with the business sector over legal compulsion and the public responsibilities that companies have toward the environment. The earliest measures to encourage companies to review their business practices were prompted by EU directives, and poorly defined. The law of 12 February 1990, which implemented the EC Directive of 27 June 1985, encouraged German businesses to undertake voluntary environmental impact tests (Umweltverträglichkeitsprüfungen). However, testing standards were not defined in any detailed way.35 The Kohl Government introduced a stronger impetus for encouraging testing in 1995, when it passed EU-inspired legislation, the Environmental Auditor and Business Site Registration Act (Umweltgutachter- und Standortregistrierungsgesetz (USG) ) to encourage companies to undergo environmental impact audits, known commonly as eco-audits, or as EMAS. For the first time, the Government promoted the possibility of ensuring certification for companies which achieved certain standards of environmentally friendly behaviour, by setting out the processes to be investigated, and the rules by which auditors could be recognised as such. Companies have had the ability since then to exploit commercially the public relations value of efforts to introduce environmental management, and there is some indication that companies are taking the expertise and competence of environmental officers more seriously, as is reflected in the higher demand for qualified people since then.36 The EMAS eco-audit system replaces the “command and control” model with an approach that combines self-regulation with transparency and cooperation. Emphasis is on active prevention, and on promoting competition in consumer markets through ecological certification. The audit requires a complete review of environmental impact, processes, and measures taken, encompassing the entire logistic chain.37 The USG’s direct impact has been small in absolute terms, but large indirectly, and much stronger than elsewhere in the European Union. Seven hundred and twenty-nine German companies had undergone ecoaudits by 1997, eleven times the number of the runner-up (Sweden), and twenty times the number in the United Kingdom.38 However, the direct intervention of federal government has remained limited. On the one hand, business associations successfully ensured that the eco-audits would remain voluntary and as free as possible from government involvement. The responsibility for supervising and certifying auditors was kept out of the hands of the Federal Ministry of Environment and placed in the hands of a new 35 36

Sträter and Mandak, “Germany”, above n. 23, at 245–8. “Nachfrage nach Umweltmanagern wächst weiter,” Blick durch die Wirtschaft, 6 Octover

1995. 37

Blecher, “Environmental Officers”, above n. 25, at 252–7. “Umwelt und Qualitätsmanagementsysteme gewinnen immer stärker an Bedeutung”, Blick durch die Wirtschaft, 26 November 1997. 38

98 Shawn Donnelly German Certification and Environmental Auditor Licensing Association (Deutsche Akkreditierungs- und Umweltgutachterzulassungs-gesellschaft mbH (DAU) ), which would be led by the German Chambers of Industry and Commerce and colleges of the liberal professions.39 In addition, the environmental association BUND and the Institute for Ecological Economic Research (Institute für Ökologische Wirtschaftsforschung (IÖW) ) have sprung into the market to provide consulting services for businesses looking to upgrade environmental protection in business management. Finally, state governments remained free to promote auditing as they saw fit. Hessen’s SPD-Green Government, for example, introduced standardised eco-audits with certification by summer of 1995.40 While there is considerable progress, there is also evidence that German companies are being cajoled into environmental management as much as they are willingly embracing it. Blecher points out that businesses have responded in part to the fact that German courts are increasingly referring to environmental standards such as ISO 14001 and DIN/ EN standards when deciding tort cases under the UmweltHG.41 Furthermore, the company’s responsibility to control risk under tort law has required companies to ensure the environmental officer’s independence from management, in order to prevent conflicts of interest that could result in criminal and civil negligence.42 Moreover, both the BUND and the IÖW suggest that many companies are simply interested in the public relations advantage of having undergone an environmental audit rather than actually reducing the impact of their operations on the environment. They reported in 1997 that many companies shied away from the audit once they feared that they would compare poorly with others in the annual rankings of environmental reports, and that some who performed poorly threatened to sue the scientists undertaking the audits.43 The aggressive approach of state governments to implementing environmental management practices seems to be crucial in explaining why German companies, despite their modest performance in absolute terms, are far ahead of their EU counterparts. State environmental authorities have increasingly given companies the choice between intrusive regulation of their business activities as they apply to environmental protection, or to submit to an independent audit. Both the BUND and the German Chambers of Industry and Commerce, or DIHT, have greeted this proposal as a means of improving the prospects for cul39

“Friewillige Umweltprüfung in den Betrieben”, Süddeutsche Zeitung, 5 April 1995. M Grabenströer, “Umweltzertifikat soll Betriebe anspornen”, Frankfurter Rundschau, 17 August 1995. 41 Blecher, “Environmental Officers”, above n. 25, at 251. 42 Heinz Adams gives an example of a firm that voted its chief executive officer to act as the company’s environmental officer, after pressure from state authorities to appoint one. This conflict of interest, in which the CEO was responsible for supervising himself, violated the company’s responsibilities under the UmweltHG. See “Im Gewissenskonflikt”, Blick durch die Wirtschaft, 3 April 1996. 43 “Der Deal mit dem Öko-Audit,” Frankfurter Rundschau, 25 November 1997. 40

The Public Interest and the Company in Germany 99 tivating environmental management, while reducing government regulation and supervision of business activities.44 No single environmental code exists in Germany, though the Kohl Government was working toward this before leaving office in 1998 in the form of an Umweltgesetzbuch (UGB). After proposals by the UBA dating back to 1978, the Kohl Government announced its intention in 1991 to legislate the code. The UGB was designed to consolidate and harmonise environmental regulations into a single, coherent body of law devoted to environmental protection and improved implementation. In would trade stronger environmental protection for a streamlining of the regulation process to contain the cost to German business. Blecher suggests that management culture regarding environmental policy has changed from Fordism/Taylorism to total quality management, which focuses on continuous improvement rather than standard operating procedures.45 The evidence since 1995, however, suggests that this is not the case. More often, companies view environmental performance information as being of only limited use. Certification may enhance the company’s public profile, but they also tend to reject extensive publication of environmental impact information in the annual report, or even ranking of environmental protection performance as unreasonable demands of a few activists rather than measures to comply with a compelling public interest.

CONCLUSIONS

German firms have developed a denser and more active institutional structure to deal with a variety of public interest concerns in the last several years. Although the public interest agendas surrounding the interests of shareholders and employees with regard to the company have changed considerably, the response has been strongly conditioned by existing structures and institutions. Works councils are acquiring greater importance for the firm, where they exist, and are seen as an alternative to direct regulation to deal with employee concerns in general and the differentiated concerns of women in the workplace. A new interest in promoting shareholding has not resulted in a rejection of institutions and practices that shielded the corporate economy from the influence of capital markets, but in a selective modification of the entire system that endows shareholders with new rights and strengthens institutions through which to exercise them. They can rely as much on the supervisory board to protect their interests as on universal banks to represent them faithfully and on the Securities Trading Office to seek out and punish unfair trading practices. 44 See, e.g., Bavaria and Schleswig-Holstein in “Bayern nutzt Öko-Audit zum Bürokratieabbau”, Handelsblatt, 11 September 1996 and “Wer beim Öko-Audit mitmacht, wird weniger kontrolliert”, Hamburger Abendblatt, 25 March 1997. 45 Blecher, “Environmental Officers”, above n. 25, at 246–8.

100 Shawn Donnelly Alongside these traditional structures, new ones are developing to deal with the more recent public interest concerns of environmental protection and equal treatment. The symbiotic relationship between responsible officers and outside advocates in the public or NGO sector is in an embryonic stage and often patchy. In part, this is because some of the new measures are voluntary, and in others, because there has been little interest in interfering in corporate governance on more than an ad hoc basis. In the future, the importance of these institutional innovations will depend on the intensity of the public interest agendas that stand behind them.

5 Worker Rights and Responsibilities in the Modern Company1 ROBERT TAYLOR

W

HAT RIGHTS AND voice if any should employees be entitled to enjoy inside the company they work for? This is not an abstract question. It ought to lie at the heart of any serious public policy discussion on the future of the modern firm in a democratic society and social market economy. After all, the nature of the employment relationship between companies and their employees has been the focus of attention since the emergence of the business enterprise under early capitalism during the nineteenth century. In the past it was invariably based on an implied or even explicit mutual contract of interest and convenience linking the forces of capitalism with those of labour. Such necessary accommodations have been reached not only through a commitment to tradition, convention, habit and inertia but as the direct result of both collective negotiation between employers and trade unions and joint regulation imposed by the state on the way workplaces are governed. Of course, the employment relationship has also always remained an inherently unequal one. Most workers on their own have lacked individually either the power and certainly the legitimacy to establish a clear domination over any relationship they might have with the enterprise that pays their wages. During the course of the twentieth century, however, different forms of workplace institution were established in companies which were designed to mediate the character of the employment relationship. Invariably, this was achieved partly through the emergence of formally structured industrial relations systems covering employers and trade unions at national, regional, sector, company or plant level. In many Western European countries laws were also introduced by governments to provide workers with rights and entitlements or at least provide benchmarks for the way workplace relations ought to develop. After the end of the Second World War in 1945 there was a growing and widespread trend to introduce regulations that required companies to establish consultative works 1 This chapter is based partly on the author’s “Partnership in the Workplace”, (1999) 6 New Economy 169.

102 Robert Taylor councils or other forms of employee representation as a method for maintaining a social dialogue between themselves and their employees, whether or not they were members of a recognised trade union. It was through this balanced mixture of legal regulation and voluntary negotiation that the unilateral power of management was modified in practice but it was always done without seeking to undermine or threaten business performance and profitability. Indeed, in many mainland European countries the provision of rights and responsibilities through legal action by governments was seen as a necessary means to ensure social cohesion and worker security. As a result the dangers of any direct attack by employees against the forces of the market were avoided or at least lessened in intensity. It is true the often autocratic character of mass production, with its subdivision of labour into specific and repetitive tasks, mass volume assembly line work and so-called scientific management techniques based partly on the theories of Frederick Winslow Taylor, did much to modify moves towards forms of industrial democracy that would have provided scope for genuine worker participation in key decision-making in companies. Only perhaps in Social Democratic Scandinavia was a genuine settlement or historic compromise reached between capital and labour that gave workers and trade unions a more substantial and legitimate participatory role in the making of decisions concerned with company performance. But during the 1990s a number of separate developments in the workplace have encouraged attempts to create a more equitable and humane relationship between employees and the companies they work for, making the encouragement of new forms of industrial democracy much more realistic and practical across the economies of advanced capitalism. The emergence of the new information-based knowledge and e-commerce economies centred on technological innovation has brought into question more traditional forms of work organisation based on mass production in large units with their hierarchical control and command power structures. It is true that a wide gulf still remains between the positive-sounding rhetoric about employability and worker empowerment beloved of human resource management literature, and the grimmer realities of many workplaces with their more intrusive forms of managerial control over the behaviour of individual workers. New forms of work in IT-dominated offices have precipitated the greater incidence of cardiovascular injuries, stress and mental breakdown and workplace disciplines have also grown more pervasive with refined methods of surveillance. However, a range of recent impressive evidence provides encouraging proof that companies are more likely to achieve a better business performance in terms of profitability and productivity if they seek to engage with the human needs of their employees through providing them with clear rights and responsibilities in the workplace. In its 1999 annual Employment Survey the Paris-based Organisation for Economic Cooperation and Development revealed, for example, that the business enterprises most likely to be developing new forms of flex-

Worker Rights and Responsibilities in the Company 103 ible work organisation were those which had created vigorous representative institutions inside their workplaces, whether in the form of employee-based consultative committees, recognised trade unions or a combination of both. From the use of job rotation processes to the introduction of team-working, from the downward delegation of responsibility by management to individual employees and work groups to the introduction of quality circles and total quality management schemes, it seems both trade unions and works councils, or employee advisory and consultative committees, can provide competitive advantage to companies in the negotiation of necessary workplace change.2 A European Union report published in 1998 on the management of corporate change under the auspices of former Volvo chief executive Pehr Gyllenhammar has provided further signs of the importance of social dialogue to the wellbeing of the workplace, with insights into the spread of a more progressive entrepreneurial way of thought among a growing number of companies about their sense of corporate responsibility towards their employees. This approach has grown more dominant in many progressive companies in mainland Europe since the early 1990s. As the Gyllenhammar Report argued: “There is, of course, a delicate balance between voluntary action and legislation, between public and private, between flexibility and security. We are acutely aware of that balance and of the need for citizens to feel basic security in taxing times. We would therefore stress the requirement that the private sector take responsibility for developing and adopting best practice. It should realise that investment in people is profitable and that trust between employees and employers is a prerequisite for success”.3

The Gyllenhammar study gave strong approval to the encouragement of a closer relationship within companies between their directors and employees. It argued this was a sensible way of ensuring an effective response in private enterprises to economic and social change. The report suggested that the systematic development of social dialogues at different levels, from the workplace to the institutions of the European Union, was fundamental to managing change and preventing negative social consequences and deterioration of the social fabric. Social dialogue ensures a balance is maintained between corporate flexibility and workers’ safety, it suggested. The Gyllenhammar study also made some sensible recommendations for reform by companies and governments. It suggested that companies ought to be encouraged to produce an annual report for their workers on employment and working conditions. This would, it suggested, enable the wider spread of best practice through benchmarking, comparability exercises and the sharing of information. However, the Report opposed the use of compulsion on companies to introduce such a reform, mainly because it feared that this would make it more likely that companies would hold back from innovating and taking the lead. But it was proposed that framework agreements for managing change 2 3

OECD Employment Outlook (June 1999). Gyllenhammer Report (European Commission, November 1998).

104 Robert Taylor should be adopted by large companies which would cover a wide policy agenda including education and training; worker health and safety; equal opportunities; structural change and communication and involvement. Central to all of this was the encouragement of greater employee information and consultation structures in companies. As the Gyllenhammar Report explained: “top performing enterprises have a good social dialogue with their employees because motivated people are the vital component for commercial success. Regular, transparent, comprehensive dialogue creates trust”. But it also suggested this did not simply mean consultation with employees over the social consequences to them of corporate restructuring or technological innovation but also in the formulation of broader and longer-term industrial and employment strategies. Such a progressive view is light years away from the narrow, limited and timid discussion on the subject we can find from the Centre-Left in the United Kingdom. However, it illustrates just how vitally important active workplace consent has become to the modernisation of companies struggling to prosper in competitive product markets. Further evidence of this can be found in the 1998 government-commissioned inquiry carried out in Germany into that country’s co-determination system (worker representatives on two-tier company boards).4 To many outside critics the German social market model has become the object of attack and derision for being allegedly too slow-moving and therefore increasingly obsolete in the new information economy where speed of decision-making is paramount and no time exists for cumbersome and bureaucratic decision-making procedures to satisfy a democratic imperative. But the Commission Report suggested that co-determination has actually proved to be surprisingly flexible in helping German firms to innovate. While it is true that it also recommended co-determination structures in companies and works councils should adapt themselves to the challenge of keeping down corporate costs, by making decision-making swifter and ensuring a rapid response to marketdriven innovation, the Report also called for joint action by management and employee directors and works councils to enable firms to push through necessary workplace change without having to face the prospect of shop floor resistance. Similar findings also indicate that the strength of the workplace-based enterprise committees in French companies help to facilitate workplace modernisation through cooperation. Such practical contemporary mainland European experience is of crucial relevance to the UK public policy debate over corporate governance and what the responsibility of private companies should be towards the accommodation and assertion of worker voice at a time of rapid economic and industrial change. At the beginning of the twenty-first century it is time for a revival of the discussion that first began more than thirty years ago in the United Kingdom over the introduction of democratic values in the development of the modern company. 4 The German Model of Co-Determination and Co-Operative Corporate Governance: An Evaluation of Current Practice and Future Prospects (Max Planck Institute, Cologne, 1998).

Worker Rights and Responsibilities in the Company 105 In doing so we need to go back, first of all, to the important debates that took place in 1976–1977 around the official publication of the report from a government-appointed committee of inquiry into industrial democracy chaired by the distinguished Oxford historian, Alan Bullock. This was the last occasion when this important issue was at the centre of any serious public policy discussion. Bullock and all his colleagues argued that the burning question was not whether there was a trend towards the cause of greater participation by employees in the affairs of the companies they worked for, but what the pace ought to be for what was widely assumed to be inevitable change, and the need to ensure industrial democracy was extended to ensure employee representation on company boards. The self-proclaimed objective of the Committee at that time was remarkably bold for the British industrial relations scene. As the Bullock Report argued their majority proposals were designed no less than to place the relationship between capital and labour on to a new basis, which would involve not just management but the whole workforce in sharing responsibility for the success and profitability of the enterprise.5 The Bullock Committee argued that the way to raise the level of productivity and efficiency in British industry was to provide the representatives of workers with a real, and not a sham or token, share in making the strategic decisions about the future of the enterprise, which in the past had been reserved to management and the representatives of the shareholders. The report accepted what was being proposed by the majority of the committee would not be a panacea in eliminating conflict from industrial relations. But it did believe it would release energies and abilities at present frustrated or not used and thereby create a framework which would allow conflicts of interest to be resolved with greater mutual advantage. “Sooner or later, we believe, this is a decision which will have to be taken, whatever government is in power”, declared the majority report. It went on to say that the change of attitude of the TUC and their willingness to accept a share of responsibility for the increased efficiency and prosperity of British companies offered an opportunity to create a new basis for relations in industry which should not be allowed to pass. Well aware of the historic importance of their proposals, they concluded with an eloquent defence of their recommendations: “The fears expressed in the nineteenth century in face of proposals to give more people the right to vote did not stop short of the subversion of the constitution and the dissolution of society. Once the franchise was extended, however, the fears were forgotten and the Reform Acts were seen as essential to the country’s stability and prosperity. We believe that over a hundred years later the extension of industrial democracy can produce comparable benefits and that our descendants will look back with as much surprise to the controversy which surrounded it as we do to that which surrounded the extension of the political suffrage in the nineteenth century”.6

5 Department of Trade, Report of the Committee of Inquiry into Industrial Democracy (Cmnd 6706, London, 1977). 6 Ibid., at 161–2.

106 Robert Taylor Such optimism expressed by the majority of the Bullock Committee may have been misplaced, even at the time of the social contract between the Labour Government and the trade unions which placed industrial democracy at the core of its policy agenda. Many of the largest and most powerful trade unions were opposed to the committee’s majority recommendation for the creation of a socalled “2x plus y” formula on company boards made up of equal numbers of shareholder and employee representatives with a swing group of independents. Critics in the unions believed such a device would blur the important distinction that existed between the independent role of trade unions as bargainers and managers and lead to a genuine confusion of strategic purpose among employees about who was ultimately responsible for company decision-making. Employers were virtually unanimous in their hostility to what was being proposed, fearing the report was a scarcely veiled attempt to extend trade union power into the decision-making processes of private companies and thereby weaken the free market system. The Labour Government was also divided over the Committee’s report. Many Cabinet members were doubtful about either its practicality or the need for any urgency to act on its recommendations. It was finally decided to refer the whole matter to a Cabinet committee. The resulting White Paper, published in 1978, turned out to be a pallid and unconvincing response to the Bullock Report and the whole issue died the death as a result of Labour’s 1979 general election defeat. But the long-forgotten minority report of the Bullock inquiry, drawn up by the Committee’s employer representatives, suggests some employers at that time were not completely hostile to the extension of the concept of worker participation in British industry. Although they rejected the Bullock majority proposals, the employer representatives on the Committee argued for forms of industrial democracy that were more than a simple capitulation to strong sectional pressure. They called for an increased accountability by management for the human, material and financial resources which the community makes available to industry and a more openly expressed concern for the rights and interests both of shareholders and employees. The employers concluded: “Everyone who works in industry has a part to play in this task. We recognise that greater involvement in many aspects of decision-making is a rational aspiration of a work force which is better educated and better informed than ever before and we believe a greater degree of appropriate involvement of employees in company affairs and a greater agreement on company objectives should lead to improved relationships and help to produce a more efficient, a more competitive British industry”.7

Their declared preference was for the introduction into UK corporate governance of a West German-style system of two-tier board structures for private companies employing 2,000 or more workers. Supervisory boards would be established by law below the main board level in each enterprise, with one-third 7 Department of Trade, Report of the Committee of Inquiry into Industrial Democracy (Cmnd 6706, London, 1977), at 171.

Worker Rights and Responsibilities in the Company 107 of its members each coming from the workforce of the company, its shareholders and independents. In an appendix to their recommendations the employer members of the Bullock Committee made an observation that undermines much of the resistance to such worker participation from companies we have witnessed in the intervening period. As they argued: “We would not expect the task of legislating in the UK for a special category of company with a two-tier board structure to be any more difficult than that of defining in statutory terms the respective functions of the board and management under a unitary system”.8

With hindsight it would have made political sense for the Labour Government to accept the employers’ minority report and legislate on their recommendations. Certainly the willingness of prominent employers such as Barrie Heath, chairman of Guest, Keen and Nettlefolds; Sir Jack Callard, former chairman of Imperial Chemicals Industries and then of British Home Stores; and Norman Biggs, formerly chairman and chief executive of Esso Petroleum and then of Williams & Glyn’s Bank, to suggest such a proposal indicated a surprising willingness on their part to respond in a flexible and positive manner to the recommendations of the majority Report. What is undoubtedly true is that no such radical set of proposals has ever emerged again from any group of employers since the publication of the Bullock Committee’s Report. But the fundamental issues raised by the public policy debate over industrial democracy in the 1970s have not gone away. Indeed, they have returned to trouble Tony Blair’s New Labour Government. In the intervening years the relationship between the modern company and its employees has certainly grown more complex and problematic. A number of reports—Hampel, Greenbury and Cadbury—have been published on corporate governance during the 1990s but they have produced only modest recommendations and enjoyed limited influence. All of them, in addition to a well-meaning but ineffectual report commissioned by the Fabian Society,9 rejected any suggestion of mandatory regulation to ensure a degree of employee participation in company decision-making as was evident in much continental European corporate governance. Instead, they favoured the encouragement of voluntary moves being made by employers to improve the transparency of their business transactions, especially over the remuneration and redundancy packages made to executives and senior management. Many enterprises continued to reward their higher level personnel with wage and benefits six times as high as those for the rest of their employees. The extraordinary generosity in what was often a process of selfaggrandisement in companies was unrestrained by appeals to equity or shared effort and values. Even proposals to promote generalised mission statements by companies, proclaiming their noble if vague intentions to take into greater account the importance of employees to the success of their business activities, were not accepted across most of UK industry. As in so many areas of employ8 9

Ibid., at 189. Fabian Society, Changing Work (London, 1996).

108 Robert Taylor ment relations, the commitment to the encouragement of a voluntary approach meant in practice next to nothing of consequence being done. Of course, there have been some changes in corporate governance since the 1970s. We have witnessed in the United Kingdom the uneven but steady expansion of different forms of employee consultation among companies. Modern human resource management theory has emphasised the practical sense for companies to abandon traditional forms of work organisation that are rigid, overcentralised and hierarchical. The introduction of flatter, more inclusive company decision-making structures is seen as a more rational response to the changing demands of corporations in the face of conflicting pressures from product markets, competitors, technological change and the need for a better educated, trained and adaptable labour force than in the past. But there is an obvious danger in exaggerating the amount of existing involvement by workers in most UK companies. Behind the hyperbole and propaganda the picture looks much less convincing. Outside unionised workplaces, consultation with employees is limited. The 1998 official workplace employee relations survey found that the sometimes predicted advent of employee representatives in workplaces without union members has simply not materialised. In 1990, 11 per cent had them and in 1998 the proportion was little different. Non-union workplaces were also less likely to have in place various forms of direct participation with employees.10 Can the modern company reconcile its need to be commercially successful on behalf of its shareholders, who now often include many pension and other institutional funds, with efforts to ensure job satisfaction and participation and a sense of social equity among its employees? Such a question ought to be at the centre of any public policy debate on the future of the business enterprise in open market economies under the impact of globalisation. In fact, recent empirical evidence from Europe as well as the USA suggests that the most effective business performance can be found inside companies that are able to integrate their economic with their social objectives, or at least ensure a clear balance is maintained between them.11 But it is not always so self-evident that the introduction of a holistic or comprehensive human resource management strategy can guarantee a company instant positive results or even prove a conditional necessity to achieve and maintain a competitive advantage over business rivals. Nonetheless, it is widely assumed that a company is much more likely to secure trust, commitment and cooperation if it treats employees as human beings and not as disposable assets to be discarded arbitrarily with any downturn in market performance. Improved productivity, business efficiency and stock market valuation depend to a considerable extent on how companies behave and interact with their own employees. 10 11

M Cully et al (eds), Britain at Work (London, 1999). TUC, Partnership at Work.

Worker Rights and Responsibilities in the Company 109 Such an observation might sound like a pious truism. But it remains surprising just how few private companies, at least in the USA and the United Kingdom, are ready to pursue enlightened programmes of mutual self-interest to advance employee participation, whatever lip-service they might pay in their inclusive rhetoric to the values of social partnership. What needs to be examined in any prescriptive approach to the company and its relationship to the workplace is the degree to which it will be necessary to encourage the creation of new institutions within and around the company that can stimulate a new approach, one that seeks to achieve a genuine synthesis in the interaction between market forces in the wider political economy with the needs and demands of employees as much as shareholders. This problem is not new on either side of the Atlantic. Nor is it sensible to juxtapose the socially responsible and regulatory approach to be found in many European firms with the untrammelled, neo-liberal corporate culture emanating from most American companies. A polarisation of view between one enterprise model and another is based on a simplistic and flawed analysis of the wide variety of nuanced responses to economic success and worker wellbeing that can be found in many companies in both the USA and mainland Europe. What needs to be assessed, however, is whether a reform of company law and new forms of social regulation can provide a minimum public policy framework within which the modern enterprise can thrive through the integration of its different objectives to the satisfaction of employees, customers, suppliers and shareholders alike. The European Union has wrestled with this problem since the early 1970s but so far it has done so without much noticeable success, not least because of the persistent difference of opinion between Member States about what can be achieved through EU-wide legislation on company obligations. The draft European company law statute and the EU Directive on European Works Councils provide examples of what may turn out to be a more rigorous approach. Recent regulation requiring companies to consult their employees over cases of mass redundancy and transfer of business ownership is more evidence of the new direction being pursued on corporate governance. The European Commission is keen to take the cause of employee participation in company decision-making a step further by bringing into force a draft legally-binding directive on information and consultation for workers employed in all enterprises operating inside the EU that employ fifty people or more. In practice, this would mean the exclusion of as many as 97 per cent of companies from its provisions. The Commission explained the case for such a reform in an exploratory memorandum on its proposal: “The vast majority of EU member states have a statutory or negotiated legal framework establishing information and consultation procedures at various management levels (establishment, undertaking, groups of undertakings)”.12 But the Commission argued that such rights embodied in the domestic legislation of many 12

European Union draft directive on information and consultation, 1999.

110 Robert Taylor Member States were not always respected in practice. Moreover, employee representatives were often involved too late in the decision-making process in the firm when economic decisions had to be made that precipitated adverse social consequences on the workers involved. The introduction of mandatory information/consultation committees or works councils of the kind the European Commission envisaged was seen in Brussels as a way of encouraging preventive and support strategies in companies that faced painful problems of restructuring and redeploying labour. The proposed committees would therefore not be ad hoc reactive and temporary bodies in the workplace hastily assembled to deal with a specific and sudden crisis, but permanent institutions contributing to the success of the undertaking. There is strong opposition in the United Kingdom to such a proposal. The Government argues that the draft directive is in conflict with the principle of subsidiarity—that companies should be left alone to devise their own ways of consulting with their employees and not become subject to any universally mandated regulation that would restrict their room for flexibility. But in practice in the United Kingdom, such workplace consultation methods are already in place over collective redundancies and the transfer of business undertakings. A similar commitment can also be found in the United Kingdom’s health and safety regulations in unionised workplaces. In other ways, the United Kingdom is witnessing a more enlightened approach to employee voice. A more promising advance seems probable in the encouragement of employee share ownership (ESOPs) in publicly quoted companies. It is estimated there are as many as 11,000 such schemes and share bonus programmes operating in companies covering nine million employees across the country. The growth of ESOPs may be less dramatic in Western Europe, but in social market economies like Germany and Sweden they are becoming more common despite those who fear such devices will encourage greater worker individualism and undermine social cohesion and workplace solidarity. In fact, the concept of social partnership in the workplace is growing more common in the United Kingdom as trade unions see the value of this kind of approach to the needs of worker voice and corporate responsibility. With the encouragement of the Trades Union Congress they are promoting agreements with companies that emphasise the need for much more information and consultation with employees in return for a commitment to workplace flexibility and improved productivity. It is true that most trade unions in the recent past did not preach or practise the class war in the workplace. They sought—mainly through voluntary negotiations with employers—to protect their members and improve their wages and conditions of employment. The improvement of company performance through productivity agreements and negotiation of workplace innovation and technological change is not something that suddenly erupted onto the British industrial relations scene during the 1990s. There is a long, if unwritten, history of the accommodations and bargains that have characterised the country’s voluntarist system that goes back into the nineteenth century.

Worker Rights and Responsibilities in the Company 111 But it is also true that the spread of more formalised and structured partnership agreements across today’s workplaces indicate a much more professional, focused and rational approach to the resolution of problems through consensus and a commitment to mutually agreed common objectives. All the shop floor opinion surveys of recent years tend to suggest that employees, whether they belong to a trade union or not, favour workplace partnerships, at least in theory. There is little evidence of deep antagonisms between workers and the companies who employ them. On the contrary, most workers believe they have as much concern as their employer to ensure they are participating in a business success. The TUC has drawn on the empirical experience of existing partnership agreements to lay down a set of principles with which to test the authenticity of such arrangements. There must be a shared commitment to the success of the enterprise between the company and its employees. Legitimate and divergent interests in the workplace must be settled through trust and respect. There must be a commitment from the company to employment security as well as an acceptance by workers of the need for job flexibility and training. The company must pledge itself to improve the quality of working life. Finally but perhaps most important of all, a genuine workplace partnership must provide added value to the company measured by profitability, productivity and other tangible benchmarks of successful business performance. However, if such partnership agreements are going to be more than documents of pious and well-meaning good intentions, they will need to be rooted in tangible change. Signing up to best practice, enhanced business performance and continuous employee improvement must involve the introduction of strong commitments by companies to consult, inform and listen to their employees in a systematic way. What we need to see is the encouragement of a new form of workplace-based voice for employees. But it must reflect the necessity of balance. On the one hand, workers need access to representation in flexible workplaces but on the other they must be willing to adapt to the demands of commercial and technological change. Social pacts, whether regulated or voluntary, have to reconcile the democratic rights of employees for security and fairness with reassurances to employers on the need for flexibility. This must mean the encouragement of mutual gains arrangements in companies focused on minimum frameworks of what constitutes “decent” or “good” work. If this is left merely to verbal exhortation it seems unlikely it will make much progress. Law is needed as a catalyst for workplace change, if only as a last resort. But the main emphasis needs to be on strategic alliances between companies and their employees that accept the paramount importance of competitiveness, productivity and profitability. It is in that wider economic policy framework that we need to assess the rights and responsibilities of companies towards their employees. Indeed, only a synthesis between business efficiency and social justice can make much practical sense in the success of the modern enterprise. The closing of the “representation

112 Robert Taylor gap” in the workplace is a prerequisite for recasting the employment relationship. But it cannot be achieved if it is done in a way that endangers the wellbeing of the company. Fortunately, mainland European experience provides incontrovertible evidence that industrial democracy is not incompatible with corporate modernisation. Indeed, experience from both sides of the Atlantic suggests credible alternatives do exist to the exclusively shareholder short-termist model of winner-take-all forms of capitalism based on swift decision-making, individualistic values and limited concern for the rights and responsibilities of employees. The widening disparities of wealth and income between the rich benefactors of our contemporary gilded age suggest the time is long overdue for the creation of countervailing forces to moderate, if not civilise, the uncontrollable forces of globalisation. Embedding new flexible rules and regulations into the running of modern workplaces should be seen as only a part, though an important one, of a much wider public policy agenda which is needed urgently on both sides of the Atlantic to tame the excesses of global capitalism.

6 The Conceptual Foundations of the Company: a Pluralist Approach1 GAVIN KELLY and JOHN PARKINSON

T

HE SYSTEM OF company law in the United Kingdom (and the USA and a number of Commonwealth countries) affords overriding importance to the interests of shareholders. Such systems have periodically been criticised, from a number of standpoints. The arguments have included that there should be a redistribution of the risks and benefits of business activity among those involved in the enterprise, a reduction in the harmful impact of company behaviour on third parties, and a broadening of participation in corporate decision-making to reflect a “democratic imperative”2 or to increase accountability. In what follows we set out a case for the recognition of a wider range of interests in company law which is based on the requirements of efficient wealth creation. We seek to show that the current governance structure in which the shareholders are the exclusive beneficiaries of governance rights (by which we mean the rights to have the company run in their interests and to appoint the board) does not fulfil the efficiency claims that are made for it by the economic analyses of the company that dominate the law and economics literature. In so doing we draw on a developing body of scholarship which challenges the assumption on which the traditional analyses rely, that only the shareholders bear residual risk, that is, risk against which the relevant parties cannot obtain full protection through contract. The approach we adopt does not dispute the efficiency of linking governance rights to risk-bearing, but rather holds that if there is a plurality of groups who are exposed to residual risk, then this should be reflected in how corporate objectives are formulated and in the design of corporate governance structures. In arguing for governance rights for non-shareholders on efficiency grounds, we do not suggest that efficiency should necessarily take precedence over other values in company law. There may be additional justifications for increasing the 1

This is a slighly amended version of an article of the same title that appeared in (1998) 2 CfiLR

174. 2 See Commission of the European Communities, Employee Participation and Company Structure in the European Community, Bull Supp 8/75 (Brussels, 1975).

114 Gavin Kelly and John Parkinson number of groups who benefit from governance rights, and different or more extensive rights than those supported by an efficiency rationale might be warranted. These issues are not, however, our present concern, though it does emerge from our argument that reforms inspired by democratic theory or the demands of distributive justice, contrary to the predictions of the conventional economic analyses, need not necessarily exact a high price in terms of efficiency foregone. The first part will briefly examine the standard economic justifications for allocating governance rights to the shareholders exclusively. This account serves as the backdrop to what we shall call the “pluralist critique”, which holds that a number of groups, and not just the shareholders, are potentially exposed to residual risk. This is described in the second part. In the third part the implications of a pluralist model for corporate objectives and governance structures are examined. The fourth part, by way of conclusion, considers why, if pluralist governance arrangements are more efficient than shareholder-exclusive ones, they have not been spontaneously adopted across a broad scale.

JUSTIFICATIONS FOR SHAREHOLDER EXCLUSIVITY

Before considering the economic case for shareholder exclusivity, it may be noted that the traditional justification for the shareholders’ favoured position, which is still frequently invoked,3 is that they possess antecedent rights, as the company’s owners, to have it operated in their interests and ultimately to control it. The ownership rights which shareholders enjoy over their capital contributions are regarded as being carried through into the enterprise, so that when shareholders invest they become part-owners of the company itself.4 It is then held to follow that the shareholders’ rights in the company should be upheld for the same moral, political, and economic reasons as apply to any other proprietary relationship in a market economy.5 This is not the approach adopted in modern economic analyses of the company. The economic perspective views companies as webs of relationships, not 3 See, e.g., Report of the Committee on the Financial Aspects of Corporate Governance (“the Cadbury Report”) (London, 1992), para 6.1; CBI, Boards without Tiers: A CBI Contribution to the Debate (London, 1996), 8. 4 For a recent example of this position, see Elaine Sternberg, “Stakeholder Theory Exposed”, (1996) 2 Corporate Governance Quarterly (no 1) 4. 5 It can be argued that even if the company is rightly regarded as being owned by its shareholders, it is a much more complex form of property than the usual subjects of property rights because of the wide range of interests that are involved, and therefore that the moral case for upholding ownership rights does not apply in the same way as it does in relation to “simple” property: see Martin Lipton and Steven A Rosenblum, “A New System of Corporate Governance: The Quinquennial Election of Directors”, (1991) U Chi Law Rev 187, at 192. See also Lynne L Dallas, “Working Toward a New Paradigm” in Lawrence E Mitchell (ed), Progressive Company Law (Oxford, 1995) 35, at 37–8, arguing that shareholders do not need ownership rights in companies in order to attain “human freedom and security” (a standard justification for upholding property rights).

The Conceptual Foundations of the Company 115 as objects distinct from their participants, and therefore as an inappropriate subject matter for ownership rights.6 It might be added that even if the provision of finance by the shareholders made them the owners of the assets used in the business (which, as a matter of law, it does not),7 it would not follow that they should be treated as the owners of the company itself, for the same reason. As Kay points out, a company is not just made up of tradeable assets, but also “a structure of internal relationships among the staff, and a collection of external relationships with suppliers”, and these are incapable of being owned.8 It is true that the legal rights that the shareholders currently enjoy are consistent with an ownership relation, but it is precisely these rights that the argument that the shareholders are the owners of the company seeks to justify. The proposition that shareholders are owners because they have control rights, and that because they are owners, they should have control rights, is invincibly circular.9 If the shareholders’ exclusive enjoyment of governance rights is justified, the justification must, therefore, lie other than in the idea of antecedent rights of ownership. Instead of relying on the inherent rights of the shareholders as owners, economic explanations for the exclusive allocation of governance rights to shareholders point to the efficiency of that arrangement.10 The dominant theory of the company among law and economics scholars views the company as a nexus of contracts. That is, the company serves as the common party to contracts with managers, shareholders, lenders, employees, suppliers, and customers. It is simply a legal device to facilitate contracting between these groups, allowing them to set the terms on which they are prepared to supply the firm’s inputs and on 6 See, e.g., Eugene Fama, “Agency Problems and the Theory of the Firm”, (1980) 88 J Pol Econ 288, at 290. It is well established as a matter of law that companies are legal persons separate from their shareholders. It is much less clear that it makes sense to regard the corporate body as capable of being owned. It is suggested in Paul L Davies, Gower’s Principles of Modern Company Law (6th edn, London, 1997), 301, that at law the “company itself is treated not merely as a person, the subject of rights and duties, but also as a res, the object of rights and duties”. Once it is accepted, however, that the shareholders do not own the company’s assets, and that the company itself has the status of being a legal person, the idea that the company is a res as well seems either empty or a contradiction. 7 It was established in Bligh v. Brent (1837) 2 Y & C Ex 268 that shareholders have no proprietary interest in the company. The earlier analysis had been that in an incorporated company, while legal title to the assets was in the company, beneficial ownership was vested in the shareholders: see Paddy Ireland, “Capitalism without the Capitalist: The Joint Stock Company Share and the Emergence of the Modern Doctrine of Separate Corporate Personality”, (1996) 17 Legal History 40 and generally, Paddy Ireland, “Company Law and the Myth of Shareholder Ownership”, (1999) 62 MLR 32; Ross Grantham, “The Doctrinal Basis of the Rights of Company Shareholders”, (1998) 57 CLJ 554, at 562–4. The modern position is as stated in Short v. Treasury Commissioners [1948] 1 KB 116, at 122, per Evershed LJ: “[s]hareholders are not, in the eye of the law, part owners of the undertaking. The undertaking is something different from the totality of the shareholdings”. 8 See John Kay, “The Stakeholder Corporation”, in Gavin Kelly, Dominic Kelly, and Andrew Gamble (eds), Stakeholder Capitalism (Basingstoke, 1997), 125, at 131. 9 See Margaret M Blair, Ownership and Control: Rethinking Corporate Governance for the Twenty-First Century (Washington, 1995), 223–5. 10 There is in economics an important literature which analyses the company in terms of the efficient allocation of property rights (see below n. 35), but this approach does not regard the shareholders as possessing an antecedent right to be treated as owners.

116 Gavin Kelly and John Parkinson which they are to be remunerated for so doing. Two, largely complementary, versions of the nexus of contracts theory will be briefly set out. The first, “pure” version, is an adjunct to agency theory and stresses the efficient consequences of coupling governance rights with the right to the firm’s residual income.11 The second version, the origins of which lie in the work of Coase on the boundaries of the firm, conceives the company as a governance structure designed to safeguard at-risk investments.12 In contrast with the rights-based property theory, neither version regards the shareholders’ exclusive possession of governance rights as inherent in their role as providers of capital. Rather, contract theory eschews the traditional foundation on which shareholder rights are legitimated in favour of an explanation which holds that the allocation of governance rights to shareholders, to the exclusion of the other parties to the enterprise, maximises the wealth of the participants as a group.

The nexus of contracts The challenge faced by the “pure” version of the theory is to explain why governance mechanisms should be designed to minimise agency costs arising only in the management/shareholder relationship, and not those occurring in relationships between management and other interested parties. The starting point involves an assessment of the party best able to bear risk. Because of uncertainty in the returns from the firm’s projects, there must be at least one party capable of absorbing any losses resulting from underperformance. It is argued that the shareholders are ideally suited to perform this function, and hence it is appropriate that the right to the firm’s residual income should be assigned to them. Other participants, notably employees, tend to be wealthconstrained and so contract for fixed, immediate returns rather than for a share in the uncertain surplus remaining after the other parties have been paid. Further, the providers of the firm’s equity are able to reduce their exposure to firm-specific risk by holding a diversified portfolio of shares, and as a result are 11 The seminal works are Armen A Alchian and Harold Demsetz, “Production, Information Costs and Economic Organization”, (1972) 62 Am Econ Rev 777 and Michael C Jensen and William H Meckling, “Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure”, (1976) 3 J Fin Econ 305. See also Fama, “Agency Problems and the Theory of the Firm”, above n. 6, and Eugene Fama and Michael C Jensen, “Separation of Ownership and Control”, (1983) 26 J L & Econ 301. This is a “pure” version of the theory in that it conceives the firm as having no institutional content: contracting among participants in the firm is not different in kind from external, market contracting: see Oliver Hart, “An Economist’s Perspective on the Theory of the Firm”, (1989) 89 Colum L Rev 1757, at 1763–5. 12 See Ronald Coase, “The Nature of the Firm”, (1937) 4 Economica 386; Oliver E Williamson, The Economic Institutions of Capitalism: Firms, Markets, Relational Contracting (New York, 1985), esp ch 12. For a comparison of the “pure” and transaction-costs versions of the contract approach, see Oliver E Williamson, “Corporate Finance and Corporate Governance”, (1988) 43 J Fin 56, reprinted in Williamson, The Mechanisms of Governance (New York, 1996), ch 7. See also William W Bratton Jr, “The ‘Nexus of Contracts’ Corporation: A Critical Appraisal”, (1989) 74 Cornell L Rev 407, at 417–23.

The Conceptual Foundations of the Company 117 more efficient risk-bearers than other groups, who may already be “overinvested” in the firm, for example, by reason of having acquired human capital specific to the enterprise which would be lost if the firm failed.13 The rest of the argument depends on the efficient consequences of allocating control rights to those who enjoy the firm’s residual income. First, it is maintained that the group that faces the greatest risk has the most powerful incentive to monitor management. Since the shareholders obtain a return only after other claims have been satisfied, but then enjoy an unlimited right to the surplus, they are regarded as having appropriate incentives to ensure that management conducts the business with vigour and competence.14 Secondly, it is contended that it is the shareholders alone, as holders of the right to the firm’s residual income, who have the incentive to ensure that management pursues policies which maximise the total value of the firm.15 Where there is one residual claimant and the other parties receive fixed returns, maximising the residual is the same as maximising the total value received by all of the parties, and hence maximises social wealth.16 Affording control rights to other groups would compromise valuemaximising behaviour on the part of management. Lenders and employees, for example, as fixed claimants, would wish the company to enter into only those ventures that increased the security of their claims, and would oppose projects that were riskier but which offered potentially higher returns. Efficiency demands not only that control rights be allocated to shareholders, therefore, but also that they be allocated to them exclusively. If it were otherwise, “people who did not receive the marginal gains would be influencing corporate discretion, and the influence would not maximise the wealth of the participants as a group”.17 This analysis does not deny that agency problems might also arise in relationships between managers and participants other than shareholders. For 13 See Louis Putterman, “Ownership and the Nature of the Firm”, (1993) 17 J Comp Econ 243, 246–8. 14 Owing to the incentive and collective action problems that arise when holdings are widely dispersed, the shareholders’ control function is not depicted as involving participation in the company’s internal control mechanisms, but takes the low-cost form of “exit”, with supervision of management being effected by means of the market for corporate control. See Frank H Easterbrook and Daniel R Fischel, The Economic Structure of Corporate Law (Cambridge, Mass, 1991), 68, 171–4. 15 It is often argued that if employees had the right to the residual they would cause the firm to be operated in a way that did not maximise wealth. In essence the charge is that worker controlled firms will adopt restrictive employment policies in order to maximise income per worker, will underinvest (assuming workers’ interests in the firm are not marketable), and will be less effective in controlling shirking, because of free-rider problems. See Jaroslav Vanek, “The Basic Theory of Financing of Participatory Firms” in Jaroslav Vanek (ed), Self-Management: Economic Liberation of Man (Harmondsworth, 1975); Alchian and Demsetz, “Production, Information Costs, and Economic Organization”, above n. 11, at 782. It has been suggested that all of these problems are capable of being solved through the adoption of an appropriate ownership structure: see, e.g., Louis Putterman, “On Some Recent Explanations of Why Capital Hires Labor”, (1984) 22 Economic Inquiry 171; Blair, Ownership and Control, above n. 9, ch 8. 16 See Paul Milgrom and John Roberts, Economics, Organization and Management (Englewood Cliffs, 1992), 291–3. 17 Easterbrook and Fischel, The Economic Structure of Corporate Law, above n. 14, at 69. See also Fama and Jensen, “Separation of Ownership and Control”, above n. 11, at 302–3.

118 Gavin Kelly and John Parkinson example, management, acting in the shareholders’ interests, might unilaterally increase the riskiness of the company’s existing debt by taking on new borrowing, making distributions to shareholders, or adopting policies to which a higher business risk is attached than originally envisaged.18 Such actions not only decrease the value of existing debt claims, but also in some circumstances reduce the total value of the firm.19 Similarly, management might seek to boost the returns to shareholders by discharging employees who have implicit, but not legally enforceable rights to deferred remuneration.20 Notwithstanding the possibilities for post-contractual opportunism of this kind, it is argued that non-shareholder groups can adequately protect themselves through ordinary market contracting and so do not require additional safeguards in the form of governance rights. Thus, “workers, bondholders, even local communities can protect their interests by contracting for the right to veto future proposed actions by management”.21 It is acknowledged that as a practical matter some of these groups may fail to secure appropriate ex ante safeguards. For example, obtaining enforceable provisions guaranteeing continuity of employment is likely to prove too costly for employees, since the employer will often require in exchange a substantial cut in wages. The point that is stressed, however, is that whatever the actual outcome may be,22 contractual protection is technologically feasible for fixed claimants (the only obstacle is price), whereas shareholders’ interests cannot be adequately safeguarded by conventional contracts because of the open-ended character of their right to the 18 See Morey W McDaniel, “Bondholders and Corporate Governance”, (1986) 41 Bus Lawyer 413; “Bondholders and Stockholders”, [1988] J Corp Law 205; Oliver Hart, “An Economist’s View of Fiduciary Duty”, (1993) 43 U of Toronto L J 299, at 305–6. 19 See Jonathan R Macey and Geoffrey P Miller, “Corporate Stakeholders: A Contractual Perspective”, (1993) 43 U Toronto L J 401, at 407–9. It follows that shareholders are not the only group in all circumstances with the correct incentives to influence management: ibid., at 409, but see these authors’ rejection of the proposition that non-shareholders should have governance rights, discussed below. 20 One explanation of the gains from take-over is that they result from breaches of these implicit contracts. See, e.g., A Shleifer and L H Summers, “Breach of Trust in Hostile Takeovers” in A J Auerbach (ed), Corporate Takeovers, Causes and Consequences (Chicago, 1988), 33. 21 Macey and Miller, “Corporate Stakeholders”, above n. 19, at 417: e.g., “workers potentially could protect their expectations concerning wages with pension guarantees, golden parachute contracts, stipulated cost of living adjustments, and other straightforward provisions”. 22 Macey and Miller contend that while making non-shareholder constituencies the beneficiaries of fiduciary duties would provide them with some protection against management opportunism, nevertheless they would not contract for such protection. The unique contracting difficulties faced by shareholders mean that they value fiduciary duties more highly than other groups. The exclusive assignment of fiduciary duties to shareholders enables them to pay compensation “in the form of higher interest on bonds, higher wages to workers and managers, and better prices for suppliers and customers”: ibid., at 411. (For a criticism of this view, see below n. 78.) In any case, Macey and Miller suggest that the courts are able to lessen the exposure of non-shareholders to opportunism in that “to the extent that future, unforeseen contingencies arise that cast doubt on the efficacy of contractual protection, courts can protect workers by construing their employment contracts in the light of the original purposes behind the agreement”: ibid., at 417. Whatever the position may be in the USA, however, the conservative basis on which the courts are prepared to imply terms in the United Kingdom, by reference to the “officious bystander” test (see G H Treitel, The Law of Contract (10th edn, London, 1999), 183–8), offers little protection in this context.

The Conceptual Foundations of the Company 119 firm’s residual income. The complexity of management decisions, and particularly their contingency on unpredictable future circumstances, mean that value-maximising actions cannot be specified in advance, and unlike rights to a fixed return, residual rights cannot be protected by a simple veto power over management policy, but need the more positive forms of support that are associated with governance safeguards. The need for shareholder governance rights arises, in short, because of the problem of inevitable contractual incompleteness in the shareholdermanagement relationship.23 To remedy this incompleteness shareholders are held to require, first, the protection of fiduciary duties, which are regarded as a gap-filling device that allows ex post judicial monitoring of the exercise of managerial discretion. Secondly, they need the right to control the composition of the board, since in that way they can attempt to ensure that management serves their interests rather than management’s own interests or those of other groups.

The transaction costs version A related explanation for assigning corporate governance rights exclusively to shareholders is derived from transaction cost economics, which has as its basic premise that the main purpose of different forms of economic organisation is to economise on transaction costs.24 Given its behavioural assumptions of bounded rationality and opportunism, transaction cost theory seeks to identify the different contractual forms that will govern the relationships between the parties to the firm. In particular, it complements the pure nexus of contracts model by focusing on the contractual implications of asset specificity. In the standard case in which parties offer generic skills/resources to the company (that is, those that are fully redeployable to alternative uses without loss of value), contractual arrangements are straightforward: these transactions will occur in what Williamson labels classical or spot markets.25 Conversely when constituencies make specialised investments in the firm a “fundamental transformation” takes place which creates a situation of bilateral dependency. These constituency groups now bear firm-specific risk, meaning that they expose themselves to the threat of opportunistic behaviour by the company, and vice versa. In these circumstances the form of safeguards offered to the contracting parties becomes pivotal and creates the rationale for thinking of the company as 23

See Oliver Hart, “Corporate Governance: Some Theory and Implications”, (1995) 105 Econ Jo

678. 24

Transaction costs are defined for this purpose as “the ex ante costs of drafting, negotiating, and safeguarding an agreement and, more especially, the ex post costs of maladaptation and adjustment that arise when contract execution is misaligned as a result of gaps, errors, omissions and unanticipated disturbances”: Oliver Williamson, The Economic Analysis of Institutions and Organisations: in General and with respect to Country Studies, OECD Economics Department Working Paper no 133 (Paris, 1993), 56 (emphasis in original). 25 See Williamson, The Economic Institutions of Capitalism, above n. 12, ch 3.

120 Gavin Kelly and John Parkinson a governance mechanism. The transaction cost approach anticipates that the parties who make firm-specific investments—depending upon the nature of the risk—will either receive compensation in the form of a higher price for bearing it, or else demand access to a variety of non-price safeguards which range from contractual provisions imposing financial penalties for breach, to full integration within the firm (that is, the replacement of a market relation with a hierarchy).26 In addressing, first of all, the type of contractual relationship that emerges between a firm and its financiers, emphasis is placed on the degree of redeployability of the assets which the funds are provided to acquire. Assets which are generic in character can be financed through some form of loan or lease relationship. Such arrangements are thought to be inappropriate for firm-specific assets, however, because of their low collateral value.27 As a result debt finance would be available for the acquisition of these assets only at premium rates. It follows that if debt were the sole financing mechanism, firms would be motivated to rely on production technologies that involved more easily redeployable assets, but which were less well adapted to their purpose. Equity enters the analysis as a form of financing that avoids the limitations of debt (the problems over collateral and also its “unforgiving”, rule-bound character) as a means of facilitating investment in firm-specific assets. It is the extent of the firm-specific risk to which holders of equity are necessarily exposed that explains the exceptional nature of the contractual relationship between the suppliers of equity finance and the firm. That is, while other constituency groups may undertake some firm-specific risk, the shareholders are said to be the only group whose entire investment is placed at risk, in that they are required to part with their investment and place it under the control of management.28 Moreover, since the investment is made for the life of the firm, comprehensive ex ante contracting is impossible, and unlike the relationship with other stakeholders, it does not “come up for periodic renewal”.29 Because suppliers of this particular input face a unique risk of their investments failing, therefore, they will seek to hold extensive safeguards of an administrative rather than a market kind, 30 including the right to replace the board. 26 See generally ibid., esp ch 12; Oliver Williamson, “The Modern Corporation: Origins, Evolution, Attributes”, (1981) 19 J Econ Lit 1537. 27 See Williamson, “Corporate Finance and Corporate Governance”, above n. 12; Oliver E Williamson and Janet Bercovitz, “The Modern Corporation as an Efficiency Instrument: The Comparative Contracting Perspective” in Carl Kaysen (ed), The American Corporation Today (New York, 1996), 327, at 341–3. 28 This account is complicated by the distinction between risk borne by shareholders in aggregate and the more limited risk faced by a single shareholder who can rely on access to liquid capital markets. Williamson holds that because shareholders as a group cannot benefit from the same exit option as the individual shareholder, shareholders as a constituency should collectively be assigned control rights. See The Economic Institutions of Capitalism, above n. 12, at 304–5. 29 Ibid., at 304. 30 See Williamson, “Corporate Finance and Corporate Governance”, above n. 12, at 580–1 and 185.

The Conceptual Foundations of the Company 121 The same contractual approach is applied to transactions between companies and other constituency groups, with labour being a critical example. Workers with generic skills will have few if any contractual safeguards while those with a higher degree of firm-specific skills will be in receipt of matching protections.31 However, transaction cost theory maintains that employees with nonredeployable skills should not have access to the same type of safeguards as the providers of finance, namely corporate governance rights. This argument is premised on the belief that adequate, and indeed more effective because less “general purpose”, protections can be installed in the form of “incentives and specialised bilateral governance structures”32 between employees and the firm, which avoid the need for open-ended governance mechanisms, such as employee representation on the board of directors. One serious difficulty with this approach (acknowledged by transaction cost theorists) is the information asymmetry that exists between labour and management with regard to the firm’s operations. This impedes the writing of long-term contracts which adequately reflect the risk of adverse change.33 Managers might, for instance, conceal information about a forthcoming plant closure (which will affect the return to firm-specific human capital) for fear that disclosure will impair employee productivity. To overcome this problem the case is sometimes made for governance mechanisms that facilitate the flow of information to employees, but which stop short of giving them decision-making rights.34 These misgivings nevertheless remain marginal to the central thesis of the transaction cost approach: all nonshareholder constituencies can protect themselves from firm-specific risk through the design of appropriate contractual safeguards.

THE PLURALIST CRITIQUE

This part of the chapter sets out a case for a wider allocation of governance rights in the public company than is supported by the standard contractual analyses outlined above. In essence, the pluralist critique involves a rejection of the claim that is central to those analyses, that the shareholders are the only bearers of residual risk.35 The approach adopted is consistent with the 31

See Oliver Williamson, “Corporate Governance”, (1984) 93 Yale L J 1197, at 1207–9. Williamson, The Economic Institutions of Capitalism, above n. 12, at 303. 33 See Robert Howse and Michael J Trebilcock, “Protecting the Employment Bargain”, (1993) 43 U Toronto L J 751, at 754–6. 34 e.g., labour membership of the board of directors purely for information purposes: see Williamson, The Economic Institutions of Capitalism, above n. 12, at 303–4; Williamson and Bercovitz, “The Modern Corporation”, above n. 27, at 343–7, 349–51. Williamson argues that affording decision-making rights to groups which already have the benefit of bilateral safeguards is likely to be damaging, since it gives them leverage to extract concessions additional to those contracted for: ibid., at 311–12. 35 Much of the theory that underpins the pluralist approach to the company draws on and develops the contemporary “property rights” analysis of the firm. According to this perspective, the key aspect of ownership is the right to the residual control of an asset; someone who enjoys this right is, 32

122 Gavin Kelly and John Parkinson conventional contractual position in so far as it accepts that efficiency is best served when governance rights are held by those who bear the residual risk in an enterprise. It is the accuracy of the judgement about who are the residual claimants, rather than the incentive effects of uniting governance rights with risk-bearing, that is at issue. To that extent the pluralist theory is not a methodological innovation, so much as an attack on the normative proposals that have been drawn from conventional contract theory. At the same time, however, once a wider view of the allocation of risk within the company is adopted, it inevitably transforms our understanding of the interests the company should serve if it is to maximise social welfare.36 It should be stressed at the outset that while we see the value of viewing the company as a set of contractual relationships for the purpose of analysing the welfare effects of different allocations of risk, returns, and governance rights, this does not imply support for a variety of other positions with which contractual theories of the company are often associated. For example, contractual language is sometimes used to promote the view that the company is “private” and accordingly that regulation is an illegitimate intrusion into the affairs of those involved in companies (other than when its purpose is to lay down rules to which the parties would themselves assent, in order to reduce transaction costs).37 We would argue, however, that the company can be understood as by definition, an owner: “ownership of an asset goes together with the possession of residual rights of control over that asset; the owner has the right to use the asset in any way not inconsistent with a prior contract, custom, or any law”: Hart, “An Economist’s Perspective”, above n. 11, at 1765. See also Oliver Hart and John Moore, “Property Rights and the Nature of the Firm”, (1990) 98 J Pol Econ 1119; Oliver Hart, “Corporate Governance: Some Theory and Implications”, (1995) 105 Econ Jo 678; Putterman, “Ownership and the Nature of the Firm”, above n. 13; Henry Hansmann, The Ownership of Enterprise (Cambridge, Mass, 1996), esp at 11–16. “Residual control” does not refer to the ultimate right to exercise control over management by the ability to remove it. Rather, it is the right to fill in gaps that inevitably exist in contracts made between the company and all the nonowning parties with which it contracts. Agents who face risks that are particularly hard to insure against contractually will have the greatest incentive to acquire residual control rights to protect themselves from post-contractual opportunism and strengthen their bargaining position with regard to the distribution of the project’s rent. In addition to the central point argued in the text, two particular limitations of the property rights approach have led to its revision by pluralist theorists. First, it is argued that the notion of shareholders as residual controllers is more applicable to ownermanaged firms than large corporations with dispersed shareholdings. Secondly, much of the property rights school has focused on the role of vertical integration by firms as a response to the problems caused by strong co-specialisation between two sets of physical assets (which gives rise to bargaining issues over the distribution of rents). This is not an option when the firm-specific investment at issue is human, rather than physical, capital. 36 Simon Deakin and Giles Slinger, “Hostile Takeovers, Corporate Law, and the Theory of the Firm”, (1997) 24 J of Law and Society 124, at 129, make a similar point in their critique of Fama and Jensen’s seminal account, see above n 11, of the “survival value” of a single group (the shareholders) holding the right to residual claims. Deakin and Slinger contend that orthodox accounts of shareholder exclusivity need to go further and “show that shareholders are inherently more exposed to risk than other owners of inputs, before the structure of the corporation can be adequately explained on efficiency grounds”. They argue that contract theorists fail to do this. 37 For a discussion of the ideological role of contract theorising, see Victor Brudney, “Corporate Governance, Agency Costs and the Rhetoric of Contract”, (1985) 85 Colum L Rev 1403, at 1407–10; Bratton, “The ‘Nexus of Contracts’ Corporation”, above n. 12, at 432–46.

The Conceptual Foundations of the Company 123 much as a political as an economic phenomenon, and correspondingly that the state is entitled to adjust the terms on which incorporation is available. Similarly, while modelling the company as a set of discrete relationships provides insights into the efficiency of different governance arrangements, use of this model need not be to the exclusion of an alternative conceptualisation of the company as a social institution or organisation.38 The latter perspective is associated with different normative assumptions from those on which efficiency analyses rely. The “organisational” view can be used, for example, to support the conclusion that employees should be afforded rights in the enterprise on grounds of status, and not merely on the basis of exchange relations.39 The pluralist model: residual risk and contract The degree to which the pluralist model predicts or advocates outcomes (in terms of the distribution of risk and returns among corporate participants and of governance arrangements) which depart from the conventional contractual models, depends on the extent to which participants make investments that expose them to firm-specific risk that they cannot protect themselves against through contract. This invites a series of questions: why do these types of investment arise, why might it be difficult to deal with them through standard contractual techniques, and how important are they? Employees Firm-specific risk arises when stakeholders undertake investment which creates capital that is of value, or will retain most of its value, only within the context of a given firm.40 An important example is firm-specific human capital, though firm-specific risk may also be a feature of relationships between customers and suppliers, a situation which is discussed separately below. The simple case in which employees undergo training that allows them to operate a piece of machinery that is peculiar to a single company will serve to illustrate the implications of firm-specificity.41 In such a case the employees are exposed to 38 cf. Jensen and Meckling, “Theory of the Firm”, above n. 11, at 311, who liken the firm to a market and suggest that such questions as “does the firm have a social responsibility” are therefore “seriously misleading”. 39 See, e.g., Hugh Collins, “Organizational Regulation and the Limits of Contract”, in Joseph McCahery, Sol Picciotto, and Colin Scott, Corporate Control and Accountability: Changing Structures and the Dynamics of Regulation (Oxford, 1993), 91. 40 It can be argued that the complexity/impossibility of writing complete contracts when participants in the firm make these investments explains the very existence of corporate governance. That is, corporate governance systems arise precisely because arms-length contracting cannot offer adequate safeguards to suppliers of inputs. This view, which permeates much of the “new institutionalist” and pluralist accounts of the firm is fundamentally at odds with the purer strands of the nexus of contracts thesis. 41 See also Blair, Ownership and Control, above n. 9, ch 7, to which this account is indebted. For a seminal examination of the effect of firm-specific human capital on employment and training and

124 Gavin Kelly and John Parkinson firm-specific risk, since the human capital that results from their acquisition of specialised skills will be worth little or nothing outside the company.42 Not only that, the employees’ human capital and the machine become co-specialised, that is, the economic rent generated by each factor depends on the performance of the other in such a way that it becomes impossible to disentangle the respective contributions of the parties.43 The crucial point as far as the pluralist model is concerned is that as a result of co-specialisation, the pay that accrues to the employees in return for their acquiring firm-specific skills, contrary to the supposition of conventional contract theory, is no longer fixed, other than in the short term. Rather, the employees will participate in the total rent generated by the project, their share being determined by a bargaining game between themselves and the company.44 That is, because of co-specialisation each side has the capacity to “hold up” the other by threatening to withdraw from the relationship, with the consequence that the parties will obtain a proportion of the project’s rent reflecting their ability to deploy that threat. It is important to note that the total rent available for division between the parties will itself be variable, being dependent on such external factors as the cost of raw materials, demand for the company’s product, and the level of competition, and also on the skill with which the firm is managed. It remuneration, see Gary S Becker, Human Capital: A Theoretical and Empirical Analysis, with Special Reference to Education (New York, 1964). Some investments made by employees, e.g. the cost of moving to a location where there is no similar employment, do not generate firm-specific capital, but do expose employees to opportunism by the company. At least in principle, employees might contract to protect themselves from this kind of risk, e.g. by negotiating for moving allowances as part of remuneration. As will be discussed later, however, this solution is of limited value where investments are co-specialised in the sense described below. 42 Employees might bear the cost of training directly, from their own resources. Alternatively, training might be provided by the employer, but there is evidence in such cases that in the early phases of employment, when employees are acquiring firm-specific skills, they are paid below their opportunity wage, and thus indirectly finance the cost of training. See Katherine Van Wezel Stone, “Labour Markets, Employment Contracts, and Corporate Change” in McCahery, Picciotto, and Scott, Corporate Control and Accountability, above n. 39, 61, at 70–4 and the material cited therein. 43 An economic rent is the return received in excess of the minimum required in order to attract a factor of production (e.g. an employee) into a particular function. Once a project is running it may generate quasi-rents, that is, payments in excess of those needed to prevent a factor of production from exiting the activity. For simplicity we will refer below to rents alone. 44 The pay of employees who have made firm-specific investments can be regarded as consisting of two elements. One reflects the market value of their generic skills (i.e. what they could earn with another employer). The other is the proportion of the firm’s rents that are allocated to the employees, reflecting their higher productivity attributable to the acquisition of specialised skills. For empirical estimates of the importance of firm-specific human capital to earnings and the corresponding costs of job losses, see Robert C Topel, “Specific Capital and Unemployment: Measuring the Costs and Consequences of Job Loss” in Allan H Meltzer and Charles I Plosser (eds), Studies in Labor Economics in Honor of Walter Y Oi (Amsterdam, 1990), and Topel, “Specific Capital, Mobility and Wages: Wages Rise with Job Security”, (1991) 99 J of Political Economy 145. See also Andrew K G Hildreth and Andrew J Oswald, “Rent-sharing and Wages: Evidence from Company and Establishment Panels”, (1997) 15 J Labor Economics 318, which uses a longitudinal panel of company data to show evidence of a long-run relationship between wages and profits. Though the evidence of rent-sharing does not in itself demonstrate a return to firm-specific human capital, it seems to be more consistent with it than with other possible accounts of rent-sharing, such as those relating it to the level of unionisation.

The Conceptual Foundations of the Company 125 follows that the portion of the rent that is paid to employees as compensation for their specialised investments is a residual payment which is conceptually similar to the payments made to shareholders.45 This being the case, the employees share in the business risk associated with the enterprise.46 They have made an investment the returns to which are not fixed, but as with the returns to equity, are affected by firm performance. The second step in the pluralist argument concerns the difficulty of writing complete contracts to protect the interests of employees (and other participants) who have made firm-specific investments. If such contracts were feasible the pluralist model would be no more than a footnote to the nexus of contracts approach, emphasising the need for sophisticated contracts that are sensitive to firm-specific risk.47 Complete contracting is not, however, a realistic possibility. The employee interests that contract would need to protect include the following: first, continuity of employment, preserving the ability of employees to obtain a return on their human capital investments in circumstances in which they might otherwise be the victims of opportunistic termination; secondly, maintenance of an “equitable” distribution of project rent, particularly in the face of fluctuations in the total rent generated as a result of changes in external market conditions;48 thirdly, the company being well run, so that the aggregate rent earned by the project is maximised. It is evident that anticipating all the future contingencies that affect these interests, determining the response to such contingencies in advance, bargaining about them, and reducing the outcome to an enforceable agreement, would be impracticable.49 In particular, once it is 45 See also Milgrom and Roberts, Economics, Organization and Management, above n. 16, at 351: “with high levels of firm-specific human capital, the decisions taken by the firm place risks on employees’ human assets that are comparable to those borne by investors’ physical capital”. 46 See Blair, Ownership and Control, above n. 9, at 257: the returns on human capital are “not ‘fixed’, but contingent on the performance of the firm. Employees therefore are also ‘residual claimants’, who share in the risk associated with the enterprise”. 47 See, e.g., Alexander C Gavis, “A Framework for Satisfying Corporate Directors’ Responsibilities under State Nonshareholder Constituency Statues: The Use of Explicit Contracts”, (1990) 138 U Penn L Rev 1451, at 1473–91, advocating, inter alia, the use of “tin parachutes” (entitlements to severance pay). For an account of the formidable obstacles to the creation and enforcement of such provisions, see Stone, “Labour Markets and Corporate Change”, above n. 42, at 74–81. It should also be made clear that a variety of contractual devices are capable of encouraging parties to make some firm-specific investments, but this is not the same as encouraging an efficient level of firm-specific investment. See James M Malcomson, “Contracts, Hold-Up, and Labor Markets”, (1997) 35 J Econ Lit 1916. 48 As Margaret M Blair, “Corporate Governance for the 21st Century”, (1995) Challenge (November–December) 2, at 14–15 explains, there is inevitably a conflict of interest between shareholders and employees in this respect: “while the total economic surplus generated and captured by a company may be a function of technology and external market factors, the division of that surplus among all the parties that contribute firm-specific inputs is a matter of negotiation and bargaining strength among parties within the firm. And the significance of this fact for the debate about corporate governance is that, in any firm where firm-specific skills or knowledge are an important input (which is probably most firms), the employees’ share of the rents can always be increased at the expense of the shareholders, and vice versa: share value can always be increased at the expense of the employees”. 49 For a detailed account of these problems, see Milgrom and Roberts, Economics, Organization and Management, above n. 16, ch 5 and Blair, above n. 48, at 14–17.

126 Gavin Kelly and John Parkinson recognised that parties who make co-specialised investments receive returns an element within which is not of a fixed character, it becomes clear that protecting the interests of such parties through contract is no more feasible than protecting the interests of shareholders in that way.50 Macey and Miller’s argument, noted earlier, suggested that while in practice groups such as bondholders and employees may be unwilling to pay the price in terms of income foregone, it is technologically possible for them to obtain complete contractual protection for their interests in the company, by contracting for the right to veto management proposals. While this may be true as regards bondholders (whose claims are of a fixed nature, but who might nevertheless be vulnerable to opportunistic conduct on the part of management, acting in the interests of shareholders), it now seems clear that stakeholders who have made investments which are co-specialised with the firm’s physical or organisational capital cannot adequately safeguard their interests in this way. A veto is of value only in protecting the status quo. The point made by the pluralist argument is that the relationship between employees and the company is a dynamic one. The total returns to human capital cannot be fixed in advance, any more than can the returns to financial capital. As already discussed, the transaction cost approach acknowledges the obstacles to complete contracting where firm-specific investments are at issue. Williamson argues, however, that investments in human capital can be adequately protected through bilateral governance safeguards, such as collective bargaining (with associated grievance procedures and facilities for arbitration)51 and mutual “hostage-taking” (the making of reciprocal investments by the company that will be wasted if the company prematurely withdraws from the relationship).52 Yet Williamson’s confidence in these mechanisms for providing satisfactory protection for employee interests seems misplaced. There is, for example, little to suggest that unions through collective bargaining are capable of maintaining continuity of employment in the face of management decisions about corporate restructuring.53 Similarly, doubt has been cast on the 50 For a fuller account of the problems of obtaining contractual protection for human capital, see Margaret M Blair, “Firm-Specific Human Capital and Theories of the Firm”, in Margaret M Blair and Mark J Roe (eds), Employees and Corporate Governance (Washington, 1999), 58, at 73–4. 51 See Williamson, Economic Institutions of Capitalism, above n. 12, at 254–6. 52 See Oliver Williamson, “Credible Commitments: Using Hostages to Support Exchange”, (1983) 73 Am Econ Rev 519, reprinted in Williamson, The Mechanisms of Governance, above n. 12, ch 5; Williamson and Bercovitz, “The Modern Corporation as An Efficiency Instrument”, above n. 27, at 343–7. Williamson also places some reliance on the employer’s interest in maintaining a favourable reputation with the company’s employees in general and with other stakeholders as an incentive to comply with implicit promises of job security: Economic Institutions of Capitalism, above n. 12, at 259–61. See also Jeffrey G MacIntosh, “Designing an Efficient Fiduciary Law”, (1993) U Toronto L J 425, at 470–2. For doubts about the efficacy of reputational effects, however, see Karl E Clare, “Comment: Untoward Neutral Principles: Market Failure, Implicit Contract, and Economic Adjustment Injuries” ibid., 393, at 395; Howse and Trebilcock, “Protecting the Employment Bargain”, above n. 33, at 761–2. 53 See Stone, “Labour Markets”, above n. 42, at 83–5.

The Conceptual Foundations of the Company 127 effectiveness of hostage-taking as a means of protecting employee investments, particularly in the context of plant closures, since “in the very circumstance where the employer may have the least to lose in terms of sunk costs in closing a particular plant (because the capital investment in machinery and the like has depreciated to close to nothing), the workers’ stake in keeping the plant open may be highest (because of end-loading of compensation and the cumulation of firm- and community-specific investments by workers)”.54

The incapacity of bilateral governance structures to provide convincing protection for employee firm-specific investments suggests therefore that there is a need to consider as well how corporate governance structures might be used to supply appropriate safeguards. A necessary condition for the pluralist model to differ substantively from other contract approaches and hence to have significant policy implications, is that firm-specific investments are pervasive. There are reasons to think that this is the case. With regard to human capital, firm-specific investment is not confined to the acquisition of skills narrowly connected with the operation of physical capital. Rather, it may take many forms, including:: “knowledge of operating procedures in the firm, of local information sources, of locally specialized language usage, and of customer, supplier, coworker, and machine idiosyncrasies; special skills in tasks peculiar to the firm, and membership in the social networks within the firm and between the firm and its suppliers and customers”.55

As an indication of the scale of these investments, Blair has estimated that in the 1980s around 14 per cent of total employee remuneration in the USA may have represented a return to firm-specific human capital. If this is figure is at all accurate, then the return to the “equity-like” component of wages and salaries is roughly equivalent to the total return to equity itself.56 The position in the United Kingdom is unclear, though it is unlikely to be radically different. It also seems probable that the importance of firm-specific human capital can only increase, with the growth of modern, information-intensive industries, with a need for teamwork and close attention to customer requirements. Customer-supplier relationships The issue of firm-specific risk arises in relation to a broader set of stakeholders than employees. It is now widely recognised that firms may make specialised investments in their relationships with other firms in the supply chain. A supplier might, for example, invest in equipment that is adapted to manufacture components tailored to the requirements of one particular customer. Or a supplier might locate its operations close to a customer (but away from other 54 55 56

See Howse and Trebilcock, “Protecting the Employment Bargain”, above n. 33, at 763–4. Milgrom and Roberts, Economics, Organization and Management, above n. 16, at 345. See Blair, Ownership and Control, above n. 9, at 265–7.

128 Gavin Kelly and John Parkinson customers) in order to reduce transport costs. In such situations a state of mutual dependency will often arise, since it may be impossible not only for the supplier to redeploy the assets it has committed to the project without significant loss of value, but also for the customer to obtain supplies from a substitute supplier without serious delay or incurring substantial additional costs. Where suppliers and customers make co-specialised investments in this way, the returns to each party will not be fixed, other than in the short term, but as with the returns earned by employees on firm-specific human capital, will depend on the outcome of bargaining between the parties and on the size of the aggregate rent generated by the project. That is, the parties will be residual claimants. The possibility of firm-specific risk in customer-supplier relationships has not been an issue for exponents of the “pure” nexus of contracts model, since they largely assume that these relationships are based on short-term, self-executing transactions. Asset-specificity in customer-supplier relationships is, on the other hand, of central importance to transaction costs theorists. They accept that the long-term character of relationships involving co-specialised investments means that the interests of the parties cannot be adequately secured by “classical contracts”, that is, contracts which attempt to prescribe for all eventualities.57 Rather, the parties deal with each other by reference to more open-ended “relational contracts” and have recourse to additional bilateral governance safeguards. Essentially the latter in this context are incentives and dispute resolution mechanisms, such as “take-or-pay clauses, penalty clauses, reciprocal trading agreements, and special information disclosure and dispute-settling arrangements of which arbitration is an example”.58 As the level of asset-specificity increases, however, and with it exposure to the risk of opportunistic conduct from the other party,59 transaction cost economics predicts that inter-firm contracting will be replaced by internal organisation, that is, the boundaries of the firm will be redrawn and the company will produce the relevant supply internally.60 While this approach is acutely sensitive, therefore, to the significance of firm-specificity, it takes the implications to be for contractual governance and the boundaries of the firm, not for corporate governance.61 Either the parties will be sufficiently protected against firm-specific risk through bilateral safeguards, or else market transacting will be replaced by hierarchy. Although integration will often be an appropriate response to the costs of external contracting, it is also a source of costs in its own right, in terms of increased bureaucratisation and the loss of “high-powered” market incen57

See Williamson, The Economic Institutions of Capitalism, above n. 12, at 69. Williamson and Bercovitz, “The Modern Corporation as an Efficiency Instrument”, above n. 27, at 341. 59 In addition, where assets are highly specialised (where the supplier has no other customer for the output) there are no compensating scale advantages from external production: Williamson, The Economic Institutions of Capitalism, above n. 12, at 78. 60 Williamson and Bercovitz, “The Modern Corporation as an Efficiency Instrument”, above n. 27, at 341. 61 Williamson, The Economic Institutions of Capitalism, above n. 12, at 308. 58

The Conceptual Foundations of the Company 129 tives.62 In principle, therefore, greater efficiency could be achieved if problems over rent-sharing in situations of high asset-specificity could be resolved without recourse to integration. These problems can be understood, as we have seen, in terms of contractual incompleteness. The point is that the traditional corporate structure, in which shareholders are seen as the only residual claimants and hence have exclusive governance rights, is not well suited to dealing with multiparty incompleteness. As Kay and Silberston explain, “if the governance structure of the firm allows, or indeed requires, all [incomplete contracts] to be resolved in favour of the shareholders, [third parties] will be reluctant to make such contracts, or indeed to do business with the firm at all”.63 What is needed is some means of providing assurance to third parties that their interests will be factored into corporate decision-making and not treated purely instrumentally. It is necessary, in other words, to create conditions in which a relationship of trust can develop. The type of safeguards necessary to promote trust will be dependent on a number of relation-specific factors (the nature of the risk faced by the parties, the pay-off schedules, the expected duration of the relationship), along with wider contextual issues such as the level of “trust” in the economy.64 But more formal governance relations between firms also appear to play a critical role in sustaining long-term relationships. It is argued that in some corporate economies, conspicuously those in Germany and Japan, forms of governance have evolved which contribute to improved performance “by facilitating relation-specific investments without using a stultifying, large vertical organization and by providing a matrix for decisionmaking across related organizations”.65 There is evidence to suggest that while British managers are increasingly aware of the advantages of long-term customer-supplier relationships, they rarely have the confidence to make significant firm-specific investments within them.66 Among other factors, the structure of company law seems likely to be an element in their willingness to do this. 62 i.e., when an activity is conducted within a division of a firm rather than by a separate firm incentives to be efficient are attenuated because decision-makers have a less direct stake in the revenues resulting from the activity: ibid., ch 6; Hart, “An Economist’s Perspective on the Theory of the Firm”, above n. 11, at 1767–8. 63 John Kay and Aubrey Silberston, “Corporate Governance” (1995) National Institute Economic Review (August) 84, at 90. See also Hart, “An Economist’s View of Fiduciary Duty”, above n. 18, at 306–7. 64 The concept of trust can be understood in a number of ways. For an exploration of this and related points, see David Campbell and Donald Harris, “Flexibility in Long-Term Contractual Relationships: The Role of Cooperation”, (1993) J of Law and Society 166; Bruce Lyons and Judith Mehta, “Private Sector Business Contracts: The Text between the Lines” in Simon Deakin and Jonathan Michie (eds), Contracts, Co-operation, and Competition: Studies in Economics, Management and Law (Oxford, 1997), ch 2; and Simon Deakin, Christel Lane and Frank Wilkinson, “Contract Law, Trust Relations, and Incentives for Co-operation: A Comparative Study”, in ibid., ch 5. 65 Mark J Roe, “Some Differences in Corporate Structure in Germany, Japan and the United States”, (1993) 102 Yale LJ 1927, at 1932. See also W Carl Kester, “Industrial Groups as Systems of Contractual Governance”, (1992) 8 Oxford Review of Economic Policy (no 3) 24. 66 See CBI and Arthur D Little, Partnership Sourcing and British Industry (London, 1995).

130 Gavin Kelly and John Parkinson

THE IMPLICATIONS OF THE PLURALIST MODEL

Accepting the difficulty of specifying long-term complex contracts for at-risk stakeholders points towards a view of the company in which a number of groups face residual risk. As has already been suggested, this has the effect of subverting established convictions about what the purposes of the company should be, but this is done using the same theoretical apparatus as the orthodox view that it challenges. The resulting pluralist model has implications for how corporate objectives should be defined if businesses are to make the maximum contribution to social welfare and for appropriate forms of governance once it is recognised that a company’s residual claimants are not confined to its shareholders.

Corporate objectives: social welfare and “total wealth creation” The pluralist critique overturns the conventional notion that the objective of the firm should be the maximisation of profit and replaces it with the view that companies should seek to maximise the total creation of wealth. This translates into the objective of maximising the sum of the rents flowing to each stakeholder group. When shareholders are the only residual claimants these two objectives (profit maximisation and total wealth creation) coincide. This is the position represented by standard contract theory, but which is now revealed as a limiting case. In the more likely situation in which other constituencies make firmspecific investments which are not protected through complete contracts the two objectives diverge. Firms which focus solely on maximising returns to shareholders may diminish the wealth currently created by the company, and by weakening the incentives of stakeholders to make firm-specific investments in the first place, reduce the company’s wealth-creating capacity for the future. Blair provides an illustration of the first of these phenomena, by reference to employees who acquire skills that are co-specialised with a piece of machinery.67 If, for instance, at some point the total returns on the project fall, perhaps because of increased product market competition, and the company’s objective is to maximise profits, it will discontinue the project once the present value of expected profits falls below the scrap value of the machine. However, the project might still be earning rents for the employees. The fact that all rents do not accrue to the shareholders drives: “a wedge between what is optimal for the shareholders and what is optimal for society as a whole. A socially optimal decision would require that the firm continue to operate as long as the present value of the total rents . . . generated by the business is positive. By

67

Blair, Ownership and Control, above n. 9, at 256–7.

The Conceptual Foundations of the Company 131 contrast, a decision that maximizes share values would require that the firm shut down whenever the present value of the profits . . . of the business falls below zero”.68

The same point can be made about co-specialised investments within customersupplier relationships. If the company is pursuing a policy of profit maximisation, the incentives of stakeholders to make firm-specific investments are likely to be damaged by the knowledge that in certain circumstances their investments will be sacrificed in favour of shareholder interests. The vulnerability of stakeholders to opportunistic changes in the division of rents has already been noted, which will have adverse effects on incentives too. These factors suggest the need for a governance framework that will give some assurance to parties making firm-specific investments that their interests will not be subordinated to those of the shareholders.69 In other words, appropriate safeguards are not just of relevance in determining how rent is distributed after firm-specific investments have been made, but the size of the ex post surplus will itself be affected by how ex ante control rights are apportioned.

Governance structures and the pluralist model So far the emphasis has been on exploring the argument that a pluralist view should be taken of the allocation of residual risk within the firm. As has been emphasised, firms may have a number of residual claimants as a result of stakeholders’ inability to obtain full contractual protection for firm-specific investments. Following Williamson’s approach to the firm, governance arrangements which confer rights of control can be interpreted as partial substitutes for complete contractual protection. While the over-arching purpose of “total wealth creation” governance structures is, however, clear enough (that is, to apportion control rights in such a way that each stakeholder group is willing to undertake the socially optimal amount of firm-specific investment), translating this objective into precise governance mechanisms is far from straightforward. One problem is that while they are likely to make a positive contribution to certain aspects of firm performance, governance mechanisms that protect nonshareholders might also, depending on their design, be a source of inefficiency. 68 Ibid., at 257. See also Blair’s rebuttal of a number of potential criticisms of this analysis, e.g., that flexible labour markets would allow recontracting, or that firms’ concern for their reputation among employees will make a commitment to fair (but not fixed) wages credible, at 258–9. 69 It might be noted that this divergence between shareholder interests and the interests of other stakeholders, and the divergence between the maximisation of shareholder wealth and social wealth, shows the falsity of the view that is sometimes expressed that the “shareholder versus stakeholder” debate is “bogus”, on the ground that so long as shareholder interests are understood as long-term ones, the interests of the various parties do not conflict. See e.g., Philip Goldenberg, “The Stakeholder Company—Myth or Reality?”, (1996) Mandate (May) 13; RSA Inquiry, Tomorrow’s Company: The Role of Business in a Changing World (London, 1995), 12; Committee on Corporate Governance, Final Report (“the Hampel Report”) (London, 1998), para 1.18.

132 Gavin Kelly and John Parkinson Looking at the matter in the abstract, to the extent that revised mechanisms involve more groups participating in decision-making, this could introduce “social choice” costs as a result of the divergence of interests between them. Putting the point in somewhat extreme terms, Easterbrook and Fischel argue that “when voters hold dissimilar preferences it is not possible to aggregate their preferences into a consistent system of choices. If a firm makes inconsistent choices, it is likely to self-destruct”.70 It is possible, however, that careful institutional design can reduce the extent of these decision-making costs. The system of co-determination in Germany, for example, does not involve strict parity of representation (thus avoiding deadlock) and limits the involvement of employees in issues of operational management.71 Moreover, the essence of collaborative governance is that the process of negotiation and compromise transforms the preferences of the participants. It is not necessarily the case that the parties come together at a discrete moment, voting on the basis of polarised views. Instead preference formation is itself, at least to some extent, the result of a deliberative process.72 A second problem is that while pluralist governance structures are likely to encourage firm-specific investment, an analysis of their efficiency properties would need to include an assessment of the cost of increasing the number of groups able to use control rights opportunistically. In other words, the risk that any one stakeholder group faces is not independent of the governance safeguards held by other stakeholder groups. It has been argued in this vein that in response to the increased risk that shareholders would face in a pluralist framework, the incentive for shareholders to invest would decline, and with it social wealth.73 A related problem, to which it has been suggested that “stakeholder economies” are prone, is that stakeholders’ control rights enable them to impede restructuring that is required by market and technological change, and thereby damage dynamic efficiency. Whether this is a price that must inevitably be paid for creating a stable environment conducive to firm-specific investment, or whether an appropriate degree of fine-tuning can be achieved, is unclear. We turn in the rest of this section to a very brief examination of specific governance controls. Optimal governance structures will vary between firms depending upon their underlying technological and risk characteristics. Rather than seeking to identify a single “best” governance structure, our aim is to provide a few illustrations that show that there is a range of feasible governance forms which represent a significant departure from the orthodoxy. 70 Easterbrook and Fischel, The Economic Structure of Corporate Law, above n. 14, at 69–70; see also Hansmann, The Ownership of Enterprise, above n. 35, at 39–44, 62–4. 71 See Hansmann, ibid., at 111–12. 72 See Peter J Buckley and Malcolm Chapman, “A Longitudinal Study of the Management of Cooperative Strategies” in Deakin and Michie, Contracts, Co-operation and Competition, above n. 64, 67, at 80, citing P J Buckley and M Casson, “A Theory of Cooperation in International Business” in F J Contractor and P Lorange (eds), Cooperative Strategies in International Business (Lexington, 1988). 73 See Macey and Miller, “Corporate Stakeholders”, above n. 19, at 421.

The Conceptual Foundations of the Company 133 Fiduciary duties Directors’ duties are a way of indicating the corporate objectives that are socially approved, and also, to a limited extent in practice, a control device. The pluralist model suggests that the company’s objectives and therefore the duties of its directors should be re-specified so that they correlate with the groups who bear firm-specific risk which is not protected by formal contracts. A number of different ways of giving verbal expression to this concept have been suggested.74 It is often argued against “multi-constituency” formulations that they render the management function indeterminate (because they involve a balancing of interests for which there are no objective criteria),75 and in the process destroy the value of fiduciary duties as a mechanism for holding management accountable.76 As to the first of these objections, while some formulations might have the claimed effect, the total wealth maximisation objective is not obviously more indeterminate than the objective of maximising shareholder wealth. The former inevitably involves issues of complex judgement, but so does the latter. The second objection relies on an exaggerated view of the current value of fiduciary duties as a control device.77 As even defenders of shareholder exclusivity have conceded, multi-constituency duties “cannot be condemned on the grounds that they upset a system of legal rules that present a pre-existing set of clearly defined behavioural guidelines for officers and directors. No such set of guidelines exists”.78 It does, however, follow that revised fiduciary duties could not in themselves provide positive governance safeguards to non-shareholder groups. As is widely recognised, the problems that the complexity of business issues create for the courts in enforcing a shareholder-exclusive standard would be even more formidable with a multi-constituency standard.79 Nevertheless, from the pluralist perspective it is important that directors should be freed from an obligation to give automatic priority to the interests of shareholders over those of all other 74 See, e.g., Kay, “The Stakeholder Corporation”, above n. 8, at 137; Steven M H Wallman, “The Proper Interpretation of Corporate Constituency Statutes and Formulation of Director Duties”, (1991) 21 Stetson L Rev 163; J E Parkinson, Reforming Directors’ Duties, Political Economy Research Centre Policy Papers no 12 (Sheffield, 1997), 15. 75 See, e.g., Sternberg, “Stakeholder Theory Exposed”, above n. 4, at 7–9. 76 The Hampel Report, above n. 69, at para 1.17. 77 As to which, see J E Parkinson, Corporate Power and Responsibility: Issues in the Theory of Company Law (Oxford, 1993), 92–6. 78 Macey and Miller, “Corporate Stakeholders”, above n. 19, at 404. Their argument in favour of shareholder exclusivity is that fiduciary duties are not a public good (i.e. their value falls significantly if they are shared with other groups), and that they are most valuable when allocated to shareholders. This depends on their view that non-shareholders can obtain adequate contractual protection. If this is untrue, as we have suggested above, then the aggregate costs of specifying the terms of non-shareholder contracts, the efficiency losses that arise as a result of sub-optimal levels of firm-specific investments in the absence of governance safeguards, and the cost of (implicit) sidepayments to compensate non-shareholders who are denied fiduciary protection, may exceed the additional benefits shareholders receive from being exclusive beneficiaries of fiduciary duties. 79 See L S Sealy, “Directors’ ‘Wider’ Responsibilities: Problems Conceptual, Practical and Procedural” (1987) 13 Monash U L Rev 164.

134 Gavin Kelly and John Parkinson groups. Moreover, fiduciary duties may be capable of influencing management conduct even though there may be little realistic possibility of their being enforced. Participatory mechanisms A number of writers have suggested board-level participation for at-risk groups.80 The likelihood that this would increase social choice costs (though that there may be ways of controlling them) has already been noted. But there is also room for doubt about the likely effectiveness of multi-party representation as a means of safeguarding stakeholder interests, since the extent to which minority representatives are capable of influencing management decisions is questionable. On the other hand, even a minority presence on the board will be of value as a means of improving the flow of information to outside groups.81 As regards employee board membership, in the most prominent example, that of German co-determination, it may be noted that representation at board level is only one component in a broader system, with interlocking channels of influence also available via collective bargaining and works councils. It has been argued that among these institutions works councils play a particularly important role, especially given the obligation of management to agree a “social plan” with the works council in the event of restructuring that has a significant effect on worker interests.82 The social plan might provide for compensation for employees made redundant, for example, or for transfer to other employment within the enterprise. In language reflecting the pluralist approach, it has been observed that co-determination means that “on all matters in the life and operation of a corporation which are not settled by explicit contracts, or where decision rights are not allocated by such contracts, there must be consensus or co-decision between employee and shareholder representatives”.83 At the same time, it appears that while they require management to take proper account of the impact of decisions on employees, these arrangements have not led to harmful employee interference in strategic planning.84 With regard to customers and suppliers, in systems in which board participation by members of these groups is common, representation tends to be linked 80 See, e.g., Blair, Ownership and Control, above n. 9, at 325–7; R Edward Freeman and William M Evan, “Corporate Governance: A Stakeholder Interpretation”, (1990) 19 Jo Behavioral Econ 337; Michael E Porter, Capital Choices: Changing the Way America Invests in Industry (Washington, 1992), 86. 81 This is perceived to be the main function of employee representation in Sweden: see Lord Wedderburn, “Trust, Corporation and the Worker”, (1985) 23 Osgoode Hall L J 203, at 241–2. The informational role of representation is also accepted by Williamson: see above n. 34. 82 See Sigurt Vitols et al., Corporate Governance in Large British and German Companies: Comparative Institutional Advantage or Competing for Best Practice (London, 1997), 19–20. 83 Michel Albert and Rauf Gonenc, “The Future of Rhenish Capitalism”, (1996) 67 Political Quarterly 184, at 185. See also Wolfgang Streek, Social Institutions and Economic Performance: Studies of Industrial Relations in Advanced Capitalist Economies (London, 1992), ch 5. 84 Vitols et al, Corporate Governance, above n. 82, at 20.

The Conceptual Foundations of the Company 135 to significant shareholdings. This is likely to have the effect of strengthening the influence of the relevant stakeholders, but also of reducing conflicts of interest between the parties and hence social choice costs. As Roe points out, “although stockholders without any other relationship to a firm will sometimes renege on an implicit agreement, stockholder-suppliers might honour the agreement because the gains they reap as reneging stockholders would be reduced by the losses they incur as affected suppliers”.85 As an alternative to direct inter-firm holdings, a similar effect might be achievable where a third-party financial institution has a significant stake in both customer and supplier. This could have the advantage of avoiding a situation in which cross-shareholders constitute a “mutual protection society”, that is, use their votes to entrench each company’s management in office.86 Employee share ownership As just noted, the most direct means of assigning control rights to groups who face residual risk is through equity. Supporters of employee ownership schemes who adopt a pluralist perspective maintain that by holding equity stakes commensurate with the equity-like element within their earnings, employees will have the necessary safeguards to encourage firm-specific investments and the appropriate incentives to support efficiency-enhancing corporate decisions.87 Advocates also stress that employee ownership is a (comparatively) precise means of assigning control rights to at-risk groups within the company, as different groups can hold different amounts of equity. It is sometimes also recommended as a less controversial means of moving towards the “total wealth creation” corporate objective as it can be implemented without a major restructuring of company law and governance mechanisms. Finally, there is an established, if contested, body of literature which points to the improvements in labour productivity that employee ownership schemes can engender.88 Despite these alleged benefits there is a long-standing and involved debate on whether employee owners will adopt policies that maximise social welfare or would instead pursue objectives such as the maximisation of revenue per employee, or employee security, at the expense of social welfare.89 At the empirical level there is also strong evidence that within the United Kingdom most employee ownership schemes do not operate in such a way as to extend meaningful control rights to their members. For instance, schemes have often been designed so that employees are treated as individual shareholders (rather than as beneficiaries of a trust in which their votes are pooled), making it difficult for 85 Mark J Roe, “Some Differences in Corporate Structure in Germany, Japan, and the United States”, (1993) 102 Yale L J 1957, at 1986; see also Kester, “Industrial Groups”, above n. 65, at 34–5. 86 See Mark J Roe, Strong Managers and Weak Owners: the Political Roots of American Corporate Finance (Princeton, 1994), 250. 87 See Blair, Ownership and Control, above n. 9, at 298–322. 88 See Alan S Blinder (ed), Paying for Productivity: A Look at the Evidence (Washington, 1990). 89 See above n. 15.

136 Gavin Kelly and John Parkinson them to exercise governance rights. Currently the most promising vehicle for the extension of employee ownership in a way that is in tune with the pluralist perspective is the employee ownership plan (or ESOP), as these tend to involve significant chunks of a company’s equity and can provide for employee participation in governance issues. Though their uptake remains limited within the United Kingdom, they extend to approximately 12 per cent of the private sector workforce in the USA.90 Stabilising control Much of the recent debate on the obligations of companies to non-shareholder groups has emerged as a response to the growth in hostile take-over activity. In particular, a number of writers have expressed concern at the adverse efficiency effects and redistributive consequences of breaches of implicit contracts with stakeholders that have followed take-over.91 The vulnerability of firm-specific investments in systems in which there is an active market in control is likely to reduce the willingness of stakeholders to make such investments.92 Similarly, to the extent that the threat of take-over is effective in inducing managers to maximise returns to shareholders, the flexibility in the allocation of rents that is necessary to promote and sustain firm-specific investment will be impaired. It is arguable therefore that measures to reduce hostile take-over activity will be necessary if total wealth creation structures are to flourish. Such a policy might, on the other hand, be unwise without first putting in place an alternative system of managerial accountability. The challenge is to devise a system which is capable of protecting shareholders’ investments but which does not at the same time give automatic priority to their interests over those of other groups. 93

CONCLUSION

There remains a great deal of work to be done in specifying the kinds of governance arrangements that are compatible with the pluralist approach. It must also 90 For information about employee ownership in the United Kingdom in general, and ESOPs in particular, see Andrew Pendleton, “Stakeholders as Shareholders: The Role of Employee Share Ownership” in Kelly et al, Stakeholder Capitalism, above n. 8, ch 15. For an analysis of the impact of employee ownership on corporate governance, see Andrew Pendleton et al, “Employee Participation and Corporate Governance in Employee Owner Firms”, (1996) 10 Work, Employment and Society 205. For an account of the spread of employee ownership schemes in the USA, see Joseph Blasi and Douglas Kruse, The New Owners: The Mass Emergence of Employee Ownership in Public Companies and What It Means for American Business (New York, 1991). 91 See, e.g., Shleifer and Summers, “Breach of Trust in Hostile Takeovers”, above n. 20; John C Coffee, “Shareholders versus Managers: The Strain in the Corporate Web”, (1986) 85 Mich L Rev 6. 92 See Julian Franks and Colin Mayer, “European Capital Markets and Corporate Control” in Mathew Bishop and John Kay (eds), European Mergers and Merger Policy (Oxford, 1993), 162, at 188–91. 93 See, e.g., the suggestions in Kay and Silberston, “Corporate Governance”, above n. 63, at 94–5.

The Conceptual Foundations of the Company 137 be accepted that there is not as yet a clear understanding of the extent of the social choice and stakeholder opportunism problems that pluralist governance structures would engender if adopted in the United Kingdom. Much turns on this issue. If the costs of assigning governance rights to a plurality of groups are judged too severe, then the relevance of the pluralist analysis for policy would be limited to cases in which the residual risk faced by shareholders is surpassed by that encountered by non-shareholders. In this instance the pluralist model would suggest that exclusive governance rights should be held by the relevant stakeholder group, leaving the suppliers of capital to seek compensation for any residual risk they faced through contract.94 An analysis that seems more plausible, however, offers a wider role for the pluralist model. Those who suggest otherwise gloss over the heterogeneous interests that already exist even within systems such as the United Kingdom, where there is conventionally thought to be an exclusive shareholder orientation.95 According to this more expansive understanding social choice and opportunism problems are still recognised, but they are compared with the benefits of pluralist governance structures in encouraging socially productive investments that would otherwise not occur. If this second interpretation is correct, that is, pluralist governance arrangements are beneficial across a wide range of firms,96 a question inevitably arises: if the pluralist approach leads to superior economic outcomes, why have more companies not voluntarily adopted governance structures of this type? There are a number of possible responses to this point. The first is that any move to new governance arrangements must overcome the resistance of existing managerial and shareholder groups who would see a diminution in the private benefits they derive, respectively, from effective control and a privileged position with regard to the firm’s residual income. The logic of the pluralist account is that the interests of shareholders may diverge from those of society at large. If so, it is unclear why those in receipt of residual control rights would voluntarily agree to changes which will impose costs on them. This type of explanation directs attention to the role that established interests may play in blocking certain kinds of development.97 Once entrenched, such interests might create 94 e.g., in those utilities which operate in markets in which competition is highly attenuated, control might be vested in consumers, with capital enjoying fixed returns. See John Kay, “The Future of UK Utility Regulation” in M E Beesley (ed), Regulating Utilities: A Time for Change? (London, 1996), 145. 95 Potential conflicts exist, e.g., between different classes of shareholder, between different types and size of shareholder (private, institutional), and between debt-holders and shareholders in nearbankruptcy states. 96 There is evidence to suggest that while UK companies are on average more profitable than their continental European counterparts (many of which have pluralist features), they create less value overall and have a lower rate of growth. See H W de Jong, “European Capitalism: Between Freedom and Social Justice” in Joseph McCahery, William W Bratton, Sol Picciottto, and Colin Scott (eds), International Regulatory Competition and Coordination: Perspectives on Economic Regulation in Europe and the United States (Oxford, 1996), 185. 97 Entrenched interests have been used to explain why some countries have mandated works councils rather than relying on companies to institute them voluntarily. Richard B Freeman and Edward P Lazear, “An Economic Analysis of Works Councils” in Joel Rogers and Wolfgang Streek

138 Gavin Kelly and John Parkinson institutional path dependency of a highly persistent kind, making significant change unlikely in the absence either of some external shock or government intervention. A second and closely related explanation of the failure of pluralist governance arrangements to develop spontaneously emphasises the effect that different national legal, economic, and political frameworks have on the costs of providing governance safeguards. In some systems the preexisting structure of company law and associated mechanisms (for example, the market for corporate control) may obstruct pluralist experiments.98 The absence of appropriate informal norms and conventions and of well developed intermediate organisations such as trade associations and standard-setting bodies,99 may also militate against firm-specific investments, high-trust relations, and the mixed governance arrangements that follow. A third explanation is less defensive. There is some evidence that skilled employees already do receive significant residual returns and hold residual rights of control. This tendency is particularly marked in the new knowledge industries.100 It may be that here the benefits of pluralist governance structures are that much greater, because of the relative importance of firm-specific investments by employees, and also that the transaction costs incurred in shifting to new governance structures are lower in view of the fact that shareholdings are typically concentrated in the hands of a small group of entrepreneurs. All of these explanations are pointers only, and do no more than highlight the need for further research. What is attractive about the pluralist model is that it does not seek to foreclose certain governance options. It recognises that the traditional shareholder-centred view of the company can have relevance, though it suggests that it may increasingly represent a special case. In policy terms it has at its core the rebuttal of two contentions which have become the orthodoxy. First, it rejects a universalistic definition of the groups who constitute the company, and hence a “one size fits all” approach to the design of governance structures. Appropriate structures will vary according to the particular economic attributes of the firm, which suggests that there may be advantages in a legal framework which allows maximum scope for organisational choice and diver(eds), Works Councils: Consultation, Representation, and Cooperation in Industrial Relations (Chicago, 1995), 27, at 29, argue that “institutions that give workers power in enterprises affect the distribution as well as amount of joint surplus. The greater the power of works councils, the greater will be workers’ share of the economic rent. If councils increase the rent going to workers more than they increase total rent, firms will oppose them”. That is, works councils will not evolve even though they may increase the total wealth generated by the enterprise. See also generally Lucian Ayre Bebchuk and Mark J Roe, “A Theory of Path Dependence in Corporate Ownership and Governance”, in Columbia Law School, Corporate Governance Today (New York, 1998), 575. 98 In other systems there may be similar problems in making changes in the opposite direction, e.g., a move to shareholder value maximisation in Germany, when the control rights of groups such as employees are entrenched. 99 See Deakin, Lane, and Wilkinson, “Contract Law, Trust Relations”, above n. 64, at 113–18. 100 See Charles Leadbeater, A Piece of the Action: Employee Ownership, Equity Pay, and the Rise of the Knowledge Economy (London, 1997).

The Conceptual Foundations of the Company 139 sity. Secondly, it rejects the view that “what is, is best”. While it is evident that evolutionary processes have been important in shaping national systems of corporate governance, it is far from clear that these have led to institutional arrangements that are unimprovable. Specifically, the pluralist model suggests that where firm-specific investments are important, shareholder interests may diverge from societal interests. In this situation it is doubtful that shareholders will spontaneously decide to adopt total wealth creation governance structures.101 Accordingly, the approach to policy advocated here should not be equated with a deregulatory one. While we see the value of allowing flexibility in the design of governance forms, there may also be a need for intervention to remove institutional blockages and to provide the necessary safeguards for atrisk groups. 101 Even in the situation in which the increase in rents to shareholders from reforming governance would be so great that it would be collectively rational for them to reform governance structures, the coordination and information costs could still block such a move.

7 Defending the Rentier: Corporate Theory and the Reprivatisation of the Public Company PADDY IRELAND

A

LL BODIES OF company law embody and reflect particular assumptions about the nature of companies and the relations between those who participate in their activities. In other words, they are all underlain by a theory of the company. While the presence of this theory usually goes largely unacknowledged, in recent years, as the issue of so-called corporate governance has risen to prominence, the nature of the company and, in particular, of the large corporations which dominate the economy has become the subject of considerable debate.1 With this, corporate theory has moved much closer to the centre of the company law stage and although the claim that this has precipitated a “crisis in corporate law”2 is rather exaggerated, there is no doubt that in an environment in which there is growing international interest in the relationship between corporate governance and competitiveness (and to a lesser extent social justice), the debates about corporate theory are proving to be of more than purely academic importance. In Britain, for example, seemingly abstract questions about the nature and character of companies figure prominently in the consultation document recently produced by the Company Law Review Steering Group for the DTI.3 The two alternative approaches to company law identified by the Steering Group, one labelled “enlightened shareholder value”, the other “pluralism”, broadly reflect the two principal rivals within Anglo-American corporate theory: contractual or agency theory, based in law-and-economics, and stakeholding 1 In most English-speaking jurisdictions, what in the United Kingdom is called company law is generally called corporations or corporate law. In this chapter the terms “corporation”, “corporate theory” and “corporate governance” are used to refer to large, publicly quoted (joint stock) companies. 2 See David Millon, “Communitarians, Contractarians, and the Crisis in Corporate Law”, (1993) 50 Washington & Lee Law Review 1371. 3 Company Law Review Steering Group, Modern Company Law for a Competitive Economy: the Strategic Framework (London, DTI, 1999).

142 Paddy Ireland theory. Contractual theories, which began to crystallise in the USA in the 1970s and whose influence in the United Kingdom and elsewhere has since steadily grown, perceive the company as a nexus of contracts, most crucially between shareholder-principals and director-agents, characterising even large publicly quoted corporations as fundamentally voluntaristic, private affairs, the products of freely negotiated contractual exchanges. For contractual theorists, the fact that existing corporate structures are the supposed products of such processes is prima facie evidence that they are “efficient”, “efficiency” in the specific and narrow sense in which the term is used within orthodox economic theory being, in their view, what company law and corporate governance are (and should be) about.4 Contractual theories thus have a clear political slant, simultaneously legitimating, as both just and efficient, existing corporate structures and the priority that company law gives to the pursuit of the shareholder interest. As Douglas Branson says, they have an “overwhelmingly apologist flavor” and with their general presumption against the regulation of corporate affairs they “dovetail nicely with the wishes and desires of the titans of corporate America”.5 They also, of course, contrast sharply with stakeholding theories which argue, in different ways, that the interests of a wide range of groups with “stakes” in public companies—employees, customers, creditors, the community at large—should be recognised and, in some cases, represented in corporate legal and managerial structures.

LOCATING CORPORATIONS ON THE PUBLIC-PRIVATE AXIS

In large part because of their political and economic implications, and their neglect of issues of justice and equity, not to mention their rather impoverished conception of individual and social wellbeing, contractual theories of the corporation have been much criticised, particularly, but not exclusively, in the USA where they originated. As part of this process, a number of American scholars, most notably William Bratton and David Millon, have sought, among other things, to expose the political dimension of contractual theories by locating them historically, tracing their origins and situating them in relation to earlier theories of the corporation.6 The history that they recount is undoubtedly 4 There are two principal variants of contractual theory. In the more extreme version, the internal functioning of companies is analysed firmly within the assumptions and methodology of neo-classical micro-economics. The “institutional” variant, associated with Ronald Coase and, more recently, Oliver Williamson, is more realistic, taking seriously Coase’s distinction between markets and firms. For the purposes of the arguments made in this chapter, however, the two variants are sufficiently similar—Coase’s non-market structures are little more than surrogates for markets—to render it unnecessary for me to elaborate their differences, important in certain respects though they are. 5 Douglas Branson, “The Death of Contractarianism and the Vindication of Structure and Authority in Corporate Governance and Corporate Law”, in Lawrence E Mitchell (ed), Progressive Corporate Law (Oxford, Westview Press, 1995), 93, at 93–4. 6 See William W Bratton Jr, “The New Economic Theory of the Firm: Critical Perspectives from History”, (1989) 41 Stanford Law Review 1471, reprinted in Sally Wheeler (ed), The Law of the

Defending the Rentier 143 remarkably rich. For a variety of constitutional, jurisdictional and political reasons, corporations in the USA have since the early nineteenth century generated a range of legal problems whose resolution has demanded direct consideration of their nature and status. Compelled to grapple with questions about the nature of corporate “citizenship” and “personhood”, American courts and lawyers, unlike their British counterparts, have found it impossible not to be drawn openly into essentialist debates about the nature of corporations. At first glance, the issues with which the courts became embroiled—such as whether corporations were artificial creations of the state or the “natural” products of private initiative, and whether they were entities with a “real” existence quite independent from that of their members or simply aggregations of people—seem abstract and academic. However, underlying them—“operat[ing] at a deeper level”, as David Millon puts it—has been the “abidingly crucial” political question of whether corporations are essentially public or private entities. Indeed, it is the different answers that have been offered to this question over time that have provided the general framework for the recent analyses of the development of American corporate theory, all of which are in their different ways concerned with plotting the relationship between different theories of the corporation and the shifting location of corporations on the public-private axis. The contrast, Millon explains, is “between a public law, regulatory conception of corporate law on the one hand, and a private law, internal perspective on the other”; between “a body of law concerned solely with the techniques of shareholder wealth-maximisation [and] a body of law that embraces and seeks to promote a richer array of social and political values”.7 In general terms, the claim is that, historically, designations of corporations as artificial creations of the state have tended to be used to counter claims that they are overwhelmingly private in nature and to support a pro-regulation, public law approach to corporate law; while designations of them as the “natural” products of private contract have usually been used to justify an anti-regulatory stance. In a similar vein, it is argued that characterisations of corporations as aggregates of individuals have tended to be used to assert their fundamentally private, contractual nature and to legitimate shareholder primacy and state noninterventionism; while characterisations of them as autonomous entities in their own right have commonly been used to underpin claims as to their public nature and to advance a less shareholder-oriented conception of corporate enterprise. Business Enterprise (OUP, 1994), 117; and David Millon, “Theories of the Corporation”, (1990) Duke Law Journal 201. For other recent explorations of the historical development of American corporate theory which do not consider the rise of agency theory, see Morton Horwitz, “Santa Clara Revisited: The Development of Corporate Theory”, (1985) 88 West Virginia Law Review 173; and Gregory A Mark, “The Personification of the Business Corporation in American Law”, (1987) 54 Chicago Law Review 1441. 7 Millon, above n. 6, at 201–2. Or as he has more recently and more fashionably put it, it is the difference between a contractarian and a communitarian conception of the corporation. See David Millon, “Communitarianism in Corporate Law: Foundations and Law Reform Strategies”, in Mitchell, above n. 5, 1.

144 Paddy Ireland From this perspective, the current wrangles within corporate theory are simply the latest chapter in the “long history of . . . tension between the public and private character of the corporation”,8 with contractual theories representing the most recent attempt to accentuate and advance a private, shareholder-oriented conception of the corporation. They are, in Millon’s words, “an elaborate justification for the now familiar view that corporate activity and corporate law are purely private matters” upon which public policy concerns should not be allowed to intrude; for the view that corporate law should concern itself only with the welfare and interests of shareholders. By emphasising the voluntary nature and market-like characteristics of corporations, contractual theory seeks to pull them to the private side of the public-private divide, bolstering shareholder primacy and diminishing the role of the state in corporate life. The corporation is reconstructed with few, if any, public elements, wringing “community values” from it.9 In portraying the present as history and by emphasising the centrality to corporate theory of the public-private divide, this work has done much to cast light on the development not only of contractual theory, the ahistoricism of which makes it unusually vulnerable to historical analysis, but of corporate theory as a whole, revealing it to be not a steadily advancing body of knowledge but a long-standing site of ideological struggle. This chapter argues, however, that while this work has provided many valuable insights, it does not fully get to grips with the issues which lie at the heart of company law and corporate theory: the constitution and allocation of rights over the assets and activities of joint stock companies. Not only does this issue precede that of efficiency, a concept which, as it is understood within orthodox economics, essentially presupposes both a preexisting allocation of rights and that those rights take a particular (alienable) form,10 it is central to understanding the historical development of corporate theory, for it is the reconceptualisation (and reallocation) of corporate property and corporate rights necessitated by the transformation of productive relations effected by the rise of the joint stock company that has been the driving force behind theoretical change in company law. In offering an alternative history of corporate theory, the chapter argues that, historically, contractual theories of the corporation, with their emphasis on efficiency-based justifications, emerged as an attempt to defend and legitimate the rights and 8 Paul Cox, “The Public, The Private and the Corporation”, (1997) 80 Marquette Law Review 393, at 394–5. Bratton explicitly eschews use of the term “public corporation” to describe the large quoted company for fear that it prejudges the vital public-private issue, preferring instead the term “management corporation”. See William Bratton, “The ‘Nexus of Contracts’ Corporation: A Critical Appraisal”, (1989) 74 Cornell Law Review 407. 9 Millon, above n. 6, at 231; Bratton, above n. 8, at 428, 440. 10 The “Coase theorem”, for example, asserts that economic efficiency will be achieved as long as property rights have been fully allocated and that completely free trade in these property rights is possible. It purports to demonstrate that it does not matter who owns what initially, only that everything is owned by someone, trade ensuring that resources are eventually placed in their occupation of highest value. Rights have to be constituted in a particular alienable form in order for the market to work its magic.

Defending the Rentier 145 privileges of rentier shareholders in face of the increasing difficulties involved in characterising corporations as private property and shareholders as corporate “owners”.11 Relying less on the fundamental moral principles traditionally associated with the ideas of private property and ownership (such as natural right, liberty, moral desert) and more on the alleged instrumental value of shareholder rights in contributing to productivity and efficiency, contractual theories of the corporation, it suggests, seek to give legitimacy to a legal status quo in which corporations are run exclusively for the private benefit of shareholders despite their overwhelmingly social and public nature.12 Indeed, in recent years, it argues, as both the power and influence of financial capital and inequalities of wealth and income have grown, the new legitimations of shareholder rights provided by contractual theories have become ever more important. In reminding us of the crucial, but increasingly neglected, issues surrounding the constitution and allocation of rights in and over corporations, the chapter hopes to broaden the focus of the debates currently taking place about company law reform and to indicate the issues which need to be addressed if an “effective ethical framework for [corporate] governance”13 is to be constructed, a framework aimed more at meeting the material needs of society and enhancing the wellbeing of its members than at maximising the financial returns of rentier shareholders.

FROM OWNING ASSETS TO OWNING COMPANIES: THE RISE OF ENTITY THEORY

What we now call “company law” began to emerge in the early-mid nineteenth century as “joint stock company law”, the body of law applied to joint stock companies. Joint stock companies, although considered types of partnership even when incorporated, were distinguished from “ordinary” partnerships by their size, their separation of ownership from management and the transferability of their shares. In contemporary parlance, they were “public” rather than “ordinary” or “private” partnerships, to which the principles of the law of partnership, slightly modified, were thought generally applicable. Correspondingly, when the first book devoted to joint stock company law appeared in 1836, it was 11 In reality, contractual theorists often use the concept of “efficiency” in clandestine support for particular allocations of rights, rather for commenting on the outcomes generated by arrangements based on a pre-existing allocation of rights. Crucially, of course, efficiency is far from being the only basis upon which property (and other) rights might be constituted and allocated: see Alan Carter, The Philosophical Foundations of Property Rights (Hemel Hempstead, Harvester Wheatsheaf, 1989). 12 John Christman distinguishes direct and indirect arguments in support of ownership rights, observing that indirect, instrumental arguments are “characteristically weaker” than direct arguments which rely on the assertion of fundamental moral principles: The Myth of Property (OUP, 1994), 8. 13 David Campbell, “The Role of Monitoring and Morality in Company Law”, (1997) 7 Australian Journal of Corporate Law 343, at 345.

146 Paddy Ireland largely confined to explaining how the principles of the law of partnership had been modified in various ways for application to incorporated and unincorporated joint stock companies.14 Early company law, such as it was, was thus treated as an adjunct to the law of partnership. These conceptions reflected the fact that, unlike their modern counterparts, early joint stock companies were still relatively small organisations whose shareholders often had a personal link of some kind to the companies in which they held shares and who, even if not directly involved in management itself, were commonly involved in its monitoring;15 and the fact that in the absence of a developed market in company securities, shares were not readily saleable and shareholders were, therefore, in a certain sense and to a certain extent, “tied” to the companies in which they held shares. The result was that, deep into the nineteenth century, both incorporated and unincorporated joint stock companies were conceptualised, like partnerships, as aggregates of people rather than, as they are now, as objects in their own right (“things”) autonomous from their shareholders. A company’s shareholders were the company. This was reflected in the conceptualisation of the property of companies. Until the mid-nineteenth century the joint stock company share was regarded in law as an equitable (and, therefore, direct proprietary) interest in a company’s assets and shareholders as the equitable co-owners of those assets.16 Indeed, although the rights of individual shareholders over the corporate assets were inevitably diluted to accommodate joint property ownership, as a result of the collective power that they exercised through company general meetings—and of the relative illiquidity of their shares—there were important senses in which shareholders really did resemble asset “owners” in something like the sense outlined by Honoré in his celebrated essay on ownership.17 From the middle of the nineteenth century, however, in the wake of the development of the railway system and the proliferation of railway companies, joint stock companies increasingly became qualitatively rather than merely quantitatively different from ordinary partnerships. Railway companies were not only much larger than their predecessors, both in terms of the size of their memberships and of the capital that they embodied, they were fundamentally impersonal organisations the great majority of whose shareholders in no way participated in management. The growing number of “detached” shareholders was both reflected in and further encouraged by the rapid emergence in the 1830s and 1840s of a developed and active market in company securities. In a 14 Charles F F Wordsworth, The Law Relating to Railway, Banking, Insurance, Mining and other Joint Stock Companies (London, Henry Butterworth, 1836; enlarged 2nd edn, 1837). 15 See, e.g., J R Ward, The Finance of Canal Building in Eighteenth-Century England (OUP, 1974). 16 For a detailed discussion of this and issues raised in the following paragraphs, see Paddy Ireland, “Capitalism Without the Capitalist: the Joint Stock Company Share and the Emergence of the Modern Doctrine of Separate Corporate Personality”, (1996) 17 Journal of Legal History 41. 17 A M Honoré, “Ownership” in A G Guest (ed), Oxford Essays in Jurisprudence (OUP, 1961), 107. Honoré distinguished eleven incidents of ownership.

Defending the Rentier 147 very short period of time, the nature of the shareholder, of shareholding and of the share itself as a form of property, had all been transformed. Very soon, the great majority of joint stock company shareholders were functionless rentiers, “investors” who took little or no direct interest in the companies in which they held shares, other, of course, than in the dividends they paid. There were many legal dimensions to these changes. Perhaps most importantly, the legal nature of the joint stock company share was transformed. With the development of a relatively sophisticated share market, shares became readily marketable, liquid commodities with a value of their own independent of (and often quite different from) the value of a company’s concrete assets. As a result, they ceased to be regarded in law as equitable interests in the assets of companies and came instead to be seen as rights to profit. Shares emerged, in other words, as an intangible form of property in their own right quite independent of the assets of companies: no longer did they constitute a direct proprietary interest in those assets. In this process, shareholders themselves ceased to be seen as owners of tangible assets—these were now owned by “companies”, conceptualised not as shareholders merged but as reified entities in their own right—but as owners of shares, titles to revenue with a (capital) value determined by the share market. There were now two quite different, legally constituted, forms of property, one owned by shareholders (shares, titles to revenue), the other owned by companies (assets); and two fully separate and quite distinct legal subjects, companies and shareholders. These reconceptualisations provided the basis for the development in the United Kingdom of the modern doctrine of separate corporate personality, with its “complete separation” of company and members; and in the USA, somewhat later, of what came to be called the “entity theory” of the corporation. The reduction of shareholders from the status of relatively active “copartners”, as they were commonly called in the late eighteenth and early nineteenth centuries, to passive owners of titles to revenue, external to companies as productive units, was further reflected in the gradual transfer of power within joint stock companies from general meetings and shareholders to boards of directors and managers, a process in which shareholders gradually relinquished many of the rights and powers traditionally associated with ownership. As a result of these and other developments related to the reduction of shareholders to the status of rentier investors external to the process of production, company law gradually diverged from the law of partnership and had, by the late nineteenth century, separated out as a quite distinct body of law in its own right. In 1889, the author of the leading treatise in the area, Nathaniel Lindley, who had for many years subsumed his coverage of company law within his book on partnership, a volume revealingly entitled A Treatise on the Law of Partnership including its Application to Joint Stock and Other Companies, finally accorded company law a volume of its own.18 18 The first edition of Lindley’s treatise on partnership was published in 1860 (by William Maxwell). It had been through five editions before the separate volume on company law appeared.

148 Paddy Ireland As the ideas of shareholders as owners of assets and as being the company were displaced, there emerged a new notion of shareholders as the owners of “the company”, a reified entity external to them. This idea persists today. So far as large publicly quoted companies were concerned, however, this idea had little basis in law, for while shareholders clearly exercised ownership rights over their shares, in relation to companies and their assets they possessed progressively fewer of Honoré’s incidents of ownership.19 On the contrary, in exchange for limited liability (and an easy life), they had given up virtually all of the rights traditionally associated with ownership either of the corporation or its assets: the right to operate and manage; the right to sell, dispose, pledge, encumber, or hypothecate; the right to create lesser titles in interests, such as leases, licences, easements of covenants; the right to bequeath.20 This prompted Merrick Dodd to distinguish the “technical” legal position—that “the corporation and not the shareholders is the owner of the corporate assets”—from the “lawyer’s theory” and the “business man’s tradition”—that “the corporation owns the business [and] the shareholders in turn own the corporation”.21 The ownership myth,22 however, served one very useful purpose. With its Blackstonian implication of absolute sovereignty, of “sole and despotic dominium”,23 of exclusive and exclusionary “mineness”, the idea that shareholders “owned” corporations, that corporations were their private property, suggested that the retention by functionless shareholders of their right to profit and to appoint and dismiss directors was underlain by the fundamental moral principles of natural right, liberty and moral desert; that the validity of these rights was free-standing and independent of their impact on, and consequences for, such things as productive efficiency and the distribution of wealth. In other words, the ownership myth preempted any proper analysis of the crucial question of what the rights and privileges of these rentier shareholders should be.

RADICAL ENTITY THEORY AND THE QUESTION OF CORPORATE OWNERSHIP

In the first half of the twentieth century, however, this was precisely the question that many began to ask. As the externality of shareholders from production and management, and their lack of purpose became ever more apparent—and 19 See Paddy Ireland, “Company Law and the Myth of Shareholder Ownership”, (1999) 62 Modern Law Review 32. 20 See Peter Rona, letter, (1989) 89 Harvard Business Review (November–December 1989) 198. 21 E. Merrick Dodd, “The Modern Corporation, Private Property and Recent Federal Legislation”, (1941) 54 Harvard Law Review 917, at 918. 22 See Ireland, above n. 19. Although the idea still persists that shareholders (including the shareholders of large public companies) “own” companies by virtue of their ownership of shares, lawyers have always found it next to impossible to give coherent legal substance to it. Hence the difficulty they have in defining the legal nature of shares and indicating how they constitute a proprietary interest in the company. 23 Sir William Blackstone, Commentaries on the Laws of England vol II, 2.

Defending the Rentier 149 by this time the great majority of shareholders had not only ceased to contribute to management but to be significant sources of new capital for companies—the ideas that shareholders were corporate “owners” and that corporations were their private property came increasingly to be challenged. In the USA, in particular, there was growing recognition that the rise of the modern corporation had contributed to fundamental changes in the nature of property and property rights. Thorstein Veblen, for example, argued that ownership, which had previously entailed the control of tangible material assets and carried with it various duties and responsibilities, had come with the rise of the modern joint stock corporation to entail mere passive possession of intangible corporate capital. Corporate shareholders, he argued, had been reduced to the status of “anonymous pensioners” detached from the process of production; they were “absentee owners” possessing claims “to unearned or free income”, “prescriptive rights to get something for nothing”. He accordingly likened them to corporate bondholders, arguing that the lines between debt and property, credit and capital, and stock and bond were becoming increasingly blurred.24 By the late 1920s, it had become commonplace to remark on the resemblance between shareholders and bondholders, thereby implicitly questioning the former’s proprietary status vis-à-vis the corporation. “The average stockholder in the large corporation”, wrote Franklin Wood, “regards himself more as a security holder than as in any sense a responsible managing partner in the corporate enterprise”. As a result, he argued, the legal distinction between bondholders and stockholders was “fast becoming a distinction unwarranted by the actual situation”.25 Ideas of this sort provided the basis for the radical reinterpretation of entity theory offered by E Merrick Dodd in the early 1930s in his celebrated exchange with Adolf Berle.26 Concerned about the growing unaccountability of many American corporate managers, Berle had some years earlier argued for a strengthening and tightening of the fiduciary duties compelling them to pursue the shareholder interest. He did so not so much for reasons of principle but because he could see no other way of preventing managers from feathering their own nests and making them accountable to someone.27 Dodd responded by contesting the close identification of corporations with their shareholders that this entailed, arguing that important changes were taking place in “public opinion” on the corporation in which society saw business not as a purely private 24 See Thorstein Veblen, The Theory of Business Enterprise (New York, Scribner’s, 1904); The Vested Interests and the State of the Industrial Arts (New York, Huebsch, 1919); and Absentee Ownership and Business Enterprise in Recent Times (New York, Huebsch, 1923). 25 Franklin S Wood, “The Status of Management Stockholders”, (1928) 38 Yale Law Journal 57, at 59. For a similar view, see Jerome Frank, Book Review of Berle and Means, (1933) 43 Yale Law Journal 989, at 992. 26 See Paddy Ireland, “Back to the Future: Adolf Berle, the Law Commission and Directors’ Duties”, (1999) 20 Company Lawyer 203. 27 See, for example, Adolf Berle, “Non-Voting Stock and ‘Bankers Control’ ”, (1926) 39 Harvard Law Review 673; “Corporate Powers as Powers in Trust”, (1931) 44 Harvard Law Review 1049.

150 Paddy Ireland enterprise but as something with wider social obligations. Some corporate managers, he argued, had responded by accepting that they had “social responsibilities” and the judiciary were showing tolerance towards the resulting changes in managerial orientation, notwithstanding the traditional view that charity had no business to sit at boards of directors. Crucially, according to Dodd, while such an extended view of corporate managerial social responsibility was “difficult to justify if [one] insist[ed] on thinking of the business corporation as merely an aggregate of stockholders”, it could easily be reconciled with a view of the corporation as a real entity, “as an institution which differs in the nature of things from the individuals who compose it”. Once one recognised the corporation as a truly separate “person”, he suggested, there was no reason why it should not operate, through its managerial agents, as a “good citizen . . . with a sense of social responsibility”. In short, Dodd used entity theory to provide a theoretical basis for the idea of the corporation as a partially, if not predominantly, public institution with broad social responsibilities.28 By the time of the publication of The Modern Corporation and Private Property in late 1932 Berle’s own position had begun to shift. The rise of the modern corporation, he argued with Gardiner Means, “involved an essential alteration in the character of property”, giving rise to important questions about both the orientation of the “great public” corporations and the allocation of rights in them. Because shareholders were now the owners of “passive” rather than of “active” property, the “traditional logic of property” was no longer applicable to them. Having relinquished so many of the rights traditionally associated with ownership, they could no longer properly, or accurately, be called the corporation’s owners. They had “surrendered the right that the corporation should be operated in their sole interest”, “releas[ing] the community from the obligation to protect them to the full extent implied in the doctrine of strict property rights”. The community was entitled “to demand that the modern corporation serve . . . all society”. Various groups should be “assign[ed] . . . a portion of the income stream on the basis of public policy rather than private cupidity”.29 After the Second World War, as many commentators came to question the belief that shareholders were corporate owners in the traditional sense of the word, sentiments of this sort became quite commonplace. There was, however, considerable disagreement as to how shareholders should be reconceived and, consequently, as to how corporations should be viewed and treated. Some began to designate shareholders “investors” rather than “owners”, but contin28 E Merrick Dodd, “For Whom are Corporate Managers Trustees?”, (1932) 45 Harvard Law Review 1147. Berle responded with “For Whom Corporate Managers are Trustees”, (1932) 45 Harvard Law Review 1365, and Dodd came back with “Is the Effective Enforcement of the Fiduciary Duties of Corporate Managers Practicable?”, (1935) 2 University of Chicago Law Review 194. 29 Adolf Berle and Gardiner Means, The Modern Corporation and Private Property (New York, Macmillan, 1932; revised edn, New York, Harcourt Brace, 1967). Berle first began to ponder the implications of the modern corporation for the institution of private property in “Corporate Devices for Diluting Stock Participations”, (1931) 31 Columbia Law Review 1239.

Defending the Rentier 151 ued nevertheless to treat their position as one akin to ownership and their rights as akin to private property rights over the corporation and its assets. They thus defended and promoted shareholder corporate primacy, though seeking to secure the interests of shareholders by means of investor protection rather than by means of measures aimed at rekindling shareholder participation.30 For others, however, the recognition that shareholders were “investors” rather than “owners” highlighted their resemblance to creditors and the weakness of their proprietary claims over the corporation itself. As Edward Mason explained in The Corporation in Modern Society, an influential collection of essays published in 1959, with the “equity holder . . . joining the bond holder as a functionless rentier” and having “only the vaguest idea where ‘his property’ is or of what it entails”, “the traditional justifications . . . of private enterprise [and] of private property [had] gone forever”. The old Lockean and Jeffersonian arguments that private property ownership was essential to the “full development of personality, to the maintenance of individual freedom . . . and to the formation of a citizenry capable of self-government” might still be valid in relation to “individual possessory holdings” but were increasingly irrelevant to corporations whose “owners” had been converted into rentiers.31 This perceived erosion of the legitimacy of shareholder corporate rights and primacy was manifested in various ways. In the USA, a number of commentators—among them Abram Chayes, Bayless Manning and Peter Drucker32— argued that shareholder voting rights should be pared down or even rescinded. Others called for a wider conception of corporate “membership” which would embrace, in particular, employees. In Britain, L C B Gower, doyen of post-war British company law, asked whether it was “not time to recognize that shareholder democracy, with its exclusive emphasis on the profit-making element in corporate activity, has a slightly old fashioned ring?”33 And a little later, George Goyder called for company law reform aimed at creating “participating” and “responsible” companies, membership of which would be extended not only to shareholders but to employees, consumers and the community. He recognised that this required what he called “a certain subordination of the shareholders’ interest”, but, likening them variously to money-lenders, investors, creditors and even usurers—anything but owners—Goyder argued that their legitimate claims over corporations and corporate income were limited. They were entitled, at most, to a fair return on their investment though not necessarily to a perpetual return; perhaps, he suggested, shares should be compulsorily 30 In the USA, the demotion of the corporate shareholder from an “inside” owner to an “outside” investor was heralded by the Federal securities legislation of the 1930s. 31 Edward Mason, “Introduction”, in Edward Mason (ed), The Corporation in Modern Society (Harvard UP, 1959; reprinted, New York, Athenaeum, 1966), 1, at 2–6, 14–15. 32 See Abram Chayes, “The Modern Corporation and the Rule of Law”, in Mason ibid., at 25; Bayless Manning, Review of J A Livingston, The American Stockholder (1958) in (1958) 67 Yale Law Journal 1477, at 1490–3. 33 L C B Gower, Book Review of Emerson and Latcham, Shareholder Democracy (1954) in (1955) 68 Harvard Law Review 922, at 927.

152 Paddy Ireland amortised.34 A few years later, K W (later Lord) Wedderburn, lamenting the lack of radicalism of the Jenkins Committee report, similarly argued that there was “no reason not to equate [the shareholder’s] position with that of a well secured creditor” and that company law “should not treat the shareholder as a ‘proprietor’ entitled to control”.35 Paradoxically, one of the reasons why the political pressure for a reduction in the legal rights of shareholders waned was because the issue was thought redundant by many on the left precisely because the de facto power of shareholders had been emasculated by their dispersal, their rentier nature and their loss of rights within the company. Indeed, by the 1950s many commentators were arguing that the declining power of private property and of corporate shareholders in particular had altered the nature of capitalism itself. In the USA, Berle began referring to the modern American business system as one of “People’s Capitalism” or “Collectivism”,36 while J K Galbraith talked of shareholders as vestigial, of the subservience of the corporation to society and the state, and of the supersession of the market.37 This was echoed in Britain by writers such as Anthony Crosland. Managers now controlled large corporations, Crosland argued, and, “independent not only of the firm’s own shareholders, but increasingly of the capitalist or property owning class as a whole”, they balanced the interests of shareholders with those of employees, customers and the community at large. For Crosland, so significant were the differences in “the nature of the profit-goal and the degree of responsibility with which economic power [was] exercised”, “present day society” had to be distinguished from capitalism, whose traditional ruthlessness and aggressive individualism had been replaced by “a suave and sophisticated sociability”. Correspondingly, the pattern of ownership of industry—whether it was nationalised or privately owned—was now largely irrelevant, for it did not determine the extent to which socially responsible goals were pursued. Large corporations, Crosland argued, “acted in fundamentally the same way, whether publicly or privately owned”. Using “a historical definition”, he concluded, it was “manifestly inaccurate” to call contemporary Britain a capitalist society.38 HENRY MANNE AND THE REPRIVATISATION OF THE CORPORATION

By this time, then, not only was the idea of shareholder corporate “ownership” under question, the old, traditional, ownership and private property-based 34

George Goyder, The Responsible Company (Oxford, Blackwell, 1961). K W Wedderburn, Company Law Reform (London, Fabian Society, 1965). 36 See, e.g. Adolf Berle, The Twentieth Century Capitalist Revolution (London, Macmillan, 1955). 37 See, e.g. J K Galbraith, American Capitalism (Oxford, Blackwell, 1956). 38 C A R Crosland, The Future of Socialism (London, Jonathan Cape, 1956); C A R Crosland, The Conservative Enemy (London, Jonathan Cape, 1962). Similar views were expressed by John Strachey in Contemporary Capitalism (London, Gollancz, 1956). 35

Defending the Rentier 153 justifications for the rights and privileges of shareholders were becoming progressively less persuasive. It is in this context that the rise of contractual theories of the corporation needs to be viewed. In this respect, the work of those most frequently associated with contractarian theory—Alchian and Demsetz, Jensen and Meckling, Easterbrook and Fischel—is in many ways less revealing than the work of Henry Manne, one of the founding fathers of law and economics. It is clear that by as early as the mid-1950s Manne was concerned with the threat posed by contemporary thinking on the corporation, which he traced back to Berle and Means, both to shareholder rights and to the capitalist market economy as a whole. He blanched at suggestions that shareholders should receive only a “fair” return on their capital and that the interests of groups other than shareholders should be considered by managers. The movement for corporate social responsibility, he argued, was undermining market mechanisms, raising the suspicion that a “radically altered form of economy [was] being proposed” in which “the ideal of the market as a resource allocator . . . [was being] abandoned”. As a result of this politicisation of the economic sphere, he later wrote, we were entering “a new phase of concern” with the “political position” of the large corporation and with “the role it is and should be playing in the distribution and enjoyment of a great variety of the values in which the community is interested”.39 Manne responded to the threat by arguing that, notwithstanding growing industrial concentration, market disciplines were still operative, preventing corporations from straying too far from their traditional, profit-making goal. It was, however, on capital, rather than on product, markets that Manne placed disciplinary reliance. The idea that capital markets might constrain corporate managers was not new,40 but most of those seeking to protect the interests of shareholders still looked to a restoration of participative shareholder democracy as the route forward,41 drawing encouragement from the emergence in post-war USA of a small group of shareholder activists who occasionally forced proxy battles for the control of corporations.42 As a result, there was still a tendency to regard the sale of shares by shareholders as not only “the weakest of all the tools in the hands of the stockholder” but as “a disloyal kind of activity which [was] really not desirable”.43 Manne sought to turn this view on its head. If done on a large enough scale, he argued, the sale of shares by dissatisfied shareholders could depress a corporation’s share price, rendering the 39 Henry Manne, “The ‘Higher Criticism’ of the Modern Corporation”, (1962) 62 Columbia Law Review 399, at 402, 414; and Henry Manne, Book Review of Richard Eells, Corporation Giving in a Free Society (1956) in (1956) 24 University of Chicago Law Review 194, at 198. 40 See, e.g., the discussion in Berle and Means, above n. 29, at 255–63 (revised edn, 1967), concluding that they were “one of the economic enigmas of the present system”. 41 See, e.g., Frank Emerson and Franklin Latcham, Shareholder Democracy (Cleveland, Western Reserve University, 1954). 42 See, e.g., J A Livingston, The American Stockholder (New York, Lippincott, 1956). 43 See Henry Manne, Review of J A Livingston, The American Stockholder (1958) in (1958) 5 St Louis University Law Journal 309, at 311.

154 Paddy Ireland corporation vulnerable to take-over and its poorly performing managers vulnerable to removal. Although proxy fights were rare, the mere threat of “a raid” would often suffice, for the constant pressure of possible take-over “condition[ed] managers to a specific point of view perfectly consistent with the shareholders’ interest . . . , keeping the price of the company’s shares as high as possible”.44 In this context, the rise of the institutional investor—by 1960, institutional investors owned 17.2 per cent of the value of American shares45—was, Manne argued, “one of the most dramatic and important events in the recent history of market finance”, for what corporate management feared most was that the institution would sell its shares with a potentially disastrous effect on their market price.46 Manne thus attempted to transform the externalisation of the rentier shareholder from the corporation—an externalisation in many ways accentuated by the rise of financial intermediaries such as institutional investors—from a vice, which arguably undermined not only shareholder control but the legitimacy of their residual rights, into a positive virtue. The very lack of commitment of shareholders to the corporation and their very readiness to “exit”, he suggested, heightened the threat to “errant managements” who dared deviate from the gospel of profit-maximisation. “The fight for control” was, in his view, “a mechanism by which the market operates to weed out the inefficient and less productive”.47 By the mid-1960s, he had further developed this argument and was claiming not only that an “active market for corporate control” existed and that a “great many mergers [were] probably the result of [its] successful workings”48 but that the market for corporate control held the key to “true corporate democracy”. Accordingly, he was highly critical of those calling for the dilution or removal of shareholder voting rights, not because he believed that these rights would (or could) be used by shareholders to restore participative democracy to corporations, but because the market for corporate control could only function to ensure “a rational allocation” of capital and managerial services49 where shares carrying votes could be bought and sold.50 Indeed, it was because of its alleged contribution to the proper working of this market that Manne defended insider dealing, arguing that it not only tied the interests of corporate managers more closely to those of shareholders, but 44 Henry Manne, “Our Two Corporation Systems: Law and Economics”, (1967) 53 Virginia Law Review 259, at 265–6. 45 See William Lazonick, “Controlling the Market for Corporate Control”, (1992) 1 Industrial and Corporate Change 445, at 474. 46 Manne, above n. 43, at 312. 47 Manne argued that in order to make management even more responsive to capital markets, the right of corporate managements to retain earnings—and thus to avoid going to the market for additional capital—should be strictly limited. They should, he argued, be required to pay out all income over the amount necessary for working capital. 48 Henry Manne, “Mergers and the Market for Corporate Control”, (1965) 73 Journal of Political Economy 110; extracted in Louis Putterman and Randall Kroszner, The Economic Nature of the Firm (2nd edn, CUP, 1996), 299. The article was an attack on prevailing antitrust doctrine. 49 Manne, “Higher Criticism”, above n. 39, at 409–13. 50 Manne, above n. 44, at 265.

Defending the Rentier 155 helped to ensure that the price of a company’s securities reflected its performance and the relative efficiency of its management. By trading in a company’s shares, knowledgable insiders were, in effect, constantly “correcting” the company’s share price.51 Crucially, in making these arguments, Manne began to develop justifications for shareholder rights which relied less on the moral force of their claims as corporate “owners”, and much more on the instrumental value of their rights in ensuring “allocative efficiency”. Rather than attempting to defend their ownership claims and lamenting their detachment from corporations, Manne insisted that shareholders had never performed the traditional functions of ownership52 but had, on the contrary, always been mere “investors”, the “traditional capital investor[s] of economic theory” who put “money at risk for use by entrepreneurs and managers”. They had, moreover, according to Manne, always been recognised as such by company law. What needed to be explained was not so much the contemporary lack of rights of shareholders—this flowed from their status as investors—but the more extensive corporate rights that they had possessed in the nineteenth century.53 In its static ahistoricism, Manne’s account of the nature of corporate shareholding prefigured contractarian and agency theories of the company, propelling him not only into unpersuasive and inelegant historical distortions as he tried to explain away the earlier partnership (and “ownership”) based rules of company law,54 but into confused and confusing assertions about the nature of the shareholder’s property and property rights. He described, for example, the claims made by Berle and Means about the passive nature of the share and about the fundamentally social nature of the large corporation—claims which posed a threat to shareholder primacy—as based on “erroneous assumptions about the nature of property”. They had wrongly assumed that the notion of private property necessarily involved “both the concept of risk assumption and that of control or use of the property”, and that “the economic reward provided to property owners is justified only if they perform both of these functions”, mistakenly concluding on this basis that the return to shareholders, as “risk takers only”, should be limited. In fact, Manne argued, the only essential characteristic of a private property system was that owners “assumed the risk of a rise or fall in the market value of [their] property”. An owner was not bound to use his property at all and was perfectly entitled to delegate control over it to managerial agents.55 51 Henry Manne, Insider Trading and the Stock Market (New York, Free Press, 1966); see also Manne, above n. 44, at 274. 52 John Parkinson succinctly sums up this view: “Since the shareholders are not owners, there is no reason to suppose that they should behave in an owner-like way, and the fact that they do not so behave does not signify that the corporate form has become dysfunctional”. See J E Parkinson, “The Contractual Theory of the Company and the Protection of Non-Shareholder Interests” in David Feldman and Frank Miesel (eds), Corporate and Commercial Law: Modern Developments (London, Lloyds, 1996), 121, at 123. 53 Manne, above n. 44. 54 See ibid., at 270–5, for examples. 55 Manne, “Higher Criticism”, above n. 39, at 406–7.

156 Paddy Ireland Lacking a dynamic historical conception of capitalism, Manne was utterly unable to grasp that Berle and Means had simply been trying to address the practical and ethical problems thrown up by the changing nature of corporations, corporate property and corporate shareholding; and, in particular, by the transformation of the shareholder into a functionless, passive investor (a money capitalist) external to the corporation. He could not see that the nature of both shareholding and ideas and forms of property were subject to change. This was something of a paradox, for it was, of course, precisely the historical changes which had occurred in the economic and legal nature of the share which provided the foundation of Manne’s own analysis, with its emphasis on the importance of the liquidity and alienability of the shareholder’s property to the proper functioning of the market for corporate control. In his attacks on Berle, Manne simply confused and conflated the two property forms which had emerged, sometimes identifying the shareholders’ property with the corporation’s assets, sometimes with its shares. In short, while he was very keen to embrace the modern conception of shareholders as mere “investors”, he was quite unwilling to confront the implications of this historic change in status for the nature and ethical defensibility of their corporate rights. Manne’s distortions did not go unnoticed or unchallenged, however. When he attacked managerialist theories which suggested that corporations were no longer subject to rigorous market disciplines—theories which he traced to Berle and Means and which, he believed, had precipitated the worrying “newer concern with political values”—Berle reentered the fray. In trying to place the modern corporation within an essentially nineteenth century theory of economics, he argued, Manne had been forced into “redescriptions” which simply did “not fit the facts”. Berle ridiculed Manne’s “wholly imaginary” account of the proxy fight and the market for corporate control (“mere misdescription”); questioned the extent to which managements were bound by the capital market (“there is some truth in this—but not much”); and lampooned Manne’s account of the role and value of the corporate shareholder. Manne simply refused, Berle argued, to face up to the difficulties involved in specifying the precise nature of the modern shareholder’s “property” and, consequently, in justifying continuing shareholder corporate primacy. His claim that shareholders were “investors” was also, Berle added, in certain important respects a distortion of reality which flattered the rentier, for it was “pure fiction” to suggest that modern shareholders “invested in” companies in the sense of providing them with capital or supplying them with funds. While the original purchaser of the company’s shares was “a genuine investor” who provided the company with money, this was hardly true of the modern purchaser of corporate shares who simply bought shares issued long ago from others who had done likewise. “When I buy AT&T or General Motors”, Berle remarked, “I do not remotely ‘invest in’ either concern”. This claim was mere “folklore habit”, part of an “unreal” attempt to describe late twentieth century processes, institutions, and relations in traditional nineteenth century terms. He reiterated the conclusion he had

Defending the Rentier 157 reached thirty years earlier with Gardiner Means—that “traditional theories of property no longer applied to the relation of stockholders in large corporations”. Passive property certainly needed “new philosophical [and] economic bases”, he argued, but they were not be found “in terms of ‘investment’ or ‘capital markets’ ”.56 It was a withering riposte, but while Berle was not much longer for this earth, Manne and his intellectual counterparts were about to inherit it.

GOVERNANCE AND THE GROWING POWER OF FINANCE

While Berle derided Manne’s theories, many economists began to see them as marking a path whereby corporations could be brought back within orthodox economic analysis. For many years, companies had been treated within neoclassical economics as unproblematic, conflict-free, profit-maximising, productive “black boxes”. Not even growing oligopolisation, nor Coase’s famous 1937 article on “the nature of the firm”, with its mildly subversive suggestion that firms entailed the supercession of the price mechanism by administrative decision,57 had dented this view. Indeed, Coase’s work had been largely ignored, and, in the wake of Berle and Means, theories of the corporation (such as they were) tended to be managerialist and non-market in nature. This began to change in the late 1960s. In what turned out to be a pivotal moment, Manne coordinated a symposium on securities legislation and economic policy. The contributors included the economists Armen Alchian, Harold Demsetz, Michael Jensen, William Meckling and Oliver Williamson, as well as lawyers such as Bayless Manning and Wilbur Katz. The principle purpose of the symposium, as Manne explained, was to “bring the techniques of economics to bear on a broad spectrum of securities regulation problems”, including capital allocation theory and the theory of the firm—issues which the economists involved readily admitted they had neglected.58 As a foretaste of the future, most revealing, perhaps, were the contrasting contributions of Williamson and Alchian. Examining the efficacy of the various markets described by Manne and others, Williamson concluded that while they operated so as to constrain managerial discretion, they did not entirely eliminate it. As a result, managerial approaches to the firm still “ha[d] something to be said in their behalf” and it was therefore necessary to “supplement” neoclassical theory with organisational theory to get “to grips with some of the 56

Adolf Berle, “Modern Functions of the Corporate System”, (1962) 62 Columbia Law Review

433. 57 Ronald Coase, “The Nature of the Firm”, (1937) 4 Economica 386. To a large extent, however, Coase merely substituted one black box for another. 58 See Henry Manne, “Introduction” to Henry Manne (ed), Economic Policy and the Regulation of Corporate Securities: A Symposium (Washington DC, American Enterprise Institute for Public Policy Research, 1969). For those who would like to put faces to the algorithms, the book provides snapshots of each of the principal contributors.

158 Paddy Ireland bureaucratic realities of large organisations”.59 Significantly, it was from around this time that the influence of Coase’s work and the transaction cost approach to the firm finally began to grow, becoming one of the central pillars upon which was built the “new institutional economics” in whose development Williamson played a leading role.60 By contrast, Alchian argued that as long as there was no interference with the ability to make profits or with the ability freely to capitalise and to sell corporate property rights, the operation of the market would ensure efficient organisational forms. “In reality”, he argued “the firm is a surrogate of the marketplace”, from which he concluded that the traditional theory of profits, of private property, market, and competition was far from obsolete.61 Alchian’s contribution was particularly warmly welcomed by Wilbur Katz, one of the lawyers present. Recanting what he called his “adolescent” attachment to the work of Thorstein Veblen, R H Tawney and Berle and Means, Katz argued that law teachers (but not, thankfully, economists) had been corrupted by “the literature that stem[med] from Berle and Means and the managerialists”. He was “shocked” by the kind of suggestions made by Merrick Dodd (that the legal duty of directors to manage in the interests of shareholders on a profitmaximising basis should be relaxed), and, more recently, by Abram Chayes (that there was no reason why shareholders should have votes) and Bayless Manning (that maybe shareholders should not be allowed to vote until they had held their shares for longer than a certain period). In relation to corporate theory and shareholder rights, Katz argued, there was a need for “more theology”, not less as Manning had suggested. What was required above all else was “mutual understanding on basic questions of policy and value”, “a discarding of . . . reticences and a sharing of basic convictions with respect to [the] good society”. He therefore welcomed the “crypto-theology” he detected in Alchian’s paper, but felt that it would be better if we could be “less cryptic”; if “somehow or other we could lose our mutual defensiveness with respect to ‘theological’ beliefs”.62 The lack of empirical support for Alchian’s emerging theology did not go unnoticed. Alchian, remarked one respondent, “very cleverly . . . refuses to do empirical work”.63 Very soon, however, the empirical validity or otherwise of the various claims being made about the operation of the stock market became 59

Oliver Williamson, “Corporate Control and the Theory of the Firm” in Manne, ibid., at 373. Williamson attempts to use transaction cost economics to explain much of social life. As a result, institutions tend to be viewed as webs of individual contracts rather than as social organisms with a life of their own. Although Williamson places administrative coordination at the centre of his analysis of the firm, politics and power still largely disappear from view. 61 Armen Alchian, “Corporate Management and Property Rights”, in Manne, above n. 58, 337, at 348–50. 62 Wilbur Katz, “Discussion”, in Manne, above n. 58, 361, at 363–5. Katz felt that Williamson had eliminated theology from his paper, to which Williamson reassuringly replied that while “a normative emphasis in economics [was] very useful . . . occasional reality testing is useful also”: “Discussion”, ibid., at 372. 63 Peter Steiner, “Discussion”, in Manne, ibid., 367. 60

Defending the Rentier 159 secondary to their ideological usefulness, for it was from around this time that the long post-war boom came to an end and that the power of finance and of rentier investors began significantly to grow.64 This precipitated the demise of managerialism and, in Britain, sounded a death knell to meaningful plans for worker participation. By the 1980s, the influence of the financial sphere had become greater than at any time since the 1920s and the corporate world which was emerging bore little resemblance to that described by Galbraith, Berle and others during the long post-war boom. For many, the takeovers and divestitures of the 1980s marked the final reversal of the trend towards managerial “nonshareholder-wealth-maximising behaviour” that had developed in the post-war period.65 Indeed, the influence of finance now extends well beyond the governance of large corporations and goes to the very heart of government policy, most notably in promoting tight monetary and fiscal policies aimed at controlling inflation and boosting the prices of financial assets. By the early-mid 1990s, it was quite clear, if it had not been before, that the post-war “Golden Age”—of social democracy, of expanding welfare states, of managerialism, of Berle’s “People’s Capitalism”—had come to an abrupt end. In form, the influence now exerted by the financial sphere and its rentiers over Anglo-American corporations differs from that of earlier periods. The direct control by banks which was so marked in the USA in the early decades of the century, for example, has gone, banned in the USA by the financial reforms of the 1930s. What we have instead seen is the rise and fall of devices such as the leveraged buy-out (LBO) and, more recently and ubiquitously, the gradual growth, prompted in the USA and the United Kingdom, in particular, by the increasing power of institutional investors, of what has come to be called “shareholder activism”. It is not insignificant that the principle academic champion of the LBO has been Michael Jensen, one of the founding fathers of contractual theory. In the 1970s Jensen began writing about the problems created by the divergence of interest between shareholders and managers, the so-called principal-agent problem. Initially, his favoured solution was the extensive use of share options as part of executive pay so as to realign the interests of managers with those of shareholders.66 By 1983, however, he was changing his mind, celebrating the market for corporate control as a market in which “alternative managerial teams compete for the rights to manage corporate resources”.67 64 The gradual re-awakening of interest in finance can be tracked back to the 1960s and 1970s. See, e.g., Robert Fitch and Mary Oppenheimer, “Who Rules the Corporations?”, (1970) 1 Socialist Revolution and David M Kotz, Bank Control of Large Corporations in the United States (Berkeley and Los Angeles, University of California Press, 1978). Interest in the role of finance also began to reappear in the pages of Paul Sweezy’s Monthly Review in the early 1970s. 65 See R Glen Hubbard and Darius Palia, “The Market for Corporate Control”, in The New Palgrave Dictionary of Economics and the Law (Peter Newman (ed), London, Macmillan, 1998), 611, at 614. 66 Michael Jensen and William Meckling, “Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure”, (1976) 3 Journal of Financial Economics 305. 67 Michael Jensen and Richard Ruback, “The Market for Corporate Control”, (1983) 11 Journal of Financial Economics 5.

160 Paddy Ireland Pursuing this, he had by the end of the decade become a leading advocate of the leveraged buy-out, which he championed, somewhat prematurely as it turned out, as the new corporate form.68 By the late 1980s, the idea of the “liquid” market for corporate control was ever more celebrated in the popular and academic literature, peaking during the leverage boom of 1989. The difference was that while the buyers in Manne’s market for corporate control had been corporations, hence his focus on “mergers”, the buyers in the late 1980s were financiers, bankers and deal-makers such as the LBO boutique Kohlberg Kravis Roberts,69 rather than firms in related industries, hence the emphasis on the “liquidity” of the market. The era of the LBO proved short-lived, however, and after various buy-outs suffered financial distress, the fashion for them waned, to be replaced by rentier assertiveness in the form of “shareholder activism” by institutional investors. This remains the dominant contemporary form. The beginnings of a marked and sustained departure from the previously well-established passivity of institutional investors can be traced back to the 1980s, by which time not only had the proportion of shares held by institutions, particularly in the USA and United Kingdom, scaled new heights, the competition between and within institutions had begun significantly to increase. Since then, with money managers increasingly judged on their quarterly performances, corporate managers have been confronted by an activism whose whole point is “to increase the profit share of national income, and to claim a larger proportion of that profit share for rentiers”. As Henwood says, shareholders today “are far less passive, boards less rubber-stampish, and managements less autonomous than at any time since Berle and Means”.70 While direct intervention in corporations by institutional investors remains relatively rare, the enormous impact that their monitoring and cajoling has had on corporate managerial culture in the USA and beyond cannot be doubted. In recent years, it has become increasingly de rigueur for corporate managers, faced by increased pressure from demanding rentiers, to pay homage to the God of “shareholder value”.71 It is not insignificant or surprising, therefore, that one of the two possible models for company law identified in the consultation paper of the UK Company Law Review Steering Group is explicitly based around precisely this idea. Correspondingly, as the 1990s have progressed, bringing with them a period of ruthless labour exploitation, downsizing, investment cutbacks and rentier greed, the efficiency-based justifications that contractual and agency theories of the corporation offer for shareholder rights have become not only 68 See Jensen’s wildly unprescient “Eclipse of the Public Corporation” (1989) 89 Harvard Business Review (September–October) 61, suggesting that the LBO association was about to replace the public corporation. 69 See Bryan Burrough and John Helyar, Barbarians at the Gate (New York, Harper & Row, 1990). 70 Doug Henwood, Wall Street (London, Verso, 1997), 293. 71 For evidence of the impact of the internationalisation of equity markets on German corporate governance, see Thomas Andre, “Cultural Hegemony: The Exportation of Anglo-Saxon Ideologies to Germany”, (1998) 73 Tulane Law Review 69.

Defending the Rentier 161 ever more welcome but ever more necessary. If Manne’s work in the 1950s and 1960s made the “marketisation” of the corporation and its return to orthodox economic analysis theoretically imaginable, the growing power of the rentier and of finance in recent years has made it ideologically indispensable.

A PRIORI EFFICIENCY AND THE CONTRACTUALISATION OF THE CORPORATION

It is far from clear even now, thirty years after Manne first posited its existence, whether the market for corporate control operates so as to weed out inefficient managers in anything like the way advertised. On the contrary, the historical record suggests that mergers and acquisitions often bring little in the way of efficiency gains. “There is”, the authors of one study typically conclude, “no broadguaged support for the ‘inefficient management displacement’ hypothesis that acquired companies [are] subnormal performers” and the evidence “mandates considerable skepticism toward the claim that mergers are on average efficiency enhancing”.72 This view has broadly been endorsed by other studies.73 In Britain, for example, Julian Franks and Colin Mayer, observing that the performance of targets of hostile take-overs in the United Kingdom is close to that of the average quoted company, conclude that the results of the research that has been carried out question the common association of markets for corporate control with the correction of managerial failure.74 There is, moreover, evidence that even where the market for corporate control does contribute to the disciplining of poorly performing companies, its overall effect may nevertheless be to encourage managerial short-termism and to discourage longer-term investment.75 The empirical validity (or otherwise) of the theories associated with the market have, however, become increasingly less important as their ideological value has grown. Thus, despite the doubts about the way in which the stock market 72 David J Ravenscraft and F M Scherer, “The Profitability of Mergers”, (1989) 7 International Journal of Industrial Organisation101. 73 See, e.g., Richard E Caves, “Mergers, Takeovers, and Economic Efficiency: Foresight vs Hindsight”, (1989) 7 International Journal of Industrial Organisation 151. 74 See Julian Franks and Colin Meyer, “Hostile Takeovers and the Correction of Managerial Failure”, (1996) 40 Journal of Financial Economics 163; and “Ownership and Control in Europe”, Palgrave, above n. 65, 722, at 726–9. They add, however, that while the market for corporate control does not appear to be associated with the correction of managerial failure as measured by past corporate performance, there is evidence that it gives rise to substantial corporate restructurings with high asset disposals and executive dismissals; they therefore draw a distinction between ex ante and ex post failure: see “Takeovers: Capital Markets and Corporate Control: a Study of France, Germany and the UK”, (1990) 10 Economic Policy 189. 75 See, for example, William Lazonick, “Controlling the Market for Corporate Control: The Historical Significance of Managerial Capitalism”, (1992) 1 Industrial & Corporate Change 445; and see also the related papers by A P Dickerson, H D Gibson and E Tsakalotos, “Short Termism and Underinvestment in Financial Systems”, (1995) 58 Manchester School 351; “The Impact of Acquisitions on Company Performance”, (1997) 49 Oxford Economic Papers 344; “Takeover Risk and Dividend Strategy: A Study of UK Firms”, (1998) 46 Journal of Industrial Economics 281.

162 Paddy Ireland actually operates, the claims made for its contribution to economic efficiency are nevertheless “among the least restrained to be found in agency theory”.76 Whatever the reality, the alleged existence and efficacy of the market for corporate control and of a close correlation between corporate managerial efficiency and the market price of the corporation’s shares has become one of the theory’s bedrocks. As David Campbell explains, the significance of Manne’s “discovery” of the market for corporate control lay in its suggestion that corporate managers were subject to market disciplines and that it was, therefore, possible to construct a market-based theory of the firm to rival the non-market based theories spawned by managerialism. The idea of the properly functioning market for corporate control is “the fundamental concept of agency theory” precisely because, theoretically at least, it “places [the managerially controlled company] back under the market”.77 That contractual or agency theories of the corporation are able to offer neoclassical economists a solution to the problems generated by the ostensibly nonmarket nature of firms, enabling them to assert the efficiency of existing corporate structures, is also due in significant part, however, to the peculiar nature of their concept of “efficiency”. Within orthodox economic theory, no attempt is made to evaluate the importance of the goal of efficiency relative to other competing goals; and the efficiency, or otherwise, of different arrangements and resource allocations is assessed not by careful, wide-ranging, empirical comparison, but by reference only to the formal nature of the arrangements and the processes of which they are a product. Put simply, if arrangements can be presented as the product of a process of free market exchange, they are deemed, a priori, to be “efficient”.78 As John Parkinson says, once it has been presumed that a governance structure is the product of contracting, “it follows that it must be efficient”.79 Spurred on by the “discovery” of the markets for corporate control and for managers themselves, contractual theorists have made precisely that presumption, leaving their only remaining task that of identifying and elaborating the “contracts” involved. It is hardly surprising, therefore, that they have engaged in endless contortions purporting to show that existing corporate arrangements are, indeed, essentially the products of free market contractual exchanges. Discovering “contracts” in every conceivable corporate nook and cranny, they have generated in Biblical proportions the theology for which Katz called. With the irritating constraints imposed by empirical reality lifted, it is equally unsurprising that this contractualisation of the corporation has produced very varied accounts of the “contracts” constituting the corporation. Once one leaves the real world and enters a realm of theoretical fantasy, 76

See Campbell, above n. 13, at 362. Ibid., at 359. 78 Conversely, if they aren’t the product of the operations of the market, they are, a priori, inefficient. See, for example, Eirik Furubotn, “Co-Determination and the Efficient Partitioning of Ownership Rights in the Firm”, (1981) 137 Zeitschrift fur die gesamte Staatswissenschaft 702, at 705. 79 Parkinson, above n. 52, at 125. 77

Defending the Rentier 163 the possibilities are—within the contractual bounds set, of course—almost endless. Indeed, many of those sympathetic to stakeholding are now joining in, cheerfully trying to fabricate corporate “contracts” that are more favourable to employees and other stakeholders.80 As David Campbell says, because the goal is simply “to bring the company within the theory”, “real” contracts are placed on the same ontological plane as “unreal” (but theoretically necessary) contracts, contracts that, in empirical reality, simply do not exist.81 As a result, despite its claims to tough, hard-nosed realism, contractual theory is, in fact, strikingly unrealistic and empirically inaccurate.82 Hence Campbell’s conclusion that, although it describes the company as a nexus of contracts, there are, in fact, “no contracts . . . only a nexus of metaphors”; that it “is not an empirically based theory” at all, but is rather “carried by metaphor and assertion based on that metaphor”, as a result of which it is “not readily open to rational debate”.83 Indeed, according to Alan Wolfe, “even as metaphor, the notion of the firm as a nexus of contracts has problems”.84 However, for all the metaphorical differences between the various contractual theories that have emerged, in one important and crucial respect they are more or less indistinguishable: they all conclude that the retention by shareholders of their residual income and control rights is legitimate and justifiable, not so much on grounds of shareholder corporate “ownership” but on grounds of efficiency. As Parkinson observes, the central purpose of nexus-of-contracts theorising has been “to establish that the large publicly owned company . . . is efficient, notwithstanding the wide dispersal of shareholdings”;85 or, to put it another way, to reprivatise the public company. AGENCY THEORY AND THE PROBLEM OF OWNERSHIP

The question of ownership is not, however, one that contractual theorists find easy to escape. Contractual theory generally tries to circumvent it and to avoid 80 See, e.g., Marleen A O’Connor, “Restructuring the Corporation’s Nexus of Contracts: Recognizing a Fiduciary Duty to Displaced Workers”, (1991) 69 North Carolina Law Review 1189. In the late 1980s, Katherine van Wezel Stone also saw the theory as granting labour equal standing with other parties in the struggle for power within the corporation, see “Labor and the Corporate Structure: Changing Conceptions and Emerging Possibilities”, (1988) University of Chicago Law Review 73, at 161. 81 Campbell, above n. 13, at 360–1. 82 “Large corporations”, explains Alan Wolfe, “are composed of people who speak many different languages, have never met each other, work in positions defined by different degrees of power and responsibility, and have wildly different motives, loyalties, and talents. Can contracts exist between people who never meet, have nothing in common, and are unavailable to pass judgment on the behaviour of the other parties to the contract? Perhaps they can in a metaphorical sense, in roughly the same way that early social contract theorists understood the body politic to operate. But no one ever claimed that the social contract was an empirical description of actual real world events”: Alan Wolfe, “The Modern Corporation: Private Agent or Public Actor”, (1993) 50 Washington & Lee Law Review 1673, at 1680. 83 Campbell, above n. 13, at 360. 84 Wolfe, above n. 82, at 1680. 85 Parkinson, above n. 52, at 122.

164 Paddy Ireland questions concerning the initial allocation of corporate (property) rights by conceptualising the corporation or “firm” out of existence. Viewed as a nexus of contracts, the corporation is deemed to be, in Jensen and Meckling’s words, “just a legal fiction which serves as a focus for the complex process in which the conflicting objectives of individuals . . . are brought in equilibrium within a framework of contractual relationships”.86 With the corporation diminished in this way, there is within agency theory a tendency to see nothing (no “thing”) to be owned. Corporate governance is thus treated as little more than a more complex version of standard contractual governance and shareholders once again characterised, as they were by Manne in his exchanges with Berle, as the owners and providers of “capital”, one of the factors of production, rather than as the redundant, functionless rentiers, the buyers and sellers of titles to revenue, which in empirical reality they now are. The kinds of questions that agency theorists pose reflect this mythology, presuming that shareholders actually give something to corporations, rather than simply place bets on their future profitability. “How does it happen”, Jensen and Meckling innocently ask, “that millions of individuals are willing to turn over a significant fraction of their wealth to organisations run by managers who have so little interest in their welfare?” Or as Kenneth Scott puts it, “why are shareholders”—who “furnish inputs into the business”—“willing to turn large sums of money over to other people (managers) on very ill-defined terms?”87 Reinvigorated in this way, shareholders are subtly returned to former glories: no longer redundant traders in titles to revenue, they are re-elevated to their earlier, more exalted status of “real” investors, restored to an entrepreneurial function as risk-taking “providers of capital”. The reality that the contemporary stock market “counts for little or nothing as a source of finance” is studiously ignored.88 Once again, this recharacterisation—or “misdescription”—of the shareholder and the corporation elides the distinction between the corporate assets and shares. The two distinctive and autonomous property forms which emerged with the development of the modern joint stock corporation and the reduction of the shareholder to the status of a pure rentier completely external to the company are conflated under the rubric “capital”, a process which discretely reunites the shareholder with the corporate assets. The curious effect of this is to eliminate the corporate entity as an owner of property, other than in a purely formal sense. Indeed, with shareholders characterised as the providers of capital, and with assets and shares conflated, the corporation more or less disappears, reduced to a mere cipher through which the owners of different factors of production are brought contractually together. The corporation, writes 86 Jensen and Meckling, above n. 66, at 312. See also Daniel Fischel, for whom the corporation is “a legal fiction that serves as a nexus for a mass of contracts which various individuals have voluntarily entered into for mutual benefit”: “The Corporate Governance Movement”, (1982) 35 Vanderbilt Law Review 1259, at 1273. 87 Kenneth Scott, “Agency Costs and Corporate Governance”, in Palgrave, above n. 65, at 26. 88 Henwood, above n. 70, at 292.

Defending the Rentier 165 Eugene Fama, is “just the set of contracts covering the way inputs are joined to create outputs and the way receipts from outputs are shared among inputs”.89 While the various factors of production employed in a firm must be owned by someone, he explains, “ownership of capital should not be confused with ownership of the firm”, for “ownership of the firm is an irrelevant concept”.90 The conceptual elimination of the corporation not only places shareholders in direct touch with the corporate assets (the “capital”), it also places them, in theory at least, in direct touch with corporate managers, for with no corporate entity of substance to come between them, the relationship between shareholders and managers is correspondingly characterised as a pure agency relationship. Corporate governance tends in consequence to be seen as involving not highly complex questions of productive organisation, social wellbeing and social justice, but simply the difficulties facing shareholder-principals trying to negotiate sufficiently binding contracts with agent-managers. Curiously, therefore, agency theory tries in many ways to turn the corporate-theoretical clock back to the early nineteenth century when the corporation was conceptualised as a purely artificial, fictional entity, harking back to the days when corporation and shareholders were perceived, for most purposes, as one and the same; when the shareholders were the corporation. Politically attractive though it is to defenders of rentier rights and corporate non-interventionism, however, the wholesale contractualisation of the firm is itself the source of a variety of conceptual problems. Most importantly, perhaps, one of the effects of the reduction of the corporation to a nexus of contracts is that, in accordance with neo-classical ideology about the nature of markets, it tends to flatten the hierarchical elements within corporations, suggesting that they lack any in-built structure of authority. Alchian and Demsetz, for example, recognise that it is “common to see the firm as characterised by the power to settle issues by fiat, by authority, or by disciplinary action superior to that available in the conventional market”, but argue that this is a “delusion”. As “a highly specialized surrogate market”, they insist, the firm “has no power of fiat, no authority, no disciplinary action any different in the slightest degree from ordinary market contracting”. To speak of the management or direction of workers is merely “a deceptive way of noting that the employer continually is involved in renegotiation of contracts on terms that must be acceptable to both parties”. In fact, they reiterate, “authoritarian, dictational, or fiat attributes” are simply “not relevant to the conception of the firm 89 Eugene Fama, “Agency Problems and the Theory of the Firm” (1980) 88 Journal of Political Economy 288; extracted in Putterman and Kroszner, above n. 48, at 302. See also Easterbrook and Fischel, “Voting in Corporate Law”, (1983) 26 Journal of Law and Economics 395, at 396. 90 Fama, ibid. (in Putterman and Kroszer), at 304. Fama took the view developed by Alchian and Demsetz, and Jensen and Meckling still further, prising apart the two functions attributed to the entrepreneur, management and risk-bearing, treating them as “naturally separate factors within the set of contracts called the firm”. He would probably be horrified to discover that in this respect he echoes Marx.

166 Paddy Ireland or its efficiency”.91 As William Lazonick wryly observes, Alchian and Demsetz’ firm, with its denial of disciplinary power, appears not to be a capitalist firm at all.92 It does, however, at least entail a central agent, referred to as the firm’s “owner” or “the employer”, who possesses, inter alia, the right to renegotiate the contracts of all the suppliers of inputs. Others go even further, refusing to grant any one of the contracting parties the privileged role of “owner” of the firm. The provision of capital, it is argued, is based on exactly the same sort of contract as the provision of other factors of production, hence the “irrelevance” of the concept of ownership of the firm.93 In these accounts, an attempt is made to derive both the manifestly hierarchical and authoritarian structure of corporations and the residual control rights of shareholders entirely from contract and the market, without any reference to ownership of the corporation or its assets. Shareholders are deemed simply owners and providers of capital, a factor of production like any other. It is argued, however, that as those entitled to the surplus, to what is left after all the other claimants have been paid, they have the greatest incentive to ensure that management operates in the most efficient and productive manner,94 but that as “residual claimants” whose entitlements are not precisely specified they cannot easily protect themselves by contract. They accept the risks associated with their residual position, therefore, only in return for the protections provided by the legal rules which grant them voting rights and compel managers to act in their interests. The distribution of authority (of property rights) within existing corporate structures are thus portrayed as market products: either because they are said to have arisen spontaneously from contract, or if it is conceded that they were not originally the products of contracting, because they are subject to a continual process of market review.95 Whatever their origins, the fact that existing governance structures have survived market selection is regarded as proof of their efficiency. There is, therefore, both a descriptive and a prescriptive dimension to the claims being made. Residual control rights and rights to the surplus are vested in shareholders as a result of market-contractual processes. Moreover, they should be vested in them—not because they “own” the assets or companies concerned but because this is the most efficient arrangement.96 These approaches have the advantage, at least in theory, of obviating the need to account for the authority vested in managers and shareholders in non91 Armen Alchian and Harold Demsetz, “Production, Information Costs, and Economic Organization”, (1972) 62 American Economic Review 777, extracted in Putterman and Kroszner, above n. 48, 193. In this respect, the work of Williamson is markedly different as from his perspective, hierarchy and authority within the firm remain very important. 92 William Lazonick, Business Organisation and the Myth of the Market Economy (CUP, 1991), 181–8. 93 See Fama, above n. 89. 94 See, e.g., Frank Easterbrook and Daniel Fischel, The Economic Structure of Corporate Law (Cambridge, Mass, Harvard UP, 1991), 67–9. 95 Parkinson, above n. 52, at 123–8. 96 It is commonly argued that the very fact that these rules and rights have emerged and survived in a market-contractual environment is evidence of their efficiency.

Defending the Rentier 167 contractual, non-market terms. Other contractualists, however, feel unable to do this without resort once more to the idea of ownership. Recognising that it is impossible to foresee let alone plan for all future contingencies, and correspondingly impossible in practice to write a contract which comprehensively specifies rights in the many varied situations which might arise, they deem the contracts that constitute the corporation, and especially those involving shareholders, inevitably to be “incomplete”.97 This is not only a source of renegotiation costs98 as contracts are revised and amended as the future unfolds, it renders vitally important the question of who is to have power over corporate assets and activities in situations where contractual incompleteness has prevented rights from being specified in advance. Power and authority—“not”, Oliver Hart tells us, “standard feature[s] of economic theory”—thus reenter the equation and, with this, the issue of ownership sneaks in through the backdoor. “A reasonable view”, Hart argues, is that where contracts do “not specify all aspects of asset usage in every contingency . . . it is the owner of the asset in question who has . . . residual control rights over [it]”, meaning “the right to decide all usages of the asset in any way not inconsistent with a prior contract, custom, or law”. It therefore “matters who owns a piece of private property”,99 for ownership is “a source of power when contracts are incomplete”. But who are the “owners” of the assets of large corporations? Formally, of course, the assets are owned by the corporation itself, a legal fact that hardly helps to resolve the question. By initially developing his so-called “property rights” theory in the context of closely-held or owner-managed firms, however, Hart feels able to assert that the owners of a company’s assets are its shareholders, because it is they who exercise residual control rights over them—a defensible assertion in economic reality, if not in law, in relation to firms of this sort. However, although he recognises that it is to closely-held firms that his theory “applies most directly”, he proceeds to extend it, virtually unmodified, to large corporations, blithely arguing that “even though there are important differences between the ownermanaged and large company cases, the main insights of the property rights approach continue to be relevant”.100 With this, corporate shareholders, as the possessors of residual control rights, are once again reunited with the corporate assets, as their “owners”, and the significance of the changes in the process of production and in the nature of property and property rights associated with the rise of the modern corporation, and their impact on the idea of ownership, are more or less dismissed.101 The complex issues surrounding the nature of the 97 Even if plans could be made for every contingency, it would be extremely difficult for the parties to capture these plans in a comprehensive written manner amenable to later adjudication: see Oliver Hart, Firms, Contracts and Financial Structure (OUP, 1995), 23. In much contractualist literature, the shareholders’ contract is regarded as the paradigmatic “incomplete” contract. 98 Some of these costs are seen as ex post, others as ex ante costs. For a discussion, see Hart, ibid., at 25. 99 Ibid., at 4–5, 29–30. 100 Ibid., at 62. 101 In other accounts, shareholders are deemed owners of “the firm”, rather than owners of the assets, by virtue of their possession of the right to control the firm and their right to appropriate the

168 Paddy Ireland corporation as an entity—crudely, whether it is and/or should be characterised as a public or private entity—and the allocation of power (and rights) in and over it are thus dealt with by the simple expedient of attenuating and redefining the meaning of ownership so as to encompass the position of shareholders. The resulting reasoning is dizzyingly circular: Hart tells us that ownership is the source of residual control rights, while at the same time asserting that the possession of residual control rights is “the definition of ownership”.102 The rights of shareholders are thus seen as flowing from the preexisting fact of their asset “ownership” while their “ownership” of those assets is inferred from their possession of residual control rights.

FROM THE MYTH OF OWNERSHIP TO THE MYTH OF EFFICIENCY: PRIVATE PROPERTY AND THE PUBLIC-PRIVATE DIVIDE

For all its many faults, however, Hart’s analysis does at least address the question of power, the whole thrust of his argument being that “[corporate] institutional arrangements are designed to allocate power among agents”.103 And in so doing, it goes to the issues at the heart of corporate governance: the constitution of corporate rights and the allocation of power in and over corporations—what John Christman calls the “structure of [corporate] ownership”.104 Indeed, it goes also to the heart of the public-private divide, for the conceptual delineation of a specifically private sphere of individual autonomy and sovereignty which not even the state can legitimately invade rests heavily on the idea of private property. This idea, as Jennifer Nedelsky says, forms “the foundation for everything from the public/private distinction to the ongoing market versus regulation debate”.105 When, therefore, theorists assert that corporations are contractual affairs in whose realm the principle of public non-interference should reign, they are, for all their emphasis on contract, in effect making a property-based claim: that the assets of corporations, if not the corporations themselves, are private property and that corporate affairs are, therefore, private matters. firm’s net earnings. See, for example, Henry Hansmann, “Ownership of the Firm”, (1988) 4 Journal of Law, Economics and Organisation 267. 102 Hart, above n. 97, at 30. Kevin Gray has also noted “the horrible circularity of such hallmarks of ‘property’ ”. If, he argues, “naively we ask which rights are proprietary, we are told that they are those rights which are assignable to and enforceable against third parties. When we then ask which rights these may be, we are told that they comprise, of course, the rights which are traditionally identified as ‘proprietary’. ‘Property’ is ‘property’ because it is ‘property’: property status and proprietary consequence confuse each other in a deadening embrace of cause and effect”: Kevin Gray, “Property in Thin Air”, (1991) 50 Cambridge Law Journal 252, at 293. 103 Hart, ibid., at 5. See also Sanford Grossman and Oliver Hart, “The Costs and Benefits of Ownership”, (1986) 94 Journal of Political Economy 691; Oliver Hart and John Moore, “Property Rights and the Nature of the Firm”, (1990) 98 Journal of Political Economy 1119. 104 Christman, above n. 12, at 4. 105 Jennifer Nedelsky, Private Property and the Limits of American Constitutionalism (University of Chicago Press, 1990), 247–8.

Defending the Rentier 169 As many have pointed out, however, the public-private divide upon which such assertions are based is itself premised upon a conception of private property as an essentially pre-political, natural phenomenon with an existence independent of the state and the public sphere; in other words, on a tacit denial that property is a social construct founded on a set of policy choices embodied in law.106 Yet there are few better illustrations of the socially constructed, contingent and dynamic nature of ideas about property and property rights than those provided by corporate history. As we have seen, the changes which have occurred in the organisation and relations of production and in the economic nature of joint stock companies and their shares over the last two centuries have been accompanied by a transformation in the way in which companies and corporate property are perceived and constituted in law. Rights in and over joint stock companies have, of course, been reconstituted in ways which favour shareholders, enabling them to maintain their right to dividends and to appoint and dismiss directors despite their lack of function. But it was not inevitable that this should be the case: the new conceptions did not flow inexorably from the economic developments which underlay them. On the contrary, they were the products of policy (political) choices made by the courts and legislature. What corporate history highlights, therefore, is the often-overlooked role of the state in defining and redefining “property”, underlining the fact that property and property rights are never truly private and always have what Kevin Gray calls a “public law character”. There is, as he says, “in every property drama a third actor, in addition to the plaintiff and defendant, . . . the state, expressing its collective judgement through the voice of the courts”.107 In short, corporate history highlights the fact that property is not a value-free phenomenon. For Gray’s near-namesake, Thomas Grey, the proliferation of property forms such as the share, which provide titles to revenue but which lack any direct link with tangible things, has precipitated a “disintegration of property”. In the last two hundred or so years, he argues, we have gone from a world in which property was “a central idea mirroring a clearly understood institution”, to a world in which “it is no longer a coherent or crucial category on our conceptual scheme”.108 He attributes this “collapse of the idea of property” to the workings of the market economy, to the inner logic of capitalism and its progressive exploitation of the division of labour and economies of scale,109 arguing that these have led to the subdivision and recombination of the rights that originally 106 It is probably because private property is commonly experienced in this way that legal entitlements to property tend to be experienced as qualitatively different from other forms of legal entitlement, see Nedelsky, ibid., at 248–9, 255. 107 Gray, above n. 102, at 297, 303–4. 108 Thomas C Grey, “The Disintegration of Property”, (1980) 22 Nomos 69, at 74. 109 The disintegration of property is “in no way fuelled by the ethics, politics or interests of socialism” but generated by the operations of the free market itself. The latter, Grey argues, sees proprietors subdivide and recombine the bundles of rights that originally constituted ownership, “creating by private agreement the complex of elaborate and abstract economic institutions and claims characteristic of industrial capitalism, particularly the financial institutions and industrial corporations”: Grey, ibid.

170 Paddy Ireland made up ownership, generating property forms “remote from tangible objects”. As a result, he says, for many specialist lawyers if not for lay people, the “robust unitary conception of ownership”—the idea of private property as entailing comprehensive and exclusive “ownership” rights over real things—has been fragmented and replaced by a “shadowy” bundle of rights conception in which property lacks any necessary connection to tangible objects.110 According to Grey, this “disintegration of property” has become a major source of political and ideological problems for capitalism. While the new forms of property and the economic structures that accompany them, the corporation and share prominent amongst them, are “entirely consistent with full loyalty to [the market capitalist] system”—it is, after all, the internal logic of the market which has created them—the dissolution of the traditional thing-ownership conception of property has, he argues, “erode[d] the moral basis of capitalism”.111 Conceived as thing-ownership, property rights are perceived as having intrinsic worth linked to notions of moral right; and capitalism, to the extent that it “connotes a general regime of protection of private property”, is able to “enlist . . . on its side” the still potent justifications associated with this view. The problem, he argues, is that the replacement of the thing-ownership conception of property by a bundle-of-rights conception threatens to expose property for what it really is—a political relation between people; and that “the forceful intuitions behind the moral arguments” for simple thing-ownership do not readily transfer to the legal institutions and intangible property forms of modern capitalism, with the result that the latter is compelled to seek a moral basis in “other, more instrumental values”, most notably that of producing material wellbeing. Arguably, nowhere is the erosion of these moral arguments more evident than in the case of shares and shareholders. The changes in the constitution of corporate property and corporate rights mark the completion of the historical process—inherent in the joint stock company as an economic form of organisa110 The idea of property as a bundle of rights is usually traced back to Wesley Hohfeld, though it can be tracked back still further, see J E Penner, “The ‘Bundle of Rights’ Picture of Property”, (1996) 43 UCLA Law Review 711; Jeanne Schroeder, The Vestal and the Fasces (Los Angeles, University of California Press, 1998), 156–84. There seems little doubt that it is currently the dominant paradigm of property, accepted by most writers on the subject (see, e.g., Jeremy Waldron, The Right to Private Property (Oxford, Clarendon, 1988); Stephen Munzer, A Theory of Property (CUP, 1990)). In recent years, however, it has been subjected to criticism (see Penner, Schroeder, above). Kevin Gray expresses similar sentiments to Thomas Grey but sees the essence of property as inherently elusive. What, he asks, constitutes the “propertiness” of property? What is it that distinguishes the rights in the property bundle as specifically “property” rights? It is not easy to say, he argues. On the contrary, in the modern world, the notion of property “readily collapses back into contract”. The “ultimate fact” about property, he concludes, is that “it does not really exist: it is more illusion . . . a vacant concept”. Just as we think that “we have found an objective reality which embodies our intuitions and needs . . . [the notion of property] dissolves into a formless void”. The conceptualisation of property as a bundle of rights, rather than as a thing is thus simply an attempt by legal theorists “to sidestep the unattainable quality inherent in the notion of private property”: Gray, above n. 102, at 252, 259, 292. Proudhon got it wrong: property isn’t theft, it’s fraud. 111 Grey, above n. 108, at 74–6. It might (but probably won’t) be a sobering thought for those who currently believe that “there is no alternative” to (global) capitalism that, only twenty years ago, Grey was writing in this context of its “declining prestige [and] decaying cultural hegemony”.

Defending the Rentier 171 tion—whereby the shareholder has been externalised from the company and transformed into a functionless rentier, a pure money capitalist standing outside the process of production. An important aspect of this has been the relinquishment by shareholders not only of any significant managerial, supervisory or capital-providing function but of many of the rights traditionally associated with asset (or company) “ownership”. Reflecting their redundancy, the bundle of rights which they have come to possess by virtue of their share ownership (the bundle of rights that constitute the share as a separate form of property) has gradually shrunk, coming to comprise but a few of the rights that would constitute “ownership” of the corporate assets (or corporation) in the traditional sense. Severed both from productive purpose and from the rest of the rights in the “thing-ownership” bundle, the moral basis for the remaining rights of rentier shareholders, rights which, despite their attenuated nature,112 are a source of extraordinary economic and social power, has become increasingly difficult to discern.113 With the justifications associated with the “robust unitary conception of ownership” weakened, it is, then, not only capitalism but rentier shareholders who are forced to seek legitimacy in “other, more instrumental, values”.114 It is in this context that the ascendancy of contractual theories of the corporation and their efficiency-based defence of shareholder property rights needs to be seen. Although usually put forward as neutral, theoretical accounts of reality, these theories are more accurately seen as attempts to legitimate rentier rights in instrumental terms; as prescriptive rather than descriptive theories. No matter how vociferous their advocates, however, claims based on grounds such as “efficiency” are inherently weaker and less compelling than the more fundamental, ethical claims surrounding the traditional ideas of private property and ownership, not least because as soon as one begins to offer a purposive account of why shareholders should possess these rights, arguing that they are justified for essentially instrumental reasons in terms of their effects, one invites not only an assessment of their effectiveness in achieving the stated goals, but an evaluation of those goals relative to other competing ones. There is certainly no doubting the current popularity of contractual theory. But this popularity rests less on its empirical accuracy, validity or intellectual merit and more on its consonance with certain powerful class interests. Contemporary company law, even if it does not yet explicitly embrace these theories, shares many of their presuppositions and values, and resembles them in its shareholder-orientation. And the current political climate, with its underlying neo-liberalism, its belief in the 112 In Christman’s terminology, they are now essentially “income rights”: see his differentiation of income rights from control rights. Christman, above n. 12, at 7–8. 113 Arguably, therefore, Grey has misplaced his emphasis. The concept of “property” has not so much disintegrated as simply been transformed in order to encompass the growing number of intangible, alienable titles to revenue which have proliferated as capitalism has developed. It is the concept of private “ownership”, at least as it applies to corporations and their assets, that has disintegrated, becoming ever harder morally to sustain and justify. 114 Grey, above n. 108, at 78.

172 Paddy Ireland inescapability of market imperatives (“globalisation”) and its overriding emphasis on identifying the most “competitive” and “efficient” (meaning profitable) forms of production and governance, is very much more congenial to contractualism and its marketisation of the corporation than it is to its stakeholding rivals. Indeed, so great is the contemporary influence of contractual theory that supporters of stakeholding increasingly seek to demonstrate that stakeholding companies are (or would be) more efficient and competitive than their shareholder-oriented rivals115 and are increasingly willing to try to conceptualise corporations in predominantly contractual terms, albeit in a manner which insists upon the relational, “implicit” and “incomplete” nature of many of the contracts involved. Notwithstanding this somewhat artificial consensus, however, the struggle between contractarians and stakeholders is, ultimately, more about ends than means, for stakeholding is animated as much by ideas of right and justice as it is by ideas of competitiveness; by a conception of the good, rather than of the efficient, life.116 Indeed, stakeholders are ill-advised to try to fight the governance battle on the terrain of efficiency, in part because, whatever its current political appeal, it is a terrain which pushes one into a contractual conception of the corporation, with all that implies, and in part because as a goal “efficiency” in the abstract lacks meaning: what exactly is it that we are trying to do efficiently? At present the goal of corporate governance is, in reality, the efficient maximisation of rentier wealth, a task it carries out with aplomb. In practice this means maximising the wealth of a few, for the financial property forms constituted and protected by contemporary company law and contemporary mechanisms of corporate governance enable a small minority to appropriate a grotesquely disproportionate share of total social wealth and production, both nationally and internationally.117 The question is whether the “efficient” attainment of this goal is defensible, let alone desirable. The power of the large transnational corporations which increasingly dominate the world economy is enormous, reminding us that the developments that have underlain the historical changes that have occurred in corporate theory— 115 Usually on the grounds that stakeholding companies are more sensitive to the interests of employees and better able, therefore, to nurture and develop the “human capital” that is said to be increasingly crucial to long-term efficiency and competitiveness. See, e.g., John Plender, A Stake in the Future (London, Nicholas Brealey, 1997); and the RSA’s Tomorrow’s Company (London, RSA, 1995). It has recently become quite fashionable to insist that the case for stakeholding is not distributive, but efficiency-based. 116 Which is not to say that stakeholding companies are not more efficient than their contractarian rivals. 117 For demolitions of the claim that ownership has become more “democratised” with the rise of pension funds and other forms of institutional investment, see Henwood, above n. 70, ch 2; and Jeff Gates, The Ownership Solution (London, Allen Lane, Penguin Press, 1998). The most recent of the three-year surveys of consumer finances (SCF) conducted by the Federal Reserve in the USA shows that the bottom 90 per cent of the American population now claims its smallest share of wealth on record. The top 10 per cent (whose wealth is itself concentrated very heavily within its upper third) account for well over 80 per cent of share and bond ownership. In 1996, the United Nations reported that the assets held by the world’s 358 billionaires exceeded the combined incomes of countries with 45 per cent of the world’s people: see Gates, ibid., at 7.

Defending the Rentier 173 the externalisation of the shareholder from the process of production, the growing difficulties involved in characterising corporations as private property and shareholders as corporate owners—are, ultimately, reflections and expressions of the growing socialisation of production, of its increasingly social and public, rather than individual and private, nature. There is, therefore, much truth in Marx’s claims that joint stock companies not only take the form of “social undertakings as distinct from private undertakings” but represent “the abolition of capital as private property within the framework of capitalist production itself”. As he observed, joint stock company shareholders receive dividends in the form of (if not at the same level as) interest, “as mere compensation for owning capital that now is entirely divorced from function in the actual process of reproduction”.118 Put simply and bluntly, in this context, the (public) constitution and protection of (private) corporate property rights by the state is more accurately seen not as the neutral enforcement of “natural” individual rights over things but as the use of collective force on behalf of haves over have-nots. Indeed, it is precisely because they “carry with them, when held in quantities larger than an individual can work by himself, power to control in some measure the lives of others” that property rights in land and capital are, in many ways, “in rather more need of justification than . . . simple property in the consumable means of life”.119 If the myth of shareholder corporate ownership and the perception and promotion of private property and private property rights as pre-social, pre-political, natural phenomena have long operated so as to “hide the structure of [corporate] power and insulate it from democratic debate”,120 what we are now seeing, as the “powerful yet wholly spurious moral leverage”121 of the idea of shareholder corporate ownership wanes, is the emergence of a new justificatory myth for shareholder property rights, a myth of “efficiency”. But we must not forget that all forms of property and property rights, including those of shareholders, represent “not a pre-transaction state of equilibrium or of harmony”, but a politically (and, therefore, publicly) constituted and contingent power relation between people that is “inherently and continually conflictual”.122 The creation, sustenance and modification of (property) rights inevitably generates conflict, but as production relations change so, inevitably, will (and should) rights and entitlements. It is to the reconstitution and reallocation of corporate rights and entitlements in pursuit of democratically agreed goals which take account of complex issues of social and individual wellbeing and justice that those concerned with company law reform and corporate governance need to turn their attention.

118

Karl Marx, Capital, Volume III (London, Lawrence and Wishart, 1977), ch 27. C B Macpherson, Property: Mainstream and Critical Positions (Oxford, Blackwell, 1980), 12. 120 Christman, above n. 12, at 3. 121 Gray, above n. 102, at 305. 122 Alan Story, “Compensation for Banned Handguns: Indemnifying ‘Old Property’ ”, (1998) 61 Modern Law Review 188, at 206. 119

8 Corporate Governance in a Political Climate: The Impact of Public Policy Regimes on Corporate Governance in the United Kingdom SUE BOWDEN

INTRODUCTION

C

ORPORATE GOVERNANCE THEORY is concerned with the rights and responsibilities of owners and managers of the firm.1 But theory is complicated in practice by the structure of share ownership. The twentieth century witnessed a switch in the ownership and management of the firm in the United Kingdom. The owner-managed firm was replaced by the predominance of the limited liability company and a divorce of ownership from control. Management is in the hands of a professional managerial group, whose members rarely hold a significant equity stake in the company. Ownership is in the hands of thousands of individual and institutional shareholders, few of whom hold a sizeable percentage of the equity in any one company and seldom have sufficient votes to influence management. Nevertheless they all have an interest in the current and future earnings from their equity holdings. The incentive is to exercise their property rights and transfer their shares in underperforming companies by off-loading them on the stock exchange. But firms and owners operate in a political environment. Their actions are influenced by prevailing public policy regimes. Despite the proliferation of material on corporate governance systems and their relevance for the long-run 1 See S J Grossman and O D Hart, “An Analysis of the Principal-Agent Problem”, (1983) 51 Econometrica 7; O Hart, Firms, Contracts and Financial Structure (Oxford, Clarendon Press, 1995) and “Corporate Governance: Some Theory and Implications”, (1995) 105 Economic Journal 678; A O Hirschman, Exit, Voice and Loyalty: Responses to Decline in Firms, Organizations and States (Cambridge, Mass, Harvard University Press, 1970); M Jensen and W H Meckling “The Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure”, (1976) 3 Journal of Financial Economics 305; M C Jensen, “The Modern Industrial Revolution: Exit, and the Failure of Internal Control Mechanisms”, (1993) 48 Journal of Finance 831.

176 Sue Bowden performance of the British economy, the impact of public policy regimes on the nature and operation of governance systems has not been central in the literature. This is a surprising omission given the importance accredited to public policy in influencing the development and operation of such systems in Germany, Japan, and the USA and the existence of large, but separate, literatures on City/industry relations and industrial and regulatory policy in the United Kingdom.2 This chapter takes an overview of the implications of public policy regimes for corporate governance over the twentieth century, stressing the effects both of actual policy initiatives and also perceptions (or more realistically fears) of potential policy changes. In so doing, the chapter adopts a thematic rather than a chronological approach, not least since given themes are repeated throughout the decades (often as issues left unresolved from one government to the next). The emphasis is on the interplay between City, industry and politicians (by which is meant politicians and civil servants), with the analysis stressing how and why attempts to reform prevailing systems developed, why tensions arose and were worked through, and the implications for the long-run development of, and problems in, corporate governance in the United Kingdom. The aim is not to repeat standard analyses of corporate governance, but to explore in more detail those under-explored episodes in the history of corporate governance 2 See, e.g., Mark Roe’s perceptive analysis of American systems in M J Roe, Strong Managers, Weak Owners: The Political Roots of American Corporate Finance (Princeton, Princeton University Press, 1994) which assesses how and why policy regimes influenced the development of corporate governance in the USA. A Schleifer and R Vishny, “Politicians and Firms”, (1994) 109 Quarterly Journal of Economics 995, develop a theoretical model which posits that where managers control firms politicians can best use subsidies and bribes to convince them to follow political objectives. The empirical evidence for the model has not (as yet) been provided. For an analysis of the superior systems and benefits of German and Japanese styles of corporate governance, see W Eltis, D Fraser and M Rickets, “The Lessons for Britain from the Superior Economic Performance of Germany and Japan” (1992) National Westminster Bank Quarterly Review (February) 1. Increasingly, voices have been raised doubting whether relations between industry and banks in Germany are so superior. See J Edwards and K Fischer, Banks, Finance and Investment in Germany (Cambridge, Cambridge University Press, 1993). Charkham has assessed corporate governance in Germany, Japan, France, the USA and the United Kingdom in the recent past but concentrates on the structural determinants of governance systems rather than the interplay between public policy and corporate governance: J Charkham, Keeping Good Company (Oxford, Clarendon Press, 1994). Key assessments of the interplay between City and industry in the United Kingdom include Stapledon’s analysis of institutional shareholders and corporate governance: G P Stapledon, Institutional Shareholders and Corporate Governance (Oxford, Clarendon Press, 1994) and the collected works in N Dimsdale and M Prevezer (eds), Capital Markets and Corporate Governance (Oxford, Clarendon Press, 1994). The debate on the role of the City in the long-run performance of the UK economy is ongoing and unresolved. Kennedy, Elbaum and Lazonick and, most recently, Hutton have all assigned a crucial, negative, role to the City, accusing the institutions of starving industry of investment funding, a view fiercely disputed by, inter alia, Capie and Collins who see the problem as being demand rather than supply determined: W P Kennedy, Industrial Structure, Capital Markets and the Origins of British Economic Decline (Cambridge, Cambridge University Press, 1987); B Elbaum and W Lazonick (eds), The Decline of the British Economy (Oxford, Clarendon Press, 1986); W Hutton, The State We’re In (London, Jonathan Cape, 1995); F Capie and M Collins, Have the Banks Failed British Industry?: An Historical Survey of Bank/Industry Relations in Britain 1870–1990 (London, Institute of Economic Affairs, 1992).

Corporate Governance in a Political Climate 177 which had, rightly or wrongly, important long-term consequences for relations between the City and industry. To that extent, the chapter is selective in its explicit attempt to explore exactly what is “new” about “new” Labour’s ideas on stakeholding: the analysis suggests that a more detailed exploration of the past reveals that the “new” is more associated with “old” than “new” Labour.

LONG-RUN ISSUES IN CORPORATE GOVERNANCE IN THE UNITED KINGDOM

The background to the evolution of corporate governance is the interplay between three separate but interrelated phenomena: the rise of the institutional investor, growing perceptions of relative under-performance (and even decline) of British firms in the global marketplace, and debate as to the extent to which the resolution of such problems should lead to government initiatives or be left to the market. The emphasis is on evolution rather than planned development, since the nature of corporate governance in the United Kingdom has emerged in response, and often as a defensive reaction, to exogenous factors. Whereas the first half of the twentieth century witnessed a transition from the owner-managed firm to limited liability and ownership in the hands of individual private shareholders, the second half witnessed a switch in equity holdings from the private to the institutional investor, made possible by the growth of the pension and insurance industries. The rise of the institutional investor was premised on the assumption of a continuation of a steady steam of dividend income.3 The “Golden Age”4 promised profit growth as UK firms participated in the buoyant trading conditions of the 1950s and early 1960s and the expectation was that dividends would continue to increase. Optimistic assumptions about industrial growth, and hence profitability, would allow institutions to derive income from their investments without any expectation of being called 3 The rise of the institutional investor resulted from the growing presence of pension funds and insurance companies. The growth of insurance and pensions led to a massive inflow of funds into their accounts, with in consequence a widening and deepening of their company share portfolios. Between 1963 and 1975 the proportion of shares held by persons fell from 54 per cent to 37.5 per cent: Committee to Review the Functioning of Financial Institutions, Progress Report on the Financing of Trade and Industry (London, 1977), para 69. See also G Clayton and W T Osborn, Insurance Company Investment: Principles and Policy (London, George Allen and Unwin, 1965); Committee to Review the Functioning of Financial Institutions, Written Evidence by Insurance Company Associations (April, 1978), 1–48; Committee to Review the Functioning of Financial Institutions, Progress Report, above, paras 69–71. See also M Gaved, Ownership and Influence (London, Institute of Management, London School of Economics, 1995), “The Rise of the Institutional Investor” in A Westall (ed), Competitiveness and Corporate Governance, Commission on Public Policy and British Business (London, Institute for Public Policy Research, 1996); and Closing the Communications Gap: Disclosure and Institutional Shareholders (London, Institute of Chartered Accountants, 1997). 4 Economists refer to the post-war decades, roughly from 1950 to 1973, as being a Golden Age in economic growth, as Western economies reaped the benefits of the expansion of international trade in manufacturing and the expansion of global financial flows. The United Kingdom participated in that growth pattern, albeit with a less impressive performance than that of its main competitors.

178 Sue Bowden on to fulfil any ownership responsibilities. Intervention in the case of underperformance was not on the institutions’ agenda. Accordingly in these decades there was little in-house sectoral or firm-level expertise among the financial institutions. Such assumptions may have held in the 1950s and early 1960s, but were increasingly difficult to sustain from the mid-1960s and thereafter as the problems of British industry escalated. Declining export shares hit profits and an inability to develop comparative advantage in the new global marketplace fed through into erratic and at times declining profit growth. Acrimonious industrial relations, low returns on capital employed, and poor productivity growth relative to our international competitors were symptoms of, and contributory factors in, the growing malaise of British industry.5 It follows that from the mid-1960s as dividend streams were threatened and asset values declined, the markets revised their expectations of future earnings growth. A feature of this period was the arrival of a new style of institutional investor: investment trusts, nominee companies, and unit trusts which had no sense of “comfortable” coexistence or loyalty to companies in which they held equity.6 This was in contrast to insurance companies which were increasingly seen as part of an “old” establishment style of owner-manager relations, whereby insurers held and maintained large equity holdings, but exercised neither voice nor exit pressure on management, which was allowed in turn to continue its increasingly out-dated strategy. The interest of the “new” financial institutions was in maximising asset values and future dividend streams. If that meant engaging in active (and heavy) market trading, then such firms felt no compunction to do otherwise. Their objective was to protect their asset and income values and their emphasis was on the right to do so. For such institutions, equity meant property rights and the right to transfer that property to the highest bidder. Responsibilities to the company counted for nothing. It is therefore a much over-looked element in the debate on City/industry relations, particularly as regards the extent to which the City has placed short-term pressure on industry (with implications for investment strategy), that not all City institutions should be tarred with the same brush.7 Detailed analyses of 5 There is now a voluminous literature detailing the poor performance of the UK economy after 1945. Falling export shares and weak productivity growth relative to other economies are seen as being symptoms of overall malaise. The absence of a competitive environment and government “interference” have recently been assigned major importance. A good overview is provided in N F R Crafts , “Economic Growth” in N F R Crafts and N Woodward (eds), The British Economy since 1945 (Oxford, Clarendon Press, 1991). 6 A Brummer and R Cowe, Weinstock: The Life and Times of Britain’s Premier Industrialist (London, Harper Collins, 1998), 118. 7 The debate on whether the financial institutions are “short-termist” is well summarised in P Marsh, Short Termism on Trial (London, Institutional Fund Managers Association, 1990) and “Market Assessment of Company Performance”, in Dimsdale and Prevezer, above n. 2, 66; C Mayer, “Stock-Markets, Financial Institutions and Corporate Performance”, in Dimsdale and Preveser, ibid., 179 and “Corporate Governance and Performance: The Evidence” in Westall,

Corporate Governance in a Political Climate 179 share registers from each decade up to the present suggests that whereas it is correct to accuse some institutions of “short-termism” it is neither true nor fair to assume all institutions behaved and behave in such a fashion.8 The oversight has clouded attempts to reform corporate governance, since evidence on “global” behavioural patterns cannot be identified and institutions which have and do demonstrate long-term loyalty can plead (correctly) their positive contribution to the external mechanisms of corporate governance. The rise of the institutional investor was parallelled in industry by the rise of the professional manager who rarely had any significant ownership (equity) stakes in the firms they managed. Nor, for the majority of this period, did they have any professional managerial expertise. Directors of UK companies were in the main appointed on the “crony” network system, sometimes emerging from the shop floor, but more usually as a result of other professional training such as engineering or accounting.9 Professional management training has only become the norm in the recent past. These directors had an unenviable task (even if it was often of their own making) of dealing with numerous problems: industrial performance compared unfavourably with that of their global competitors as export markets slipped and relative productivity and profitability exposed the weaknesses of UK industry. Alongside such symptoms of malaise, directors were to complain of two negative influences. The first, as already noted, was short-termism from a City increasingly preoccupied with short-run financial returns, which in turn prompted financial directors and their boards to emphasise short-term dividend returns rather than long-term investment. This was to put a drain on capital investment plans.10 Secondly, industry was also the subject of government intervention (or interference as some would see it) as regional, labour, fiscal, and competition policy compelled and cajoled firms to conform to government policies to regenerate depressed areas, protect employment, raise taxation, and control “ruinous” competition.11 Pleas for room to manoeuvre, “the right of Competitiveness and Corporate Governance, above n. 3; and S Nickell, The Performance of Companies (Oxford, Blackwell, 1994) . Such analyses do not address how and why institutions, distinguished by type and size, may face different incentive structures and thus adopt different policies. Such observations have been noted however in the USA by H Demsetz and K Lehn, “The Structure of Corporate Ownership: Causes and Consequences”, (1985) 93 Journal of Political Economy 1155; and by A Schleifer and R Vishny, “Large Shareholders and Corporate Control”, (1986) 94 Journal of Political Economy 461. 8 Recent analyses of behaviour which distinguishes share transactions behaviour by institutional type and which disputes any “short-termist” behaviour by the large insurance companies include S Bowden and J Maltby, “Under-Performance, Short-Termism and Corporate Governance: The ‘City’ and the British Motor Corporation 1952–1967”, (1998) 5 Financial History Review 179. 9 The need to improve the quality of industrial management thus became a priority area in The National Plan (Cmnd 2764, London, HMSO, 1965), paras 38–44. 10 See Nickell, The Performance of Companies, above n. 7, at 25–42; Marsh, Short-Termism on Trial, above n. 7, at 50–71, and the collected articles in S Milner (ed), Could Finance Do More for British Business? Commission on Public Policy and British Business (London, Institute for Public Policy Research, 1996), especially those by Nickell, Rough, Miles, and Mayer. 11 See chapters by, inter alia, Kirby, Armstrong, Walshe, Dunkerley and Hare in Crafts and Woodward, The British Economy Since 1945, above n. 5.

180 Sue Bowden management to manage” and a release from short-termist pressure from the City were a continuous refrain from managements which felt besieged from all quarters. Against this background, public policy in the United Kingdom has tested, tried, but never fully worked through whether corporate governance should be left to the market or be the rightful domain for government intervention and regulation. Exponents of the former have argued that the malaise of industry may be attributed, in large part, to impediments to the operation of market forces and the price mechanism. Realisation of optimal performance by firms may best be ensured through the market system. The price system (that is the price of shares) acts as the ultimate arbiter of the fortunes of the company, and of its management. Disappointing performance leads to the marking down of prices, the inevitable exposure to take-over and the replacement of underperforming management by more successful management. If and when the takeover is not allowed to operate, under-performing managers will only continue, and with them under-performance by the company and, ultimately, of the economy as a whole. 12 Governments, however, have been less persuaded of the virtues of the market. The “full-bodied” operation of the price system may prompt monopoly with its concomitant problems. It may equally lead to the demise of firms with long-run potential growth, and with immediate implications for employment and regional policy. The market may need prompting, guidance, and if need be direct regulation. But such activity requires government to intercede in relations between owners and managers. In doing so, it must ensure the optimal performance of “industry”, while at the same time setting a regulatory framework which protects the comparative advantage of the “City” in the global financial markets. In some respects, the history of policy regimes represents an uneasy compromise between these sometimes opposing interests and a bewilderment on the part of government as to how one can legislate that the “right” people do the “right” thing. Convincing the “right” people to do the “right” thing has, however, remained on the government agenda throughout the twentieth century. Who the people are, and what the “right thing” is have never been satisfactorily established, although attempts have been made to define what responsibilities shareholding entails. The belief that government could, and should, set a public agenda which established a framework in which the external mechanisms of corporate governance would ensure optimal performance of industry while protecting the global interests of the City, has been a constant, if unresolved, theme.

12 A view propounded, interestingly enough, by the CBI which argued that there was no evidence “showing that market forces are inadequate to produce the necessary structural changes in industry at the pace required”: CBI Submission, in IRC, Industrial Studies and Investigations (EW27/196, Public Record Office, Kew).

Corporate Governance in a Political Climate 181

FEARS, THREATS AND PHOBIAS

It is a truism that government may influence the framework of corporate governance less by the imposition of legislative controls on relations between owners and managers than by perceptions of what government might do: hence this section dealing with “fears, threats, and phobias”. Two fears predominated: that of public ownership of industry and government regulation of the City. The twentieth century witnessed periods of active intervention by government in pursuit of public ownership. We think of public ownership in terms of nationalisation, and hence the initiatives of the post-war Atlee (1945–1951), and Wilson (1964–1970) and Wilson/Callaghan (1974–1979) Governments. Perceptions, however, were that public ownership of given firms was always a possibility: a perception which, in some quarters, held during the resurgence of “market economics” under Margaret Thatcher. Despite that Government’s selfproclaimed policy that government would not protect lame ducks, but would rather permit the market to sort the efficient from the inefficient and allow the latter to fail, lame ducks continued to be protected, as, for example, in the continuance of public funds for British Leyland in order to avoid the employment implications of closure.13 The issue of public ownership has influenced corporate governance in several crucial respects. First, and most importantly, the real or threatened taking of industry into public ownership has encouraged any latent propensity on the part of owners (and in particular financial institutions) to renounce ownership responsibilities. If and when under-performance is an issue at times when nationalisation is on the political agenda, the prospect of public ownership acts to relieve owners of their responsibilities, as government, not owners, can be expected to take over the problems of ailing companies. This is what occurred in the infamous case of Rolls Royce, which collapsed in January 1970 in the face of a complete failure of the external and internal mechanisms of corporate governance.14 If the structure of share ownership acts to deter voice, then this has been accentuated by a recurrent belief that if and when ownership became an issue (as, for example, when liquidation was a real possibility) government, not the financial institutions, would assume responsibility.15 Of course, this 13 See S Wilks, Industrial Policy and the Motor Industry (Manchester, Manchester University Press, 1984), ch 8. 14 The collapse of Rolls Royce in 1970/71 was characterised by a singular absence of voice by any of the financial institutions. The lead, in trying to identify and then deal with the problems of the company, was taken by the merchant banks working alongside Bank of England and Department of Trade and Industry officials. The official report, DTI, Rolls Royce Ltd and the RB 211 Aero-Engine (Cmnd 4860, London, 1972), did not mention this. A later, more detailed analysis, DTI, Rolls Royce Ltd, Investigation under Section 165(a)(I) of the Companies Act 1948 (London, 1973), did however analyse in detail the role of these officials. 15 See Roe, Strong Managers, Weak Owners, above n. 2, at 201. Roe argues that these political considerations were crucial in explaining the aversion to voice options on the part of financial institutions up to the Thatcher era.

182 Sue Bowden tendency may be self-fulfilling. The more shareholders stand aloof from companies in difficulty, the more likely it is that the need for government intervention will arise. Secondly, and at first sight contradictorily, the possibility of public ownership may encourage owners not to trade in the shares of underperforming companies, which acts to distort the operation of the market mechanism. If the price of shares does not signal the company’s poor performance under existing management, then the company may be allowed to continue to trade with no significant pressure to rectify performance. The prospect of a public buy-out may reduce exit since owners may stand to get a better price from government than from the market. This is indeed what happened in the infamous case of British Leyland in 1975 when the major shareholders, contrary to the predictions of standard corporate governance theory, failed to exit at all, but gained a higher price from the government than if they had sold on the open market in the months leading up to the buy-out.16 The issue of public ownership did not apply only to the “under-performing” company. In the late 1960s and through the 1970s the agenda included firms in strategic sectors, identified as being crucial to the long-term health of the economy. Such anticipation was at its height in the early and mid-1970s and reached its apogee in 1973, when influential voices in the Labour Party called for the nationalisation of twenty-five of the country’s top one hundred companies.17 The reasoning behind such a move was to influence all key sectors of the economy. If government owned the largest firm in each sector, it could set an agenda on profit performance, dividend pay-outs, industrial relations, and so on. Other firms would be forced to follow suit.18 Dominant price leadership tactics would be ensured if government owned the largest firms, and imposed on them its own views on best practice. But such ideas ignored a dynamic scenario in which it is not difficult to predict that the government-owned firm would be overtaken by other firms in the industry. Nor do they take account of the incentives of other firms to break rank and gain market share, since there was an automatic assumption that other firms would have no alternative but to follow the leader’s example, and to do so indefinitely. The companies to be taken over were never identified, but the prospect of widescale public ownership of top companies was, for a time and in certain circles, real. It was the threat of public ownership, rather than the detail of how such schemes would effect the performance of other firms which mattered at the time. The message was that public ownership was a real option for the successful as well as the under-performing firm. 16 An analysis of the share registers of British Leyland is surprising insofar as so few of the major financial institutions expressed exit, despite the evident problems of the company: British Leyland Motor Corporation, Annual Register of Shareholders (London, Companies House, 1968–1975). 17 Labour Party, Report of the Seventy-Second Annual Conference of the Labour Party (Blackpool, October 1973, Tuesday morning session), 170–1. 18 This was the subject of an extended debate at the Labour Party Conference in October 1973.

Corporate Governance in a Political Climate 183 This period in the evolution of corporate governance was thus to add an additional incentive to the financial institutions to abstain from any “voice” activity. Voice involves time and hence money. Given the structure of share ownership, there are also free-rider problems if one institution incurs the costs of voice, but all benefit. If, in addition, there were reasonable grounds for believing that government would assume ownership, there was all the more reason why the financial institutions should refrain from voice. The risk, of course, was what price the government would pay. On this, many financial institutions bargained that they would get a better price from the government than the market.19 If government policy in relation to industry created a self-fulfilling prophesy that in the final analysis government would assume ownership responsibilities, then government policy in relation to the financial institutions created further tensions in government/City relations.20 The spectre which haunted City/industry relations throughout the twentieth century was that of the public ownership and/or government regulation of City institutions.21 The threat of nationalisation of the financial institutions constrained their ability to exit, not least since there was a risk that, if they brought down a major company, this could be used to justify growing arguments within certain sections of the Labour Party that they should be taken into public ownership.22 The former assumed heightened intensity in the early 1970s, when influential sections of the Labour Party promoted nationalisation of all banking and insurance companies as an active policy option.23 In 1976, the Labour National Executive Committee proposed that the seven largest UK insurance companies be nationalised.24 It is not without significance that it was banks and insurance companies which were the prime target of government proposals. Again, a self-fulfilling prophesy was created. As specific named institutions were targeted as potential public ownership candidates, the more reluctant those institutions were to attract adverse attention by putting pressure on industry. Insurance companies through these years (and previously) had not engaged in active exit policy in 19 This bargaining stance was particularly evidenced in the months leading up to the rescue of British Leyland by the Government in 1975. The leading financial institutions held on to their shares in expectation of a government buy-out while the Treasury held on as long as possible before agreeing the rescue package. The Treasury bargained (rightly as it turned out) that the smaller institutions would sell and drive down the market price. The larger institutions, unaware of this view, held on to their shares in the belief that the Government was not pursuing any such policy: see The Economist, 21 December 1974, 91. 20 See L Whyte, One Increasing Purpose—The Annals of an Investor (London, Hutchinson Benham, 1984). 21 Committee to Review the Functioning of Financial Institutions, Second Stage Evidence, vol 2, Written Evidence by the Insurance Company Associations (London, 1978), paras 43, 149, and 157. 22 This will be intensified if the company in question is a large employer at a time when low unemployment is a major policy objective and/or a major exporter at a time when the balance of payments is precarious and a matter of major policy concern. 23 Committee to Review the Functioning of Financial Institutions, Second Stage Evidence, vol 3, Synopsis of the Written Evidence by the Committee of London Clearing Banks (London, 1977), para 113. 24 In September 1976: see Committee to Review the Functioning of Financial Institutions, Written Evidence by Insurance Company Associations, above n. 21, para 160.

184 Sue Bowden relation to the firms in which they held equity. Again, “threats” rather than the reality of public ownership added to the incentives to maintain arm’s-length relations. Unit and investment trusts and nominee companies were not, however, earmarked by government. Not surprisingly, these were the financial institutions who engaged in exit activity. But this created a dilemma for the larger institutions. If they were to intervene to “correct” performance they would incur time and money costs. The other, smaller institutions would free ride on any successful outcome. But the balance of probability weighed against any successful outcome of intervention by insurance companies to rectify underperformance in portfolio companies, especially where the firm in question was a large employer (at a time when low unemployment was a high priority) or a major exporter (given balance of payments problems). If the reality of any threat of public ownership of the financial institutions was limited to the early post-war years and the early 1970s, then threats of government regulation of the City were a recurrent theme throughout the twentieth century. In the 1930s and again in the 1960s and more recently, perceptions that if the City did not put its own house in order, government would intervene and do this, has been an effective mechanism for prompting change.25 It was the City rather than government which introduced a take-over code of practice in the 1960s, in response to fears that if it did not implement its own code, then government would do so. Recent self-regulation, overseen by the City itself but under the watchful eye of government, has allowed City institutions to establish and monitor their own codes of practice: changes at the margin which retain independence but keep at bay government regulation. Not surprisingly, periods in which the threat of public ownership of the financial institutions seemed real met with relative quiescence on the part of the relevant institutions and a heightened reluctance to be held responsible for bringing down companies through heavy share trading. In the long run, however, bargaining leverage lay with the City rather than industry or indeed government, as the relative contribution of the service sector, and in particular the overseas earnings of the financial sector, assumed greater importance to the economy. In the meantime, periods of quiescence and mutual suspicion were interrupted by periods of intense activity as government policy veered to the support of take-over as a mechanism for resolving the problems of industrial performance. TAKE-OVERS AND MERGERS

City/industry relations and the operation of the external mechanisms of corporate governance have rarely in the United Kingdom been dominated by either 25 Thus the Cadbury Committee (Committee on the Financial Aspects of Corporate Governance, 1992) could recommend best practice for companies, but was to favour a voluntary code of practice rather than an extensive reform of company law. See N H Dimsdale, “A Postscript on the Draft Report of the Cadbury Committee” in Dimsdale and Prevezer, Capital Markets and Corporate Governance, above n. 2, 42.

Corporate Governance in a Political Climate 185 the full exit (that is, the disposal of all equity holdings in a given company) or the voice strategy. If the structure of share ownership prompted the former over the latter, public policy regimes have influenced and encouraged a propensity for limited exit (partial disposal of a holding) and the latent tendency of shareholders to treat equity as conferring property rights, which may be transferred to the highest bidder, rather than as conferring ownership responsibilities. Limited exit has always been the key option. In this scenario, the principal sells sufficient shares to effect a fall in the market price which makes the company vulnerable to take-over. This gives warning to management that unless performance is improved, they are at risk of displacement. This mechanism assumes the credibility of the threat that another company might wish to launch a take-over bid and the existence of a public policy regime which welcomes take-over. For the former to operate, there must be agents willing and able to prompt and effect take-over; for the latter to function, public policy has to stress the benefits of take-over against the costs of potential monopoly if and when mergers and take-overs occur. At various points of time in the twentieth century government favoured take-over as a mechanism for restoring the fortunes of industry: as in the 1930s and again in the 1960s and 1980s. In the 1960s, the emphasis was on “big is beautiful” and the benefits which would follow if and when large firms emerged capable of reaping economies of scale which, it was believed, would enable them better to cope in the global marketplace.26 Faith in such policies in the late 1960s led to the creation of a special government agency, the Industrial Reorganisation Corporation, to encourage mergers and take-overs. Such was the zeal for this policy within that agency that it intervened in the market to ensure successful take-over by its favoured candidates of given companies. In the 1980s policy stressed the survival of the fittest and the benefits which would accrue from imposing effective management on underperforming companies. The message to the City was that take-over was to be welcomed, and to industry, that take-over was to be accepted as a mechanism for restoring its fortunes. Public policy could and did send signals that limited exit and the takeover mechanism were appropriate strategic options, in which case (and in contrast to regimes when public ownership and regulation were threatened), public policy acted to encourage the exercise of the limited exit rather than the voice option. Public policy regimes which favoured the encouragement of take-over brought in their wake tensions between government, the City, and industry as government found its policies at the mercy of financiers who, from the mid1960s, took advantage of the policy regimes to instigate take-over bids backed by international finance and facilitated by the share-trading activities of nominee, unit and investment trust funds. Lohnro, Goldsmith, and Slater prompted 26

See L Hannah, The Rise of the Corporate Economy (London, Methuen, 1976).

186 Sue Bowden frenzied share-trading in target companies. Their activities underlined the sense in which the “old” and “comfortable” arm’s-length relations between City and industry could be overruled and replaced by aggressive take-over activity made possible by the trading of the “new” financial institutions with access to international flows of finance. “Old” institutions may have pleaded (with good reason) to an absence of “short-termism”; the “new” institutions felt no such loyalty. The globalisation of finance, the arrival of the “new” aggressive shorttermist financial institutions and the rise of the asset-stripping, risk-taking financial entrepreneurs combined to pose serious threats to any semblance of government influence over corporate governance. The activities of such individuals and institutions prompted policy realignments as governments reacted to and sought to contain the effect of take-over booms on industry. The take-over booms of the 1960s were largely responsible for the increasing calls for public ownership and/or greater regulation of the financial institutions in the early 1970s. Those of the 1980s prompted active debate and a revival of interest in political and academic circles in best practice in corporate governance. Take-over booms may have encouraged the limited and full exit options, but the reaction to them has been equally significant for the development of corporate governance in this country. Public policy in the United Kingdom has, then, been either to prompt the exercise of limited exit (take-over eras) or to dissuade certain institutions from exit or limited exit (public ownership eras). The emphasis has never until recently been on the exercise of the voice option. To that extent public policy in relation to corporate governance has stressed ownership rights rather than responsibilities and reinforced the disincentives to exercise those responsibilities.

THE STAKEHOLDER FIRM: WHAT IS REALLY “NEW” ABOUT “NEW” LABOUR?

In recent years, interest has grown in redefining the role of the firm in modern society and, in particular, attention has been paid to the notion of the “stakeholder” firm in which suppliers, owners, managers, workers and consumers all have “stakes” in the company. Corporate governance falls into this agenda. As presented in the literature, the impression is that this is all new: part of a modernising Britain in which performance is enhanced by the productive efforts of all stakeholders working together.27 The truth is that such ideas are over thirty years old. They have been tried and tested before. Then, as now, initial zeal and enthusiasm have waned—and corporate governance is left unreformed. The story of those attempts to re-think corporate governance thirty years ago is as 27 See, e.g., Hutton, The State We’re In, above n. 2; J Kay, The Business of Economics (Oxford, Oxford University Press, 1996); and G Kelly, D Kelly, and A Gamble, Stakeholder Capitalism (Basingstoke, Macmillan, 1997).

Corporate Governance in a Political Climate 187 much an integral part of the development of corporate governance in this country as are take-over booms or indeed the structure of share ownership. Stakeholding was the subject of active discussion in the Wilson Government of the 1960s. Proposals on, inter alia, the changing role of the firm and its relations with different groups of stakeholders, namely shareholders, workers, suppliers, etc., abounded. What is striking about the recently released materials on such initiatives is how modern they are and how they pre-empt so many contemporary ideas. The initiatives were followed in three separate but mutually reinforcing developments: the role of the Industrial Reorganisation Corporation (IRC); investigations into the responsibilities of shareholding; and finally into the nature and role of the firm in modern society. The IRC was established in 1966 as an independent statutory body by the Labour Government with a remit to increase industrial efficiency and profitability and assist the UK economy by promoting industrial reorganisation and development.28 The premise was that in order to compete in world markets, British firms needed to achieve scale economies, and that this could only be achieved through rationalisation. International comparative advantage did not lie with many small-scale, but with a few large-scale firms.29 Since industry had been unable to rationalise itself, government intervention was necessary to promote and push through mergers and take-overs.30 The role of the IRC has entered the literature in terms of its contribution to a series of mergers in the late 1960s: of GEC with AEI and EE, of BMH and Leyland, and so on.31 But an equally important, but neglected aspect of its activities, was its attempts to reform corporate governance through its own presence and participation on executive boards of companies. The industrial leaders who led the IRC felt that the promotion of take-over and merger was not a sufficient condition to ensure optimal long-run industrial performance.32 That would only follow if the IRC had active presence on the executive boards of companies. Presence would guarantee a two-fold advantage: if would ensure informed and active guidance on company decision-making by some of the top industrial leaders in the country as appointed by the IRC to represent that body. It would 28 GEC/AEI: Rationalisation of the Electrical Engineering Industry. Merger between AEI and GEC (EW27/293, Public Record Office, Kew, 12 October 1967) Note that hereinafter all EW file references are located at The Public Record Office, Kew; IRC, Financial Policy (Draft, EW 2/10, 5 June 1968); IRC, Corporation Act 1967, Appendix A, “Investment Grants Sterling Group” (EW 26/42); IRC, Financial Policy (Draft, EW 2/10, 5 June 1968). 29 See The National Plan, above n. 9, at 47. 30 GEC/AEI (EW 27/293), above n. 28, Item 3, paras 5 and 6; Memorandum “Rationalisation of the Electrical Engineering Industry” (EW 27/293, 6 October 1967). Note by IRC for DEA on “Plessey Bid for English Electric”, GEC/English Electric Correspondence (EW 26/69, 3 September 1968), 11; Mergers Panel, Proposed Acquisition, Notes; George Kent and Cambridge Instruments Merger (EW 26/60, 10 May 1968) para. 4. 31 See D Hague and G Wilkinson, The IRC—An Experiment in Industrial Intervention: A History of the Industrial Reorganisation Corporation (London, George Allen and Unwin, 1983). 32 Draft brief for Secretary of State’s meeting with IRC, IRC Policy (EW 27/291, 27 October 1967).

188 Sue Bowden secondly ensure that other non-executive directors (there to represent shareholders) could be monitored in their activities.33 The initiatives of the IRC have modern overtones: a monitoring function and the presence of expert advice on the main boards of leading companies and an emphasis on decision-making which was in the company’s best immediate and long-run interests. The effect of the enthusiasm of the IRC was, however, subsequently to frustrate any such attempts to influence corporate governance, as the increased expenditure of that body in take-over activities, its tendency to take decisions alone and without government approval, and its active intervention in the markets to ensure the success of its favoured candidates in disputed take-over bids, met with increased alarm not only from the Treasury but also from other key interested departments who saw their own areas of expertise being challenged and undermined.34 The resurgence of Treasury dominance in the wake of the 1967 devaluation appears to have put an end to this attempt to influence the mechanisms of corporate governance “from the inside”. That is not, however, the full story, since the interests of the IRC (which was wound up in 1970) were taken over and, if anything, extended by civil servants at the Board of Trade. An unrecorded part of the history of corporate governance in the UK is the role played by these individuals in monitoring, guiding, and pressurising leading United Kingdom industrial companies. “Voice” rarely, if ever, derived from financial institutions in their role as shareholders. Voice was exercised, however, by civil servants. From 1970, there were regular meetings between the senior directors of leading UK companies and officials from the Department of Trade and Industry, at

33 Notes of a meeting 6 September 1968 between the Minister of Technology and the IRC, GEC/English Electric Correspondence (EW 26/69). 34 In the autumn of 1967 the IRC publicly and actively backed GEC’s bid for AEI: see Brummer and Cowe, Weinstock, above n. 6, at 107–20. In the early summer of 1968, the IRC actively intervened in the markets to ensure the success of Kent’s bid for Cambridge Instruments (Notes for the Secretary of State (EW 26/61, 5 July 1968); Minutes of a meeting between MinTech and the DEA, George Kent and Cambridge Instruments (EW27/291, 14 June 1968); DEA File note of 31 May 1968, George Kent and Cambridge Instruments (EW 26/60). Such was the public outcry at this intervention that the matter was subjected to a special debate in the House of Commons (House of Commons, 8 July 1968). A year later the IRC backed one party in a contested take-over bid by GEC for English Electric (IRC, Statement, GEC/English Electric Correspondence (EW26/69, 9 September 196) 2; Plessey Bid for English Electric, Note sent by the IRC to the DEA “on a personal basis” with the instruction that it “not be shown or mentioned to other departments”: GEC/English Electric Correspondence (EW 26/69, 3 September 1968)). In a two-year period, policy had moved from gentle persuasion, to public backing, to active intervention in the markets. The Treasury complained that the IRC had “for a matter of months” been “building up its activities substantially and casting its net wider” and requested that it should be asked to “be more selective in its activities in the interests of keeping down public expenditure” (letter from the Treasury to the DEA, IRC Financial Policy (EW2/10, 21 June 1968); Treasury note estimating the cost of the IRC intervention, George Kent and Cambridge Instruments (EW26/60, 24 June 1968)). By September 1968, the President of the Board of Trade was noting his own concerns that the IRC “might speed up its operations so as to go too far and too fast with its schemes of industrial reconstruction”: Extract from Meeting, GEC/English Electric (EW26/69, September 1968), 6 and File note, 17 September 1968, para. 5. (EW, 26/69).

Corporate Governance in a Political Climate 189 first on a quarterly, then on a monthly basis.35 These meetings were a regular part of the work of civil servants, not only in the 1970s, but throughout the 1980s and 1990s.36 The premise was the constant theme of the need to have regard to the balance of payments implications of industrial performance, as well as the employment implications of any threatened closures.37 What is interesting about these meetings was that, for the companies involved, it was the first time they had every been subjected, in any real form, to rigorous questioning and held to account for their performance. This was to all intents and purposes corporate governance in which firms were held to answer not for their short-term dividend policy, but for their long-run investment decision-making, constraints on realising productivity, profits growth and managerial performance. Those who were involved in such meetings recalled that the DTI took more interest than either the banks or shareholders, subjected the company to regular meetings at which “penetrating” questions were asked, answers demanded, and outspoken comments made about the company’s inadequacies. The meetings were remembered, not surprisingly, by those who attended them as being uncomfortable.38 From this time on, and throughout the 1980s and 1990s, the DTI effectively assumed the role of principal and operated, in part, the external mechanisms of corporate governance which the City had been unwilling or unable to do. But the DTI also faced constraints. Its leverage was its interest in employment protection and the balance of payments. The Department had to adopt the position that it could not intervene directly until it became financially involved in the companies.39 In addition, in many cases the position of the Department was weak as it was basically reduced to trying to find out if it could salvage what was salvageable.40 Corporate governance, in the case of the DTI, involved asking questions, requiring answers, and identifying shortcomings. It could never force management to change, nor could it change management. Moves to reform corporate governance from within were accompanied by wider, more philosophical, discussions on the nature of the firm. Although through the early 1960s the Jenkins Committee had considered company law, and its main proposals were embedded in the Companies Act 1967, it was agreed amongst politicians and civil servants that there were wider fundamental “stakeholding”questions relating to the operation of companies which the 35 Interview with John Barber, former managing director of British Leyland, London, 27 August 1997; DTI interview, 27 August 1997. The latter was an interview conducted in London with one of the senior civil servants involved in these meetings. The source wishes to remain anonymous and we respect that request. 36 DTI interview, ibid. 37 Ibid.; Committee to Review the Functioning of Financial Institutions, vol 4, Oral Evidence by the National Enterprise Board (London, 1977), 31; British Leyland Motor Corporation, Annual Report (1971), 14. 38 Barber interview, above n. 35. 39 DTI interview, above n. 35; Barber interview, ibid. 40 DTI interview, ibid; Barber interview, ibid.

190 Sue Bowden Committee could not consider because it was not concerned with these wider issues of public policy.41 Momentum grew within government circles, prompted by the activities of the Board of Trade, to set up working groups and a commission to address explicitly what role the firm should adopt and how it could maximise performance, and hence international competitiveness, by reforming its relations with its myriad stakeholders.42 Long-run success, it was believed, derived from a re-thinking of these relationships. Stakeholding, as an active area for policy initiatives and debate, was firmly on the agenda over thirty years ago. The “fundamental questions” vexing ministers’ minds concerned the relation of the company with its shareholders, the state, its suppliers and employees. The starting point was a growing appreciation that there was no agreement on what should be the aims and responsibilities of companies and what needed to be done to see that they were carried out.43 Still less was there agreement on what the rights and responsibilities of shareholders should be. The explicit issues raised in connection with shareholder relations were what control the shareholders should have over managers, whether shareholder power should be strengthened, and if so how, and whether institutional shareholders should be encouraged to take a more active part in controlling the managements of the companies in which they invested: again, all “modern” questions. Then, as now, the issue of the responsibilities of non-executive directors and whether these should be legislated for exercised government officials. Discussions were not vague, nor did they fail to lead to substantive proposals. The reform agenda included the abolition of non-voting shares and the relaxation of libel laws so as to permit more press analysis and criticism. Of particular concern was how shareholders and in particular institutional shareholders could be encouraged to take a more active role in the exercise of ownership responsibilities. The role of the shareholder within such stakeholding relations was seen as being crucial. IRC intervention was again a plank in a wider agenda, not of enhanced public ownership of the firm but in a re-thinking of what shareholding actually entailed. A momentum grew within government circles, prompted by the Department of Economic Affairs, to set up working groups to address explicitly what rights and responsibilities shareholding involved. The agenda looked to neither the legal process nor the operation of the financial markets, but rather considered how governance could be reformed via the influence of government as a shareholder and was based on the realisation that the state had acquired by default shares in many companies, not as a result of deliberate policy but through a series of events over the years. Increasingly, politicians and civil servants were to believe that the problem was not one that could be solved by legislation. Then, as now, the issue was 41 Inquiry into the Functions of the Company in Modern Society (EW 27/242, 11 November 1966). 42 Ibid. 43 Ibid., at 3 and 10.

Corporate Governance in a Political Climate 191 whether the law could be amended effectively to improve value judgements by executive directors. A consensus grew that the requirement was not for more legislation on duties, but that directors should be encouraged to understand their duties, since “in the companies court and in practice at the Bar, the impression is gained that directors are generally not only unaware of their fiduciary duties but are also little aware of any of their duties at all”.44 Understanding would prompt awareness and (hopefully) more effective exercise of managerial responsibilities. Who, however, was to be responsible for ensuring that directors understood their responsibilities? Again, the feeling was that law could not dictate, still less enforce, an awareness of responsibility. But the thinking was that here the City could be expected to show awareness, particularly in relation to the appointment of non-executive directors. Reluctantly, a feeling was to emerge that the City, not government, had to deal with the quality of non-executive directors and the part they played in management decision-making. The refrain, then (as now) was that “if only the City would put the right people on boards, they could do a lot to counter the self-perpetuating oligarchies . . . [but] too often the people appointed are . . . purely financial and, what is worse, unimaginatively financial”.45 Increasingly, ministers were to come to the conclusion that one could not legislate for the “right” people to do the “right” thing: “the value of any director . . . can only be decided by the boards of directors concerned and in theory by the shareholders who elect them. It is difficult to see how the law can intervene effectively in value judgements of this kind”.46 Nor was there any inclination to increase the quantitative as opposed to the qualitative exercise of ownership responsibility, since it was deemed “unlikely that greater efficiency will be obtained by increasing shareholders’ power if this proceeds to the extent of day to day intervention”.47 Although more active participation by institutional shareholders was warranted, it was not clear how this could be enforced, or indeed what it really amounted to.48 It did not take long for a consensus to emerge that the scope for legislative involvement was limited. Government could, however, influence corporate governance by indirect means, through example in its own position as shareholder. By the mid-1960s, government had become by default as well as design a significant shareholder in many industries.49 Responsibility for government 44 Submission from the Registrar of Companies, Company Law Committee, Oral Evidence, (BT 147/52, Public Record Office, Kew, 29 March 1960). 45 File note on company law reform, Company Law Reform (EW 27/4, 7 April 1965). 46 File note on company law reform, ibid. 47 File note of meeting held on 7 December 1966, Inquiry into the Functions, above n. 41. 48 Note of 2 December 1966, ibid. 49 The Treasury, for example, was the holding company for shares in inter alia British Petroleum, Cable and Wireless, Suez Finance, British Sugar Corporation, and Cunard, whilst the Board of Trade was the holding company for Fairfields (Glasgow), the Ministry of Aviation for S.B. (Realisations) Ltd, the Ministry of Power for Itaira Iron Ore Co: Government Holdings in Public Companies, Responsibility for Government Shareholding Correspondence (EW27/236).

192 Sue Bowden shareholdings was widely spread among different departments. In most cases the shareholder was the sponsor department for the industry concerned. But government had two distinct interests as a shareholder in a private firm: in the general welfare of the industry to which the firm belonged and in the performance of the firm itself. The first was termed the “industrial” and the second the “proprietorial” or “shareholder” interest, concerned largely with return on capital.50 Problems arose if the two interests conflicted, for example, “over the question of whether profits should be ploughed back or distributed”.51 Given the emphasis on rates of return, it followed that the Treasury should take the lead responsibility for government holdings. As against this, many departments were to argue that “the companies concerned would almost inevitably get a raw deal as a result, because the Treasury’s reaction to any proposal to spend money was to oppose it”.52 Shareholding for some meant the use of equity holdings to give government a dominant position in a given industry, and thus to set the competitive agenda. For the Treasury, however, shareholding was to be measured and executed in the strictly financial terms of the company in question and the “effective management” of equity.53 Ownership, then, generated questions on responsibility. Who was responsible for the shares owned by government, how did government interpret its ownership responsibilities, and how might that ownership be used to influence the behaviour of other shareholders?54 The impetus behind such questions (and attempts to answer them) was derived from the growing realisation of the scale to which government had become a shareholder in its own right. The line of causation led not from an explicit (or implicit) desire to increase public ownership, but rather from a growing awareness of the extent of existing government shareholdings.55 Proposals emerged to enhance the government’s rights to “influence the policies of companies in which they have a shareholding” in line with current incomes, prices or industrial policy. In addition government shareholding should be used to “ensure that companies in which they have a shareholding are run efficiently and profitably”.56 The rights of share ownership, then as now, may be relatively easy to define. The responsibilities are less clear-cut. Corporate law would dictate that all parties operate in the best interests of the company. Initiatives to rethink the meaning of responsibility in the 1960s failed to add to that definition. The nearest to 50 Note by the Treasury, Ad Hoc Group on Departmental Responsibility for Government Shareholdings (EW26/77, prepared 2 December 1966). 51 Ibid. 52 Minutes of Meeting held on 18 January 1967, ibid. 53 Letter from the Treasury to the DEA, Responsibility for Government Shareholding (EW 27/236, 8 March 1967). 54 Questions, 5 January 1966, Responsibility for Government Shareholding, ibid. 55 Minutes of Meeting held on 5 January 1967, ibid.; Terms of Reference: Responsibility for Government Shareholding, ibid. 56 Government Shareholding in Mixed Enterprises, Interim Report by the DEA, The Government’s Purpose in Acquiring Shares in a Company and the Government’s Rights as a Shareholder, Ad Hoc Group (EW 26/77, 4 May 1967).

Corporate Governance in a Political Climate 193 a clear interpretation was the maxim that shareholding should be used to ensure that companies in which they have a shareholding are run efficiently and profitably. The markets could respond, of course, that this is, and has always been, one of their prime functions and the operation of the market mechanism untrammelled by government regulation and intervention the best way of fulfilling those goals. The issues on the stakeholding firm and the rights and responsibilities of shareholding were never resolved. This was not surprising given the fact the issues involved reflected basic conflicts of interests and policy between the DEA and the Treasury.57 In the event, the feeling that “there was much to be said for leaving things as they were”58 meant the issue of the meaning of shareholding was left in abeyance.59 The practice of government acquiring shares ‘[not] as a result of a consistent policy but for a variety of different reasons” was allowed to continue.60 By May 1967, the working party set up to consider the role of the firm in modern society and its relations with stakeholders was having “serious” doubts as to whether it was necessary to set up such a commission so soon after the Jenkins Committee and, more to the point, whether there was time in the life of the current Parliament to deal with the questions raised. The final stamp of disapproval came in the decision of the Prime Minister on 7 June that there should be no such enquiry.61 The nature of the stakeholder firm and related issues of “new” Labour thinking by “old” Labour which preempt so many modern discussions were never resolved. These modern ideas came to nought as the Government became embroiled in the economic crises of 1967. Reformist initiatives crumbled in the face of the Government’s mounting economic difficulties, the resurgence of Treasury influence, and inter-departmental rivalry. Devaluation marked the final victory of the “Treasury” view and the quiet death of any proposals to question the nature of shareholding or to re-think the role of the firm. But the evidence also suggests that once government had moved beyond its initial enthusiasm in raising the questions, the reality of how practically it could define and then impose best practice was beginning to quell its initial zeal. Such reform was of a long-term nature—something the electoral cycle could not sustain, unless there was all party (and City/industry) support. 57 The DEA was established in 1964 with a remit to provide the impetus for change. It was to be “the economic counter-weight to the Treasury”: see D Marquand, The Unprincipled Society (London, Jonathan Cape, 1988), 46; see also B Pimlott, Harold Wilson (London, Harper Collins, 1992), 279. The aim was to encourage economic growth and as such was an implicit criticism of the Treasury’s alleged inability to raise growth rates: see J Tomlinson, Public Policy and the Economy since 1900 (Oxford, Clarendon Press, 1990), 250. Not surprisingly, there were tensions between the Treasury and the DEA from the outset: see A Howard, The Crossman Diaries 1964–70: Selections from the Diaries of a Cabinet Minister (London, Hamish Hamilton, 1979), 58, 216. 58 Minutes of Meeting, held on 5 January 1967, Ad Hoc Group, above n. 56. 59 Minutes of Meeting held on 18 January 1967, EW 26/77. 60 Minutes of Meeting held on 5 January 1967, ibid. 61 File note, 7 June 1967, Inquiry into the Functions (above n. 41).

194 Sue Bowden In the absence of over-whelming pressure for change, there is an incentive to leave things as they are. The satisficing behaviour of industry in this country is mirrored by a lack of political will to tackle the complex issues of corporate governance. The Wilson Government ultimately was to believe that it was better to leave things as they were. Who is to say whether the Blair Government will come to the same conclusion?

CONCLUSION

The evolution of corporate governance in the United Kingdom over the twentieth century has acted to confirm and increase the emphasis on share ownership as conferring rights rather than imposing responsibilities. To a very large extent, this is the natural outcome of a structure of share ownership where equity is split among thousands of shareholders, none of whom have sufficient shares to affect the market price and thereby influence management. But in the long run, this latent tendency has been encouraged by public policy regimes which, by alternating between periods of public support for take-over and merger, which encourage limited exit, and periods of threats of public ownership and/or regulation which negate any voice activity, has acted to dissuade institutions from pursuing the responsibilities of ownership. The absence of consistency in public policy regimes has encouraged arm’s-length relations between City and industry and, not surprisingly, an emphasis on shareholder rights. In the current climate of “modernisation” this chapter has argued that insights from previous attempts to reform corporate governance, most notably in attempts to address the philosophical questions on stakeholding and the role of the firm in modern society, demonstrate that initial zeal may be quelled by the difficult but hardly insurmountable issues of defining responsibility. In government, as in industry, it is all too easy for a satisficing approach to dominate and for the difficult questions to slip to the bottom of the political agenda. The initial will of the Wilson Government to deal with such questions was quashed by the aftermath of the devaluation of 1967, but also by the increased realisation that such issues required lengthy and complex consultation and decisionmaking. Short-termism may be a facet of government behaviour. It is not unique to financial institutions.

9 Institutional Investors: What are their Responsibilities as Shareholders? G P STAPLEDON

INTRODUCTION

T

HE CORPORATE GOVERNANCE debate has produced a range of suggestions as to how institutional investors might become more active shareholders. For example, Sykes proposes a “radical compact” between institutional shareholders and the managements of large listed UK companies, involving negotiation of five to seven year performance targets for executive directors (to which salary would be linked), and appointment of institutional-investor nominees as non-executive directors.1 Gilson and Kraakman set out a slightly different scheme under which American institutions could elect professional non-executive directors to a minority of positions on the boards of quoted American companies.2 In each case the authors envisage no need for legislation for their proposals to be implemented.3 However, arrangements of this kind have not been observed in practice. The fact that these suggestions have not been observed in practice can be explained largely by reference to the economic incentives and disincentives facing institutional investors. The interview studies of Coffee,4 Holland5 and the present author6 indicate that fund managers managing the assets of external clients face numerous disincentives to the performance of detailed monitoring of investee companies. The disincentives reflect what economists term an 1 A Sykes, “Proposals for a Reformed System of Corporate Governance to Achieve Internationally Competitive Long-Term Performance”, in N H Dimsdale and M Prevezer (eds), Capital Markets and Corporate Governance (Oxford, Clarendon Press, 1994), 111. 2 R J Gilson and R Kraakman, “Reinventing the Outside Director: An Agenda for Institutional Investors”, (1991) 43 Stanford Law Review 863. 3 See Sykes, above n. 1, at 126; Gilson and Kraakman, above n. 2, at 905. 4 Reported in B S Black and J C Coffee, “Hail Britannia? Institutional Investor Behavior Under Limited Regulation”, (1994) 92 Michigan Law Review 1997. 5 J Holland, “Self Regulation and the Financial Aspects of Corporate Governance”, [1996] Journal of Business Law 127. 6 G P Stapledon, Institutional Shareholders and Corporate Governance (Oxford, Clarendon Press, 1996), ch 10.

196 G. P. Stapledon “agency problem” at the level of fund manager/client.7 They stem from a number of factors, including:8 • the fact that the external investment manager (but not necessarily the client) will often stand to gain more from “exit” rather than “voice”;9 • collective-action problems: these problems arise because it is invariably the case that, in order to be effective, institutional investor activism requires several institutions to participate; • the fact that in the usual case the performance of an external fund manager is measured relative to that of its competitors, an index, or both, rather than absolutely: this means that costly monitoring10 will only rationally be undertaken in limited circumstances; and • conflicts of interest: large institutional investors are likely to provide, or offer to provide, financial services to the companies in which they invest, e.g., an institution which holds shares in an investee company might also be an investment manager of that company’s pension scheme, or another division of the same institution might provide insurance, banking or investment banking services to the investee company. These other relationships may sometimes impact on a decision whether or not to intervene in the corporate governance of an investee company. But what is the legal position if a fund manager refuses to vote against, say, a contentious executive share scheme proposed by a company’s board, because of a conflict of interest? Or what if a fund manager chooses not to exercise voting rights delegated to it by a pension scheme trustee client, in order to minimise its own expenses? This chapter focuses on the legal duties of the trustees and investment managers of pension funds and unit trusts, and of the directors of life insurers and investment companies, in regard to corporate governance. The central issue is this: to what extent does the law require these trustees, investment managers and other fiduciaries to play an active role in corporate governance? The structure of the chapter is as follows. The next part explains the practical relevance of the legal issues discussed later in the chapter. The third part describes the structure of institutional share ownership and control. This is an 7 See, e.g., E B Rock, “The Logic and (Uncertain) Significance of Institutional Shareholder Activism”, (1991) 79 Georgetown Law Journal 445; J C Coffee, “The SEC and the Institutional Investor: A Half-Time Report”, (1994) 15 Cardozo Law Review 837 at 843; Stapledon, above n. 6, at 257. 8 For a comprehensive review, see G P Stapledon, “Disincentives to Activism by Institutional Investors in Listed Australian Companies”, (1996) 18 Sydney Law Review 152 at 175; see also Stapledon, above n. 6, at ch 10. 9 A O Hirschman, Exit, Voice and Loyalty: Responses to Decline in Firms, Organizations and States (Cambridge Mass, Harvard University Press, 1970). 10 As Leigh Hall, a former senior investment manager at AMP, points out: “The not inconsiderable cost of being involved in a corporate governance action comes out of the investment manager’s return. It is a direct reduction of his or her profit. While the benefit of the action will go to the clients, the cost is borne by the manager”: L Hall, “Making the Boss Behave: Who Blows the Whistle, and Who Pays the Bill?”, (1996) JASSA (April) 4.

Institutional Investors: What are their Responsibilities? 197 important section because institutional share ownership typically involves several interest-holders—for example, a trustee, a fund manager and a custodian— and it is not possible to focus clearly on the issue of legal obligations in relation to corporate governance unless the status and role of each interest-holder is clarified. The fourth part addresses the central issue of whether the various players are obliged, under current law, to play an active role in corporate governance. The main conclusion reached is that failure to vote an equity investment will not normally involve a breach of duty so long as active and genuine consideration has been given to the issue of whether to vote. However, whether trustees, investment managers and directors of UK institutional investors are obliged, and whether they ought to be obliged, to exercise voting rights are two entirely different questions. Therefore, the fifth part examines the expediency of a legislative requirement to vote. It is argued that a compulsory voting rule would not be a worthwhile reform. This part also examines alternative reform options. The sixth part details a few “self-help” options available to pension fund trustees who use external investment managers, but who are also committed to a systematic and informed approach to corporate governance. The seventh part is the conclusion.

WHY FOCUS ON INSTITUTIONS’ LEGAL OBLIGATIONS?

Whether the trustees, investment managers and directors of UK institutional investors currently do owe duties related to corporate governance, or should owe such duties, are two increasingly important issues. Two factors, in particular, indicate that this is the case. First, overseas-based institutional investors (especially American institutions) have growing UK shareholdings. And some of these institutions are required by regulation to play an active role in corporate governance, including in regard to shareholdings in UK companies. Secondly, there is some evidence indicating a positive link between institutional investor activism and corporate performance.

Increasing influence of foreign institutional investors The assets of pension funds and other institutional investors have been growing rapidly not only in the United Kingdom, but also in many overseas countries. A very large number of overseas institutions have shareholdings in listed UK companies. Recent figures show overseas holdings (institutional and other) accounting for 24 per cent of the listed UK equity market, with American institutions holding 8 per cent.11 11 Office for National Statistics, Share Ownership: A Report on the Ownership of Shares at 31st of December 1997 (London, The Stationery Office, 1999); B Riley, “Now for Tracker Cats”, Financial Times, 6 March 1999, FT Money 16.

198 G. P. Stapledon The increasing presence of American institutions on the share registers of listed UK companies is significant because, since the mid-1980s, the largest group of American institutional shareholders (private-sector pension plans) have been required by their regulator (the US Department of Labor) to exercise the voting rights attached to their equity investments “on issues that may affect the value of the plan’s investment”.12 This voting requirement was initially contained in informal guidelines, based around the “Avon letter”, but in mid-1994 the guidelines were consolidated into regulations made under the Employee Retirement Income Security Act (ERISA).13 In 1994, the Department of Labor confirmed that this requirement applies to foreign as well as American equity holdings.14 The Department has taken the view that voting rights are an asset of a pension plan, and therefore must be exercised “solely in the interests of . . . and for the exclusive purpose of providing benefits to participants and beneficiaries”.15 Where, as in the usual case, the pension plan trustees have delegated the investment management task to an external fund manager (or managers), the regulations state that the obligation to vote rests with the external fund manager unless the trustees have expressly retained the voting right. Further, where voting is the responsibility of the external fund manager, the trustees are obliged “periodically [to] monitor [the] decisions made and actions taken by the investment manager with regard to proxy voting decisions”.16 Therefore, as Coffee says, there is both a duty to vote (which usually falls on the external investment manager), and a duty to monitor voting (which falls on the trustees, and which is effectively a duty of care imposed on the trustees to supervise the voting performance of the investment manager).17 A senior executive of the US Department of Labor said in 1994 that “monitoring and other active investment strategies”, in addition to voting, may be an aspect of the fiduciary duties of the trustees and investment managers of American non-public pension funds.18 ERISA does not apply to public-sector pension schemes. However, a number of large American public-sector pension funds, including the California Public Employees’ Retirement System (CalPERS), have been “activist” shareholders 12 P S McGurn, “DOL Issues New Guidelines on Proxy Voting, Active Investing”, IRRC Corporate Governance Bulletin (July/August 1994) 1 at 5 (citing Department of Labor, Interpretive Bulletin 94–2). The determination of which issues may affect the value of the shares is left to the party with voting authority, whether that be the trustees or the external investment manager(s): ibid. 13 29 USC §§ 1001–1468 (1988). See McGurn, ibid. 14 Ibid. at 3. 15 J C Coffee, “Liquidity Versus Control: The Institutional Investor as Corporate Monitor”, (1991) 91 Columbia Law Review 1277 at 1353. 16 McGurn, above n. 12, at 5 (citing Department of Labor, Interpretive Bulletin 94–2). 17 Coffee, above n. 15, at 1354. 18 R H Koppes and M L Reilly, “An Ounce of Prevention: Meeting the Fiduciary Duty to Monitor an Index Fund Through Relationship Investing”, (1995) 20 Journal of Corporation Law 413 at 447 (n. 209).

Institutional Investors: What are their Responsibilities? 199 for more than a decade. Several of these institutions have over recent years “exported” their shareholder activism, becoming activist shareholders in regard to overseas as well as American investee companies.19 As the Newbold Committee recognised, the activism of American institutions has implications for the control of UK companies: “unless UK-held shares are voted, effective control may be overly influenced by US owners”.20

The impact of institutional investor activism on corporate performance There is some empirical evidence that the rise in institutional shareholdings in recent decades has been associated with better corporate performance. Admittedly, the only evidence indicating a positive link between institutional investor activism and corporate performance is from the USA, and even there the studies have not universally found a positive relationship. Black has reviewed the American empirical studies.21 These studies have, collectively, addressed these five issues: • whether companies with a high level of institutional ownership, and therefore the possibility for accompanying monitoring, outperform companies with lower institutional ownership; • whether institutional activism targeted at particular companies affects performance; • whether there are abnormal share price returns around the date when a formal shareholder proposal is announced, or the date when a company announces acquiescence to an informal proposal; • whether discrete corporate events (for example, subsequent CEO turnover or corporate restructuring) occur more frequently at companies that have been targeted by institutions for governance efforts; and • whether a regulatory change that increases the potential effectiveness of shareholder activism results in abnormal share price returns for companies that had been targeted before the regulatory change. Black’s review found that the studies produced mixed results: some indicate that institutional investor activism has a positive impact on corporate performance, some indicate that it has a negative impact, and some show no significant impact at all. There are at least two possible explanations for these mixed results. 19 See M Dickson, “Ballot Box Crusaders Ride to Foreign Wars”, Financial Times, 3 March 1993 21; N Cohen, “US Investors Use Foreign Voting Rights” Financial Times, 29 November 1994, 30; J Gapper, “US Investors May Target Poor Performers”, Financial Times, 29 March 1997. 20 Committee of Inquiry into UK Vote Execution (Yve Newbold, Chair) (“Newbold Committee”), Report (London, National Association of Pension Funds, 1999), para 4.6. 21 B S Black, “Shareholder Activism and Corporate Governance in the United States” in P Newman (ed), The New Palgrave Dictionary of Economics and the Law (New York, Stockton Press, 1998), vol 3, 459.

200 G. P. Stapledon First, as Black points out, nearly all of the studies focus on “visible” activism.22 Behind-the-scenes (or “invisible”) activism also occurs in the USA, but by definition its impact is very difficult to study.23 Yet it is entirely plausible that invisible activism is more effective than visible activism: UK institutions have emphasised that their most effective interventions have occurred away from the public spotlight.24 Secondly, the mixed results may be a factor of which specific corporate governance feature was being targeted in the institutional investor action. Romano, who analysed the same studies reviewed by Black, rationalises the mixed results on this basis.25 She demonstrates that institutional activism aimed at board structure and composition, for example, does not generally produce a statistically significant effect on company performance. This, according to Romano, is explicable by the fact that board structure and composition itself does not have a statistically significant impact on corporate performance (a fact discernible from a review of the broad range of empirical studies in this area).26 On the other hand, institutional investor activism aimed at dismantling certain kinds of take-over defences is, in certain circumstances, associated with positive share-price performance. Romano attributes this to the fact that these types of take-over defences have themselves been shown, empirically, to be shareholderwealth destroying.

22 Studies reported since Black’s review (and which also focus on visible activism) include S Choi, “Proxy Issue Proposals: Impact of the 1992 SEC Proxy Reforms”, Journal of Law, Economics, and Organization (forthcoming, April 2000); S L Gillan, and L T Starks, “Corporate Governance Proposals and Shareholder Activism: The Role of Institutional Investors”, Working Paper (Department of Finance, University of Texas, 1998); S Rajgopal and M Venkatachalam, “The Role of Institutional Investors in Corporate Governance: An Empirical Investigation”, Working Paper (Graduate School of Business, Stanford University, 1998); C Crutchley, C Hudson and M Jensen, “The Shareholder Wealth Effects of CalPERS’ Activism”, (1998) 7 Financial Services Review 1; A K Prevost and R P Rao, “Of What Value are Shareholder Proposals Sponsored by Public Pension Funds?”, (2000) 73 Journal of Business (forthcoming, April issue); see also I M Ramsay and M Blair, “Ownership Concentration, Institutional Investment and Corporate Governance: An Empirical Investigation of 100 Australian Companies”, (1993) 19 Melbourne University Law Review 153 at 182. 23 For an American study which examined the behind-the-scenes activism of one large pension fund, see W T Carleton, J M Nelson and M S Weisbach, “The Influence of Institutions on Corporate Governance Through Private Negotiations: Evidence from TIAA-CREF”, (1998) 53 Journal of Finance 1335. 24 See the findings of the interview studies reported in Black and Coffee, above n. 4, at 2041–55; M Gaved, Ownership and Influence (Report, Institute of Management, London School of Economics, 1995) at 84; Holland, above n. 5, at 135; Stapledon, above n. 6, at 117. 25 R Romano, “Making Shareholder Activism a More Valuable Mechanism of Corporate Governance”, Paper presented at the Tilburg University Conference on Convergence and Diversity in Corporate Governance Regimes and Capital Markets, Eindhoven, 4–5 November 1999. 26 For a review of international studies of the impact of board composition on corporate performance, see G P Stapledon and J J Lawrence, “Board Composition, Structure and Independence in Australia’s Largest Listed Companies”, (1997) 21 Melbourne University Law Review 150 at 155, 163. For a recent Australian empirical study, see J J Lawrence and G P Stapledon, “Do Independent Directors Add Value?” (Research Report, Centre for Corporate Law and Securities Regulation, University of Melbourne, 1999).

Institutional Investors: What are their Responsibilities? 201 The upshot of the American empirical studies appears to be that the growth in institutional shareholdings over recent decades has had an impact on corporate performance, but not in an across-the-board sense. As far as the United Kingdom is concerned, Faccio and Lasfer found that listed UK companies in which internally managed pension funds held large stakes did not outperform their industry counterparts.27 This accords with the finding of Franks, Mayer and Renneboog, that listed UK companies with a high concentration of institutional share ownership performed, on average, no better or worse than other listed companies over the period 1988 to 1993.28 The latter study also found no significant relationship between high levels of institutional share ownership and managerial disciplining (that is, regardless of whether or not poorly performing companies had a high concentration of institutional share ownership, the level of board turnover was not significantly different). These two studies did not, however, focus on voting or activism by institutional investors. Rather, they used the relative level of institutional share ownership in the companies studied as a proxy for the level of institutional investor involvement in the governance of the sample companies. It may be that a positive impact of active use of voting rights and other activism by some institutional investors has been masked by the methodology employed in these two studies.

THE STRUCTURE OF INSTITUTIONAL SHARE OWNERSHIP

Introduction: The Interest-Holders in Shares Institutional share ownership typically involves several interest-holders. In the case of a pension scheme’s equity investments, for example, different “interests” in the shares will often be held by the scheme’s trustee, its fund manager/s and its custodian/s. Before turning to the legal obligations of institutional investors (below), it is important first to identify the status and role of each interestholder. The three main interest-holders in any parcel of shares are: • the registered holder of the shares, that is, the person/entity entered on the company’s register of members. The registered holder is referred to in the Companies Act 1985 as a “member” of the company,29 e.g., where a custodian holds shares on behalf of a client, the custodian is the registered holder. It is common to refer to shares held by custodians as being held by “nominees”; this reflects a structure under which a custodian holds shares on a bare trust for its client; 27 M Faccio and M A Lasfer, “Do Occupational Pension Funds Monitor Companies in which They Hold Large Stakes?”, (2000) 6 Journal of Corporate Finance 71. 28 J Franks, C Mayer and L Renneboog, “Who Disciplines Management in Poorly Performing Companies?”, Working Paper (London Business School, 2000). 29 See, e.g., Companies Act 1985, s 22.

202 G. P. Stapledon • the beneficial owner of the shares, e.g., where the registered holder is a trustee, it holds the shares on trust for the beneficiaries of the trust, who are (collectively) the beneficial owners of the shares. Even where the registered holder is a custodian appointed by the trustee, the shares are still—ultimately—held on trust for the beneficiaries of the trust;30 • the holder of the voting rights attached to the shares, e.g., where the trustee of a pension scheme engages a fund management firm to manage the scheme’s equity investments, the fund management contract typically provides the fund manager with the power to give voting instructions to the custodian (the registered holder), subject to any overriding instruction from the trustees.31 Here, the fund manager holds the voting right attaching to the shares.32 Sometimes all three interests are held by the one person/entity, but, as shown below, in the case of institutional share ownership it is more common for at least two different parties to be involved.

Pension funds Background Nearly all funded occupational pension schemes are constituted as trusts, separate from their sponsoring entities.33 They may have individual trustees, but most large schemes have a corporate trustee, which is usually a wholly owned subsidiary of the sponsoring employer. The directors of a corporate trustee are usually senior executives of the sponsor, plus member representatives.34 There are three ways in which the cashflows of funded pension schemes may be invested: • in insurance policies;35 30

See below n. 40, and accompanying text. Stapledon, above n. 6, 89. See Pensions Act 1995, s 34, in relation to the power of pension scheme trustees to delegate their investment powers. The allocation of the voting control right is by no means a static area. There is anecdotal evidence that some large UK institutional investors have varied the typical arrangements described in the text. 32 The terms on which different fund managers hold those rights will differ according to specific contractual arrangements with beneficial owners. 33 Local authority schemes are not formally constituted as trusts. They are constituted under the Superannuation Act 1972, and regulated under various sets of regulations made under that Act. The local authority (“administering authority”) is nevertheless in a position analogous to that of a trustee: J J Quarrell, The Law of Pension Fund Investment (London, Butterworths, 1990), ch 4. 34 See Pensions Act 1995, ss 16–21, in relation to member representatives. The directors of a corporate trustee are sometimes loosely referred to as the scheme’s trustees. In law, though, the company is the trustee. 35 Small pension schemes often just take out insurance policies. The policy is usually a with-profits endowment policy or a deposit-administration contract (which operates similarly to a bank account): Pension Law Review Committee (Roy Goode, Chair), Report (Cm 2342, London, HMSO, 1993), paras 2.4.23–2.4.26. The policy of an insured pension scheme is treated like most other insurance policies: the premiums are pooled together with those of other policies into a large fund which 31

Institutional Investors: What are their Responsibilities? 203 • in pooled funds;36 or • directly invested. Most large pension schemes are directly invested. Here, the scheme trustee invests directly in assets such as equities, bonds, real property, etc. Registered holder In the case of a directly invested pension scheme, the registered owner of equity investments may be the trustee of the scheme, or a custodian engaged by the trustee. The latter is very common. Some custodians use a “pooled nominee system” under which the shareholdings of all clients are registered in just one nominee name (with reliance on internal records to differentiate the different underlying holdings). The single nominee holding is sometimes called an “omnibus account”. Other custodians use a “designated nominee system” under which each client’s holding is registered in a unique name (for example, “ABC Nominees Ltd, A/C 001”, “ABC Nominees Ltd, A/C 002”, etc).37 Beneficial owner The beneficiaries of a directly invested pension scheme are, collectively, the ultimate beneficial owners of the scheme’s equity investments. This is the case regardless of whether the registered owner is the scheme trustee or a custodian. Where the scheme trustee is the registered owner, it, like the trustee of any trust, holds the shares on trust for the scheme beneficiaries. It does not matter whether the pension scheme has individual trustees or a corporate trustee.38 is invested in the name of the insurance company. The insurance company is the beneficial owner of any equity investments, and (as detailed below) normally also the registered owner and the holder of the control rights. The pension scheme trustee is simply the owner of one or more insurance policies. 36 A pooled pension fund is one in which the moneys of a number of different pension schemes are aggregated and invested, as one fund, by an external fund manager. Most pooled funds are either unit-linked insurance funds (known as life company “managed funds”) or authorised unit trusts. Unit trusts are discussed, below nn. 48–53, and accompanying text. In relation to managed funds, a unit-linked insurance fund is not a separate legal entity: the life company merely keeps separate accounts recording the assets representing the fund, the present value of those assets, and transfers of cash into and out of the fund: Linklaters and Paines, Unit Trusts: The Law and Practice (London, Longman, 1998), para A2.0310. The fund forms part of the insurer’s life fund, and is notionally divided into units. Trustees of pension schemes effectively buy “units” in the fund, which are then liquidated as necessary to meet the schemes’ obligations as they fall due: Pension Law Review Committee, above n. 35, para 2.4.27. In law, however, the beneficial owner of the assets comprising a managed fund is the insurance company. The insurance company is (as detailed below) normally also the registered owner and the holder of the control rights. The investing pension scheme trustees own just their insurance policies. 37 See Securities and Investments Board, Custody Review Discussion Paper (London, Securities and Investments Board, 1993), ch 6. 38 As mentioned above, the more common of the two options is a corporate trustee.

204 G. P. Stapledon Even a corporate trustee, under trust law principles, has no beneficial interest in the scheme assets. The assets are held by the corporate trustee on trust for the scheme beneficiaries.39 Where a custodian is the registered owner, that custodian holds the shares on a bare trust for its client, in this case the trustee of the pension scheme. But the trustee itself holds scheme assets on trust for the scheme beneficiaries.40 The scheme beneficiaries are, therefore, collectively the ultimate beneficial owners of a directly invested pension scheme’s equity investments, regardless of who is on the share register. Voting rights Where the scheme trustee is the registered owner of a directly invested pension scheme’s equity investments, the law of trusts dictates that the exercise of voting rights is a matter for the trustee. It would be open to the trustee to retain those voting rights or to delegate them, for example, to an external fund manager hired to manage the scheme’s assets.41 Where a custodian is the registered shareholder, it is the member and therefore receives general meeting notices and proxy voting material. It, as a matter of company law, has the right to exercise voting rights or to appoint a proxy to do so on its behalf.42 However, the custodian holds the shares as a bare trustee, and as such it is required under equitable principles—and usually also by an express provision in its contract with the pension scheme’s trustee—to exercise the voting rights as directed by the trustee, or somebody specified by the trustee. A modern fund management agreement (the contract between the scheme trustee and the external fund manager) will often provide that the fund manager may, at its discretion, give voting instructions to the custodian, subject always to any specific instructions from the trustee.43

Insurance companies Background Major insurance companies operating in the United Kingdom fall into three groups:

39 The beneficial interest of the scheme’s beneficiaries is reflected in the wording of the Companies Act 1985, s 209(1)(a). 40 In similar circumstances, an Australian court was prepared to “look through” the two trusts and find that the registered owner of the assets owed fiduciary duties to the ultimate beneficiaries: Australian Securities Commission v. AS Nominees Ltd (1995) 18 ACSR 459 at 472. 41 See Pensions Act 1995, s 34. 42 Companies Act 1985, s 370(1), (2); Table A, art 38. 43 See above nn. 31–2 and accompanying text.

Institutional Investors: What are their Responsibilities? 205 • mutually owned companies: mutuals are “owned” by their policyholders (or certain types of policyholders), that is, the policyholders are the members of a mutual insurance company;44 • companies limited by shares and listed on the London Stock Exchange; as with other companies limited by shares, it is the registered shareholders who are the members of a share-capital insurance company; • companies limited by shares and which are subsidiaries of other companies (including overseas-based insurance groups and UK and overseas banks). Most of the equity investments of insurance companies are in their life funds (as opposed to their general funds—household, vehicle, health, etc). Registered holder Although practices vary among the insurers, it is common for equity investments to be registered in the insurance company’s own name. Less commonly, a custodian may be engaged to be the registered holder of the shares (in which case the custodian is the member of the investee company concerned; but it holds the shares on a bare trust for the insurance company, which is the beneficial owner). Beneficial owner The insurance company is the beneficial owner of the equity investments and other assets which make up its insurance funds, and back the policies issued by it. Policyholders have no collective rights of ownership (legal or beneficial) in respect of the assets backing their insurance policies. Instead, they are creditors of the insurance company. This is the case regardless of whether the insurer is a mutual or a share-capital company. In addition, the members (that is, the shareholders in the case of a sharecapital insurance company; and the policyholders, in their capacity as members, in the case of a mutual) have no ownership interest—legal or beneficial—in the equity investments or other assets of an insurance company. The insurance company is treated by the law as a legal entity separate from its members.45 The insurance company is the owner of the assets backing the policies that it issues. The company’s members have a membership interest and membership rights, but no ownership interest in the company’s assets.46 Voting rights Virtually every well-known UK company authorised to write life insurance has a fund management subsidiary (or division) which manages the investment of 44 45 46

Many mutuals are companies limited by guarantee. Salomon v. A Salomon & Co Ltd [1897] AC 22. Ibid.; Macaura v. Northern Assurance Co Ltd [1925] AC 619.

206 G. P. Stapledon most, if not all, of the group’s insurance funds. Where an insurer’s equity investments are managed in-house in this way, the voting control rights attaching to the shares would normally rest with the insurer’s fund management staff. Some small insurers, which do not have the resources to conduct investment management, use external fund managers.47 In these cases, the voting rights would normally be delegated to the external fund management firm.

Unit trusts Background Unit trusts are open-ended investment funds which operate under a trust structure. They may be authorised or unauthorised. Only authorised unit trusts may be marketed to the public.48 Authorised unit trust schemes must have a trustee independent of a manager.49 The trustee is responsible for the custody or control of the scheme’s assets.50 Registered holder The registered holder of a unit trust scheme’s equity investments may be the trustee of the scheme, or a custodian engaged by the trustee. Beneficial owner Beneficial ownership of a unit trust’s assets rests with the collective body of unitholders.51 Where a custodian is the registered owner, the unit-holders’ collective beneficial interest arises in the same indirect way that the beneficiaries of a directly invested pension scheme enjoy beneficial ownership of assets registered in a custodian’s name.52 Voting rights Ordinarily, the manager of an authorised unit trust scheme possesses the voting rights attached to the scheme’s equity investments. Under the 1991 Regulations, 47 e.g., in 1993 Crown Financial Services Ltd, the UK life insurance, pensions and unit trust subsidiary of Crown Life of Canada, ceased to manage its funds in-house. Its funds under management, some £700 million, did not amount to the “critical mass” necessary for high quality fund management. Therefore, fund management was contracted out to an external fund management firm: “Lazard to Manage Crown Funds”, Financial Times, 19 January 1993, 21. 48 Financial Services Act 1986, s 76. 49 Ibid., s 78(2). 50 Financial Services (Regulated Schemes) Regulations 1991, reg 7.10.2. 51 Charles v. Federal Commissioner of Taxation (1954) 90 CLR 598 at 609; Linklaters and Paines, above n. 36, para A2.0420. 52 See above, n 40, and accompanying text.

Institutional Investors: What are their Responsibilities? 207 the voting rights attached to the property of an authorised unit trust scheme must be exercised or not exercised as directed by the manager.53

Investment trusts Background Investment trusts are closed-end investment funds. Several are listed on the London Stock Exchange, and invest solely or primarily in listed UK equities. Despite their name, they are not trusts; they are public companies. As companies, they are legal entities separate from the persons who invest in them (that is, their shareholders).54 Most investment trust companies engage a fund management firm to manage their assets. In fact, many existing investment trusts were promoted (and effectively established) by fund management firms. The choice of (and contractual engagement of) the fund management firm to manage the assets of a newly established investment trust might therefore seem a foregone conclusion. However, the Financial Services Authority Listing Rules include a requirement that the board of directors of a listed investment trust “must be able to demonstrate that it will act independently of any investment managers of the investment [trust] and a majority must not be employees of or professional advisers to the investment managers or any other company in the same group as the investment managers”.55 Registered holder The registered holder of an investment trust’s equity investments may be the investment trust company itself, or a custodian engaged by it. Where a custodian is the registered owner, it holds the shares on a bare trust for the investment trust company. Beneficial owner The beneficial ownership of an investment trust’s equity investments rests with the investment trust company. The investment trust’s own shareholders have no ownership interest—legal or equitable—in the assets of the investment trust.56 53 Financial Services (Regulated Schemes) Regulations 1991, reg 7.11.1. There is an exception where the scheme property is shares or units in collective investment schemes managed or otherwise operated by the manager or its associates. 54 Saloman v A Saloman & Co Ltd [1897] AC 22. 55 Financial Services Authority, The Listing Rules, paras 21.9(d), 21.10, 21.20. 56 Salomon v. A Salomon & Co Ltd [1897] AC 22; Macaura v. Northern Assurance Co Ltd [1925] AC 619.

208 G. P. Stapledon Voting rights The voting rights attached to an investment trust’s equity investments are commonly delegated by the board of directors of the investment trust to the fund manager of the trust’s assets.

OEICs Background An open-ended investment company (OEIC) is a pooled investment vehicle which (as its name suggests) is open-ended like a unit trust. However, OEICs differ from unit trusts because OEICs are companies. Investors receive shares rather than units.57 OEICs must have: • one or more directors; one director must be a body corporate authorised under the Financial Services Act 1986 to carry out investment business. This director, called the Authorised Corporate Director (ACD), is responsible for the day-to-day management of the scheme; and • a “depositary” to whom the scheme property is “entrusted” for “safekeeping” under the Regulations. The depositary must be independent of the OEIC and its directors. Registered holder The registered holder of an OEIC’s equity investments may be the depositary of the OEIC, or a custodian engaged by the depositary.58 In either case, the shares are held on a bare trust for the OEIC.59 Beneficial owner The beneficial ownership of an OEIC’s equity investments rests with the OEIC. The OEIC’s own shareholders have no ownership interest—legal or beneficial—in the assets of the OEIC.60 57 OEICs are regulated under the Open-Ended Investment Companies (Investment Companies with Variable Capital) Regulations 1996 (SI 1996/2827), and the Financial Services (Open-Ended Investment Companies) Regulations 1997. 58 The depositary is permitted to entrust some or all of the scheme’s property to a third party (e.g., a custodian): Open-Ended Investment Companies (Investment Companies with Variable Capital) Regulations 1996 (SI 1996/2827), reg 5(2)(b). 59 G Morse (ed), Palmer’s Company Law (London, Sweet & Maxwell: loose-leaf), para 5A.006. 60 Open-Ended Investment Companies (Investment Companies with Variable Capital) Regulations 1996 (SI 1996/2827), reg 39(2).

Institutional Investors: What are their Responsibilities? 209 Voting rights The voting rights attached to an OEIC’s equity investments are the responsibility of the ACD. The depositary (or other registered holder) must exercise, or not exercise, the voting rights attached to equity investments as directed by the ACD.61

INSTITUTIONAL INVESTORS’ LEGAL OBLIGATIONS

Introduction In addressing the central issue of whether the various institutional players are obliged, under current law, to play an active role in corporate governance, this section pays particular attention to the exercise of the voting right. There are two reasons for focusing on voting. First, apart from occasional dramatic interventions such as the one which occurred at Mirror Group in 1999,62 the most visible form of institutional involvement in corporate governance is the exercise of voting rights. Secondly, voting is probably the only aspect of institutions’ involvement in corporate governance that could realistically be the subject of specific regulation, for example, a rule compelling the use of voting rights by or on behalf of pension trustees. It is possible for an obligation to exercise voting rights to be imposed by the provisions of a trust deed. For example, a pension trust deed could include a provision requiring the trustees to exercise, or procure the exercising of, the right to vote attached to any equity investments of the scheme. Similarly, a unit trust deed could expressly require the manager to exercise voting rights. Alternatively, such a requirement could be imposed on the investment manager of a pension scheme under the investment management agreement entered into between the trustees and the investment manager. Or it could be contained in the trustees’ policy on exercise of voting rights. If pension scheme trustees have a policy on voting, they must now include it in the statement of investment principles mandated by the Pensions Act 1995.63 If the last option were adopted, the fund manager would not be under an absolute duty to vote. The Act requires a fund manager to act “with a view to giving effect to” the statement of investment principles “so far as reasonably practicable”.64 Another option would be to introduce a statutory provision specifically requiring the exercise of voting rights by or on behalf of, say, pension fund 61

Financial Services (Open-Ended Investment Companies) Regulations 1997, reg 6.02, para 3b. Here, the CEO of Mirror Group resigned after pressure from some of the company’s large institutional shareholders. See J Gapper, “Tricky but Talented with a £1.4m Pay-off”, Financial Times, 29 January 1999, 21. 63 See below n. 160, and accompanying text. 64 Pensions Act 1995, s 36(5). 62

210 G. P. Stapledon trustees. There were calls from the British Labour Party (while in opposition) and from a minority of the House of Commons Employment Committee, in 1995, for voting to be made compulsory for the trustees of UK pension funds.65 After coming to power, the Labour Government indicated that it may legislate to mandate voting if the level of institutional investor voting did not increase.66 The Government subsequently backed away from compulsory voting,67 although the Newbold Committee suggested that a failure to increase the overall level of voting from 50 per cent to around 60 per cent during the next few years “would . . . justify further investigation by the Government”.68 In the absence of a contractual or express statutory obligation, it seems that the only possible source of an obligation to vote might be an existing general law or statutory duty. This section of the chapter examines the general law and statutory duties owed by the various categories of UK institutional investors, to see whether a voting obligation lies within any of those duties.

Pension funds Trustees Where a pension scheme has individual trustees, each of those persons is in a fiduciary relationship with the beneficiaries of the scheme, and owes fiduciary duties and other general law duties69 to those beneficiaries. As mentioned earlier, it is more common for a pension scheme to have a corporate trustee. Like individual trustees, a corporate trustee is in a fiduciary relationship with the beneficiaries of the scheme, and owes fiduciary duties and other general law duties to those beneficiaries.70 65 See L Buckingham, “Labour Pushes Pension Funds to Fight Gravy Train”, Guardian, 16 January 1995, 13; House of Commons Employment Committee, Third Report: The Remuneration of Directors and Chief Executives of Privatised Utilities (HC 159, Session 1994–95, London, HMSO, 1995), lxiii. Contrast the non-prescriptive statement of the majority of the Committee: “institutional shareholders . . . ought, as a matter of course, to exercise their voting rights”: para 98. 66 J Martinson, “Beckett Retains Option of Law to Enforce Corporate Best Practice”, Financial Times, 5 March 1998. 67 J Martinson, “Pension Fund Principles ‘Should Include Voting Policy’ ”, Financial Times, 22 April 1999, 8. 68 Newbold Committee, above n. 20, at 3. The option of a mandatory voting rule is analysed, below, nn. 145–55, and accompanying text. 69 There is a growing literature arguing that the only truly “fiduciary” duties relate to the conflict and profit rules, and that the other duties owed by trustees and other fiduciaries (such as the duty of care and the “positive” duty of good faith) are not strictly fiduciary duties at all: see P D Finn, “The Fiduciary Principle” in T G Youdan (ed), Equity, Fiduciaries and Trusts (Toronto, Carswell, 1989), 3; R P Austin, “Moulding the Content of Fiduciary Duties” in A J Oakley (ed), Trends in Contemporary Trust Law (Oxford, Clarendon Press, 1996), 153; see also L S Sealy, “Fiduciary Obligations, Forty Years On” (1995) 9 Journal of Contract Law 37. 70 It is common for pension trustees to give an external fund manager power to exercise voting rights attached to equity investments, subject to any directions that the trustees may choose to give: see above nn. 31–2, and accompanying text. As discussed, below at nn. 116–17, and accompanying text, this has implications for the content of the duties owed by the trustees.

Institutional Investors: What are their Responsibilities? 211 The duties of a pension scheme trustee include: • • • • • •

the duty of efficient management (that is, to preserve the trust property); the duty of loyalty; the duty to keep and render to the beneficiaries full and candid accounts; the duty to act personally; the duty to consider from time to time whether to exercise powers; and the duty to exercise powers for proper purposes and upon relevant considerations.71

The fourth duty on this list has been qualified by the Pensions Act 1995. Section 34 of that Act gives pension scheme trustees power to delegate investment decision-making to a fund manager. The first two and the last two duties are of particular importance in the present context. This is because it has been argued that, in order to fulfil their duties, the trustees of a pension fund must take an interest in the way in which investee companies are managed, and exercise or procure the exercising of the voting rights attached to the shares of investee companies.72 The Newbold Committee went so far as to say that “Regular, considered voting should be regarded as a fiduciary responsibility”.73 But can a legal requirement to vote—or to procure voting by a fund manager— be distilled from the duties mentioned above? (i) Duty of efficient management. The duty of efficient management requires the trustee, on assumption of office, to become acquainted with the terms of the trust and to get in the trust property. Importantly, it also embraces an ongoing duty of care. The standard of care expected of trustees in this regard is that which an ordinary prudent business-person would exercise in regard to his or her own business, if minded to benefit other people for whom he or she felt morally bound to provide.74 71 The list is adapted from the summaries in H A J Ford and W A Lee, Principles of the Law of Trusts (3rd edn, Sydney, LBC Information Services, 1996), para 9030; and R P Austin, “The Role and Responsibilities of Trustees in Pension Plan Trusts: Some Problems of Trusts Law” in Youdan, Equity, Fiduciaries and Trusts, above n. 69, 111 at 115. See also Pensions Act 1995, s 35 (requirement to have a set of investment principles prepared and maintained); s 36 (requirements to obtain proper advice before investing; to have regard to the need for diversification of investments; to have regard to the suitability of proposed investments; and to exercise powers of investment with a view to giving effect to the investment principles formulated under s 35); s 49 (responsibilities regarding separate bank accounts and record-keeping). 72 See J Plender, “Survey: Pension Fund Investment: Focus on Investors’ Behaviour”, Financial Times, 6 May 1993, section III, VII; Lord Nicholls of Birkenhead, “Trustees and Their Broader Community: Where Duty, Morality and Ethics Converge” (1996) 70 Australian Law Journal 205, at 214. There are clear parallels with the US Department of Labor’s rulings under ERISA: see above nn. 12–18, and accompanying text. See also Committee on the Financial Aspects of Corporate Governance (Sir Adrian Cadbury, Chair) (“Cadbury Committee”), Report (London, Gee & Co, 1992), para 6.12: “Voting rights can be regarded as an asset”. 73 Newbold Committee, above n. 20, at 7. 74 Speight v. Gaunt (1883) 22 Ch D 727 at 739–40; Re Whiteley (1886) 33 Ch D 347 at 355; Austin v. Austin (1906) 3 CLR 516 at 525; Australian Securities Commission v. AS Nominees Ltd (1995) 18 ACSR 459 at 469.

212 G. P. Stapledon Where a trustee (for example, a trust corporation) holds itself out as a specialist in the business of trust management, a higher standard of care applies.75 Where a trustee has a controlling interest76 in the share capital of a company, the courts have held that the trustee must (as an ordinary prudent businessperson would) place itself in a position to make an informed decision as to whether it is appropriate to take any action for the protection of the shareholding.77 The court in Re Lucking’s Will Trusts suggested that this necessitates board representation: “[W]hat steps, if any, does a reasonably prudent man who finds himself a majority shareholder in a private company take with regard to the management of the company’s affairs? He does not . . . content himself with such information as to the management of the company’s affairs as he is entitled to as shareholder, but ensures that he is represented on the board. He may be prepared to run the business himself as managing director or, at least, to become a non-executive director while having the business managed by someone else. Alternatively, he may find someone who will act as his nominee on the board and report to him from time to time as to the company’s affairs. In the same way . . . trustees holding a controlling interest ought to ensure so far as they can that they have such information as to the progress of the company’s affairs as directors would have. If they sit back and allow the company to be run by the minority shareholder and receive no more information than shareholders are entitled to, they do so at their risk if things go wrong”.78

In Bartlett v. Barclays Bank Trust Co Ltd (No 1), Brightman J said that he did not understand the court in Re Lucking’s Will Trusts: “to have been saying that in every case where trustees have a controlling interest in a company it is their duty to ensure that one of their number is a director or that they have a nominee on the board who will report from time to time on the affairs of the company. [The court] was merely outlining convenient methods by which a prudent man of business (as also a trustee) with a controlling interest in a private company, can place himself in a position to make an informed decision whether any action is appropriate to be taken for the protection of his asset. Other methods may be equally satisfactory and convenient . . . Alternatives . . . are the receipt of copies of the agenda and minutes of board meetings if regularly held, the receipt of monthly management accounts in the case of a trading concern, or quarterly reports. Every case will depend on its own facts. . . . The purpose to be achieved is not that of monitoring every move of the directors, but of making it reasonably probable . . . that the trustee . . . will receive an adequate flow of information in time to enable the trustees to make use of their controlling interest should this be necessary for the protection of their trust asset, namely, the shareholding. The obtain75 Bartlett v. Barclays Bank Trust Co Ltd (No 1) [1980] 1 Ch 515 at 534; Australian Securities Commission v. AS Nominees Ltd (1995) 18 ACSR 459 at 470–1. 76 In the two main cases (Bartlett v. Barclays Bank Trust Co Ltd (No 1) [1980] 1 Ch 515; and Re Lucking’s Will Trusts [1968] 1 WLR 866), the shareholding of the trustee was substantially in excess of 50 per cent of the issued share capital. However, the courts may well extend the “controlling interest” rule to situations where a trustee with a stake of less than 50 per cent is, nevertheless, effectively in a controlling position. 77 Bartlett v. Barclays Bank Trust Co Ltd (No 1) [1980] 1 Ch 515 at 532–4. 78 [1968] 1 WLR 866, at 874–5.

Institutional Investors: What are their Responsibilities? 213 ing of information is not an end in itself, but merely a means of enabling the trustees to safeguard the interests of their beneficiaries”.79

However, most if not all UK pension schemes do not have controlling interests in listed industrial or resources companies.80 And there seems to be no case requiring a trustee with a non-controlling interest to take these additional types of measures.81 (ii) Duty of loyalty. The duty of loyalty includes the conflict and profit rules, a duty to observe the terms of the trust, a duty of impartiality, a duty to act honestly and in good faith, and a duty to act in what the trustee considers to be the interests of the beneficiaries. In regard to the latter limb, the “interests” of the beneficiaries under a pension trust will almost always mean their financial interests.82 As Sir Donald Nicholls VC put it, where property is held by trustees “for the purpose of generating money . . . with which to further the work of the trust . . . prima facie the purposes of the trust will be best served by the trustees seeking to obtain therefrom the maximum return . . . which is consistent with commercial prudence”.83 It is submitted that the trustees of a pension fund can fulfil their general law duty of loyalty, in relation to corporate governance, by regularly reviewing and assessing the scheme’s shareholdings, and taking whatever of a range of possible actions (which would sometimes include doing nothing) is appropriate in the circumstances. It would commonly be suitable to pursue any of a number of different courses of action in a given set of circumstances. Exercising—or procuring the exercise of—voting rights or seeking to influence the directors would sometimes be among the appropriate actions, but there would often be alternative courses of action available which would also satisfy the relevant duties. Where there are problems with a company’s management, selling the shares may well be a quite satisfactory exercise of power by the trustees—except perhaps where the shares are trading at a considerable discount to the net tangible asset backing. It is considered unlikely that a court would hold that the trustees, 79

[1980] 1 Ch 515, at 533–4. There may be an occasional controlling interest in a listed investment trust company. 81 But note Butt v. Kelson [1952] Ch 197, where it was held that trustees holding shares in a company could be compelled by the beneficiaries to vote the shares according to the wishes of the beneficiaries (or of the court, if the beneficiaries were not unanimous). This decision is difficult to reconcile with Re Brockbank [1948] Ch 206, and other authorities which state that beneficiaries are not entitled to compel trustees to exercise a discretionary power in a certain way. See also Re George Whichelow Ltd [1954] 1 WLR 5, at 7–9; Walker v. Willis [1969] VR 778, at 781–2. 82 Cowan v. Scargill [1984] 2 All ER 750, at 760; Harries v. The Church Commissioners for England [1992] 1 WLR 1241, at 1246–8 (re charity trustees). 83 Harries v. The Church Commissioners for England [1992] 1 WLR 1241, at 1246. But a recent reform to the regulations made under the Pensions Act 1995 now requires pension scheme trustees to include, in their statement of investment principles, their policy on “the extent (if at all) to which social, environmental or ethical considerations are taken into account in the selection, retention and realisation of investments”: Occupational Pension Schemes (Investment, and Assignment, Forfeiture, Bankruptcy, etc) Amendment Regulations 1999 (SI 1999/1849), inserting a new reg 11A into the Occupational Pension Schemes (Investment) Regulations 1996 (SI 1996/3127). 80

214 G. P. Stapledon in such a situation, were under a duty to remain a shareholder and to exercise (or procure the exercise of) their rights of ownership. Doing nothing at all (that is, not selling the shares; not voting the shares; not entering into informal dialogue with the company’s directors) may even be appropriate sometimes, provided that the trustees have considered the issues and the options available (see below). This may be the case, for example, if the trustees reasonably believed that a take-over bid would soon be made. Equally, where a company is performing well, and has a management with a good track record, it is surely implausible that the trustees of a pension fund with a holding in that company could be found to be in breach of their duty to the beneficiaries through not exercising voting rights on uncontroversial or unexceptional resolutions. On the other hand, a duty to exercise the voting right may well arise where there is a motion or series of motions which, if passed, would have a sizeable impact on the value of the fund’s shareholding (for example, a proposed reconstruction or scheme of arrangement). Even here, though, it would often be very difficult to establish the necessary causative link between the trustees’ lack of voting or other involvement in the company’s governance and any losses incurred by the trust funds on the shareholding in question.84 (iii) Duty to consider and duty to exercise powers for proper purposes. In the case of a mere power, trustees are under a duty to consider whether or not the power should be exercised,85 and to exercise it with due consideration for the purpose for which it was conferred.86 The power to exercise the voting rights attached to a trust’s equity investments is unlike a conventional mere power, given to a trustee by case law, statute or the trust deed. Instead, it is a power that the trustee possesses simply by being the owner of the shares.87 It is unlikely that the distinction has any importance in the present context. Real and genuine consideration must be given.88 The trustees must put themselves in a position where they can make a rational judgement—that is, there is an obligation to be informed.89 This is obviously significant in the present context: pension trustees who retain the voting right are obliged to acquire adequate information before making a decision on whether, and if so how, to vote a particular shareholding. There are real problems when it comes to enforcing the duty to consider. Trustees are not obliged to give reasons for their decision (for example, as to why they did not vote a particular shareholding). Provided that the discretion 84 See A F Conard, “Beyond Managerialism: Investor Capitalism?”, (1988) 22 University of Michigan Journal of Law Reform 117, at 151. 85 McPhail v. Doulton [1971] AC 424, at 449, 456; Re Gulbenkian [1970] AC 508, at 518. 86 R P Meagher and W M C Gummow, Jacob’s Law of Trusts in Australia (6th edn, Sydney, Butterworths, 1997), para 1609. 87 See Ford and Lee, above n. 71, para 1220. 88 Karger v. Paul [1984] VR 161; I J Hardingham and R Baxt, Discretionary Trusts (2nd edn, Sydney, Butterworths, 1984), 95, 110. 89 Meagher and Gummow, above n. 86, paras 1608–9.

Institutional Investors: What are their Responsibilities? 215 has been exercised (i) in good faith, (ii) upon real and genuine consideration, and (iii) for a proper purpose, the court will not examine the validity of the trustee’s reasons.90 However, if the trustees state their reasons voluntarily, the court may consider the validity of them.91 In addition, the court will look at evidence of the inquiries made by the trustees, the information they had, and the reasons for and manner of exercising their discretion, solely in order to determine whether there has been a failure to exercise the discretion in good faith, upon real and genuine consideration, and for a proper purpose.92 Importantly, gaps and errors in a trustee’s information and belief upon matters relevant to the exercise of discretion, if sufficiently extensive, could found an inference that the trustee had not been in a position to give real and genuine consideration.93 The better view is that beneficiaries have standing to complain of a breach of duty arising from a failure to consider.94 However, the courts are extremely reluctant to substitute their judgment for that of the trustees, and therefore the only realistic remedy is the replacement of the trustees—which is a drastic step and not a direct remedy as such.95 Problems with enforcement are probably the major weakness with the duty to consider. This illustrates the lack of practical legal incentives for institutional investors to be active in corporate governance in the United Kingdom. However, it does not necessarily follow that law reform is desirable.96 Directors of a corporate trustee Under the general law the directors of a corporate trustee owe fiduciary duties and a duty of care to the company and not, in the absence of special circumstances,97 also to the beneficiaries under the trust.98 It has been suggested in a few cases that the directors of a corporate trustee are in a fiduciary relationship with not only the company but also the trust 90

Karger v. Paul [1984] VR 161, at 163–4; Meagher and Gummow, above n. 86, para 1611. Karger v. Paul [1984] VR 161, at 166. 92 Ibid. at 164. 93 Ibid. at 175. 94 Hardingham and Baxt, above n. 88, para 205. 95 See P D Finn, Fiduciary Obligations (Sydney, Law Book Company, 1977), 35; Hardingham and Baxt, above n. 88, para 206; J W Harris, “Trust, Power and Duty”, (1971) 87 Law Quarterly Review 31, at 51. A failure to consider in the case of a vote of major financial significance could amount to negligence or a breach of the duty of loyalty, however even here there are problems of causation, as mentioned earlier. 96 See below. 97 See Allen v. Hyatt (1914) 30 TLR 444; Coleman v. Myers [1977] 2 NZLR 225; Glandon Pty Ltd v. Strata Consolidated Pty Ltd (1993) 11 ACSR 543; Brunninghausen v. Glavanics (1999) 32 ACSR 294. 98 Bath v. Standard Land Co Ltd [1911] 1 Ch 618; Hurley v. BGH Nominees Pty Ltd (1982) 31 SASR 250; Cope v. Butcher (1996) 20 ACSR 37; A R Coleman, “Duties of Directors of Corporate Trustees to Beneficiaries”, (1984) 2 Company and Securities Law Journal 147; H A J Ford and I J Hardingham, “Trading Trusts: Rights and Liabilities of Beneficiaries”, in P D Finn (ed), Equity and Commercial Relationships (Sydney, Law Book Company, 1987), 58. 91

216 G. P. Stapledon beneficiaries.99 In Australian Securities Commission v. AS Nominees Ltd,100 Finn J described this as a “controversial suggestion”, and doubted whether such a development would be “a desirable or necessary one”. Finn J found it unnecessary to express a concluded view on this argument, because he considered that there was a more orthodox legal mechanism available for protecting trust beneficiaries from misuse by directors either of their company’s trustee powers or of their own position vis-à-vis the trust property. Finn J said that: “the position now reached in the accessorial liability rule of Barnes v Addy101 is such as to render the directors of trust companies particularly and peculiarly vulnerable to suit by the trust beneficiaries for acts etc which constitute breaches of trust or of fiduciary duty on their company’s part”.102

Based upon the authorities, Finn J formulated “conservatively” the accessorial liability rule in Barnes v. Addy as “one which exposes a third party to the full range of equitable remedy [sic] available against a trustee if that person knowingly or recklessly assists in or procures a breach of trust or of fiduciary duty by a trustee”.103 The peculiar vulnerability of the directors of a corporate trustee to this rule is explicable by the fact that, “often enough, it will be their own conduct in exercising the powers of the board which causes their company to commit a breach of trust”.104 Therefore, it is fair to say that, due to the accessorial liability rule in Barnes v. Addy, the directors of a corporate trustee of a pension fund will, in many instances, effectively be subject to the same standards of conduct as individual pension trustees. Therefore, to use an example relevant to this chapter, any failure on the part of a corporate trustee to give genuine consideration to the exercise of voting rights could have consequences not only for the trustee but also for its directors.

99 Hurley v. BGH Nominees Pty Ltd (No 2) (1984) 37 SASR 499, at 510; Inge v. Inge (1990) 3 ACSR 63, at 69–70. See also Savin v. de Vere (1986) 3 NZCLC 99,703, at 99,707; Lion Breweries Ltd v. Scarrott (1987) 3 NZCLC 100,042. 100 (1995) 18 ACSR 459, at 475. 101 (1874) 9 Ch App 244. 102 (1995) 18 ACSR 459, at 475. See also Ford and Hardingham, above n. 98, at 63. 103 (1995) 18 ACSR 459, at 475. 104 Ibid. at 476. On the issue of accessorial liability for directors whose acts have been attributed to the company so as to render the company liable as principal, see Hamilton v. Whitehead (1988) 166 CLR 121. Note that in ibid., at 470, Finn J also said that where directors of a corporate trustee “are themselves ‘concerned in’ the breaches of trust of their company, they are liable to the company according to the same standard of care and caution as is expected of the company itself . . . To affirm such a limited coalescence in the standard of care of directors and trustees in the case of directors of trust companies is not to reignite the arid debate on whether directors are trustees. . . . It is merely to say that in this context the duties of trusteeship of the company can give form and direction to the common law and statutory duties of care and diligence imposed on directors, where the directors themselves have caused their company’s breach of trust . . . It needs, though, to be emphasised . . . that the coalescence noted is only operative when the trust business itself is involved. Where the company is engaged in its own affairs . . . the directors’ duty of care and skill will for that reason be unaffected by trust law considerations”. Emphasis added.

Institutional Investors: What are their Responsibilities? 217 Investment managers An investment manager appointed by the trustees of a pension fund is an agent of the trustees. The relationship of principal/agent is one of the established categories of fiduciary relationship. Therefore, an investment manager retained by pension fund trustees owes fiduciary, as well as contractual, duties to the trustees. It is, however, unclear whether an investment manager is also in a fiduciary relationship with the pension fund beneficiaries. In a discussion paper that led eventually to the enactment of the current Australian superannuation statute,105 the Australian Law Reform Commission (ALRC) and the Companies and Securities Advisory Committee (CASAC) said that an investment manager “owes, and should continue to owe, fiduciary duties to the members of the [superannuation] scheme, because it is superannuation funds it is managing”.106 However, the final Report released later by ALRC and CASAC noted that several submissions made in response to the discussion paper had disagreed with this view. The Report continued: “The main thrust of those submissions was that the relationship between the [trustees] and a hired investment manager is purely contractual and that this excludes any fiduciary duty being owed to the members. The Review is now of the view that the duties owed by an external hired investment manager are owed to the [trustees] principally under the contract between them. This does not, however, mean that the manager may not owe a fiduciary duty to the members. It may be argued that the benefit of the fiduciary duty owed by the hired investment manager to the [trustees] is held by the [trustees] on trust for the members of the scheme”.107

In the final sentence of this passage, ALRC and CASAC suggest that fiduciary duties may well be owed by the investment manager to the beneficiaries indirectly through the trustees. A prominent UK pensions lawyer, John Quarrell, has a similar view. Quarrell has been reported as stating that, as an agent of the trustees, a fund manager of a pension scheme is “a quasi trustee or constructive professional trustee” as regards the scheme’s beneficiaries.108 There is some support for this view in the case law. In Phipps v. Boardman,109 a solicitor, Boardman, was acting for the trustees of a trust. The relationship of solicitor and client is one of the established fiduciary relationships, and hence Boardman owed fiduciary duties to the trustees. Lord Hodson stated: “[T]here was a potential conflict between Boardman’s position as solicitor to the trustees

105

Superannuation Industry (Supervision) Act 1993 (Cth). ALRC and CASAC, Collective Investment Schemes: Superannuation (ALRC Discussion Paper No 50, Canberra, AGPS, 1992), para 5.27. 107 ALRC and CASAC, Collective Investments: Superannuation (ALRC Report No 59, Canberra, AGPS, 1992), para 8.38. 108 Cited in Plender, above n. 72; see also Quarrell, above n. 33, at 54. 109 [1967] 2 AC 46. 106

218 G. P. Stapledon and his own interest in applying for the shares. He was in a fiduciary position vis-a-vis the trustees and through them vis-a-vis the beneficiaries”.110 An analogous approach was adopted by the Court of Appeal in Powell & Thomas v. Evan Jones & Co.111 E appointed P as its agent to assist in finding a firm that would advance money to E. With the assent of E, P then engaged C as a sub-agent. C introduced a lender to E, and the loan was made. Unknown to E, the lender paid a commission to C for introducing E as a customer. The issue was whether E was entitled to recover from C the amount of the secret commission. C argued that E was not entitled to recover on the ground that there was no privity of contract between them, because C was merely a sub-agent employed by P. The Court of Appeal agreed with the trial judge’s finding that there was privity of contract between E and C. Importantly, the Court of Appeal also agreed that, even if there was no privity (that is, even if C was merely a subagent): “inasmuch as [C] knew that [P], in employing him, were acting as agents for [E], for the purpose of procuring an advance for them, either directly or through an intermediary, he stood in such a fiduciary relation to [E] as debarred him from acting in a manner contrary to their interests, or putting himself in the position of having an interest of his own in the matter which might lead him not to obtain from [the lender] the best terms possible for [E]”.112

In Australian Securities Commission v. AS Nominees Ltd, Finn J found that a company, Securities, which acted as manager of two pooled superannuation trusts (PSTs), owed fiduciary duties directly to the beneficiaries of the superannuation funds that held units in the PSTs.113 This is possibly the first reported case in which the investment manager of a superannuation or pension scheme has been held to stand in a fiduciary relationship with scheme beneficiaries. (i) Duty to consider. For present purposes, it is merely a starting point to conclude that an investment manager is, or at least commonly is, in a fiduciary relationship with the beneficiaries of a pension fund under its management. The focus earlier in this chapter, when dealing with the duties of pension trustees, was on the duty to consider. The case law on the duty to consider has, as Finn observes, been concerned primarily with the powers of trustees.114 However, as Finn states: “the duty itself must be of general application to all holders of fiduciary offices. Each such office, and the discretionary powers attached to it exist for the benefit of its beneficiaries. In every case it must be inconsistent with the fiduciary’s obligation to act in what he con110

Ibid. at 112. Emphasis added. [1905] 1 KB 11; applied in Blair v. Martin [1929] NZLR 225. 112 [1905] 1 KB 11, at 18–19. 113 (1995) 18 ACSR 459, at 472–4. A PST is a superannuation scheme that takes the legal form of a unit trust: Superannuation Industry (Supervision) Act 1993 (Cth), s 10 (definition of “pooled superannuation trust”); Superannuation Industry (Supervision) Regulations, reg 1.04(5). 114 Finn, above n. 95, at 34 (n. 3). 111

Institutional Investors: What are their Responsibilities? 219 siders to be his beneficiaries’ interests if he simply refuses to consider doing anything other than that which his office positively obliges him to do”.115

As mentioned earlier, it is common for the investment management contract between pension trustees and a fund management firm to give the fund manager power to exercise voting rights attached to equity investments, subject to the trustees having power to direct the fund manager how to vote on any particular occasion. In this situation, the duty to consider, on each occasion, whether and if so how to vote, would rest with the investment manager. And, as in the USA,116 the trustees would have a duty to monitor and supervise the investment manager’s exercise of its discretion in regard to voting. This general law duty of the trustees to monitor the investment manager is supported by section 34(4) of the Pensions Act 1995, under which pension scheme trustees are not responsible for an act or default of a fund manager retained by them only if they have taken all reasonable steps to satisfy themselves that the fund manager: • has appropriate knowledge and experience for managing the scheme’s investments; and • is carrying out its work competently and complying with section 36 of the Act (which imposes obligations relating to diversification and suitability of investments, and giving effect to the trustees’ statement of investment principles).117 In some circumstances, the trustees’ monitoring duties would require them to consider whether to give a voting direction to the investment manager. Examples of the sort of circumstances in which this obligation may arise include a vote on a contentious motion, or on a motion the passing or defeat of which could have a material effect on the value of the fund’s shareholding. Ford has expressed the opinion that trustees who have retained the voting power “would be bound on each occasion on which the question of voting arose to consider their course of action and to reach a conclusion in relation to each such occasion. A settled policy of not voting could constitute a breach of trust”.118 Where an investment manager has been given voting power, it is likely that the same principle would apply to it. Therefore, a policy of voting only on contentious or major issues, or otherwise where the shareholding exceeds a certain percentage of the company’s issued ordinary capital,119 would constitute a breach of duty if a court found that no consideration had been given to whether to vote on resolutions falling outside these categories. However, it is arguable that consideration would have been given at the point when a particular resolution was categorised as non-contentious or routine. 115

Ibid. See Coffee, above n. 15, at 1354. 117 If someone other than the trustees has delegated power to the fund manager on behalf of the trustees, the relevant requirement is for that person to take all reasonable steps as discussed in the text: Pensions Act 1995, s 34(4). 118 H A J Ford, “Unit Trusts”, (1960) 23 Modern Law Review 129, at 142. Emphasis added. 119 See Stapledon, above n. 6, at 95, 183. 116

220 G. P. Stapledon (ii) Duty of loyalty. One limb of the duty of loyalty discussed above in relation to trustees is the duty to avoid a conflict of duty and interest. Of course, the conflict rule applies even where the fiduciary has not made a profit.120 The conflict rule is of relevance where a pension scheme uses an external investment manager. Many investment management firms are part of large financial conglomerates (that might also have, for example, a stockbroking arm, a commercial banking arm, and an investment banking arm). In these circumstances, the investment manager can face subtle pressures to restrict its involvement in corporate governance matters in order to avoid loss of business elsewhere in its own organisation. If it could be proven (which would probably be extremely difficult) that an investment manager had not exercised a voting right due to a fear that, if it voted, another part of its organisation would lose business; and if it could be proven (which would also be very difficult) that this caused a decrease in the value of the trustees’ shareholding, then a remedy might be available to the trustees.121

Life insurance companies The directors of a life insurance company, like the directors of any other company, owe fiduciary and other duties to their company and not, in the absence of special circumstances,122 directly to all or any of the company’s members.123 As a corollary, the ability of an individual member to sue a director for breach of duty is limited by the rule in Foss v. Harbottle.124 These duties would require: • that the board of directors give genuine consideration to the exercise of rights attached to equity investments; or 120

Regal (Hastings) Ltd v. Gulliver [1967] 2 AC 134. And also directly to the beneficiaries if, as suggested above, there is a direct fiduciary relationship between the investment manager and the beneficiaries of a pension fund. 122 See above n. 97, and accompanying text. 123 Percival v. Wright [1902] 2 Ch 421; Esplanade Developments Ltd v. Dinive Holdings Pty Ltd (1980) 4 ACLR 826. Nevertheless, the “interests of the company” means (while the company is solvent) the interests of the members as a group: Greenhalgh v. Arderne Cinemas Ltd [1951] Ch 286, at 291; Peters’ American Delicacy Co Ltd v. Heath (1939) 61 CLR 457, at 512; Ngurli v. McCann (1953) 90 CLR 425, at 438. 124 (1843) 1 Hare 461; 67 ER 189. In effect, the directors of a life insurance company also owe duties to protect the interests of policyholders, under the Insurance Companies Act 1982. These duties arise indirectly, as follows. The Insurance Companies Act imposes several obligations on authorised insurance companies that are designed to protect policyholders’ interests. For example, s 29 requires that assets supporting a life insurer’s long-term business must not be used in other activities of the company. Section 30 prohibits certain transfers of surplus in which long-term policyholders are eligible to participate. Section 35A requires an insurer to ensure that liabilities under insurance contracts are covered by assets of appropriate safety, yield and marketability, and that investments are appropriately diversified. If the insurance company does not comply with one of these obligations, and the breach is proved “to have been committed with the consent or connivance of, or to be attributable to any neglect on the part of, any director, chief executive, manager, secretary or other similar officer” of the company, then the officer, as well as the company, is treated as having breached the section in question: s 91. 121

Institutional Investors: What are their Responsibilities? 221 • if a fund manager has been engaged and given power to vote shareholdings, that the board actively monitor the fund manager’s exercise of its discretion regarding voting.

Unit trusts The trustee The trustee of a unit trust is clearly in a fiduciary relationship with the unit-holders. However, the duty to consider whether (and if so how) to vote would normally rest with the manager. This is so because, under the Regulations, the voting rights attached to the property of an authorised unit trust scheme must ordinarily be exercised or not exercised as directed by the manager.125 That is, there is a statutory basis for the duty to consider resting with the manager rather than with the trustee.126 Under trust law principles and also under the Regulations,127 the trustee of a unit trust would be under a similar duty to that owed by the trustees of an externally managed pension fund—namely, to supervise actively the voting practices of the manager. The discussion earlier128 about Barnes v. Addy is of equal relevance to the directors of a unit trust’s corporate trustee. The manager It has not yet been established conclusively that a manager of a unit trust stands in a fiduciary relationship with the unit-holders. However, many commentators have argued persuasively that this is so.129 Also, several decades ago McLelland J of the New South Wales Supreme Court held, as a matter of construction of a unit trust deed, that: “the custodian trustees and, so far as it may be relevant the managers, would be responsible to the holders for any improper exercise of power and for any breaches of duty in a manner not essentially different from the responsibility of trustees to beneficiaries under many common forms of trust instruments”.130 125

See above n. 53, and accompanying text. In addition, this duty would arise from the fiduciary relationship that probably exists between the manager and the unit-holders of a unit trust. See below nn. 129–35, and accompanying text. 127 Financial Services (Regulated Schemes) Regulations 1991, reg 7.10.2. 128 See above nn. 101–4, and accompanying text. 129 See R A Hughes, The Law of Public Unit Trusts (Melbourne, Longman Professional, 1992), 98; D Brewster, “Fiduciary Obligations of Trust Managers and the Takeover of Unit Trusts”, (1990) 8 Company and Securities Law Journal 303, at 313; R Stewart, “Unit Trusts—Legal Relationships of Trustee, Manager and Unitholders”, (1988) 6 Company and Securities Law Journal 269, at 274; Ford and Hardingham, above n. 98, at 69; H A J Ford, “Public Unit Trusts” in R P Austin and R Vann (eds), The Law of Public Company Finance (Sydney, Law Book Company, 1986), 402; Finn, above n. 95, at 13. 130 Australian Fixed Trusts Pty Ltd v. Clyde Industries Ltd (1959) 59 SR (NSW) 33, at 59. 126

222 G. P. Stapledon Interestingly, one of Australia’s leading investment management firms, County Investment Management Ltd, refers in its proxy voting policy to its “fiduciary responsibility to take account of the collective interests of unitholders” in unit trusts which it manages.131 In Australian Securities Commission v. AS Nominees Ltd,132 Finn J found on the facts that the manager of several unit trusts owed fiduciary duties to the trusts’ unit-holders. Referring to the above passage in the judgment of McLelland J in the Australian Fixed Trusts case, Finn J said that the terms of the unit trust deeds in Australian Securities Commission v. AS Nominees Ltd might well have been sufficient to place the manager in a fiduciary relationship with the beneficiaries of the unit trusts. However, Finn J chose not to “proceed on this particular basis of itself to justify the finding of a fiduciary relationship”.133 Rather, he identified a number of factors which collectively met the main criteria relied upon in Australian authorities for identifying fiduciary relationships: (i) undertaking; (ii) vulnerability to another’s power or vulnerability necessitating reliance; and (iii) reasonable expectation.134 The factors identified by Finn J were: • the functions performed for the unit trusts by W, who was the “alter ego” of the manager, combined with the level of responsibility for identifying and securing trust investments conceded to W by the trustees of the unit trusts; • in the case of two unit trusts, the terms of the trust deeds and of the manager’s undertakings in them; • the appreciation that W must objectively have had of the vulnerability of the unit trusts to the manager’s actions; and • the awareness that W must objectively have had that the function that the manager was performing was for the benefit of the trusts’ beneficiaries.135 If one were to substitute “the senior executives of the manager” for the references to “W”, then the factors highlighted by Finn J would, it is submitted, exist in many unit trusts. Therefore, it is strongly arguable that, in the case of many unit trusts, the manager would owe fiduciary duties to the unit-holders. Assuming a fiduciary relationship exists, the manager would normally—as a consequence of the fiduciary relationship—be under a duty to consider whether to vote. In any event, as mentioned above, there is a separate statutory basis for the duty to consider resting with the manager.136

131

County, Corporate Governance and Proxy Voting Policy (Melbourne, County, 1996), 22. (1995) 18 ACSR 459. 133 Ibid., at 473. Emphasis added. 134 Ibid., at 474, citing Hospital Products Ltd v. United States Surgical Corporation (1984) 156 CLR 41, at 72, 96–7, 142; Mabo v. State of Queensland (No 2) (1993) 175 CLR 1, at 200–1; Glandon Pty Ltd v. Strata Consolidated Pty Ltd (1993) 11 ACSR 543. 135 (1995) 18 ACSR 459. 136 See above nn. 125–6, and accompanying text. 132

Institutional Investors: What are their Responsibilities? 223 Investment trusts The directors of an investment trust company owe fiduciary duties to the company, and not—in the absence of special circumstances137—directly to all or any of the shareholders.138 The duties of directors of an investment trust company would require: • that they give genuine consideration to the exercise of rights attached to equity investments; or • if an investment manager has been engaged and given power to vote shareholdings, that the directors actively monitor the manager’s exercise of its discretion. Once again, therefore, the legal issues discussed above, in relation to the duty to consider in the context of pension funds, are of relevance here.

OEICs The directors of an OEIC—that is, the ACD and the other directors if there are any others—owe fiduciary duties to the OEIC and not, in the absence of special circumstances,139 directly to all or any of the OEIC’s shareholders.140 The duty to consider whether (and if so how) to vote rests with the ACD. This is so because, under the Regulations, the voting rights attached to the property of an OEIC must be exercised or not exercised as directed by the ACD.141 The depositary of an OEIC may owe fiduciary duties directly to the OEIC’s shareholders.142 Alternatively, it may stand in a bare trust relationship with the OEIC.143 The former possibility is supported by the depositary’s quite extensive obligations to ensure that the OEIC and its ACD comply with Financial Services Authority regulations—regulations which are aimed at protecting the OEIC’s shareholders.144 Regardless of to whom it owes fiduciary duties, the depositary would appear to have a duty to monitor the exercise by the ACD of its discretion over voting.

137 138 139 140 141 142 143 144

See above n 97, and accompanying text. See above n 123, and accompanying text. See above n 97, and accompanying text. See above n. 123, and accompanying text. See above n 61, and accompanying text. M Thomas, “A Hybrid Form of Investment”, (1998) 19 Company Lawyer 26, at 27. Morse, above n. 59, para 5A.006. Thomas, above n. 142, at 27.

224 G. P. Stapledon REGULATORY OPTIONS

Compulsory voting Whether trustees, investment managers and directors of UK institutional investors are obliged, and whether they ought to be obliged, to play an active role in corporate governance are two entirely different questions. A case can be made for the introduction of a requirement, for example, that institutions vote their shares on all occasions “as a useful discipline to monitoring”.145 It is submitted, however, that the benefits of a mandatory voting rule would probably be outweighed by the costs. Voting does not exist in a vacuum Supporters of a compulsory voting rule appear to proceed on the premise that lack of voting is equivalent to lack of interest and lack of involvement in corporate governance. But the empirical evidence shows that this is not the case. Voting is merely one method by which institutional investors participate in corporate governance.146 The removal of the Mirror Group CEO in early 1999, for instance, involved behind-the-scenes lobbying and meetings.147 Financial costs Voting involves time and resources. The additional costs involved with a compulsory voting rule would initially be borne by fund managers. However, if the regulation applied effectively across the board then these additional costs could be expected to be passed on (directly or indirectly) to clients (for instance, pension fund trustees and ultimately beneficiaries). Contract In the case of the largest category of institutional investor—pension schemes— voting is currently a matter of contract between the fund manager and the trustee. It is perfectly open to the trustee (the fund manager’s client) to negotiate a provision in the fund management agreement obliging the fund manager to vote.148 Indeed, as discussed below, some UK pension fund trustees already 145 P L Davies, “Institutional Investors in the United Kingdom” in D D Prentice and P R J Holland (eds), Current Issues in Corporate Governance (Oxford, Clarendon Press, 1993), 92. 146 See, e.g., J Holland, “Influence and Intervention by Financial Institutions in their Investee Companies”, (1998) 6 Corporate Governance: An International Review 249; Stapledon, above n. 6, at 79, 177. 147 See above n. 62. 148 Technically, such a clause would usually oblige the fund manager to give instructions to the custodian, the registered owner of the shares. See above nn. 41–3, and accompanying text.

Institutional Investors: What are their Responsibilities? 225 insist on a clause like this being in their fund manager’s mandate. Sometimes it is combined with a requirement to vote in accordance with the recommendations of a specialist proxy advisory service, in order to ensure “informed” voting rather than window-dressing. Therefore, clients such as pension fund trustees can, if they consider it appropriate, already insist that their shares be voted by their fund managers. They don’t need a government-imposed regulation. Competitive industry The fund management industry in the United Kingdom is competitive and client funds are quite mobile. Combine this with the fact that some fund managers are now openly adopting an “activist” stance on corporate governance,149 and it is clear that clients have the freedom to move their funds (or a portion of their funds) to a “voting” fund manager if dissatisfied with the stance on corporate governance adopted by their existing fund managers. That is, assuming for the sake of argument that there is currently a problem in the area of voting, it is inappropriate to construe this as a problem whose source lies with the fund management industry. If clients of fund managers want them to vote, they will vote or they will eventually lose that business. If clients want fund managers to vote in an informed manner, the clients have available the means to ensure this—the proxy advisory services described below. Not all motions are equally important Some fund managers take the view that their votes have greater impact if used only on motions that are contentious or of major significance. They avoid voting on the routine AGM matters, believing that boards and CEOs will “stand up and take notice” when their votes are used. Proportionate influence If all institutions are forced by regulation to vote, the proportionate influence of those institutions that currently vote willingly will decrease. Assume a fund manager controls 4 per cent of the votes in a particular listed company. At general meetings, on average only 40 per cent of the company’s shares are voted. When the fund manager votes its 4 per cent stake, it is actually casting 10 per cent of total votes cast. The introduction of compulsory voting for institutional shareholders sees an increase in the total votes cast: now 80 per cent of the company’s shares are voted. The fund manager’s 4 per cent stake now translates to just 5 per cent of total votes cast. Many of the extra votes cast as a result of the regulatory 149

See below nn. 171–3, and accompanying text.

226 G. P. Stapledon requirement to vote involve “box ticking” by fund managers not convinced of the value of voting. The votes of the active fund manager have therefore lost a large amount of their proportionate influence. Implications of American evidence As discussed earlier,150 since the mid-1980s the US Department of Labor has required that the voting rights attached to the equity investments of each American private-sector pension plan be voted “on issues that may affect the value of the plan’s investment”. The American experience would not instil confidence into proponents of a compulsory voting rule. There is evidence that some external fund managers have created formalised procedures and voting guidelines that are basically window-dressing.151 Further, there is little legal incentive for fund managers to take their voting responsibilities seriously, because fund beneficiaries have not brought any actions for breach of fiduciary duty based on failure to vote, or failure to vote in an informed or proper manner,152 and the Department of Labor has inadequate resources to take widespread legal actions. The Department of Labor has not examined proxy voting activities as part of its normal audits of ERISA funds.153 The Department conducted only two enforcement efforts in the seven years to 1994. In 1988 it queried one hundred and twenty investment managers on how they voted on controversial voting issues at twenty-three companies; and in 1993 it questioned seventy-five bank nominee companies as to their performance in passing proxy forms on to the voting party. In 1995, the Department announced its third initiative, an examination of the conduct of those responsible for voting, with a focus on the process adopted in deciding how to vote (on a limited number of issues at 1994 general meetings, including “incentive stock option plans in companies that had poor performance; the elimination of existing shareholder rights and protections; shareholder proposals to adopt confidential voting; and election of [directors]”).154 The American evidence indicates that, as one would expect, a regulator charged with enforcing a compulsory voting rule is likely to focus on process rather than substance when devising its method of monitoring compliance. If the regulator did look for evidence of informed voting, what evidence could it realistically gather? Presumably interviewing fund managers would not produce the most reliable evidence—actions are more reliable than words in this area. Actions can of course be documented. This in turn would likely see fund managers producing lots of paper “proving” how dedicated they had been in per150

See above nn. 12–18, and accompanying text. Coffee above n. 15, at 1353 (see also at 1341 (n. 244)). 152 See Rock, above n. 7, at 476; Conard, above n. 84, at 151. 153 McGurn, above n. 12, at 7. 154 P O’Hara, “DOL Launches New Investigation of Proxy Voting by Pension Funds”, IRRC Corporate Governance Bulletin ( January/March 1995), 1. 151

Institutional Investors: What are their Responsibilities? 227 forming their voting task. Producing this paper trail would be expensive, but would it produce much benefit? If a compulsory voting requirement were introduced in the United Kingdom, pension scheme members would, due to the lack of an American-style contingency fee and costs system, have far fewer incentives than their American counterparts to take legal action against the trustees or a fund manager. And even if members of pension schemes (for instance) had the incentives to litigate, it would often be extremely difficult to establish the necessary causative link between the lack of voting (or lack of informed voting) and any losses incurred by the trust funds on the shareholding in question. Finally, and most importantly, in the face of these very weak legal incentives to take a voting requirement seriously, it is to be expected that many external fund managers would, given the economic disincentives to detailed monitoring which they face,155 rationally adopt only the sort of window-dressing approach evident in the USA. For these reasons, it is suggested that a compulsory voting requirement would not be a worthwhile reform.

Requirement for fund managers to disclose voting actions Before coming to power, the Labour Party considered introducing a policy which would require fund managers, after each general meeting, to disclose publicly how they had voted.156 A requirement like this would be inappropriate for two reasons. First, fund managers should be accountable to their clients, not to all other shareholders in the company concerned or some wider audience. Any disclosure by them should be made to their clients. Secondly, where a fund management firm is part of a larger financial group (as is commonly the case), the obtaining by that fund manager of an “activist” reputation carries with it the potential for a loss of business, both in the fund management area and in affiliated businesses (which might include investment banking, stockbroking, provision of general insurance, etc.).157 Less, rather than more, detailed monitoring is likely to result from any regulation which exposes to a wide audience the way in which individual fund managers have exercised their voting rights.158 Indeed, 155

See above nn. 7–10, and accompanying text. See W Lewis and G Parker, “Labour Attacks Investor ‘Secrecy’ ”, Financial Times, 5 June 1995, 16. 157 See Stapledon, above n. 8, at 185; Stapledon, above n. 6, at 264. 158 American empirical studies of voting behaviour on anti-take-over proposals (generally found to be wealth-decreasing for shareholders) have found evidence of a bias towards pro-management voting by institutional investors having actual or potential business ties with the companies concerned: see J A Brickley, R C Lease and C W Smith, “Ownership Structure and Voting on Antitakeover Amendments”, (1988) 20 Journal of Financial Economics 267; J Brickley, R Lease and C Smith, “Corporate Voting: Evidence from Charter Amendment Proposals”, (1994) 1 Journal of Corporate Finance 5; T H Payne, J A Millar and G W Glezen, “Fiduciary Responsibility and BankFirm Relationships: An Analysis of Shareholder Voting by Banks”, Working Paper (Department of Finance, University of Arkansas, 1995). 156

228 G. P. Stapledon there have been calls in the USA for confidential voting—in the sense that a company’s management would not be able to discover how any of its shareholders had voted—in order to avoid conflict-of-interest-induced passivity.159

Requirement for trustees to adopt a voting policy Under recent regulatory changes, if pension scheme trustees have a policy on voting, they must now include it in the statement of investment principles mandated by the Pensions Act 1995.160 So, there is no requirement actually to adopt a voting policy; only to cover it in the statement of investment principles if there is one. If trustees do adopt a voting policy, any fund manager engaged by them is not under an absolute duty to follow it. The Pensions Act requires a fund manager to act “with a view to giving effect to” the statement of investment principles “so far as reasonably practicable”.161 This is a fairly gentle regime from the point of view both of trustees and of fund managers. A case can be made for increasing these requirements so that: • trustees are required to formulate a voting policy (and to include the policy in the statement of investment principles); and • fund managers are required to use best endeavours to give effect to the trustees’ policy. While the first requirement would need to be imposed by regulation, the second requirement could be implemented by regulation or by the trustees themselves as a matter of contract with their fund manager/s. The second requirement would, in effect, promote an extra element in competition between fund managers. Not all fund managers take an active interest in corporate governance. The trustees of a pension scheme (or any other client of a fund manager) who wanted their fund manager to vote on all occasions and play an active role in the governance of investee companies could shop around for a new fund manager if the incumbent did not offer these services. 159 See Rock, above n. 7, at 489; C K Brancato, Institutional Investors and Corporate Governance: Best Practices for Increasing Corporate Value (Chicago, Irwin Professional Publishing, 1997), 107. 160 The statement of investment principles is “a written statement of the principles governing decisions about investments for the purposes of the scheme”: Pensions Act 1995, s 35(1). Under s 35(2)(f), the statement must cover any matters prescribed by regulations. The voting policy requirement was introduced by the Occupational Pension Schemes (Investment, and Assignment, Forfeiture, Bankruptcy, etc) Amendment Regulations 1999 (SI 1999/1849), inserting a new reg 11A into the Occupational Pension Schemes (Investment) Regulations 1996 (SI 1996/3127). The same requirement applies to the administering authority of a local government pension scheme: Local Government Pension Scheme (Management and Investment of Funds) (Amendment) Regulations 1999 (SI 1999/3259), inserting a new reg 9A into the Local Government Pension Scheme (Management and Investment of Funds) Regulations 1998 (SI 1998/1831). 161 Pensions Act 1995, s 36(5).

Institutional Investors: What are their Responsibilities? 229 SELF-HELP

In the absence of regulatory reform, what can pension fund trustees do if (i) they have a policy of active and informed use of voting rights, and (ii) they use external fund managers? They would have at least four options to overcome the “agency problem” associated with the exercise of voting rights by external fund managers.162

Retain the voting right The trustees could retain fully the power to exercise the votes attached to equity investments. Some large American pension scheme trustees—for example, the trustees of CalPERS—have an internal staff dedicated to implementing the trustees’ corporate governance policy, including exercising voting rights. In many cases, however, the trustees of UK schemes would lack the time and expertise to be able satisfactorily to perform such a task themselves, and the scheme’s resources would be inadequate to employ an in-house team to do the job.

Require the fund manager to vote The trustees could include a clause in the investment management agreement requiring the fund manager to vote in accordance with a statement of corporate governance standards provided by or approved by the trustees. So, the trustees could adopt a corporate governance policy, including a policy on voting as envisaged by the regulations made under the Pensions Act 1995,163 and then contractually oblige their fund manager/s to exercise delegated voting rights as described in the policy. The clause in the investment management contract would bolster the statutory requirement, namely, that the fund manager must act with a view to giving effect to the voting policy “so far as reasonably practicable”.164 Alternatively, the trustees could put the onus on the fund manager to develop a policy, and then “vet” it. The corporate trustee of C+BUS, a large Australian superannuation fund, has adopted what is effectively a combination of the two approaches just outlined: “All fund managers employed by C+BUS must have detailed corporate governance policy standards. These must be submitted to the C+BUS [trustee] board. They need not necessarily be consistent with each other, but all must accommodate the corporate governance priorities established by the C+BUS board. The standards agreed by C+BUS 162 163 164

See above nn. 7–10, and accompanying text. See above n. 160, and accompanying text. Pensions Act 1995, s 36(5).

230 G. P. Stapledon are based upon the AIMA guidelines165 and C+BUS expects its fund managers to scrupulously keep to these standards, and to deal with corporate governance matters with a view to adding maximum value to the portfolio.”166

Use a proxy adviser A third option would be to include a clause in the investment management contract requiring the fund manager to vote in accordance with the recommendations of a specialist proxy voting adviser. Some UK pension fund trustees require their external fund managers to vote according to recommendations made by Pensions and Investment Research Consultants (PIRC).167 Competing advisory services are provided by the Association of British Insurers (ABI)168 and the National Association of Pension Funds (NAPF).169 The trustees of an externally managed pension fund could subscribe to an advisory service, request voting recommendations, and then require their external investment managers to vote the fund’s shares in accordance with the adviser’s recommendations. The trustees would be required, both under trust law principles and under section 34(4) of the Pensions Act 1995, to monitor both the investment manager’s exercise of the voting rights and the standard of the proxy advisory service. There are electronic voting services that can facilitate this type of approach.170

Use a fund manager with a commitment to governance Over the past few years, a small number of specialist “active investors” has emerged in the UK fund management industry. One is Hermes LENS Asset Management, a joint initiative of United Kingdom-based Hermes Pensions Management Ltd and USA-based LENS Inc.171 Another is UK Active Value. Each of these organisations has attracted funds from CalPERS and other over165 The AIMA guidelines are the corporate governance guidelines of the former industry association for Australian fund managers: the Australian Investment Managers’ Association. AIMA merged with two other organisations in 1998 to form the Investment and Financial Services Association (IFSA). The current guidelines are IFSA, Corporate Governance: A Guide for Investment Managers and Corporations (IFSA Guidance Note No 2.00, Sydney, IFSA, 1999). 166 D Olsberg, “Trustees’ Expectations of Corporates and Fund Managers”, paper delivered at the Pre–1996 Proxy Season Conference, Sydney, 19 July 1996. 167 The PIRC product is called the PIRC Corporate Governance Service. Details of the service are available at 168 The ABI product is called the Institutional Voting Information Service (IVIS). A link to the service is provided at: 169 The NAPF product is called the Voting Issues Service. It is described at 170 See the services summarised in Newbold Committee, above n. 20, para 3.11. 171 See

Institutional Investors: What are their Responsibilities? 231 seas institutional investors, as a result of their focus on improving value through detailed attention to corporate governance.172 In addition, several traditional United Kingdom-based fund managers now have one or more “governance professionals”. These executives are charged, commonly on a full-time basis, with playing an active role in the governance of investee companies, particularly those that are underperforming.173 The fourth option for pension fund trustees committed to good corporate governance is, therefore, to select a fund manager or managers sharing that commitment.

CONCLUSION

The issue of whether institutional investors are legally obliged to be involved in corporate governance revolves largely around the duty of fiduciary office holders actively and genuinely to consider whether and how to exercise their powers. The duty to consider suffers from problems of enforceability. A stricter requirement could be imposed by regulation, but a range of factors, including the American experience with compulsory voting for trustees of private-sector pension plans, suggests that the benefits of mandating voting are likely to be outweighed by the costs. However, there have been a number of promising market developments from the point of view of pension fund trustees who are committed to good corporate governance. Several avenues are now open to these trustees. This is, in turn, a positive development in the light of the empirical studies showing a positive relationship between institutional investor activism—or at least certain types of activism—and corporate performance.

172 J Martinson, “UK Active Fund Raises $800m for Targets in Europe”, Financial Times, 3 February 1999, 25; C Daniel, “US Fund Calpers Invests £124m in Hermes”, Financial Times, 26 April 1999, 23. 173 J Waples, “Revolting Investors—Business Focus”, Sunday Times, 31 January 1999.

10 Evolution and Policy in Company Law: The Non-Executive Director JOHN PARKINSON

INTRODUCTION

M

ANY THEORISTS OF the company argue that corporate governance structures are determined by the requirements of efficiency. An evolutionary process is at work, whereby the operation of market forces over time reveals which mechanisms best contribute to performance and obliges companies to adopt them if they are to prosper.1 The recasting of the company itself as a “nexus of contracts”2 creates an easier fit with this evolutionary account than more traditional conceptualisations of the company which place greater emphasis on the constitutive role of legislation and other forms of regulation.3 The contract model is accordingly relied on by evolutionists not only as an analytical device, used to investigate the allocation of risk, returns, and control rights in the company from an efficiency perspective,4 but also as providing a realistic description of the processes by which governance controls are designed and adopted. These processes are said to be consensual and adaptive. This being so, and as there is no reason to suppose that the sophisticated

1 See Frank H Easterbrook and Daniel R Fischel The Economic Structure of Corporate Law (Cambridge, Mass, Harvard University Press, 1991), 7: “firms and managers can compete with each other over the decades to design governance structures . . . there is no substantial impediment to the operation of the competitive process at the level of structure”. Williamson contrasts “strong-form” evolutionary theory adopted by agency theorists (see, e.g., Michael C Jensen, “Organization Theory and Methodology”, (1983) 58 Accounting Review 319, at 331–2, referring to the “survival of the fittest”) with a “weak-form”, associated with transaction cost economics, in which the fitter survive, but are not necessarily the fittest in any absolute sense (quoting Herbert Simon, Reason in Human Affairs (Stanford, Stanford University Press, 1983), 69): Oliver E Williamson, The Mechanisms of Governance (New York, OUP, 1996), 177. See also Mark J Roe, “Chaos and Evolution in Law and Economics”, (1996) 109 Harv L Rev 641, and n. 2, citing “several classics of natural selection in economic and organizational evolution”. 2 See Paddy Ireland, Chapter 7 above. 3 The contractual view assimilates statutory and other legal rules as being provisions the parties would themselves have bargained for in the absence of transaction costs: for a discussion, see Brian Cheffins, Company Law: Theory, Structure and Operation (Oxford, OUP, 1997), ch 6. 4 See Gavin Kelly and John Parkinson, Chapter 6 above.

234 John Parkinson investors who dominate the financial markets would part with their money unless satisfied that their interests were fully protected, we can be confident that an effective combination of governance controls will be in place in the vast majority of companies at any particular time.5 This reasoning generates, then, a strong presumption in favour of the efficiency of prevailing structures: if governance could be improved, those involved in the company would already have brought about the necessary changes. It follows that in general there is no case for regulatory intervention.6 But even if there were scope for increasing the effectiveness of governance arrangements, it is further argued that external interference in them is liable to be counterproductive. Public authorities have no greater insight into the effectiveness of governance controls than the contracting parties.7 They lack information about the varying circumstances of individual companies, and statutory rules, which are necessarily of a general character, are likely to misfire. Regulation is also dangerous, as it is “more failure-prone than markets, because there are few automatic forces that correct regulation gone awry”.8 The rise of the non-executive or “outside” director, with which this chapter is concerned, looks, at least at first sight, like an example of the evolutionary process in operation. There is no legal requirement for companies to appoint non-executives. Indeed, the Companies Act 1985 does not recognise a distinction between executive and non-executive office. Nevertheless, the boards of virtually all listed companies in the United Kingdom now have a significant proportion of non-executive members.9 Evolutionists have explained reliance on non-executives as a market-induced mechanism to limit agency costs in companies with widely dispersed shares.10 It 5 It is argued that since owners floating a company on the stock market will be forced to bear anticipated agency costs in the form of a reduced price for the shares they sell, they have an incentive to offer governance controls that will minimise agency costs: Michael C Jensen and William H Meckling, “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure”, (1976) 3 J Fin Econ 305, at 312–13. Similarly, during the life of a company it is in the interests of managers to adopt governance controls that serve shareholder interests: the “history of corporations has been that firms failing to adapt their governance structures are ground under by competition”: Frank H Easterbrook and Daniel R Fischel, “The Corporate Contract”, (1989) 89 Colum L Rev 1416, at 1427. 6 Oliver Hart, “Corporate Governance: Some Theory and Implications”, (1995) 105 Econ Jo 678, at 686–7 concedes that the presence of externalities might justify intervention (e.g., because employees might share in the firm’s rents: as to which, see Kelly and Parkinson, Chapter 6, above, but dismisses the possibility on the ground that companies create many types of externality and it is unclear that intervention could cause them to behave appropriately in relation to them. See also generally, Cheffins, Company Law, above n. 3, ch 3. 7 Oliver Williamson, “Organization Form, Residual Claimants, and Corporate Control”, (1983) 26 J Law & Econ 351, at 361. 8 Easterbrook and Fischel The Economic Structure of Corporate Law, above n. 1, at 303. 9 See PIRC, Compliance with the Combined Code: A Study Prepared for the Company Law Review (London, 1999) and the discussion below. 10 See Eugene F Fama, “Agency Problems and the Theory of the Firm”, (1980) 88 J Political Economy 288; Eugene F Fama and Michael C Jensen, “Separation of Ownership and Control”, (1983) 26 J of Law and Economics 301. See also strong support for the monitoring board in Oliver Williamson, “Corporate Governance”, (1984) 93 Yale L J 1197, at 1219–20 and The Economic

Evolution and Policy: The Non-Executive Director 235 has been suggested that sub-standard managers who resist removal are the costliest manifestation of the agency problem.11 Monitoring by non-executives, that is, subjecting senior managers’ performance to ex post review and if necessary taking steps to remove them, offers a way of overcoming managerial entrenchment. It may also play a part in controlling improper self-dealing and other “hygiene” issues, and in combatting the adoption of growth and diversification strategies that benefit managers but which may be suboptimal from the point of view of the shareholders and putatively, the economy as a whole. In addition to monitoring, non-executives may be of value to the company in providing advice and contacts, and in contributing to strategy by bringing an “outsider’s” perspective to bear on management’s plans.12 The particular concern of this chapter is with the monitoring role,13 though this is not to suggest that the other functions carried out by non-executives are not also important, or that the categories are entirely discrete.14 It will be noted later that the degree to which non-executives in the United Kingdom actually engage in monitoring, at least in the most extreme sense of being involved in the removal of poorly performing managers, is in some doubt.15 To the extent that they do, however, it is suggested that to regard the necessary arrangements as having come about through a process of market evolution is a serious over-simplification. A crucial part in strengthening governance mechanisms, particularly in relation to board composition and structure, has been played by a series of sector-wide initiatives of varying degrees of formality, of which the codes of best practice that have resulted from the work of Institutions of Capitalism (New York, Free Press, 1985), 316–18 (viewing the board as a control instrument of the shareholders necessitated by the limited redeployability of assets funded by equity). From this transaction cost perspective, the board is also regarded as arising endogenously: see Oliver E Williamson “Corporate Finance and Corporate Governance”, (1988) 43 J of Finance 567, The Mechanisms of Governance, above n. 1, at 174–5 and 184–5; cf. H Demsetz, “The Monitoring of Management” in Statement of the Business Roundtable on the American Law Institute’s Proposed Principles of Corporate Governance and Structure: Restatement and Recommendations (New York, 1983), B 6: “the board of directors can do very little to improve on the powerful incentives that presently guide management to serve the interests of shareholders”. Jensen’s subsequent disillusionment with the workings of the board in practice is clear: see Michael C Jensen, “The Eclipse of the Public Corporation”, (1989) Harv Bus Rev (October) 61, at 64. See also “The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems”, in Donald H Chew (ed), Studies in International Corporate Finance and Governance Systems: A Comparison of the US, Japan, and Europe (New York, OUP, 1997), 18, at 32–5, in which Jensen makes proposals for activating the board as an effective control mechanism. 11 See Andrei Shleifer and Robert W Vishny, “Management Entrenchment: The Case for Manager-Specific Investment”, (1989) 25 J Fin Econ 123; Michael Jensen and Richard Ruback, “The Market for Corporate Control: The Scientific Evidence”, (1983) 11 J Fin Econ 5. 12 For the nature of non-executive involvement in strategy, see Terry McNulty and Andrew Pettigrew, “Strategists on the Board”, (1999) 20 Organization Studies 47. 13 This is potentially more problematic than the other functions from an evolutionary perspective, given likely resistance by management to the erosion of their autonomy that board monitoring entails. 14 See, e.g., McNulty and Pettigrew, “Strategists on the Board”, above n. 12, especially at 71. 15 See below nn. 129 and 130, and accompanying text.

236 John Parkinson the Cadbury and Hampel Committees are the most conspicuous examples.16 These developments cannot be regarded simply as the operation of the market in another form. First, the current Combined Code (and similarly its predecessor, the Cadbury Code), relies on markets for enforcement, but it is also accompanied by rules that are designed to make market pressure more focused. Thus, although the Code has no statutory basis and compliance with its detailed recommendations is not expressed to be mandatory, there is a requirement in the Listing Rules, which are legally binding on listed companies, to disclose how the recommendations have been applied and to explain the reasons for any non-compliance.17 In addition, the provisions which are capable of objective verification are subject to audit. While non-statutory and devised by bodies in the private sector, the codes are, then, not merely a means of publicising what is perceived to be good practice, and at the same time are more than just a device for making governance arrangements transparent. Rather, as has been persuasively suggested elsewhere, their effect is to create a regulatory presumption in favour of compliance: managements are obliged explicitly to consider the issues raised by the codes and to face the penalties associated with shareholder discontent if reporting a departure from their recommendations that cannot be satisfactorily explained.18 Secondly, although market pressure is part of the enforcement mechanism, the fact that there has been a need for regulatory intervention in order to stimulate and channel it suggests the existence of a market failure in the generation and dissemination of appropriate governance arrangements. The immediate background to Cadbury was a number of major corporate collapses associated with managerial malpractice, but there is a much longer history of concern about inadequate board-level controls over management. The main cause of this concern has been the difficulty of removing poor quality managers and the effect of this on corporate performance generally, and not just the rather narrower issue of protecting the company from unscrupulous chief executives. Over a period of at least twenty years prior to Cadbury views were frequently expressed, not least by the Bank of England, that there was a need for board 16 See Report of the Committee on the Financial Aspects of Corporate Governance (London, 1992) (“the Cadbury Committee”); Committee on Corporate Governance, Final Report (London, 1998) (“the Hampel Committee”). The recommendations of these committees are now consolidated, together with those contained in the Report of the Study Group on Directors’ Remuneration (London, 1995) (“the Greenbury Committee”), in The Combined Code: Principles of Good Governance and Code of Best Practice, appended to the Listing Rules. See now Financial Services Authority, Listing Rules (London, 2000), r 12.43A. 17 More specifically, the Code distinguishes “Principles of Good Governance” and the “Code of Best Practice”. The annual report must contain a narrative statement of how the company has applied the Principles, i.e. compliance with them appears to be mandatory. This is not the case as regards the more specific provisions in the Code. See Financial Services Authority, Listing Rules, ibid. 18 Jonathan Rickford, “Do Good Governance Recommendations Change the Rules for the Board of Directors?”, paper presented at conference on Company Law and Capital Market Law, Siena, March 2000.

Evolution and Policy: The Non-Executive Director 237 reform. These views were accompanied by informal pressures and repeated exhortations to increase the numbers and quality of non-executive directors, against a public policy background in which there were recurrent demands for improved managerial accountability (see below). The record suggests, therefore, that over an extensive period competitive forces alone were failing to bring about what was perceived by many to be a necessary strengthening of internal control. The contention of this chapter is, therefore, that monitoring by nonexecutives, as evolutionists accept, is a potentially valuable governance control, but that the operation of the market has not been sufficient to “induce” satisfactory monitoring arrangements. It will be questioned later whether the governance codes, viewed here as a response to market failure, have gone far enough to bring them about and if not, whether further intervention might be appropriate. Doubts about the evolutionary account of the development of the monitoring board bear on the broader issue of how we should approach company regulation in general. It was mentioned above that evolutionary theory is relied on to raise a strong presumption in favour of the efficiency of the status quo. The presumption is important because of the difficulties associated with empirical demonstrations of the efficiency or otherwise of particular governance arrangements or types of corporate system as a whole.19 Contract theorists typically side-step such problems by constructing theoretical positions that account for governance arrangements in efficiency terms and then seeking to validate these positions and the underlying arrangements by drawing an inference of efficiency from existence.20 Whether the inference is justified, however, depends on the validity of evolutionary theory itself, which cannot simply be assumed.21 No doubt governance structures are responsive to environmental change and it is plausible that seriously defective arrangements will be selected out over the long 19 See, e.g., Colin Mayer, “Corporate Governance, Competition and Performance”, (1997) 24 J Law and Soc 152, at 152–3; William W Bratton and Joseph A McCahery, “Comparative Corporate Governance and the Theory of the Firm: The Case against Global Cross Reference”, (1999) 38 Columbia Journal of Transnational Law 213, at 216–17. 20 See Lynne L Dallas, “Two Models of Corporate Governance: Beyond Berle and Means”, (1988) 22 U of Michigan Journal of Law Reform 19, at 46–7, describing this approach as “outcome determinative”. Existing structures “are presumed efficient by definition. [They] are then compared to see if cost and incentive arguments can be made to justify their special features. The problem is that virtually any institution can be justified if enough subjective and objective cost, benefit, and incentive factors are taken into account, because there is no way to weigh any of these variables”. Fama and Jensen’s treatment of board monitoring in “Separation of Ownership and Control”, above n. 10, illustrates this approach. The “special features” of contemporary American boards, i.e. insider domination and the appointment of outside directors by management, are said to be “explained” by the existence of the stock market and the market for corporate control. No evidence is adduced, however, to support the view that market mechanisms adequately substitute for internal control. Fama and Jensen’s reasoning is particularly tortuous, since their opening premise is that the separation of “decision control” (putatively by independent directors) and “decision management” is the product of efficient evolution in companies with widely dispersed shares. 21 See Gregory K Dow, “The Function of Authority in Transaction Cost Economics”, (1987) 8 Journal of Economic Behavior and Organization 13, especially at 34.

238 John Parkinson term. But it is also now widely recognised that evolutionary forces operate within constraints set by the social, political, and economic inheritance of the community in question22 and are also likely to be muted owing to limited competitive pressure in the relevant markets.23 The efficiency of existing arrangements is therefore a more open question than evolutionists customarily admit. It does not necessarily follow that it is desirable to attempt to remedy any resulting deficiencies by external intervention, but nor does our understanding of the efficacy of the processes of evolutionary change suggest that it is justifiable to impose on those who advocate reform the burden of adducing evidence of a degree of conclusiveness that for practical purposes is unachievable, and which is unavailable to substantiate the efficiency of “unreformed” arrangements. The rest of this chapter proceeds as follows. The next part considers explanations of a largely theoretical kind for the limited evolution of the monitoring board in the United Kingdom. The third part provides an historical account of the factors that have influenced the appointment of non-executive directors and the development of a monitoring role up to the present time. The purpose of this part is to support the claim made above that evolutionary processes have been deficient in this area. The fourth part examines the case for more rigorous regulation of board function and composition. The fifth part concludes.

REASONS FOR THE LIMITED EVOLUTION OF BOARD-LEVEL MONITORING

There are a number of explanations why an independent monitoring function at board level might not evolve. First, it might simply not be needed: agency costs are controlled effectively by other means. Secondly, whether or not existing controls are adequate, board monitoring might not improve the situation. Finally, monitoring by independent directors, while potentially beneficial, might fail to develop spontaneously because of deficiencies in the evolutionary process. The three possibilities will be briefly considered in turn.

Alternative accountability mechanisms The two main mechanisms that might substitute for board monitoring are intervention by institutional shareholders and the operation of the market for corporate control.24 As to the first of these, the argument is that the growth of 22 See, e.g., Mark J Roe, “Chaos and Evolution in Law and Economics”, (1996) 109 Harv Law Rev 641; Douglass C North, “Institutions and Credible Commitment”, (1993) 149 Journal of Institutional and Theoretical Economics 11, especially at 17–18. 23 See further below nn. 64–8, and accompanying text. 24 Other markets, e.g. the market for managers, and of course the company’s product market, are also sources of discipline. For a review of the arguments, see J E Parkinson, Corporate Power and Responsibility: Issues in the Theory of Company Law (Oxford, OUP, 1993), 113–19. Debt

Evolution and Policy: The Non-Executive Director 239 institutional investment since the Second World War has resulted in a reconcentration of shareholding, so that managerial entrenchment and unconstrained discretion, associated with the “separation of ownership and control” have for some time ceased to be a reality, if they ever were. The proportion of shares in listed companies controlled by institutions has risen steadily over recent decades, standing now at about 70 per cent, but has been in excess of 50 per cent for over thirty years.25 While for reasons of liquidity and risk-diversification a given institution will rarely hold more than a small percentage stake in a company, in many companies for a considerable period (that is, the period in which non- executive monitoring might otherwise have developed) relatively small coalitions of shareholders have had the ability to effect changes in management or policy.26 The governance activity of institutions generally takes place behind the scenes and so its extent is difficult to assess, but there is anecdotal evidence suggesting that it has not been uncommon.27 There are also plenty of indications, on the other hand, that institutions have failed to intervene in companies that have underperformed, in some cases, for many years.28 A number of factors explain why this might be so.29 These include free-rider problems (the activist institution captures only a small proportion of the total gains), agency problems in external fund manager/beneficiary relationships (in a competitive market, managers find it difficult to pass on the costs of intervention to their clients, who receive the benefits), and conflicts of interest (institutions may be reluctant to damage wider commercial relationships with portfolio companies). It also seems that there are severe practical difficulties involved in forming and holding together a coalition of sufficient size to be able to effect interventions as extreme as replacing management.30 Such are the problems facing institutional monitoring, it has been suggested that “only in exceptional circumstances will institutional investors act financing may also have a disciplinary effect: see Oliver Hart, “Corporate Governance: Some Theory and Implications”, (1995) 105 The Economic Journal 678, at 685–6. 25 See G P Stapledon, Institutional Shareholders and Corporate Governance (Oxford, OUP, 1996), ch 2. 26 Ibid., at 106–17; Julian Franks, Colin Mayer, and Luc Renneboog, “Who Disciplines Management in Poorly Performing Companies?”, Working Paper, 2000. 27 See Stapledon, Institutional Shareholders, above n. 25, at 122–9. The level of activity seems to be growing: evidence to this effect was presented in confidence to the Company Law Review: see Company Law Review Steering Group, Modern Company Law for a Competitive Economy: Developing the Framework (London, 2000), para 3.160. 28 See, e.g., Julian Franks and Colin Mayer, “Governance as a Source of Managerial Discipline” (prepared for the Company Law Review) http://www.dti.gov.uk/cld/review.htm; Jane Martinson, “Shares in the Action”, Financial Times, 27 April 1998. 29 See generally, Helen Short and Kevin Keasey, “Institutional Shareholders and Corporate Governance in the United Kingdom” in Kevin Keasey, Steve Thompson, and Mike Wright (eds), Corporate Governance: Economics, Management, and Financial Issues (Oxford, OUP, 1997), 18; John C Coffee, “Liquidity versus Control: the Institutional Investor as Corporate Monitor”, (1991) 91 Colum L Rev 1278; Bernard S Black and John C Coffee, “Hail Britannia?: Institutional Investor Behaviour under Limited Regulation”, (1997) 92 Mich L Rev 1997. 30 See Stapledon, Institutional Shareholders, above n. 25, at 106–17.

240 John Parkinson as direct agents of change in a company”,31 mainly when matters have reached crisis point and the company is attempting to raise additional funds.32 While institutional shareholders have, therefore, played a part in the overall governance framework, the indications are that their role in practice has been a limited one and not such as to suggest that the accountability problems associated with dispersed shareholding have been overcome. It is often contended, however, that the take-over market serves as a good substitute for shareholder intervention,33 or at least in combination with it creates an effective disciplinary environment. Hostile take-overs began in the United Kingdom in the 1950s34 and an active market has developed since. Where the rationale for a bid is poor performance on the part of the target’s management, the success of the bid will result in their removal, and the threat of this happening is likely to act as a stimulus to efficiency. Given these effects it can be argued that there has been no need for non-executive directors to take a major role in monitoring.35 As against this view, however, there is evidence to suggest that hostile take-overs are not in practice associated with conspicuously poor pre-bid performance in targets.36 This casts doubt on the disciplinary effect of the threat of take-over on the worst performing companies. It also indicates that the hostile take-over mechanism is not a reliable means of replacing the managements of badly run companies, who may remain in place for a considerable period without attracting the attention of a bidder.37 Among the factors inhibiting disciplinary take-overs are the size of the bid premium that must be paid to win control, transaction costs, and uncertainties stemming from inadequate information about the value of the target.38 While, therefore, there is no reason to doubt that the take-over market is an important influence on managerial behaviour, the evidence does not support the view that it provides anything like a complete solution to the problems of disciplining poor management.39 31 Matthew Gaved, Closing the Communications Gap: Disclosure and Institutional Shareholders (London, 1997), 7. 32 Franks, Mayer, Renneboog, “Who Disciplines Management”, above n. 26. 33 For an early statement of this position, see Henry G Manne, “Mergers and the Market for Corporate Control”, (1965) 73 J Pol Econ 693. 34 See Ross Cranston, “The Rise and Rise of the Hostile Takeover” in Klaus Hopt and Eddy Wymeersch (eds), European Takeovers: Law and Practice (London, Butterworths, 1992), 77. 35 See Fama and Jensen, “Separation of Ownership and Control”, above n. 10. 36 See A Cosh, A Hughes, K Lee, and A Singh, “Institutional Investment, Mergers and the Market for Corporate Control”, (1989) 7 International J of Industrial Organisation 73; Julian Franks and Colin Mayer, “Hostile Takeovers in the UK and the Correction of Managerial Failure”, (1996) 40 J Fin Econ 163. The position in the USA appears to be different: see Franks and Mayer, “Governance as a Source of Managerial Discipline”, above n. 28. 37 Ibid. 38 See Hart, “Corporate Governance”, above n. 24, at 684–5. 39 There are a number of other, largely unresolved issues relating to take-overs, in particular: the extent to which improvements in performance are actually realised post-merger; whether gains obtained by shareholders (mainly in the target) represent increases in efficiency or transfers of wealth from other stakeholders; and whether an active take-over market contributes to shorttermism: see generally, Pauline O’Sullivan, “Governance by Exit: An Analysis of the Market for Corporate Control” in Keasey, Thompson, and Wright, Corporate Governance, above n. 29, at 122.

Evolution and Policy: The Non-Executive Director 241 In short, notwithstanding the governance role played by institutional shareholders and the existence of an active hostile take-over market, serious weaknesses in accountability, manifested particularly in the difficulties of removing poorly performing managements, have remained. Whether board monitoring is an appropriate solution or not, the indications are that there is a significant gap to fill.

The monitoring board and efficiency If monitoring of senior management by non-executive directors is unlikely to improve corporate performance then there is of course no reason why that practice and associated institutional arrangements should evolve, even if there are weaknesses in governance overall. The claim that board-level monitoring can have positive effects on performance is, however, intuitively plausible. One advantage over other mechanisms for evaluating management and ultimately removing poor performers is that non-executive directors potentially (though not necessarily in practice)40 have unlimited access to company information. Shareholder activists, in contrast, suffer from serious and largely inescapable information deficits as a result of the requirements of commercial confidentiality, obligations on companies to treat shareholders equally, and the need of shareholders themselves to avoid insider-dealing.41 Information problems similarly impede the efficient operation of the take-over market. The proper functioning of the market requires that the share price of the target be an accurate reflection of the prospects of the company under its current management and that potential bidders are able to predict the value of the company’s assets if put under their control. Both these preconditions are problematic, however.42 Board monitoring is also free from the collective action and other problems mentioned earlier that are liable to frustrate shareholder interventions,43 and avoids the very considerable costs associated with take-overs, in the form of bid premiums and transaction costs that significantly blunt their disciplinary effect.44 40 In one survey only one-third of finance directors (in a mixed sample of sizes of company) thought that non-executives should have unrestricted access to company information: 3i, The Independent Director (London, 1992). With the importance attributed to non-executive directors post-Cadbury, presumably the position has improved. On the sources of information received by non-executives, see KPMG, The Role and Responsibilities of Non-Executive Directors: A Survey (London, 1999). 41 Outsiders typically rely on published financial results, but in large diversified companies the effects of poor management might not show up in profits for a number of years: see C K Prahalad, “Corporate Governance or Corporate Value Added: Rethinking the Primacy of Shareholder Value” in Chew, Studies in International Corporate Finance, above n. 10, 46, at 47. 42 See Edward S Herman and Louis Lowenstein, “The Efficiency Effects of Hostile Takeovers” in John C Coffee, Louis Lowenstein, and Susan Rose-Ackerman (eds), Knights, Raiders, and Targets: The Impact of Hostile Takeover (New York, OUP, 1988), 211. 43 See generally Stapledon, Institutional Shareholders, above n. 25, especially ch 5. 44 It has been argued that “a truly independent board would not tolerate suboptimal performance by management resulting in a share discount large enough to elicit a takeover at any historically

242 John Parkinson While board monitoring has apparent strengths, it does not follow simply because there are a number of non-executives on the board that those strengths will necessarily be realised in practice. Whether they are depends on such factors as the independence of the non-executives, whether they recognise that they have a monitoring role and pursue it energetically, and their practical ability to influence management behaviour and the composition of the management team. More will be said about these issues below in considering the design of the regulatory framework.45 In the meantime a factor which is often argued to be a fundamental barrier to their effectiveness is that non-executives will inevitably lack incentives to monitor at an appropriate level.46 If managers are not sufficiently motivated to perform well, why should non-executives be more strongly motivated in monitoring them? This objection tends to overlook that the problem with management may often be that they lack ability rather than incentives, but the general point is not without substance. One response is that non-executives in companies that perform poorly will be penalised in the market for their services.47 The motivation argument also suggests the value of appointing nonexecutives who have an interest in developing and protecting a reputation as diligent and skilled monitors, and more broadly of attempting to create a distinct profession of non-executive director in order to promote these qualities.48

prevailing premium level”: John C Coffee, “Regulating the Market for Corporate Control: A Critical Assessment of the Tender Offer’s Role in Corporate Governance”, (1984) 84 Colum L Rev 1145, at 1203. 45 See below nn. 129–48, and accompanying text. 46 See Ronald J Gilson and Reinier Kraakman, “Reinventing the Outside Director: An Agenda for Institutional Investors”, (1991) 43 Stan L Rev 863, at 873–6; Mahmoud Ezzamel and Robert Watson, “Wearing Two Hats: The Conflicting Control and Management Roles of Non-Executive Directors” in Keasey, Thompson, and Wright, Corporate Governance, above n. 29, 54, at 64. Gilson and Kraakman recommend the establishment of an agency funded by institutional investors to act as a clearing house for professional outside directors and to monitor their performance, thereby solving the “who monitors the monitors” problem, ibid. at 884–92. In the United Kingdom, institutions have shown little interest in appointing their own employees as non-executives in listed companies: see Stapledon, Institutional Shareholders, above n. 25, at 149–52. It has been suggested that non-executives’ interests might be better aligned with those of shareholders by remunerating them with share options: see Peter Ibison, “Independent Directors ‘Paid Double’ in US”, Financial Times, 17 January 2000; Michael Skapinker, “Stars Pay for the Privilege”, Financial Times, 9 June 2000. This practice is disapproved in the Cadbury and Hampel reports as tending to undermine independence: above n. 16, paras 4.13 and 4.8 respectively. 47 See Fama, “Agency Problems and the Theory of the Firm”, above n. 10, at 294: “outside directors are . . . disciplined by the market for their services which prices them according to their performance as referees”. There is some evidence that non-executives in companies that perform badly find it difficult to obtain new employment: see Stuart C Gilson, “Bankruptcy, Boards, Banks, and Blockholders”, (1990) 27 J Fin Econ 335; Steven Kaplan and David Reishus, “Outside Directors and Corporate Performance”, (1990) 27 J Fin Econ 389. 48 See Gilson and Kraakman, “Reinventing the Outside Director”, above n. 46; Evan Davis and John Kay, “Corporate Governance, Take-Overs, and the Role of the Non-Executive Director” in Matthew Bishop and John Kay (eds), European Mergers and Merger Policy (Oxford, OUP, 1993), 200, at 214; Roberta Romano, “Corporate Law and Corporate Governance” in Glenn R Carroll and David J Teece (eds), Firms, Markets, and Hierarchies: The Transaction Cost Economics Perspective (New York, OUP, 1999), 365, at 371–2.

Evolution and Policy: The Non-Executive Director 243 While the theoretical case for independent monitoring appears fairly strong, the empirical evidence, most of it American,49 on the contribution of outside directors to economic performance is more equivocal. A number of studies fail to find a positive correlation between the presence of non-executives and performance,50 and some even suggest a negative one.51 A recent major survey conducted by Millstein and MacAvoy on the other hand concludes that boards comprising a majority of directors who are independent of management and who actively engage in monitoring improve the performance of the company.52 They discount a number of the earlier studies that suggest otherwise as predating developments over the last few years which have transformed the role played by outside directors in many American corporations.53 They also question the methodology of previous studies, which have tended to link to performance a single element of board structure, for example, the proportion of outside directors on the board. It is naive, they argue, to think that “any single structural characteristic of a board, without further analysis of its board activation implications, can correlate with better corporate performance”.54 Their own methodology takes boardroom behaviour to be critical. They accept that it is not possible to know with certainty how a board is working from the outside, but rely on a number of proxies to determine whether active monitoring and disciplining are taking place. These include whether the independent directors have separate leadership, whether they meet periodically without management present, and whether there are formal rules or guidelines for the relationship 49 For the United Kingdom, see N Vafeas and E Theodorou, “The Relationship between Board Structure and Firm Performance in the UK”, (1998) 30 British Accounting Review 383 (who fail to find a relationship between firm performance and board structure); Mahmoud Ezzamel and Robert Watson, “Organizational Form, Ownership Structure and Corporate Performance: A Contextual Empirical Analysis of UK Companies”, (1993) 4 British Journal of Management 161 (presence of external members on board little impact on profitability). See also Franks, Mayer, and Renneboog, “Who Disciplines Management”, above n. 26, and Steve Letza, Philip Hardwick, and John Ashton, “Who Disciplines Management in Poorly Performing Companies? An Updated Study”: study prepared for the Company Law Review Steering Group, discussed further below. 50 For a recent study to this effect, see Sanjai Bhagat and Bernard Black, “The Relationship Between Board Composition and Firm Performance” in K J Hopt et al., Comparative Corporate Governance: The State of the Art and Emerging Research (Oxford, OUP, 1998), 281. See also the overview of a number of studies in Lex Donaldson and James H Davis, “Boards and Company Performance: Research Challenges the Conventional Wisdom”, (1994) 2 Corporate Governance 151. 51 e.g., A Agrawal and C Knoeber, “Firm Performance and Mechanisms to Control Agency Problems between Managers and Shareholders”, (manuscript, North Carolina State University 1994), cited in Romano, “Corporate Law and Corporate Governance”, above n. 48, 375–7. 52 Ira M Millstein and Paul W MacAvoy, “The Active Board of Directors and Performance of the Large Publicly Traded Corporation”, (1998) 98 Colum Law Rev 1282. 53 These developments include increased pressure from institutional investors (e.g. the grading of board practices by CalPERS in terms of consistency with the guidelines prepared by General Motors in 1994), judicial decisions emphasising the importance of informed, independent directors, and increased media attention on board members of underperforming companies. A more fundamental factor contributing to the activatism of the board appears to have been the severe shock administered in the early 1990s by the plummeting market values of leading corporations: ibid., at 1285–6. 54 Ibid., at 1297.

244 John Parkinson between the board and management.55 Applying this methodology, they conclude that the presence of an active, independent board correlates with significantly superior corporate performance. Millstein and MacAvoy concede that this correlation does not establish causation. There is, for example, a problem of endogeneity: better managers (with less to fear) might be more disposed to appoint effective monitors.56 Taking account also of the number of variables that might affect performance, a demonstration of causation is likely to be elusive.57 Millstein and MacAvoy’s findings are nevertheless strongly indicative and coincide with beliefs that are widely held in the business community about the value of independent directors.58 The point is perhaps worth repeating that studies that have found no connection between board composition and performance do not demonstrate that internal monitoring if appropriately constituted is incapable of contributing to performance, but only that the particular arrangements examined have failed to do so. An alternative explanation for the absence in these studies of a positive correlation between the presence of a significant proportion of outside directors and performance, suggested by Romano, is that they are capable of testing only a “strong” form of the monitoring hypothesis, and not a “weak” form.59 The strong form (its “strength” relating to the level of information accessible to outside directors about management effort and ability) assumes that outsiders will have a continuous effect on performance, on the ground that they are capable of reacting immediately to any sign of managerial failure, however slight.60 The weak form supposes instead that outside directors are likely to recognise only serious underperformance, and hence to respond intermittently, in crisis or near-crisis situations. Romano contends that the weak form hypothesis would not lead us to expect a general connection between board composition and performance over time (which many of the surveys were designed to detect), but rather the occurrence of particular events, most obviously the replacement of 55

Ibid. See Romano, “Corporate Law and Corporate Governance”, above n. 48, at 384. 57 e.g., appropriate board structures may vary between companies and sectors; in the event of a strong monitoring board being appointed in a company in which agency costs might otherwise be high, its presence would not necessarily be associated with superior performance: ibid., at 374. 58 See, e.g., Melvin A Eisenberg, “Corporate Law and Social Norms”, (1999) 99 Colum Law Rev 1253, at 1278–83, who notes the widespread adoption of boards with majority independent members, and endorsement of the monitoring board by business representative bodies and financial institutions. See also Romano, above n. 48, at 372, noting regulatory support for outside directors and positive stock price reactions to their appointment. In the United Kingdom a survey on the appointment of non-executive directors reports that “the value of non-executive directors is almost universally accepted and the vast majority of companies have now appointed them”: PIRC, Non-Executive Directors in FTSE 350 Companies: Assessing Independence, A PIRC Research Report (London, 1998), 10. 59 Romano, above n. 48. 60 This assumes that appropriately informed outsiders have the practical ability to remove management: this will not necessarily be the case (at least without shareholder assistance), when, as frequently in the United Kingdom, the outsiders are in a minority. 56

Evolution and Policy: The Non-Executive Director 245 the chief executive in cases of conspicuously poor outcomes. A number of American studies to which she refers indicate that there is a correlation between board composition and such events.61 It seems plausible, and indeed desirable, that the main contribution of nonexecutives should be in addressing serious management failure, rather than in frequent interventions in the running of the business. The latter is likely to be counter-productive, in that it might make management over-cautious and may inhibit the development of a coherent strategy.62 It also invites the question why, if the non-executives have greater insight into how the company should be managed than the executive directors, they are not employed in the latter role themselves. As a rider to Romano’s argument, however, if outside directors are effective in removing poorly performing managements, it also seems reasonable to assume that their presence will have a positive effect on performance overall (by analogy with the disciplinary effect of the threat of take-over). This takes us back to the territory in which the evidence is more equivocal. While it is clear that outside directors in the USA play an important role in replacing weak chief executives, this appears not to be the case in the United Kingdom.63 This calls into question whether boards in this country are yet appropriately constructed to carry out effective monitoring. This issue is taken up below.

Market failure If there are significant weaknesses in the governance regime overall and at the same time monitoring by non-executive directors is potentially a valuable control mechanism, the non-appearance of effective monitoring arrangements would seem to indicate some kind of market failure. An obvious candidate is the collective action problems faced by shareholders in attempting to force companies to strengthen their governance arrangements. While generally conceding that governance provisions are not determined through a process of direct interaction where shareholders are widely dispersed, contract theorists deny the relevance of this issue. Rather, governance controls are devised by managements but are contractual “in the sense that they are fully priced in transactions among interested parties”.64 That is, they are susceptible to evaluation by the capital market and as managers are assumed to have incentives to respond to the 61

See, e.g., Michael S Weisbach, “Outside Directors and CEO Turnover”, (1988) 20 J of Fin Econ

431. 62 This is not the same as saying that non-executives should not participate cooperatively with management in strategy formation, the independent perspective they can bring being widely regarded as a valuable aspect of their role. 63 Franks, Mayer, and Renneboog, “Who Disciplines Management”, above n. 26, suggest that this may be attributable in part to differences in directors’ duties and their enforcement between the two countries. 64 Easterbrook and Fischel, “The Corporate Contract”, above n. 5, at 1430.

246 John Parkinson market’s preferences there is no reason to suppose that appropriate arrangements will not emerge. This account places a heavier weight on the incentive and deterrent effects of market forces in shaping governance structures than may be warranted. It is safe to assume that the majority of executive directors will regard the appointment to the board of robustly independent monitors, who will limit their discretion and may in some circumstances seek to remove them from office, distinctly unappealing and that they are unlikely to initiate action to bring this situation about. The issue is accordingly whether market pressure is sufficiently strong to overcome managerial resistance and stimulate board reform.65 The position appears to be that governance structures become “traditionalised”, that is, companies adopt similar structures to each other because in practice their executives have only very limited incentives to innovate.66 Even if the market rewards improved structures,67 the personal impact on management (of an increased share price) may not be sufficient to outweigh the disadvantages of stricter controls. This conclusion is consistent with significant and widespread changes in governance requiring regulatory intervention, as has been the experience in the United Kingdom (where it has presented an alternative to the traditionalised structure and provided a focus for shareholder pressure), or an extreme form of market turbulence, as in the USA.68

THE DEVELOPMENT OF THE MONITORING BOARD

This part traces the development of the independent monitoring role of nonexecutive directors in the United Kingdom up to the present date. The term “non-executive” will be used throughout, though the term itself is a relatively modern one.

The nineteenth century and the transition to management control Non-executive directors have been a feature of British companies from the earliest days of incorporation. They were particularly common in banks, insurance companies, railways, and public utilities, where they often made up the entire 65

See generally Parkinson. Corporate Power and Responsibility, above n. 24, at 181–8. See Dallas, “Two Models of Corporate Governance”, above n. 20, at 46–7. 67 There are problems with this, e.g. because share purchase decisions represent a “lump” choice: see Victor Brudney, “Corporate Governance, Agency Costs, and the Rhetoric of Contract”, (1985) 89 Colum L Rev 1403, at 1424. 68 It has been reported that IBM, General Motors, and Sears together lost $32.6 billion in market value in 1992 alone: Carol J Loomis, “Dinosaurs?”, Fortune, 3 May 1993, 36, cited in Millstein and MacAvoy, “The Active Board”, above n. 52, at 1285. See also Jensen, “The Modern Industrial Revolution”, above n. 10, at 31–2, and support for the managerial entrenchment analysis in Eisenberg, “Corporate Law and Social Norms”, above n. 58, at 1281–2. 66

Evolution and Policy: The Non-Executive Director 247 board.69 An insight into how their role was perceived can be gained from a number of reported decisions from that time. It is evident that they were not regarded as having a responsibility to monitor management, at least in the sense that liability would attach for mis- or non-performance. In a number of the cases the non-executive directors had not even the most cursory acquaintance with the affairs of the company,70 but were nevertheless held not to have been negligent when, as a result, they failed to detect serious managerial impropriety.71 Neville J summed up the position in 1911, presumably reflecting the generally accepted understanding of the non-executive’s role, when he held that a director was not “bound to take any definite part in the conduct of the company’s business”.72 No doubt in practice some non-executive directors did exercise a general oversight responsibility, but this does not appear to have been their main function. Rather it was to provide assurance to outside shareholders about the integrity of those managing the company, as indicated by the non-executives’ willingness to be associated with it. Many non-executives were titled or public figures. In an era in which fraudulent promotions were commonplace their presence on the board might serve as a sign of respectability and help distinguish companies in which shareholders could safely invest from enterprises of a more dubious character.73 In ordinary manufacturing and trading companies it would in any case largely have been unnecessary to have had non-executives performing a monitoring role,74 since “ownership and control” in the bulk of these companies had yet to separate. Even with enterprises that had a stock exchange listing and hence some “outside” shareholders, it was still common in the early years of the twentieth century for a majority of the shares to be in the hands of the founder or his family.75 The replacement of family control by anonymous, widely dispersed shareholdings, and with it the ascendancy of the professional manager, was 69 See Youssef Cassis, Big Business: The European Experience in the Twentieth Century (Oxford, OUP, 1997), 158. In these companies shares were often widely dispersed and day to day management delegated to officers below board level. 70 See, e.g., Re Cardiff Savings Bank [1892] 2 Ch 100 (attendance by the Marquis of Bute at one board meeting in thirty-eight years). See also Re Denham & Co (1883) 25 Ch 752 (“country gentleman” inattentive for four years). 71 Proposals by the Davey Committee in 1895 to impose a statutory duty on directors to behave with reasonable care and prudence met with considerable opposition and were rejected: directors were there only to discuss and to be consulted; they were not well paid; such a duty would “terrify” directors and they would refuse to serve: see P L Cottrell, Industrial Finance: the Finance and Organization of English Manufacturing Industry, 1830–1914 (London, Methuen, 1980), 71–2. 72 Re Brazilian Rubber Plantations and Estates Ltd [1911] 1 Ch 425, at 437. 73 See generally Cottrell, Industrial Finance, above n. 71, ch 3. The appointment of respectable but ignorant directors could also, however, be part of a deliberate strategy to defraud investors: see Re Brazilian Rubber, ibid. 74 Though in theory they might safeguard the interests of the minority, “outside” shareholders. 75 Family control was also perpetuated by the practice of issuing non-voting preference shares to “outside” shareholders: see Cottrell, Industrial Finance, above n. 71, ch 6; Peter Mathias, The First Industrial Nation: An Economic History of Britain 1700–1914 (2nd edn, London, 1983), 353–4.

248 John Parkinson comparatively slow in the United Kingdom.76 It is interesting to note that it was not until 1908 that Table A authorised a company to appoint directors to salaried, managerial positions.77 Before then the model articles had expressly prohibited directors from holding any paid employment with the company.78 The change corresponds to the growing practice of appointing managers to the board who were not also significant shareholders, and therefore needed to be paid for their services. By the 1930s the dispersal of shareholdings was well advanced and it had become exceptional for founding families to hold majority stakes in listed companies,79 though they continued to be represented on boards, with family members serving as directors in nearly 60 per cent of the two hundred largest companies as late as 1948. But in terms of control of the board it is clear that by that date a majority of directors in most large companies were fulltime executives without significant holdings;80 that is, the transition to managerial domination was more or less complete. Once management and shareholding had split the case for non-executive directors performing a more active role becomes apparent. But while at this time many companies had non-executives, it is much less clear that they performed an oversight function.81 Many of them were of the passive “guinea pig” variety already mentioned. In a sample of the largest companies in 1936 (those with a capital over £500,000), 15 per cent of their directors were found to be titled and 48 per cent of the companies had a titled director on the board. It has been estimated that about half of the directors in question inherited their titles or acquired them for prowess other than in the field of business.82 The main purpose of many of these was presumably to create an appearance of trustworthiness or simply decorative. Further, whether or not those appointed possessed 76 See Leslie Hannah, The Rise of the Corporate Economy (2nd edn, London, Methuen, 1983), especially ch 5. The comparison is with the USA: see Alfred D Chandler Jr, The Visible Hand: The Managerial Revolution in American Business (Cambridge, Mass, Harvard University Press, 1977). See also P L Payne, “The Emergence of the Large-scale Company in Great Britain, 1870–1914”, (1967) 20 Econ History Rev 519. 77 Companies (Consolidation) Act 1908, Table A, reg 72, providing for the appointment of one or more managing directors. 78 Though they were entitled to directors’ fees, voted on by the shareholders. 79 See Leslie Hannah, “Visible and Invisible Hands in Great Britain”, in Alfred D Chandler Jr and Herman Daems, Managerial Hierarchies: Comparative Perspectives on the Rise of the Modern Enterprise (Cambridge, Mass, Harvard University Press, 1980), ch 2; P Sargant Florence, Ownership, Control and Success of Large Companies: An Analysis of English Industrial Structure and Policy 1936–1951 (London, Sweet and Maxwell, 1961), ch 4. 80 See generally, P Sargant Florence, The Logic of British and American Industry: A Realistic Analysis of Economic Structure and Government (3rd edn, London, Routledge and Kegan Paul, 1972), 244. 81 It was apparently not uncommon, particularly in the financial and railway sectors, for boards to contain a majority of non-executives before the Second World War: ibid. and Sir Brandon Rhys Williams MP (in a debate in the House of Commons on one of his Companies Bills requiring the appointment of non-executives: see below): “before the war, and in some cases even since the war, it was commonplace for the boards of British companies to consist mainly, if not entirely, of notabilities who might bring business acumen and reputation to the service of the company but who did not engage full-time in its management”: House of Commons Debates 1971–2, vol 834, col 1649. 82 Florence, above n. 80, at 245.

Evolution and Policy: The Non-Executive Director 249 the qualities needed to perform a monitoring role, it is unlikely that they were expected to do so, given that in most cases it was executive management who had selected them. That executive directors would have had no incentive to appoint candidates who would present a threat to their own positions was the subject of contemporary comment. The Liberal Industrial Inquiry of 1928 observed that “management rather like to have an ineffective Board which will know too little to have views or to interfere”.83 Summing up the character of the board, the committee remarked that “a [non-executive] director would consider himself greatly aggrieved if he were to be dropped merely because he was elderly, useless, or without special qualifications for the work. . .Directorships are, in fact, the ‘pocket boroughs’ of the present day”.84 In an early recognition of an apparent failure of governance institutions to adapt to modern circumstances, the Inquiry also observed that: “a large part of our company system has grown up quite recently out of conditions in which the directors, or at any rate the governing group of the Board, were either themselves the proprietors of the concern or the direct and responsible representatives of the proprietors. We have carried on practices which would be reasonable and proper on such assumptions into conditions in which frequently these assumptions are no longer satisfied. Consequently the method of appointing Boards of Directors and the qualifications necessary now require in many cases serious reconsideration”.85

In other words, at a time when “owner” directors were being rapidly displaced by professional managers, there appeared to be no significant compensating changes by way of the inclusion of an independent element on the board to oversee and hold accountable executive management. The governance roles of institutional shareholders and hostile take-overs had of course also yet to come about. While an independent monitoring role did not seem to be developing, in the decades following the Second World War boards began to contain increasing numbers of non-executive directors who were appointed to provide professional or other sorts of advice or contacts. These included representatives of the company’s banks or other finance providers, solicitors, and accountants.86 Although capable of bringing a degree of “outside” judgement to bear on issues of strategy, non-executives of this kind were unsuited to acting as robust monitors, given the nature of their relationship with management and business connections with the company, nor doubtless were they expected to.

83

Britain’s Industrial Future: being the Report of the Liberal Industrial Inquiry (London, 1928),

91. 84

Ibid., at 90. Ibid., at 89–90. 86 See British Institute of Management, The Board of Directors: A Survey of Its Structure, Composition and Role, Management Survey Report no 10 (London, 1972), ch 6. 85

250 John Parkinson The modern era By the start of the 1970s (though there had been some earlier stirrings87) the idea that non-executive directors should perform an explicit monitoring role and that a proportion of them should be independent of management had entered public debate. Before examining the reasons, it may be useful to provide a snapshot of public company boards in this period. In a survey conducted on behalf of the British Institute of Management based on the Times 500 list of industrial companies for 1969–70, 80 per cent of boards were found to include some nonexecutive directors, on average amounting to between one-quarter and onethird of the board.88 In a study of Times 1000 companies for 1975–76 (therefore including smaller companies that the previous survey), 75 per cent of companies had non-executives, with 35 per cent having more than two.89 The British Institute of Management survey also casts some light on the composition of the non-executive element and how their functions were perceived. By far the largest group was made up of bankers, lawyers, accountants, and other technical specialists. Most of these were presumably appointed for their advice or contacts and cannot be regarded as independent. The next largest cohort was retired executive directors of the company, of whom the same can be said. The other significant groups were directors with family or historical connections with the company and other substantial shareholders, many of whom may well have been independent of management but not necessarily competent to carry out monitoring duties.90 The survey goes on to remark that other than in the largest companies, the true objective outsider was a rarity. Around one-third to one-half of companies surveyed intimated that there was no serious intention that non-executives should play a role as independent assessors of management. There is also cause to be sceptical about some of the others who appeared more supportive of the idea of monitoring, since in nearly all of the companies non-executives were in practice selected by the chairman or chief executive. Many interviewees occupying the latter positions accepted that this was unlikely to lead to effective internal scrutiny. Indeed, they believed that the British system of company control failed to “spot bad management easily and get rid of it quickly largely because executive directors in many companies, particularly the chairman, were effectively appointing judges in their own cause when it came to selecting non-executive directors”.91 Most respondents accepted that this was the situation in other companies, but rather curiously, not 87

See Sue Bowden, Chapter 8 above; British Institute of Management, ibid., foreword. British Institute of Management, ibid., ch 2. In addition to the Times 500 companies, some additional Institute members, chosen at random, were included. See also the figures in Stapledon, Institutional Shareholders and Corporate Governance, above n. 25, at 140–2. 89 Department of Trade, The Conduct of Company Directors (Cmnd 7037, London, 1977), para 19. 90 British Institute of Management, The Board of Directors, above n. 86, ch 5. 91 Ibid., at 13. 88

Evolution and Policy: The Non-Executive Director 251 their own. In short, at the start of the 1970s there was little reason to suppose that independent monitoring was a significant feature of British boards. By this date views were increasingly being expressed that there was a need for change, if necessary, by legal intervention. The British Institute of Management Report itself argued that in companies above a certain size there should be a minimum number of non-executives, that they should have a legally defined role, and that a way should be found for appointing them that did not depend on cooption by management.92 What lay behind this interest in non-executives was the perception that many British companies were badly managed and that there were considerable difficulties involved in removing those responsible. This was certainly the view of the Bank of England, which had taken part in a number of rescue operations in the wake of the secondary bank crisis. Charkham explains that “in many cases of impending disaster” in which the assistance of the Bank had been sought, “there was clear evidence of the company’s executive management having lacked proper control for some time and of the board’s inability to do anything about it”.93 It is not that boards necessarily were without non-executive members. Rather, while some companies “had bloated boards studded with great names”, they lacked non-executive directors of sufficient calibre and independence to be able to rectify management failure.94 An early attempt to strengthen boards through external intervention was made in 1971 by Sir Brandon Rhys Williams, a Conservative backbencher. He introduced a private member’s Bill requiring what would in effect have been around the thousand largest companies to appoint at least three non-executive directors, who would have a duty to report annually to the shareholders on their assessment of the quality of the company’s management and on the use of its assets. While recognising some merit in the Bill, the (Conservative) Government’s view was that mandating a distinct monitoring function would provoke unhealthy division in the boardroom. It commended instead the recent establishment of a committee (the Watkinson Committee) by the CBI, the City and other institutions to undertake a more rounded investigation of possible solutions to what it accepted was a genuine problem, that is, how to improve the accountability of management.95 This way of dealing with the issue set the trend for future efforts at board reform. 92

Ibid., ch 7. Jonathan Charkham, “The Bank and Corporate Governance: Past, Present and Future”, (1993) Bank of England Quarterly Bulletin 388. What follows is indebted to Charkham’s account. One response of the Bank was to begin a series of statistical surveys on board composition, beginning in 1979: see (1979) Bank of England Quarterly Bulletin 392 and others referred to below. See also the lecture given by the Governor to the Institute of Directors supporting the appointment of non-executives: (1978) Bank of England Quarterly Bulletin 536. Earlier/other initiatives aimed at improving corporate governance in which the Bank had been involved include setting up the Council of Security Investors (early 1970s) and the Institutional Shareholders Committee: see Ezzamel and Watson, “Wearing Two Hats”, above n. 46, at 67; Stapledon, Institutional Shareholders, above n. 25, at 49–53. 94 Ibid., 388–9. 95 House of Commons Debates, 1971–72, vol 834, col 1661. 93

252 John Parkinson The Watkinson Committee reported in 1973. It accepted that non-executives could make a valuable contribution in regard to accountability. But it argued that companies should not be required to have them by law. The right number of directors for any given company needed to be decided case by case, and it was impossible to set measurable qualifications. On the other hand it accepted that it was appropriate to require a statement in the annual report about the composition of the board, and as regards non-executive directors, their qualifications and interests.96 Subsequent discussions between City and industry groups, including the CBI, the British Institute of Management, the Stock Exchange, the clearing banks, the Institutional Shareholders’ Committee, and the Bank of England led to agreement that legislation in this area was indeed undesirable, but that companies should be persuaded to “add enough able non-executives to their board to achieve critical mass”.97 A government White Paper in the same year echoed these sentiments. It acknowledged that there was “an argument for saying that every company over a certain size would benefit from the presence on the board” of a number of non-executive directors, though it did not favour their having specific responsibilities different from those of the executives, which might “reflect adversely both on the responsibility of the other directors and on the harmony of minds which the board should represent”.98 Nor did it suggest that there was a need for legislation, the government’s preferred strategy being to leave the issue to the business and investment communities to sort out. The subsequent Labour Government was more forthright in its support for an active monitoring role for non-executive directors. In the White Paper, The Conduct of Company Directors in 1977 it argued that they “should provide independent supervision of the company’s management. In order to do this effectively. . . the non-executive directors need free access to management information and there need to be enough of them. One or two non-executive directors on a board which is 20 strong are unlikely to exercise real influence”.99 Nevertheless, it did not accept that legislation was necessarily the right approach. Referring specifically to audit committees, but by implication to board structure more generally, it noted that “the time may come when it will be appropriate to legislate in this field, but the Government believes initially at least that it will be better for companies, investors and their representative bodies to work out schemes which can benefit from a degree of flexibility which the law could not provide”.100 96

CBI, The Responsibilities of the British Public Company (London, 1973), ch 9. PIRC, Non-Executive Directors in FTSE 350 Companies: Assessing Independence (London, 1998), foreword by Jonathan Charkham, at 6. 98 DTI, Company Law Reform (Cmnd 5391, London, 1973), para 61. 99 Department of Trade, The Conduct of Company Directors (Cmnd 7037, London, 1977), para 20. 100 Ibid., para 21. In 1977 an abortive (Conservative) private member’s Bill called for all companies (above a certain size) to have not less than three non-executive directors: see R I Tricker, Corporate Governance (Aldershot, Gower, 1984), 188. 97

Evolution and Policy: The Non-Executive Director 253 It is worth pausing here to observe that there were broader political pressures in this period that are likely to have provided additional incentives to put such schemes into effect, or at least to stimulate industry bodies to promote voluntary board reform. Disenchantment in the Labour Party with public ownership as a means of securing industrial democracy and other social objectives had created an interest in finding ways of widening the responsibilities of private industry.101 Poor economic performance also gave support to the idea “that companies must be subjected to such control as will make their profit-seeking congruent with the Government’s overall economic strategy”.102 The best developed, and most radical, proposals for company law reform were those of the Bullock Committee103 in 1977, for employee directors. While not addressing directly the broader policy issues, voluntary efforts to strengthen the independence of the board and improve the accountability of management might be of value in resisting government intervention by increasing the legitimacy and effectiveness of existing structures. In the 1970s (and beyond) the much-contested draft EC Fifth Directive on company law104 also provided a reason for companies to “put their house in order” so as to be in a stronger position to argue against the need for the more radical change that the directive would have represented. In addition to mandating employee participation, one of the main objects of the directive, as an issue in its own right, was to separate management and supervisory functions. This could be achieved either by way of a two-tier structure, or in Member States which opted to retain the unitary board, by a majority of the board comprising non-executive directors, who would have the power to appoint and remove the executive members. It may be noted that this goes significantly further than have the subsequent governance codes.105 101 In introducing what became the Companies Act 1967, the President of the Board of Trade announced an intention to “re-examine the whole theory and purpose of the limited joint stock company, the comparative rights and obligations of shareholders, directors, creditors, employees, and the community as a whole” (House of Commons Debates, vol 741, col 359): see Bowden, “Corporate Governance in a Political Climate”, Chapter 8 above. The Working Group of the Labour Party Industrial Policy Sub-Committee (Company Law), The Community and the Company (London, 1974), made proposals for a major restructuring of the company to strengthen community and employee interests, and rejected the self-regulatory approach: see Ben Clift, Andrew Gamble, and Michael Harris, Chapter 3 above. There was some, limited, exploration of “wider responsibilities” in the Conservative White Paper, DTI, Company Law Reform (Cmnd, 5391, London, 1973), and the report of the Watkinson Committee, above n. 96. 102 Barbara Shenfield, Company Boards: Their Responsibilities to Shareholders, Employees, and the Community (London, George Allen and Unwin, 1971), 13. 103 Department of Trade, Report of the Committee of Inquiry on Industrial Democracy (Cmnd 6706, London, 1977). See generally Clift, Gamble, and Harris, Chapter 3 above. 104 Draft Fifth Directive on the structure of public companies and the powers and obligations of their organs, COM (72) Final, 18 July 1972. For a brief account of the progress of the directive, see Vanessa Edwards, EC Company Law (Oxford, 1999), 387–90. 105 As to which, see Oxford Analytica Ltd, Boards of Directors and Corporate Governance: Trends in the G7 Countries over the Next Ten Years (Oxford, 1992): “the UK government and industry appear to be trying to institute boardroom change voluntarily in an attempt to head off what they regard as the least favourable aspects of proposed EC legislation. Recommendations from the Association of British Insurers, the Institutional Shareholders’ Committee and the Cadbury

254 John Parkinson The most visible manifestation of a voluntary, but collective approach to board reform was the setting up in 1981 of PRO NED,106 again with the active support of the Bank of England, and also of other business and investment institutions.107 The function of PRO NED was to publicise the value to companies of increasing the number and quality of their non-executives, and also to act as a clearing house, bringing together companies and suitably qualified candidates. By the mid-1980s Charkham notes that it was securing around fifty appointments a year, but he also observes that it was involved with only a small fraction of companies. These almost by definition were the more progressive ones, with others in which the need for governance reform was perhaps greater being less willing to take remedial action.108 Nevertheless, a Bank of England survey in 1985 revealed that more companies were appointing non-executives and that the proportion was increasing. The average proportion of non-executives on the boards of quoted Times 1000 companies in that year was 35 per cent. In 1982 it had been 33 per cent, and in 1979 30 per cent.109 The study shows that 20 per cent of companies had a majority of non-executives, though also that 40 per cent had fewer than three. Furthermore, one-third of appointees could not be counted as independent, because they had previously served as executive directors in the company or were involved with the company in some other capacity, such as professional adviser.110 Striking a cautionary note, the author observes that “the study provides no evidence that the trend towards greater use of non-executive directors is gathering pace. These findings raise some doubts about the adequacy of the current approach, based on argument and persuasion, towards extending the use of non-executive directors on company boards in this country”.111 Similarly, Charkham explains that while there was evidence that board structures were changing as more nonexecutives were added, and that these were of higher quality than previously,112 Committee are all designed to lay down a blueprint for ‘best practice’ which, it is hoped, will meet many of the requirements in the EC’s Company Law Directive . . . the Cadbury report is part of this effort at ‘pre-emptive’ self-regulation”. 106 The government announced the formation of PRO NED in the House of Commons during a debate on an amendment to what became the Companies Act 1981 tabled by Sir Brandon Rhys Williams (see also above n. 95 and accompanying text), which would have required companies that did not have three non-executive directors to bring the matter to the shareholders’ attention: see R I Tricker, Corporate Governance, above n. 100, at 188. 107 See also Institute of Directors, A Code of Practice for the Non-Executive Director (London, 1982), recommending a minimum of two independent non-executive directors, whose role would include monitoring executive performance against agreed objectives. 108 Charkham, “The Bank and Corporate Governance”, above n. 93, at 389. 109 “The Boards of Quoted Companies”, (1985) Bank of England Quarterly Bulletin 233. 110 The position had improved by 1988, a survey in that year finding that slightly less than onequarter of non-executives were either former executives of the company or professional advisers: “Composition of Company Boards”, (1988) Bank of England Quarterly Bulletin 242. 111 Ibid., at 236. 112 There was a marked change in the background of non-executives as compared with the position in the 1970s (see above n 90, and accompanying text): in 1992, in a sample of the top hundred companies from the Times 1,000, 62 per cent of non-executives were executive directors of other companies, and 12 per cent professionals or from the financial sector. See Jonathan Charkham,

Evolution and Policy: The Non-Executive Director 255 the Bank of England was still concerned that the systemic weakness that it had earlier identified were far from having been eliminated.113 A further Bank of England survey in 1988 did little to allay these fears.114 While in part attributable to an increase in the size of the sample,115 causing it to take in more smaller companies, the trend towards increasing numbers of non-executives appeared to have slowed, or even reversed: 44 per cent of respondents had fewer than three non-executives (a recommendation of a code published by PRO NED in 1987).116 Just under 11 per cent had no non-executives, more than 12 per cent only one, and 21 per cent only two. The report of the survey notes an unhealthy complaisance in the reasons given for non-compliance with the PRO NED code. In essence many respondents appeared content with a system of accountability in which the board was dominated by executive management. That continuing concerns about accountability were nevertheless justified was evidenced in the wave of company collapses in the recession of the late 1980s. A common theme was the presence of a forceful, and in some cases wayward, chief executive unconstrained by countervailing power on the board. In response, the financial institutions made renewed efforts to underline the importance to good governance of strong, independent non-executives. This led in 1990 to the publication of guidelines by the Association of British Insurers,117 which were reissued in 1991 by the more broadly-based Institutional Shareholders’ Committee as its statement of best practice on The Role and Duties of Directors. This emphasised the importance of non-executives being independent and recommended that they be “in sufficient number and calibre for their views to carry significant weight on the board” (particularly if the roles of chairman and chief executive were combined). It also made explicit the importance of the monitoring role, stating that non-executives should “acknowledge a particular duty to monitor the performance of the Board as a whole”.118 In the midst of these exhortations came a further spate of well publicised collapses of major companies. Their most recent accounts, either as a result of falsification or the use of dubious accounting practices, had seriously misrepresented their financial condition. This feature in particular prompted the setting up of the Cadbury Committee in 1991 by the Financial Reporting Council, the Stock Exchange and the accountancy profession, to investigate the financial

Keeping Good Company: A Study of Corporate Governance in Five Countries (Oxford, OUP, 1994), 269. 113 Ibid. 114 “Composition of Company Boards”, above n. 110. 115 The sample was drawn from all the companies in the Times 1000, rather than just those that were listed and had appeared in the 1983 survey. 116 See (1987) Bank of England Quarterly Bulletin 252. 117 ABI, The Roles and Duties of Directors (London, 1990). 118 Institutional Shareholders’ Committee, The Role and Duties of Directors—A Statement of Best Practice (London, 1991), 3.

256 John Parkinson aspects of governance.119 As Charkham explains, however, the Committee soon realised that it could not address the issue of improving the reliability of financial information and controls without looking more deeply into the mechanisms of corporate governance, in particular the role of the board.120 The ensuing Code of Best Practice, among other things, endorsed earlier efforts to promote the use of independent non-executives. It recommended that companies should have at least three non-executive directors, a majority of whom were to be independent, that the board as a whole should monitor the executive management, and that within the board the non-executive directors should bring “an independent judgement to bear” on, among other things, performance and key appointments.121 In areas in which executive directors face particularly acute conflicts of interest, namely in relation to audit and fixing their own remuneration, the Code suggested the setting up of specialist board subcommittees with strong non-executive representation. It also favoured the establishment of a nomination committee to recommend board appointments, but did not include a requirement to that effect in the Code. On the important issue of the roles of chief executive and chairman, Cadbury stressed that these positions should be held separately in order to avoid the excessive concentration of power. The Code did not, however, rule against combining the positions, though where this was the case it was “essential that there should be a strong and independent element on the board, with a recognised senior member”.122 The Cadbury Code clearly built on the work of PRO NED, the ABI and the ISC, but a significant break with earlier initiatives was the introduction of an element of compulsion.123 This was not, as mentioned earlier, compulsion to comply with the Code, but rather to disclose information about the extent of compliance and reasons for non-compliance. This would enable shareholders, in particular the institutions, to judge whether a given company’s governance arrangements were satisfactory in its particular circumstances, and if not, to press for change.124 119 The underlying problems were seen as “the looseness of accounting standards, the absence of a clear framework for ensuring that directors kept under review the controls on their business, and competitive pressures both on companies and on auditors which made it difficult for auditors to stand up to demanding boards”: Report of the Committee on the Financial Aspects of Corporate Governance, above n. 16, at para 2.1. 120 PIRC, Non-Executive Directors, above n. 97, at 7. 121 Report of the Committee on the Financial Aspects of Corporate Governance, above n. 16, at 58. 122 Ibid. 123 Though this was not wholly without precedent. In 1987 the Stock Exchange listing rules were changed to require companies in their annual reports to give brief biographical details of directors and their functions. This, it has been suggested, “encouraged companies to examine their own position on the appointment of non-executive directors”: ICAEW, The Report of the Study Group on the Changing Role of the Non-Executive Director (London, 1991), para 8.4. 124 For statistics on compliance with the Cadbury Code, see Committee on the Financial Aspects of Corporate Governance, Compliance with the Code of Best Practice (London, 1995); Martin J Conyon, “Corporate Governance Changes in UK Companies between 1988 and 1993”, (1994) 2 Corporate Governance 87. In addition to the Code, a number of institutional investors have their own guidelines addressed to companies in which they have holdings, which include recommendations on non-executive directors: see PIRC, A Guide to the Guidelines: A Survey of Institutional Shareholder Corporate Governance Policies (London, 1997), ch 5.

Evolution and Policy: The Non-Executive Director 257 The final developments came with the establishment of the Hampel Committee in 1995 to review the provisions and operation of the Cadbury Code (as the Cadbury Committee had recommended). The Committee’s report largely endorsed the Code, and despite some criticism that there had been an overemphasis on the role of governance in securing accountability rather than contributing to business prosperity,125 it recommended a number of changes that have the effect of strengthening the monitoring function. These are that not less than one-third of the board should be non-executives (as opposed to the Cadbury requirement of a minimum of three), a majority of whom should be independent; that there should be a nomination committee (a Cadbury recommendation, but not part of the Code); and that a lead non-executive, whether or not the posts of chairman and chief executive were divided, should be identified in the annual report. The amended Code, also incorporating the recommendations of the Greenbury Group on directors’ remuneration,126 was brought into effect via the Stock Exchange Listing Rules as the Combined Code at the end of 1998. Following the transfer of the listing function from the Stock Exchange to the Financial Services Authority, the Code is currently administered by the latter body.

THE BOARD AND MONITORING TODAY: A CASE FOR FURTHER INTERVENTION?

The previous part outlined the various initiatives from the 1970s onwards designed to encourage the appointment of non-executive directors in greater numbers, of better quality, and with a more clearly defined role. The presence of political pressures on companies to improve accountability at board level has also been noted. The extent to which the monitoring role of boards would have increased in the absence of these initiatives and pressures is difficult to assess. Certainly, the figures cited above show that non-executives were present in not insignificant numbers in the early 1970s and grew steadily for the next two decades, even before the position became more formalised with Cadbury. Companies were presumably themselves recognising the value of non-executive 125 Committee on Corporate Governance, Final Report, above n. 16, at paras 1.1 and 3.8–3.9. The suggestion that there is an incompatibility between accountability and performance indicates that the authors of the Report regarded monitoring as being connected only with rather narrow issues of “hygiene”, rather than being to ensure that the management team is up to the job, which is clearly crucial to performance. This approach is in keeping with the immediate circumstances that led up to the formation of the Cadbury Committee, but not the longer history of initiatives in this area, as considered above. There is survey evidence to suggest that institutional investors do not consider that accountability issues are separate from questions of performance: PIRC, A Guide to the Guidelines, above n. 124, at 13. Presumably reflecting concerns about the over-emphasis on monitoring, the Combined Code, unlike the Cadbury Code, does not refer to an explicit obligation of the board to monitor executive management. 126 Directors’ Remuneration: Report of a Study Group chaired by Sir Richard Greenbury, above n. 16.

258 John Parkinson directors and being pressed by their institutional shareholders to appoint them. It might be argued that this supports the view that competitive forces were themselves shaping an effective monitoring board. However, crude increases in numbers cannot necessarily be equated with the performance of a monitoring role, and the contention ignores that the various initiatives that have been discussed were largely responses to the perception that market forces alone were not securing sufficiently radical or widespread governance reforms. Even after two decades of exhortation to strengthen boards it had become clear by the time of the Cadbury Report that in many companies the position was largely unchanged and that the pressure needed to be racheted up, by introducing a measure of compulsion. The effect of the Cadbury and Combined Codes has since been further to increase the proportion of non-executives on boards,127 and especially to make more consistent the appointment of a significant nonexecutive element across the listed sector. The point has now been reached, for example, in which 92 per cent of companies in the All-Share Index have a board comprising at least one-third non-executive directors.128 The conclusion to be drawn from this experience, it is suggested, is that market forces alone have proved to be an unreliable means of inducing necessary (as argued by this chapter) improvements in board-level governance. There has in consequence been a limited form of regulation. It is appropriate to ask whether this regulation goes far enough in mandating an effective monitoring board. There are reasons to think that it does not. Strengthening the monitoring role It was noted earlier that there is evidence that in the USA, independent directors play a significant role in removing the managements of poorly performing companies. The evidence in relation to the United Kingdom suggests otherwise. A study by Franks, Mayer, and Renneboog concludes that the presence of nonexecutive directors is not related to managerial changes when company performance is very poor.129 A follow-up study using more recent data reaches a 127 Conyon, “Corporate Governance”, above n. 124, records an increase of the average proportion of non-executives in the Times 1000 companies from just under 36 per cent in 1988 to over 41 per cent in 1993 (the proportions being 33, 35, and 36 per cent in 1983, 1985, and 1988 respectively). Conyon also notes very large increases in the use of the board committees recommended by Cadbury: in the sample of listed companies, remuneration committees up from 54 (in 1988) to 94 per cent (in 1993), and audit committees from 35 to 90 per cent. 128 PIRC, Compliance with the Combined Code, above n. 9. There are, however, significant variations according to size of company; e.g. in 97 per cent of FTSE 100 companies non-executives comprise one-third of the board, a majority of whom are independent. The figure falls to 81 per cent for All-Share Index companies. Also in relation to some other provisions compliance is significantly lower; e.g. only 69 per cent of companies in the All-Share Index publicly identified the chairman, CEO, and senior independent director. 129 Franks, Mayer, and Renneboog, “Who Disciplines Management”, above n. 26. See also Franks and Mayer, “Governance as a Source of Managerial Discipline”, above n. 28. The survey used a random sample of 250 companies listed on the London Stock Exchange and relates to

Evolution and Policy: The Non-Executive Director 259 similar conclusion.130 These results are particularly significant in the context of the wider finding by Franks et al. that unusually high board turn-over is a feature only of the very worst performing companies, normally where they are financially distressed and seeking fresh equity capital. That is, the weakness of the board as a disciplinary mechanism does not appear to be adequately compensated by other aspects of the governance system. There are a number of possible reasons why non-executives appear not to be making much of an impact as monitors (which is not to deny that they may be making a valuable contribution in their other roles). First there are several issues connected with independence. It remains the position that senior managers are involved in appointing non-executives. The role of the nomination committee as envisaged in the Combined Code is not to make appointments, but to recommend candidates to the board, which makes the final decision (subject ultimately to shareholder approval).131 Further, the requirement that the majority of non-executives should be “independent of management”132 means that they should not, for example, be employees of the company or its professional advisers. It does not prevent the chief executive from screening out candidates who might adopt too rigorous an attitude to their monitoring responsibilities. The large number of non-executive positions that are held by executives of other companies may also reduce the rigour of monitoring.133 It has been suggested that such directors share management’s “ideological disposition toward the single issue most central to their monitoring responsibilities: how intensely outside directors should monitor management”.134 The seeming failure of remuneration committees, on which executives of other companies are well represented, to moderate increases in directors’ pay,135 supports the view that non-executives drawn from the ranks of management are unlikely to adopt a challenging attitude to their role. A final issue is that the combination of functions that nonexecutives are expected to perform may impair their ability to act as independent monitors. In particular, if non-executives are involved in strategy, that is, in reviewing the company’s future plans, their ability to evaluate management 1988–1993. It did find that there was a positive relationship between the separation of chairman and CEO positions and the dismissal of CEOs in response to earnings losses or dividend cuts. 130 Letza, Hardwick, and Ashton, “Who Disciplines Management? An Updated Study”, above n. 49. 131 And it appears that in many cases the board already has a candidate in mind, making the nomination committee superfluous: see Egon Zehnder International/ICAEW, Chairmen and NonExecutive Directors: Fees, Facts and Attitudes—1998 (London, 1998), 5. 132 Combined Code, above n. 16, at para A.3.2. 133 See above n. 112, and accompanying text. The Cadbury Committee sought to encourage the appointment of executives of other companies: see Report of the Committee on the Financial Aspects of Corporate Governance, above n. 16, at para 4.17. 134 Gilson and Kraakman, “Reinventing the Outside Director”, above n. 46, at 875 (emphasis in original). 135 See Brian G M Main and James Johnson, “Remuneration Committees and Corporate Governance”, (1993) 23 Accounting and Business Research 351 (companies with remuneration committees awarding greater increases than those without).

260 John Parkinson performance ex post is compromised, since they are themselves partly responsible for the policies that contribute to that performance.136 A second type of problem concerns the powers of the non-executive element. As company law does not confer any powers on non-executive directors as such, their ability to take action against management ultimately depends on their numerical strength. Executive directors might join with non-executives to depose the CEO, and the non-executives’ position may be considerably enhanced by cooperation with major shareholders, but if they are in a minority on the board there are likely to be circumstances in which they must either put up or resign (though the latter may at times be a valuable remedy). In fact, in a substantial number of companies non-executive directors do now constitute a majority, but it is rare (as distinct from in the USA) for there to be an independent (even as narrowly defined in the Combined Code) majority.137 The Code does not require non-executives to be in a majority, either independent or otherwise. A possible response to both the independence and power issues is the adoption of a two-tier structure. This is considered by the Company Law Review Steering Group in a recent consultation document, but rejected, rightly, it is suggested.138 One drawback is that the creation of separate boards would limit the access of non-executives to information about the business and the qualities and performance of management, thereby hampering the monitoring function. A second is that it is likely to inhibit or even preclude the contribution of nonexecutives to strategy. Their involvement in strategy formation was noted above as a factor tending to detract from independence in monitoring. This is a valid criticism, but the external perspective that non-executives can bring to strategic management is an important contribution that it would be damaging to lose. Monitoring and involvement in strategy are in any case not entirely discrete. Non-executive participation in such issues as capital allocation, acquisitions, and disposals may improve the quality of decisions (strategy), but is also a way of regulating the managerial conflicts of interest to which these decisions may give rise (monitoring). Although rejecting two-tier boards, the Company Law Review canvasses a number of other ways of strengthening the monitoring role.139 These include requiring boards to contain a majority, of possibly independent, nonexecutives, and/or requiring appointment (not just nomination) of nonexecutives to be made by a committee consisting exclusively of independent directors. Another possibility would be to introduce into legislation an explicit 136 See Davis and Kay, “Corporate Governance”, above n. 48, at 208–15; Williamson, The Economic Institutions of Capitalism, above n. 10, at 316–18. 137 See PIRC, Non-Executive Directors in FTSE 350 Companies, above n. 97. In 1996, 74 per cent of FTSE 350 companies had a majority of non-executives. The average proportion of independents among non-executives was 68.5 per cent. 138 Company Law Review Steering Group, Modern Company Law for a Competitive Economy: Developing the Framework (London, 2000), paras 3.137–3.141. 139 Ibid., paras 3.142–3.153.

Evolution and Policy: The Non-Executive Director 261 duty, either on the board as a whole or on the non-executives, to monitor whether the company is being properly managed. This is already implicit in directors’ common law duties,140 but an explicit formulation would give greater emphasis to the monitoring role.141

A continuing role for codes? The last point raises the more general question whether board structure and composition should continue to be regulated by codes, or brought within companies legislation. The first aspect of the issue concerns in whom the responsibility to make rules in this area should be vested. The governance codes have hitherto been private sector initiatives, though they have enjoyed government support.142 While no doubt being good faith efforts to rectify governance weaknesses, the codes can also be interpreted defensively, as attempts to improve governance to the extent necessary to forestall potentially more restrictive state intervention. Further, if an important factor in the failure of effective monitoring boards to evolve “naturally” is managerial resistance, then it might be expected that this would also affect the output of governance committees in which management and their representatives have played an important role.143 The inclusion of the Combined Code within the scope of the current Company Law Review signals a change of approach to the location of responsibility for the content of governance rules. The terms of reference of the Review require it to “consider the proper relationship between company law and nonstatutory standards”.144 The Government added that “the broad picture in this area requires a fresh look”.145 The Review has since examined the provisions of the Combined Code and consulted on a number of ways in which the monitoring 140 The duty of diligence at common law involves some responsibility to oversee the conduct of the company’s business. Historically, the content of this duty has been minimal (see above nn. 70–3, and accompanying text), but shows signs of becoming more onerous: see, e.g., Dorchester Finance Company Ltd v. Stebbing [1989] BCLC 498 (decided in 1977); Re Barings plc (No 5) [1999] 1 BCLC 433. Note also the proposal of the Company Law Review to impose by statute an objective standard of care, linked to the functions being performed, following the trend of recent cases (e.g., Re D’Jan of London [1993] BCC 646): Company Law Review Steering Group, above n. 138, paras 3.40 and 3.66–3.68. 141 Franks, Mayer, and Renneboog, “Who Disciplines Management”, above n. 26, cite the weak enforcement of fiduciary duties in the United Kingdom as a factor explaining the differences in the effectiveness of boards as monitors between the United Kingdom and the USA. 142 e.g., the DTI supplied the secretary to the Cadbury and Hampel Committees. 143 It has been suggested that responsibility for reform “has been semi-privatised, with the initiative firmly in the hands of fairly small and unrepresentative committees, championing a narrow range of interests”: C A Riley, “Company Law: Whither UK Corporate Governance”, (1997) 1 Amicus Curiae 16. See also Alan Dignam, “Exporting Corporate Governance: UK Regulatory Systems in a Global Economy”, (2000) Co Law 70, at 73–4; Gary Wilson, “Business, State, and Community: ‘Responsible Risk Takers’, New Labour, and the Governance of Corporate Business”, (2000) 27 Journal of Law and Society 151, at 163–5. 144 DTI, Modern Company Law for a Competitive Economy (London, 1998), para 5.2. 145 Ibid., at para 5.4.

262 John Parkinson role of non-executives might be strengthened.146 It is not clear at the time of writing what the outcome of this process will be, or which body (following the transfer of listing functions to the Financial Services Authority)147 will ultimately have responsibility for the application and further revisions of the Code, but the approach adopted indicates an acceptance that there is a public interest in governance rule-making and that this is not something that should be left to purely private bodies with a limited range of membership. A second issue concerns the relative merits of a prescriptive approach on the one hand, and the use of codes of best practice on the other, with reliance on disclosure and market pressure as the enforcement mechanism. The arguments here are well known. Codes are flexible, with the result that companies are not obliged to adopt practices that might be inappropriate in their particular circumstances. To that extent, they are responsive to the objections to regulation mentioned at the beginning of this chapter. As against this, some managements may disregard code provisions without good reason and successfully resist pressure to conform for a considerable period, often in situations in which the need for improved governance is particularly acute. This suggests a case for compulsion through statute. The generally high levels of compliance with the Combined Code seem to indicate that market enforcement has been reasonably successful, though whether it would continue to be so if more rigorous requirements were introduced is unclear. Whatever the appropriate response may be, the issue of compulsion or market enforcement is not an “all or nothing” one. For example, the monitoring obligations of the board could be underlined by imposing an explicit statutory duty to that effect, while leaving the details of board composition and the precise distribution of responsibilities to a code. And with compliance with the Combined Code’s disclosure obligations no longer a matter for the Stock Exchange,148 it will be possible to devise more effective penalties for non-compliance than the (idle) threat of de-listing.

CONCLUSION

This chapter has argued that there are good reasons to believe that monitoring of senior managers by independent non-executive directors is a valuable governance control. Notwithstanding, market pressure alone has not been effective to bring into existence satisfactory monitoring arrangements. It may also be that the codes of practice which have been relied on to stimulate and shape board reform may need to be further refined, or even a more prescriptive approach adopted. 146 See Company Law Review Steering Group, Modern Company Law for a Competitive Economy: Developing the Framework (London, 2000), paras 3.112–3.153. 147 This was necessitated by the demutualisation of the Stock Exchange. Responsibility for the Combined Code currently lies with the FSA, but this is under review. 148 See above n. 147, and accompanying text.

Evolution and Policy: The Non-Executive Director 263 State intervention in the rules governing board function and composition would break fresh ground, but would hardly be something new in the broader scheme of company law. Many of the arrangements that shape the relationships between corporate participants are attributable to private ordering, but there are also crucial elements of the governance framework, for example, the financial disclosure regime and controls on management self-dealing, that are the product of regulation. Contract theorists rationalise legal rules as terms the parties would themselves agree in the absence of transaction costs. Whether or not this is an appropriate characterisation of the content of company law rules, it is an acknowledgement that markets fail. They seem to be failing in relation to the board.

11 Comparative Corporate Governance: Sociological Perspectives GREGORY JACKSON

INTRODUCTION

C

ORPORATE GOVERNANCE REFERS to the patterns of control and decision-making within corporations. While a variety of theoretical frameworks exist for studying corporate governance, the conventional approach is agency theory. In the words of a recent survey, “Corporate governance deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment”.1 International comparisons in this tradition have devoted most of their attention to the relative merits of banks versus markets in bringing managerial behaviour in line with the interests of shareholders. Upon closer examination, agency theory has led to a very narrow view of corporate governance. A first set of problems relate to what can be called dyadic reductionism.2 Agency theory adopts the perspective of isolated bi-lateral contracts between shareholders and management, focusing on their contractual “efficiency”. By contrast, sociological research has pointed to the interdependence between owner-management relations and broader aspects of corporate organisation and strategy. Corporate governance arrangements are not just driven by agency costs, but by many dimensions of interdependence between firms and their market, technical, cultural, social, political, and institutional

1 See Andrei Schleifer and Robert W Vishny, “A Survey of Corporate Governance,” (1996) NBER Working Papers, no. 5554, 2. By contrast, another recent survey gives a more encompassing definition: “Corporate governance relates to the internal organisation and power structure of the firm, the functioning of the board of directors both in the one-tier and the two-tier system, the ownership structure of the firm, and the interrelationships among management board, shareholders, and other stakeholders, in particular the company’s workforce and its creditors”. See Klaus J Hopt, Hideki Kanda, Mark J Roe, Eddy Wymeersch, and Stefan Prigge, Comparative Corporate Governance: The State of the Art and Emerging Research (Oxford, Oxford University Press, 1998), 5. 2 Mustafa Emirbayer and Jeff Goodwin, “Network Analysis, Culture, and the Problem of Agency”, (1994) 6 American Journal of Sociology 1411.

266 Gregory Jackson environments.3 For example, whereas agency theory treats employment relations as exogenously determined by market institutions, employee voice is important in monitoring management in many countries. Such a fact suggests that a coalition or game-theoretic theory of the firm might be more appropriate than straight agency theory.4 Likewise, corporate ownership is an important type of tie within business networks which shape many aspects of competition and cooperation, strategy, structure, and innovation.5 By excluding such other dimensions, agency theory has difficulties understanding corporate governance in terms of institutional interdependence and complementarities.6 A second set of problems relate to the efficiency view of institutions. By assuming that institutions result from efficient equilibriums (e.g., minimising agency costs), economics has trouble explaining why corporate governance differs so greatly across countries in terms of ownership patterns, corporate law, or employee participation. In particular, efficiency perspectives have neglected the role of politics.7 Corporate governance reflects the power relations and political settlements between shareholders, creditors, management, and labour as they are embodied in a particular institutional history. Such political outcomes do not necessarily reflect any abstract view of efficiency. In addition, actors formulate their interests and strategies under high levels of uncertainty, and thus rely in part on cognitive models (ideas or ideology) and existing social norms to help define relevant problems and their solutions.8 A viable theoretical alternative could be informed by “actor-centred institutionalism”,9 where actor interests remain important but institutions also reflect social and political processes of how those interests are defined (“socially constructed”), aggregated, represented, and strategically interact in other arenas. One element of 3 These dimensions of interdependence include agency costs, transaction costs, population density, information, trust, power, and institutional legitimacy. For a review, see Neil Fligstein and Robert Freeland, “Theoretical and Comparative Perspectives on Corporate Governance”, (1995) 21 Annual Review of Sociology 21. 4 See Richard M Cyert and James G March, A Behavioral Theory of the Firm (Englewood Cliffs, Prenctice Hall, 1963) and Masahiko Aoki, The Cooperative Game Theory of the Firm (Oxford, Clarendon Press, 1986). 5 See, e.g., Richard Whitley, Divergent Capitalisms: The Social Structuring and Change of Business Systems (Oxford, Oxford University Press, 1999). 6 Masahiko Aoki, Towards Comparative Institutional Analysis (Cambridge Mass, MIT Press, forthcoming). 7 For political perspectives on the American case, see Mark Roe, Strong Managers, Weak Owners: The Political Roots of American Corporate Finance (Princeton, Princeton University Press, 1994) and Neil Fligstein, The Transformation of Corporate Control (Cambridge, Mass, Harvard University Press, 1990). Britain and Germany are compared in Shawn Donnelly, Andrew Gamble, Gregory Jackson, and John Parkinson, The Public Interest and the Company in Britain and Germany (London, Anglo-German Society for the Study of Industrial Society, forthcoming). 8 e.g., mimetic processes (where organisations may model themselves on other organisations) and normative pressures from professionalisation (formalisation and legitimation of knowledge) also lead to institutionalisation. The role of ideas is prominent in much of “new institutionalism” in the sociology of organisations, e.g. Walter W Powell and Paul J DiMaggio (eds), The New Institutionalism in Organizational Analysis (Chicago, University of Chicago Press, 1991). 9 Fritz W Scharpf, Games Real Actors Play: Actor-Centered Institutionalism in Policy Research (Boulder, Westview Press, 1997).

Comparative Corporate Governance 267 such an approach would be a greater empirical and historical contextualisation of actors rather than deriving actor interests from theoretical assumptions a priori to their institutional environments.10 In sum, the unmet challenge of the corporate governance literature remains better to conceptualise the firm and its governance structures in terms of their embeddedness in social structures.11 This chapter argues for a broader view of corporate governance that takes account of a wider range of relations and institutional arrangements that shape who controls corporations, what interests corporations serve, and how risks and rewards are allocated among stakeholders.12 Such a view could be grounded in economic sociology, drawing on both institutionalist and network paradigms of organisational research. Such approaches have thus far remained marginal relative to comparative research in the “law and economics” tradition. As a first step, this chapter outlines a number of conceptual alternatives and extentions to agency theory, and explores their implications for comparing corporate governance regimes. The first part reviews the agency theory literature on ownership and control. An alternative framework is outlined based on variations in the identities and interests of shareholders. The second part examines the role of employees in corporate governance. Whereas agency theory considers shareholders as the only bearers of residual risk, this account stresses the special features of employment contracts13 and the problems of creating and legitimating authority within the firm14 as a central aspect of corporate governance. The third part outlines some additional features of the social world of management, such as careers and coalition-building, that impact how they respond to stakeholder constituencies in corporate decision-making. The fourth part briefly synthesises these considerations from the perspective of comparing national corporate governance systems. The alternative suggested here is examining corporate governance institutions in terms of their linkages and complementarities.15 Rather than viewing mechanisms in isolation, governance institutions impact each other in ways that give national regimes their coherence or characteristic governance dilemmas. While “efficiency” may relate to complementarities between institutions, the same phenomenon can lead to 10 Efficiency approaches tend to collapse two levels of analysis, namely actors’ interests and institutions, since institutions are derived from the strategic interactions of actors who rationally attempt to minimise costs. 11 On the concept of embeddedness, see Mark Granovetter, “Economic Action and Social Structure: The Problem of Embeddedness”, (1985–86) 91 American Journal of Sociology 481. 12 For a detailed discussion, see Margaret M Blair, Ownership and Control: Rethinking Corporate Governance for the Twenty-First Century (Washington D.C., The Brookings Institution, 1995), 202. 13 See Herbert Simon, “A Formal Theory of the Employment Relationship,” (1951) 19 Econometrica 293 and Herbert Simon, Administrative Behavior (New York, The Free Press, 1976) at 123. 14 For a sociological perspective on the role of authority in employment relations, see Reinhard Bendix, Work and Authority in Industry (Berkeley, University of California Press, 1956). 15 See Aoki, Towards a Comparative Institutional Analysis above n. 6.

268 Gregory Jackson “inefficient” lock-in effects. In this sense, efficiency should be understood in terms of relative advantages in adapting to strategic opportunities rather than absolute advantages in dealing with a single dimension of environmental dependence.

OWNERSHIP AND CONTROL: A REEXAMINATION

In agency theory, the firm is viewed as a “nexus of contracts” between different factors of production that each pursue their own interest.16 Ownership and control constitute separate factors of production wherein management makes decisions and owners bear the residual risk of profit or loss. Owners are assumed to be interested in maximum profit at reasonable risk, maximum distribution of profits as business interests will allow, and rising stock prices. Management interests are less well defined in the theorectical literature. Managers may prefer growth over profits (since empire-building may bring prestige or higher salaries), be lazy or fraudulent (“shirking”), or maintain labour or product standards above the necessary competitive minimum. Given these differences in interest, contracts involve agency costs that are intrinsically non-zero and may be defined as the sum of: monitoring expenditure by the principal, bonding expenditures by the agent, and residual loss. These costs are presumably outweighed by economies of specialization in management expertise and risk-bearing.17 Agency costs arise because contracts are necessarily incomplete, and shareholders face a variety of problems monitoring management. Shareholders are rarely informed enough to make qualified decisions or monitor management in detail. Contractual limits to management discretion may be difficult to enforce in courts. And most importantly, shareholders face free-rider problems where resources devoted to monitoring can be jointly appropriated by all shareholders, reducing individual incentives to exercise actively their rights. Free-rider problems are particularly great where shareholding is fragmented, and investors hold diversified portfolios that favour strategies of exit rather than voice. In sum, substantial barriers exist in constructing effective mechanisms of shareholder control that limit possibilities for managerial opportunism. 16 See Ronald Coase, “The Nature of the Firm”, (1937) 4 Economica 386. This perspective was further developed in several classic articles outlining the agency theory approach, e.g. Michael Jensen and William Meckling, “Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure”, (1976) 3 The Journal of Financial Economics 305; Eugene Fama, “Agency Problems and the Theory of the Firm”, (1980) 88 Journal of Political Economy 288; Eugene Fama and Michael Jensen, “Separation of Ownership and Control”, (1983) 26 Journal of Law and Economics 301; and Eugene Fama and Michael Jensen, “Agency Problems and Residual Claims”, (1983) 26 Journal of Law and Economics 301. 17 Efficiencies outweigh agency costs due to three factors: (1) small equity claims make it easier to accumulate capital from a larger pool of small investors; (2) the separation of ownership and control leads to specialisation in management expertise; and (3) if ownership is fragmented, investors achieve more optimal diversification of their portfolios.

Comparative Corporate Governance 269 Agency costs may result in two significant problems: underinvestment and overinvestment. First, underinvestment is likely to occur where agency costs are not effectively reduced. Adequate corporate governance mechanisms are needed to stablise the flow of investment from the household savings to the corporate sector.18 Comparative studies in this vein have examined issues such as the impact of bank-firm ties on levels of investment, the development of venture capital firms, the degree to which market-based systems lack a supply of longterm funds, or the role of bank and market finance in economic development.19 Secondly, agency theorists focus on the inverse problem: rather than underinvestment, dangers of managerial opportunism also exist in firms with excess cash flow and insufficient opportunities for growth.20 Here, managers may reinvest free cash flow in suboptimal assets rather than paying it out to shareholders. In one critique, “the task of the financial system may not be the traditional one of chanelling funds from households to firms, but rather to channel funds from firms with excessive cash flow to firms with insufficient cash flow”.21 At a sectoral level, problems of capital misallocation may result between declining industries and new growth oriented industries. The shareholder value paradigm developed in this spirit, responding historically to the problems of overdiversification, and slowed growth among American corporations in the 1980s. Given the problems and consequences of agency, how can shareholders assure that once they invest their funds, management will act in their interests? The corporate governance literature has identified several possible mechanisms to reduce agency costs.22 • Incentive contracts: granting managers contingent, long-term incentives to align management to shareholder interests. However, high-powered incentives raises the dangers of self-dealing. • Reputation building: managers may act in shareholder interests because they want to maintain the good will of capital markets in the future or to succeed in managerial labour markets, and hence need to establish good reputations.

18 “Much of the subject of corporate governance deals with constraints that managers put upon themselves, or that investors put on managers, to reduce the ex post misallocation and thus to induce investors to provide more funds ex ante”: Schleifer and Vishny, “A Survey of Corporate Governance,” above n. 1, at 10. 19 While not presenting systematic empirical evidence, the classic statement on the role of banks during industrialisation can be found in Alexander Gerschenkron, Economic Backwardness in Historical Perspective (Cambridge Mass, Bellknap, 1966). A more recent discussion is found in Masahiko Aoki and Hugh Patrick, The Japanese Main Bank System: Its Relevance for Developing and Transforming Economics (Oxford, Oxford University Press, 1994).. 20 See, e.g., Michael Jensen, “Agency Costs of Free Cash Flow, Corporate Finance and Takeovers”, (1986) 76 American Economic Review 323. 21 See Martin Hellwig, “On the Economics and Politics of Corporate Finance and Corporate Control,” in Xavier Vives (ed), Corporate Governance (Cambridge, Cambridge University Press, 2000). 22 The list largely follows the discussion in Schleifer and Vishny, “A Survey of Corporate Governance”, above n. 1.

270 Gregory Jackson • Legal protection: legal provisions may give control and information rights to shareholders, particularly the right to appoint managers, to vote on important corporate decisions, and elect corporate boards. Corporate disclosure, accounting, and bankruptcy rules all have an important impact on the inherent level of agency costs. • Blockholders: concentrated ownership (by banks, government, corporate groups, or families) may reduce agency costs, since large stakes give investors greater incentives to monitor and lower the associated information costs. • Market for corporate control: where ownership is fragmented and most shareholders prefer strategies of exit, markets for corporate control can emerge to restructure underperforming firms through hostile take-overs. Most comparative research has made international comparisons in terms of these mechanisms. Country typologies represent different mixes of the different ways countries “solve” agency problems. Corporate governance regimes are normally classified in terms of insider versus outsider or bank-based versus market-based systems. Britain and the USA are viewed as market-based forms of control—where legal regulation, contractual incentives, and the take-over market are all important. These countries have dispersed ownership structures, and firms rely on equity finance. By contrast, German and Japanese corporate governance rely more on “blockholders”, particularly banks, as active monitors. Due to their greater capacity for direct control, blockholders are presumed to rely less on market-oriented rules for disclosure and giving management highpowered incentives. Firms rely less on outside equity finance, and draw primarily upon bank loans. An underlying similarity is that both types of systems ultimately utilise some form of ownership concentration, but differ precisely in the ways this is achieved—either through large shareholders and banks, or through markets for corporate control.23 International differences in corporate governance systems put into question whether a single type of system is best at reducing agency costs. While fragmented ownership was long considered an efficient evolution, increasing evidence showed that the Berle-Means type separation of ownership and control was the exception rather than the rule around the world. Given its documented importance in Western Europe, interest grew in the agency implications of blockholding.24 While a review of the evidence is beyond the scope of the present chapter, the performance implications of banks versus markets remain controversial. Most studies have examined the isolated effects of particular 23 Many of the mechanisms discussed above may be seen as prerequsites for an effective take-over market. For example, disclosure and accounting rules increase transparency necessary for the price mechanism to operate rationally. However, shareholder exit has only an indirect influence on management as an intermediate step toward reconcentration through take-overs. 24 The work of the European Corporate Governance Network on ownership patterns in Europe can be found at http://www.ecgn.ulb.ac.be/ecgn/control.htm or Marco Becht and Ailsa Roel, “Blockholding in Europe: An International Comparison”, (1999) 43 European Economic Review 1049.

Comparative Corporate Governance 271 governance mechanisms. Yet it would be incorrect to conclude that overall welfare is better or worse based on the incidence of one type of agency costs, since this may lead to a rise in other sorts of agency costs or other governance problems.25 Corporate governance regimes vary not simply in terms of “levels” of agency costs, but the fact that corporate governance institutions are in fact doing different “things”. At a most basic level, this is because shareholders have different underlying identities and interests not well accounted for in the agency theory framework.

Sociological dimensions of ownership The agency theory literature largely views shareholder interests as homogenous functions of risk and reward. Ownership concentration leads to different capacities to exercise control, as well as different exposure to risk. Whereas concentrated ownership leads to stronger external influence on management, fragmentation tends to passify shareholders. Less well conceptualised is the fact that corporations have very different sorts of owners such as banks, pension funds, individuals, industrial companies, families, etc. These groups tend to have different motivations, time horizons, and strategies. Furthermore, their identities differ across institutional environments in which they are embedded. As an obvious example, whereas German banks are universal banks, the functions of investment and commercial banking are separated by regulation in the USA. Table 1 illustrates broad differences in corporate ownership patterns in selected OECD countries. Germany and Japan have high levels of bank and intercorporate shareholding, with relatively low levels of financially-oriented shareholders such as individuals, pensions funds, and investment funds. In Germany family owners are also important, since many large companies remain unlisted private corporations (the GmbH). By contrast, Britian and the USA have very high levels of institutional investors such as pension funds. France is somewhere in between these extremes. The comparison suggests a number of important distinctions between the identities and interests of shareholder groups. Financial versus strategic interests A first distinction can be made between financial interests and strategic interests of shareholders. Individual investors and pensions funds normally have purely financial interests in their ownership stakes. Depending on the time horizons 25 e.g., hostile take-overs may reduce the agency costs of free cash flow, but conversely increase problems of human capital due to breaches of trust. See Ralph Heinrich, “Complementarities in Corporate Governance. A Survey of the Literature with Special Emphasis on Japan”, Kiel Working Paper no. 947, 28.

272 Gregory Jackson Table 1: Ownership of listed corporations, 1990s*

Banks Insurance firms Pension funds Investment firms and others Non-financial firms Individuals Government Foreign

USA 1996

UK 1994

Germany 1997

Japan 1999

France 1996

6%

1% 50% 17% 1% 21% 1% 9%

21% 13% 4% 3% 24% 25% 1% 10%

7%

28% 13% — 49% — 5%

11% 15% — 11% 31% 17% 3% 12%

9% 11% 19% 23% 2% 9%

* Sources: Deutsche Bundesbank, “Ergebnisse der gesamtwirtschaftlichen Finanzierungsrechnung für Deutschland 1990 bis 1997,” (1998) Statististische Sonderveröffentlichung 4; Tokyo Stock Exchange, Tokyo Stock Exchange Fact Book, various years; and OECD, “Shareholder Value and the Market in Corporate Control in OECD Countries”, (1998) 69 Financial Market Trends 1.

and liquidity of investors, financial interests may be long- or short-term, or may be weighted toward dividend payments or capital gains from share price appreciation. By contrast, often times business corporations and banks are not directly motivated by the financial returns to their shares. Rather, strategic organisational interests may dominate: regulating competition, underwriting relational contracts, securing markets, managing technological dependence, protection of managerial autonomy, etc.26 Put another way, the direct benefits of control may override prospects of financial returns.27 The horizontal keiretsu groups in Japan provide an excellent example of most of these functions, which has led observers to describe them as a system of “contractual governance”.28 Company groups shield management from outside shareholder pressure through cross-shareholdings, which underwrite commitments to cooperative busines relations (such as the use of a group wholesalers, subcontracting arrangements, etc.). Ownership is but one dimension within ties that are reciprocal and multiplex: they relate to the totality of relationships, rather than primarily one sort of exchange relation. For example, main bank relationships use ownership to support many other sorts of exchange, such as lending, foreign exchange, or securities underwriting. Also, main bank relations 26 Salaried managers exercise property rights on the basis of their bureaucratic authority—they control shares owned by their companies and pursue a wide variety of company goals. Management neither receives direct financial benefits, nor represents fiduciary interests of private investors. 27 Recently, the term “private benefits of control” has been used in a somewhat similar fashion as strategic interests. However, private benefits most often refers to benefits of privately held firms in family control in contrast to widely held public firms. Such benefits include prestige, reputation, and commitment. The stress here is rather on benefits accumulating to firms in dimensions of industrial organisation. See, e.g., Colin Mayer, “Firm Control”, (mimeo, 1999). 28 W Carl Kester, “American and Japanese Corporate Governance: Convergence to Best Practice?” in Suzanne Berger and Ronald Dore (eds) National Diversity and Global Capitalism (Ithaca, Cornell Univesrity Press, 1996), 107.

Comparative Corporate Governance 273 comingle debt and equity claims in ways that reduce the conflicts of interests between creditors and shareholders. Japan is sometimes described as “capitalism without capitalists” referring to the strength of strategic organisational interests over financial interests within the corporate economy.29 Liquidity versus commitment A second distinction relates to the degree of liquidity or commitment of ownership stakes. Financial commitment involves dependence on the specific enterprise to generate returns, as well as some ability to control appropriation of those returns.30 Commitment generally increases with ownership concentration, but also depends conversely on the diversification of investor portfolios. If two investors each hold a 25 per cent stake in a firm, an investor will be much more committed to that firm if that stake represents 20 per cent rather than; just 1 per cent of their portfolio. By contrast, liquidity reflects fragmented shareholders, diversified portfolios, and deep securities markets that facilitate exit without negatively impacting share prices. Liquid investors will prefer strategies of exit rather than voice to influence corporate management, and will thus differ in their response to organisational decline. Highly liquid investors may also be myopic, pursuing capital gains by following the trends of other investors without strong regard for company performance fundamentals.31 Placing owners along these two dimensions (commitment/liquidity and financial/strategic interests) yields a pragmatic “map” for viewing the different identities and interests of owners. As mentioned above, commitment may be increased by strategic interests, a multiplexity of relations, or reciprocal ties that make exit more costly or give control-related benefits. Such considerations account for the stability of long-term stable shareholding arrangements in Japan despite the relatively low level of bi-lateral ownership concentration. By contrast, institutional investors represent a case combining financial interests with medium levels of commitment. Institutional investors aggregate individual savings into very large investment funds, which are bound by fiduciary duties to act according to financial interests. The concentration of funds among institutions and the broad use of predefined index strategies (the S&P 500, DAX 30, or Nikkei 225) greatly decreases the liquidity of these holdings. Thus, an important 29 Within Japanese cross-shareholding schemes it often is difficult to speak of ultimate ownership. In other countries, interorganisational networks often do have ultimate owners, such as when families and individuals use pyramiding schemes to control other organisations. 30 See William Lazonick and Mary O’Sullivan, “Organization, Finance and International Competition”, (1996) 1 Industrial and Corporate Change 1. 31 See Sigurt Vitols, “The Reconstruction of German Corporate Governance: Reassessing the Role of Capital Market Pressures”, First Annual Meeting of the Research Network on Corporate Governance, Berlin, 23–24 June 2000. My main argument is not that long-term investors are more rational than short-term investors, but that stock prices generally have only very indirect links to company performance as conventionally defined.

274 Gregory Jackson segment of institutional investors have increasingly come to use strategies of voice rather than exit to promote their financial interests, and have become a driving factor in corporate governance reform around the world. Family ownership is another interesting case that can occupy a wide range along these two dimensions. Family ownership has strengths when the noneconomic solidarity of family ties supports economic functions such as capital mobilisation, organisational trust, and value-orientations. Families offer nonfinancial commitment to ownership through patriarchical and personal authority, loyalties, emotion, and traditions.32 Embeddedness in families often leads to a long-term view and expectations to subordinate individual interests—for example, by reinvesting a high proportion of profits into the company. Such embeddedness often gives capital a more patient quality and enables transactions in the absence of other formal institutions. Family solidarity may be undermined by the rational orientations of capitalist organisation, or may take on dysfunctional characteristics. For example, family ownership may have disadvantages such as limiting access to outside funds, conservative business policies, growing uninterest of family members in strategic decisions, loss of motivation for salaried managers due to the monopolisation of top positions by family members, and the conflicts between the private interests of the family and rational management. It should be noted that these two dimensions (commitment/liquidity and financial/strategic interests) should both be seen as on a continuum. Few owners with organisational interests operate with complete disregard to financial returns. Likewise, commitment and liquidity are not categorical distinctions, but differences of degree. How these dimensions actually translate into capacity for control, however, depend on a variety of additional factors, which will be mentioned briefly below. Financial autonomy versus dependence Thirdly, the form and scope for outside influence depends on the financial autonomy or dependence of the corporation.33 Where firms need to issue new capital, existing property rights become diluted and shareholding more fragmented. Bank debt does not dilute existing control rights, unless the corporation defaults. The evolution of control rights is likely to be shaped by the relative supply of bank versus market finance. Conversely, maintaining managerial autonomy or control rights are important factors in financial decisions. Against this background, the conventional banks versus markets debate has generally overestimated the importance of external finance. Existing evidence shows that 32 For an excellent discussion, see Jürgen Kocka, “Familie, Unternehmer und Kapitalismus. An Beispielen aus der frühen deutschen Industrialisierung”, (1979) 3 Zeitschrift für Unternehmensgeschichte 99. 33 For a general formulation of resource dependence, see Jeffery Pfefffer and G Salancik, The External Control of Organizations (New York, Harper & Row, 1978).

Comparative Corporate Governance 275 internal finance is the dominant form among large firms.34 Hence, the influence of bank relationships in countries like Germany and Japan have declined. Given that external finance tends to play a role only at critical moments in the company life cycle, “residual” control rests with management (or sometimes blockholders) rather than shareholders. The strength of control varies with levels of financial autonomy, and suggests that banks and markets reflect rare and highly contingent mechanisms of control. Control rights A fourth dimension shaping shareholder influence is the legal framework of corporate law. Law defines the institutional mechanisms through which shareholders exert control—voting rights, terms of office, competencies of the board and shareholders meetings, etc. Corporate law must balance shareholders´ interests in control with a degree of autonomy for management to act within its own discretion.35 International differences in corporate law are substantial, both in the substantive power of shareholders, as well as the board of directors. The complexity of these differences often defy simple classifications in terms of strong and weak shareholder rights. This can be illustrated with brief reference to Japan, Germany, and the USA. I describe these three “models” in stylised terms as shareholder sovereignty, constitutional, and liberal market-oriented approaches. Japanese law conforms closely to a property rights view of the firm. Shareholder sovereignty is taken seriously and rather unproblematically. The shareholders’ meeting retains very broad powers, and thresholds for exercising many rights are low. However, the law does not include measures designed to address agency problems stemming from a voluntaristic shareholder sovereignty approach to control—neither a liberal approach oriented toward improving control through capital markets through information and disclosure, nor a German approach oriented toward institutionalised monitoring in the legal structure of the board.36 Given the structure of ownership in Japan, shareholder control is relatively neutralised. Germany has taken a different approach by constitutionalising shareholder control through a legally mandated two-tier board structure. Historically, shareholder control was seen as problematic due to the weaknesses of monitoring by small shareholders. The corporate law reform of 1884 strengthened shareholder control by transferring many control rights away from the shareholders’ meeting to a supervisory board (Aufsichtsrat) designed specifically to 34 See, e.g., Jennifer Corbett and Tim Jenkinson, “The Financing of Industry, 1970–1989: An International Comparison”, (1996) 10 Journal of the Japanese and International Economies 71. 35 For a thorough discussion with regard to Japan, see Zenichi Shishido, “Japanese Corporate Governance: The Hidden Problems of Corporate Law and Their Solutions,” Deleware Journal of Corporate Law, forthcoming. 36 See Donnelly, Gamble, Jackson and Parkinson, The Public Interest and the Company in Britain and Germany, above n. 6, for a detailed comparison of the British and German approaches.

276 Gregory Jackson monitor managerial decisions. As such, corporate structure became substantially less voluntaristic and departed from the principles of shareholder sovereignty, while seeking to strengthen shareholder control in the public interest. An important consequence of the two-tier system was to help sustain the influence of large shareholders, such as family owners, banks, and corporate holding companies.37 At the same time, the separation of management and supervision in two separate boards sought to address the need for managerial autonomy and expertise in daily management. Last, American law is perhaps the most contradictory in terms of its aims, not in the least due to political federalism. Without going into detail here, one current of American law is strongly shareholder-oriented in strengthening individual shareholder rights, defining directors’ duties in terms of shareholder interests, and facilitating market-oriented mechanisms of control through strict guidelines for information and disclosure, as well as independent directors. However, another current emphasises the autonomy of directors, particularly in the notion of a business judgement rule, anti-take-over legislation, and the wide variety of managerial defences allowed such as golden parachutes, poison pills, etc. The result is a fairly politicised system of corporate control that leaves a large scope for company level variation in terms of decision-making structure. Network structures A fifth aspect shaping shareholder influence are the structures of corporate networks.38 Network approaches in sociology have demonstrated the importance of the structural positions which influence actors’ access to information and other resources. Thus, networks define structures of power and opportunity. An illustration of such effects can be found in interlocking boards of directorates, where actors “meet again” on multiple boards that link their propensity for cooperation and opportunities for reciprocation.39 Another example concerns the different shapes of intercorporate networks in Germany and Japan. Whereas reciprocal cross-shareholding in Japan creates structures of “mutual hostages” that prevent exit and serve to reinforce commitments within the company group, German corporate groups (Konzern) are much more hierarchically controlled by holding companies. Where the Japanese structure tends to neutralise capital market influences (for example since dividends paid or new 37 Although commonly assummed, the political initiative for the supervisory board does not appear to reflect the political interest of the universal banks. Rather, state bureaucratic elites played a very active role in developing this non-liberal approach to problems of control following a stock market crisis. A detailed account of German corporate law can be found in Gregory Jackson, “Public Interest and the Evolution of German Corporate Law”, mimeo. 38 For example, Ron Burt, Corporate Profits and Cooptation (New York, Academic Press, 1983) or Paul Windolf and Jürgen Beyer, “Cooperative Capitalism: Corporate Networks in Germany and Britain”, (1996) 2 British Journal of Sociology 205; and Frans N Stokman, Rolf Ziegler, and John Scott, Networks of Corporate Power (Oxford, 1985). 39 In Germany, both bankers and labour unionists hold multiple seats on many of the same boards, which increases their dependence on each other.

Comparative Corporate Governance 277 capital raised within cross-shareholding arrangements cancel each other out), the German structure has much more dispersed ownership in its core. A last example might contrast the multiplex business networks in Germany and Japan with networks in the USA and Britain, where networks are less durable and tend not to represent underlying business rationales, while having a comparatively stronger elite or social class character.

Explaining patterns of corporate ownership As argued above, shareholder influence is shaped by the identities and interests of shareholders, as well as the institutional channels available to influence management. Both insights point toward the renewed stress on politics. Given its stress on efficiency, agency theory offers little direct explanation for how international differences in ownership structures arise in the first place. Much of the literature still treats the Berle-Means corporation as an efficient evolutionary outcome possessing advantages over insider models. More recently, several authors have sought to elaborate the agency theory framework by showing how political factors impact the level of agency costs. A research agenda has emerged tracing the historical development of corporate law and corporate governance that focuses on the political contestation over the corporation, and how particular structures of ownership emerged in relation to these political as well as economic factors. A first theme in the literature traces international differences back to the regulation of the financial system. Mark Roe’s thesis is characteristic of this approach, which stresses how the American political system fragmented corporate ownership through its regulation of banks, insurance firms, mutual funds, and pension funds.40 In countries such as Germany and Japan, the banking system was not fragmented politically and often times supported through state intervention and regulation. It remains doubtful whether the political power of banks also discouraged minority shareholder protections. But political explanations of financial systems are an important improvement from conventional explanations related to the late-development effect.41 A second theme traces differences in ownership structures back to the different legal rights of shareholders.42 The argument relates different corporate law regimes to different levels of agency costs. Specifically, common law countries developed stronger rights for minority and small shareholders than civil law countries, thereby reducing agency costs and facilitating the development of a 40

See Roe, Strong Managers, Weak Owners, above n. 7. Little evidence suggests that the late-development effect alone explains the dominance of banks. The main bank system in Japan only emerged in the post-war period, rather than during industrialisation. And while German banks played an earlier role, bank lending does not appear to have been a main source of finance for Germany’s industrial growth. 42 R La Porta, F Lopez-de-Silanes, A Schleifer, and R Vishny, “Law and Finance”, (1998) 6 Journal of Political Economy 1113. 41

278 Gregory Jackson more fragmented ownership structure. Absent strong minority protections, blockholding is viewed as an efficient adaptation to solve agency problems. A third theme posits a negative correlation between the rights of shareholders and the rights of employees.43 Political alliances between workers and management are as seen as a factor promoting ownership concentration. Employee influence may deter the development of legal shareholder protections and incentives to align management with shareholders. More directly, workers’ participation rights or employment protections are viewed to hinder managerial alignment with shareholders. This results in higher agency costs. Concentrated ownership is a resulting adaptation to cope with these higher costs and the weaknesses of other governance mechanisms to reduce them. It should be noted that this literature reflects a relatively zero-sum view of employee control. It remains unclear why the costs to shareholders of protecting employee interests should outweigh the benefits of greater managerial accountability on the whole or more rational management with regard to human resources.44 Comparative case studies examining the historical evolution of corporate governance remain rare.45 The search for single variable explanations will likely fail, and is no substitute for detailed empirical work. The above discussion suggests two shifts in emphasis for future research. The sociological aspects of ownership discussed above suggest looking more seriously at what motivates ownership stakes, and how control rights coevolved with other sets of institutions such as corporate finance, industrial organisation, and employment practices. Given that outcomes are not determined solely by agency costs, better theories of institutional change must be developed that take into account a more heterogeneous set of factors in such areas as the financial system, corporate law, anti-trust regulation, industrial relations, and the provision of pension finance (see below).46

43 For a cross-national statistical analysis, see Marco Pagano and Paolo Volpin, “The Political Economy of Corporate Governance,” (mimeo, 1999), or a broad discussion of the issues in Mark J Roe, “Political Preconditions to Separating Ownership From Corporate Control”, Working Paper no. 155 (Columbia Law School, Center for Law and Economic Studies, 2000). 44 A central effect of co-determination in Germany has been to rationalise human resource management and adopt long-term strategic perspectives, which have positive effects on firm performance. 45 A comparison of Germany and Japan can be found in Gregory Jackson, “The Origins of NonLiberal Corporate Governance in Germany and Japan” in Wolfgang Streeck and Kozo Yamamura (eds), The Origins of Non-Liberal Capitalism: Germany and Japan Compared (forthcoming). For a detailed overview of Japan, see Tetsuj; Okazaki, “The Japanese Firm under the Wartime Planned Economy” in Masahiko Aoki and Ronald Dore (eds), The Japanese Firm: The Sources of Competitive Strength (Oxford, Oxford University Press, 1994). 46 On the role of pensions, see Gregory Jackson and Sigurt Vitols,“Pension Regimes and Financial Systems: Between Social Security, Market Liquidity and Corporate Governance”, in Bernhard Ebbinghaus and Philip Manow (eds), Varieties of Welfare Capitalism (London, Routledge, forthcoming).

Comparative Corporate Governance 279 FIRMS AS HIERARCHIES: EMPLOYEES IN CORPORATE GOVERNANCE

The corporate governance literature largely neglects the role of employees. On a practical level, this probably relates to the marginal role of employee participation in Anglo-Saxon countries. On a more theoretical level, corporate governance is defined in terms of owners and managers because agency theory considers shareholders as the only bearers of residual risk.47 Employees enter into the theory of the firm by selling their labour for a definite price, and then “they become completely passive factors of production employed by the entrepreneur in such a way as to maximise his profit”.48 In other words, the labour market exogenously determines the wage-effort bargain. This view ignores basic characteristics of the employment relation. Corporate property rights form not only a basis for control over material assets, but also create an authority relationship with employees who are dependent on gaining access to those assets in the labour market. In addition to this asymmetry, labour contracts are fundamentally indeterminate and employment tasks must be coordinated through the hierarchical authority of the employer. Yet all authority relations share that “those in command cannot fully control those who obey”.49 Particularly where the many contingencies of the labour contract cannot be specified in advance, effective authority requires legitimacy to promote the goodwill of the subordinates to follow the spirit rather than the letter of the rules.50 The legitimation of managerial authority finds its limits in the reactions to the differences between formal equality of citizens before the law and substantive inequality of parties in the labour contract. The legitimation and limits of managerial authority involves a complex intersection of economic, political, and social forces. Put another way, the question is the extent to which property rights supersede other sorts of rights. Still, why should we consider employees as part of corporate governance? First, the constraints placed on managers by owners and employees are interdependent. Underlying economic trade-offs may exist between wages and profits, internal investment and paying out dividends, or levels of employment and shareholder returns. Given this practical interdependence of outcomes, the institutional mechanisms involving (or excluding) shareholders, employees, and management in decision-making must also be viewed as interdependent. In this 47

For a detailed critique, see Gavin Kelly and John Parkinson, Chapter 6 above. See Simon, “A Formal Theory of the Employment Relationship”, above n. 13. Agency theory views firms as a nexus of contracts and gives no special role for the employment relation. In one formulation, the firm “has no power of fiat, no authority, no discplinary action any different in the slightest from ordinary market contracting between two people”, see AA Alchain and H Demsetz, “Production, Information Costs, and Economic Organization” (1972) 62 American Economic Review 777. 49 Bendix, Work and Authority in Industry, above n. 14, at xlv. 50 Herbert Simon, Administrative Behavior (New York, The Free Press, 1976), 123 describes this as a “zone of acceptance” of managerial prerogative that must be supplemented with a “zone of judgment” involving the initiative and judgment of the worker during the execution of the directive. 48

280 Gregory Jackson sense, employee influence may lead to greater agency costs for owners. However, a purely antagonistic relation should not be implied. Shareholder and employee interests often coincide and they sometimes form alliances to remove poorly performing or fraudulant management or to make corporate information more transparent. Furthermore, power vis-à-vis management is not a zerosum situation because increasing managerial accountability to one group may increase accountability in general. Secondly, the impact of corporate governance regimes on corporate behaviour depends greatly on the linkages and complementarities between different institutions. A large literature on Japan stresses the complementarities between the financial commitment of shareholders and the long-term nature of the lifetime employment system.51 Likewise, parallels are drawn between the more active markets for corporate control in the USA and the more flexible labour market institutions. Different combinations of institutional factors give rise to comparative advantages in particular strategies of production, innovation, etc. Thus, a stronger view toward institutional complementarities is needed if we are to establish more clearly links between institutions and company performace. A few brief examples can illustrate that the social and political limits to the authority vested in corporate property can be significant. In Germany, employee influence in corporate governance is very extensive and formalised. Codetermination at the level of the supervisory board and the works councils institutionalises employee voice. Works councils have extensive rights to information, consultation, and co-determination on matters relevant to employment conditions. The works council is legally bound to represent the employees as a whole, maintain social peace, and promote the welfare of the enterprise and its employees. Employee representatives on the supervisory board give a counterweight to capital in the appointment of management, as well as involving employees in the ex post monitoring of strategic business decisions. In particular, the appointment of a labour director to the management board by the employees greatly reinforces the consensus nature of decision-making within the board. Given the different constituencies of managers and the “dual loyalty” of the labour director, horse-trading and compromise have become particularly important, in contrast to systems such as the USA with more hierarchical influence by the CEO. Industrial democracy has been an integrated feature of German corporate governance. In Japan, employee voice is not institutionalised by law but is nonetheless central in corporate governance. Labour unions are generally enterprise-based, and support the formation of strong internal labour markets and the lifetime 51 Masahiko Aoki, “The Japanese Firm as a System of Attributes” in Masahiko Aoki and Ronald Dore (eds), The Japanese Firm: Sources of Competitive Strength (Oxford, Oxford University Press, 1994), 11; Gregory Jackson, “Corporate Governance in Germany and Japan: Liberalization Pressures and Responses” in Wolfgang Streeck and Kozo Yamamura (eds), Germany and Japan: The Future of Nationally Embedded Capitalism in a Global Economy (forthcoming); Ralph Heinrich, “Complementarities in Corporate Governance. A Survey of the Literature with Special Emphasis on Japan”, Kiel Working Paper no. 947.

Comparative Corporate Governance 281 employment system. Union voice is institutionalised through informationsharing, joint consultation, and co-determination rights that are established through collective bargaining. Joint-consultation agreements exist in most large firms, and are often retained unchanged for decades. For example, Mitsubishi Heavy Industries collective agreement provides for company-level and workslevel councils that confer co-determination rights regarding personnel issues and consultation rights concerning business strategy. While employees have no board representation, they do influence management selection indirectly, since many senior managers are also former union officials. While we might be tempted to ignore employees within liberal corporate governance regimes such as the USA, employees also play a role there. Attempts to build strong “corporate cultures” in the USA may be viewed as functional analogues to more democratic systems of employee participation in Germany, Japan, or other European countries. Stock options and other performancerelated incentives play an important role in legitimating authority, or better— appearing to replace authority with high-powered contingent incentives.52 Conversely, organised labour has increasingly attempted to use its control over pension fund capital to exercise voice through the traditional channels of shareholder control. The AFL-CIO has particularly targeted egregious managerial pay in its shareholder activism, and has found some allies among institutional investors. Employee ownership, such as at United Airlines, also represents an alternative model of employee voice within a legal framework of adversarial industrial relations and stronger shareholder control.

THE SOCIAL WORLD OF TOP MANAGERS

The notion of managerial interests is a common, but underspecified concept. As discussed above, managerial opportunism is central to agency theory. But apart from the possibility of shirking, little is said about management. What are the interests of management? How do managers prioritise and attend to the multiple and conflicting goals of organisations and their members? What conditions are required effectively to influence management? This chapter has conceptualised organisational decision-making in terms of coalitions.53 Organisational goals result from coalition-building among multiple actors, whose objectives may be conflicting or complementary. Most organisational goals are experienced as constraints upon decision-makers that must be obtained at minimum levels (“satisficing“).54 Only under very specific conditions, can managers be said to maximise regarding single organisational goals such as 52

Gideon Kunda, Engineering Culture (Philadelphia, Temple University Press, 1992). For detailed theoretical expositions, see Cyert and March, A Behavioral Theory of the Firm, above n. 4; Aoki, The Cooperative Game Theory of the Firm, above n. 4; and Henry Mintzberg, Power In and Around Organizations (Englewood Cliffs, Prentice Hall, 1983). 54 Herbert Simon, “On the Concept of Organizational Goal”, (1964) Administrative Science Quarterly, 1. 53

282 Gregory Jackson profitability or shareholder value. Here maximisation is not meant in the sense of optimisation of outcomes, rather as residual discretion that can be used in pursuit of a primary goal. More often goals are attended to sequentially, for example when organisations oscillate between cycles of expansion and consolidation. Beyond the constraints placed by shareholders and employees, managerial decision-making is structured by a variety of other factors: • Careers. How is top management selected? Although shareholders normally appoint management in the formal sense, the labour market for top management is already highly structured prior to shareholder approval. Shareholders’ factual influence is nominal and generally limited to approving candidates already selected by corporate boards. Thus, greater attention should be paid to the structures of managerial labour markets—the degree of internal promotion versus external mobility, systems of eduction and training, methods of employee evaluation, and mechanisms of remuneration. • Incentives. Management pay is a hotly debated topic. International differences in managerial compensation are great both in level and in terms of the sorts of incentives used. Stock options remain rare in countries such as Germany and Japan, while being viewed as central to limiting agency costs in Anglo-Saxon contexts. However, many existing pay schemes linking pay to performance have been strongly criticised for giving perverse incentives in practice. Some observers doubt whether stock prices reflect managerial performance at all, while others suggest that downward risks are very small compared to the high-powered pay-offs. • Routines and interactions. Boards have different legal and normative routines for making decisions and monitoring their implementation. Boards differ in their composition of insiders and outsiders, the role of consensus or unilateral decision-making, and the social distance of top management from operational management. • Internal and external coalitions. Management autonomy depends on the structure of internal and external coalitions. Where competition is fierce or internal conflicts arise among managers, some factions may seek the support of other stakeholder groups in forming coalitions to effect changes in management personnel or strategy. Here, internal politics can become very important and gravitate against established patterns of authority. • Ideas. Ideas or cognitive models shape managerial perception of relevant organisational problems and their solutions. The diffusion of ideas is shaped by a wide variety of mimetic and normative processes, as well as coercion from outside institutions. The adoption of particular technical and organisational practices not only represents functional demands or direct interest group pressures, but more subtle processes of diffusion and influence.55 55 An excellent study has examined the diffusion of different organisational models in the USA, Spain, Germany, and Britian. See Mauro F Guillén, Models of Management (Chicago, University of Chicago Press, 1994)

Comparative Corporate Governance 283 Again a few examples will have to suffice here to illustrate how these factors influence corporate governance. In Germany, top management tend to be functional specialists and board positions are often allocated according to different specialisations. Scientific and engineering backgrounds dominate the highest positions, while more recently finance specialists have increased their influence at several prominent companies. This shift is symptomatic not only of shareholder demands, but of the internationalisation of managerial labour markets and the growing encounter of German junior management with AngloAmerican management cultures. Special mention should also be made of the labour director (Arbeitsdirektor) nominated or appointed with consent of the employees on the supervisory board. This director plays a “dual role” in being a member of the board, as well as enjoying the trust of employees. The legal principle of collegiality in the management board both militates against strong dominance of the president, and helps balance financial considerations with other management functions such as operations and personnel. Functional orientation and consensus principles exist within the context of a pluralist set of external influences in the supervisory board. The difficulties of unilateral action by single organisational constituencies have lead to a consensus-oriented management culture. It is rare that management is captured by single constituencies, because three-way bargaining can constitute an additional degree of autonomy. Stakeholder interests must be negotiated in shifting coalitions that involve patterns of horse-trading, issue-linking, and package deals. Monitoring involves both shareholders and employees, compensation systems do not traditionally use high-powered stock option type incentives, and the collegial decision-making structure balances financial considerations with other management functions such as operations and personnel. In Japan, the board system is weakly defined by law, and leaves great discretion for its internal make-up. Boards are very autonomous, facing little prospect of external intervention. Management are largely internally promoted employees and boards are often very large (sometimes around forty members) in order to integrate a large number of division managers in the internal promotion system. Having risen through the ranks of the internal labour market with its extensive job rotation, Japanese management are usually generalists with extensive knowledge of the company as a whole rather than specialists in particular fields. The president and chairman usually have a fairly dominant role, particularly in the selection of board members. Outside directors are rare, and are dispatched from the main bank to provide advice or as crisis intervention. While authority is relatively centralised with the president, Japanese management has a large number of mechanisms that tend to decentralise control. The information structure in Japanese firms is quite dispersed and promotes a bottom-up rather than top-down information flow that militates against centralised control.56 Bureaucratic and financial control are relatively weak, while ideological 56 Masahiko Aoki. Information, Incentives, and Bargaining in the Japanese Economy. (Cambridge, Cambridge University Press, 1988).

284 Gregory Jackson control (identification and company mission) is be said to be strengthened. This emphasis on long-term group management and the civil service-like nature of the internal promotion system is reflected in the extremely low salary differentials between Japanese top management and average employees. American management is likely the most politicised and finance-oriented. Given the lack of federal legal requirements on board structure, most American firms developed a directoral principle that concentrates power in the hands of the CEO, unlike the collegial principle of German boards. In principle, management is held accountable to the board, but in fact American boards integrate monitoring and management functions in a single board. Appointment is usually strongly influenced by the CEO, particularly since the the CEO often also serves as the chariman of the board. Given this blurred structure, the main issue of debate has been the roles of inside versus independent directors.57 Independent directors are outsiders who tend not to represent specific interests of major stakeholders, but are supposed to represent shareholder interests as a whole.58 New York Stock Exchange listing regulations have helped to increase the number of indepedent directors, and strengthen the work of committees to counter the influence of the CEO. The actual impact of board membership appears to be the diffusion of practices rather narrowly related to management itself.59 Strong centralised control is also related to the use of sophisticated financial control within corporations, stringent rules on external disclosure, and a compensation system strongly linked to stock prices and rewards management disproportionate to employees. Neil Fligstein has characterised this complex of factors as a “financial conception of control”.

NATIONAL CORPORATE GOVERNANCE “MODELS”?

The previous sections have outlined numerous important dimensions of corporate governance research neglected by agency theory. It remains beyond the scope of this chapter to propose a detailed theoretical framework or alternative typologies for national systems. However, the central argument for comparative research is to view corporate governance in terms of its linkages and comple57 In 1973, only 8 per cent of corporations had an independent nominating committee compared to 64 per cent in 1993. By the 1990s, over 90 per cent of firms have a majority of outside directors. See Jeremy Bacon, Corporate Boards and Corporate Governance (New York, The Conference Board, 1993). 58 60 per cent of firms had no directors that represent a major customer or supplier, or who have significant business connections to a member of the firm’s management. Only 25 per cent of survey firms had a major supplier represented on the board and 14 per cent had major customers represented. See Bacon, Corporate Boards, above n. 57. 59 e.g., one major study summarises some of the effects of corporate interlocks: a high correlation of CEO salaries, high recruitment from interlocked boards, correlation of take-over activities between linked firms, correlations in adopting the M-form, and the adoption of poison pills. See G F Davis and H R Greve, “Corporate Elite Networks and Governance Changes in the 1980s” (1997) 103 American Journal of Sociology 1.

Comparative Corporate Governance 285 mentarities. In economics, the concept of complementarities refers to situations where institutions become more viable in combination with specific other institutions.60 Rather than viewing governance mechanisms in isolation, institutions impact each other in ways that give national regimes their coherence or characteristic governance dilemmas. Such a perspective developed in sociology as the “societal effect” approach to the study of international differences in work organisation.61 One example mentioned already was that shareholder and employee rights display a wide array of conflicts and complementarities that depend upon institutional arrangements. In Japan, the dominance of organisational interests and long-term commitments among shareholders supports managerial alignment with employees and stablises long-term cooperation. Likewise in Germany, stable blockholders and employee co-determination institutionalise a positive-sum relation between capital and labour, where minimal guaranteed returns to shareholders balance claims to stable employment. The existence of complementarities should not imply a standard of efficiency. While competitive advantages may relate to complementarities between institutions, the same phenomenon of interdependence can lead to “inefficient” lockin effects. In this sense, efficiency should be understood in terms of relative advantages in adapting to strategic opportunities rather than absolute advantages in dealing with a single dimension of environmental dependence. What perspective do the concepts of institutional linkages and complementarities offer for explaining institutional variation? Elsewhere I have developed the notions of coevolution and unintended fit to describe institutional change with regard to corporate governance in Germany and Japan.62 These cases suggest that governance systems were not designed to fit together, but result from the piecemeal coevolution of governance institutions each responding to a wide range of social forces. The overall “path” of change can only be described in terms of historical sequence. For example, the Japanese model was initially shareholder-oriented but inherited a legacy of strong family ownership in zaibatsu firms that served to stabilise the financial commitment of owners and give rise to paternalistic labour management. Strong state intervention during the Second World War weakened the institutions of shareholder control and bolstered employee participation. Finally, during the post-war period, both ownership and labour management were “democratised” along with the introduction of political 60 e.g., the welfare effects of an institution A may increase in combination with institution B, but not with institution C. Here, A and B are complements, but not A and C. 61 See Arndt Sorge and Malcom Warner, Comparative Factory Organization: An Anglo-German Comparison of Manufacturing, Management and Manpower (Aldershot, Gower, 1986); Marc Maurice, Francios Sellier, and Jean-Jacques Silvestre, The Social Foundations of Industrial Power: A Comparison of France and Germany (Cambridge, Mass, MIT Press, 1986). 62 See Gregory Jackson, “The Origins of Non-Liberal Corporate Governance in Germany and Japan” in Wolfgang Streeck and Kozo Yamamura (eds), The Origins of Non-Liberal Capitalism: Germany and Japan Compared (forthcoming).

286 Gregory Jackson democracy. Zaibatsu families were purged from ownership and their firms split into numerous separate companies. A new generation of managers were internally promoted and forged new cooperative relations through constructed corporate networks centred around a main bank. Meanwhile, internally, a strong post-war union movement democratised paternalistic traditions of labour management and gained voice in enterprise management. This history shows remarkable parallels to Germany, which followed a similar developmental sequence whereby non-liberal corporate governance institutions from the period of industrialisation were gradually democratised in the wake of political democratisation, thereby preserving many non-market features within a largely liberal post-war order.

CONCLUSION

What accounts for differences in corporate governance around the world? And what implications do these differences have for company performance and social welfare? The conventional literature on corporate governance still has substantial gaps for studying international diversity. Most of these derive from a theoretical foundation built too narrowly upon the assumptions of agency theory. This chapter has argued that corporate governance is not just about shareholder returns, nor efficiency. Different shareholder groups pursue a variety of interests, and utilise a diversity of governance mechanisms. Furthermore, shareholders are not alone. Employees are an important force in corporate control. And management responses are shaped by the possibilities of coalitions with stakeholders, as well as the dynamics of their own careers, ideas, and incentives. Corporate governance institutions are not driven only by agency costs. Theoretical perspectives will have to account for institutional processes involving a broader host of political and social factors. These have yet to be studied in their detailed historical evolution, although first efforts have been made. A good starting point would be conceptualising actors in terms of their embeddedness in social structures. Such a view suggests a shift from viewing corporate governance systems in terms of absolute advantages in reducing agency costs. The performance implications of corporate governance systems are likely to be more subtle and yet more pervasive at the same time. The way an organisation is controlled impacts its entire corporate culture—strategy, information, skill formation, organisation, and so on. The impacts of governance institutions can be examined from the perspective of institutional linkages and complementarities. Many observers might feel this broadens the research task beyond the question of “corporate governance” in its conventional sense. However, this chapter may have helped illustrate that such a perspective makes better sense in understanding the rationale and strengths of existing systems, as well as explaining their historical ori-

Comparative Corporate Governance 287 gins and future evolution. It may also offer a remedy to the current debates on globalisation that posit that the internationalisation of capital markets will force a covergence of corporate governance structures around the world on the American model due to its greater efficiency in reducing agency costs. If such convergence would occur, it will be the result of politics.

Index Accountability: alternative mechanisms, 238–41 directors, 4, 51 institutional shareholders, 16, 46 managers, 45, 106, 149, 280 non-executive directors, 17, 253, 257 participation, 113 pension funds, 16, 46 political pressure, 253 shareholders’ rights, 36, 46 Accounting practice: banks, 65 Cohen Committee (1945), 62, 63 consolidated accounts, 62 disaggregation, 62 Germany, 85 Jenkins Committee (1962), 65 Laski’s proposals, 56–7 see also Monitoring Activism: corporate performance, 15–16, 199–201 costs, 183, 184, 224, 239 disincentives, 195–6, 227 external fund managers, 195–6, 227, 230–1, 239 information requirements, 241 institutions, see under Institutional shareholders proxy battles, 153, 154, 156 rentiers, 160 shareholders’ rights, 45–6 stakeholders, 47 United States, 153, 198–201, 226–7, 229 voting, see Voting see also Exit AFL-CIO, 281 Agency: agency costs: blockholders, 270, 278 cash flow, 269 company law, 277–8 definition, 268 employees’ rights, 278, 280 incentive contracts, 269 incomplete contracts, 268 inefficient managers, 235 legal protection, 270 minimised/limited, 116, 234, 238, 266, 269–70 overinvestment, 269

politics, 277 reductionism, 18 stock options, 282 underinvestment, 269 variation, 271 agency problem, 196, 229, 235 corporate governance, 18 critique, 18 directors, 142 dyadic reductionism, 265 efficiency, 18, 116, 162, 277 employment relations, 266, 278, 279 external fund managers, 196, 217, 218, 229 interdependence/complementarities, 266 investment managers, 217, 218 managerial opportunism, 281 market for corporate control, 44, 162, 270 non-shareholders, 117–18 ownership, 163–8 pension funds, 196, 217, 218, 229 political economy, 2 private ownership, 4 privity of contract, 218 property rights, 155 residual risk, 267, 279 return on investment, 265 secret profits, 218 shareholders/managers: bilateral contracts, 18, 265 costs minimised, 116 different interests, 19 market for corporate control, 44 negotiation, 13 nexus of contracts, 142, 165 Alchian, Armen A., 153, 157, 158, 165, 166 Anglo-German Foundation, 1, 2 Aoki, Masahiko, 19 Assets: contractual theories, 119–20, 128 entity theory, 145–8 insurance companies, 205 ownership, 29, 147, 148, 164, 167 redeployment, 120, 128 specificity, 119, 128, 129 suppliers, 128 Association of British Insurers (ABI), 230, 255, 256 ASTMS, 67 Atlee, Clement, 181 AUEW, 74

290 Index Australia: Australian Law Reform Commission (ALRC), 217 pension funds, 217, 229–30 unit trusts, 221–2 Authoritarianism: Conservative Party, 39 pluralism, 4 Autonomy: financial, 274–5 managers, 4, 37, 152, 282 Bain, George, 77 Bank of England: inefficient managers, 17, 251 limited liability, 31 non-executive directors, see under Nonexecutive directors rescue operations, 251 Banks: accounting practice, 65 bank debts, 274 Circular to Bankers (1840), 31 economic development, 269 Germany, 83, 84, 86, 270, 271, 275, 277 Japan, 270, 271, 272–3, 275, 277 joint stock companies, 31 leveraged buy-outs (LBOs), 160 managerial behaviour, 265 monitoring, 270 nationalisation, 183 secondary bank crisis, 251 strategic interests, 272 United States, 159, 271, 277 Bare trusts: insurance companies, 205 nominee shareholders, 201 open-ended investment companies (OEICs), 208, 223 pension funds, 204 Beneficial owners: corporate trustees, 203–4, 210, 215–16 insurance companies, 205 interests, 202 investment trusts, 207 open-ended investment companies (OEICs), 208 pension funds, 203–4, 213, 215, 217, 218 unit trusts, 206, 222 see also Share ownership Benn, Tony, 70, 73, 80 Berle, Adolph, 4, 36, 40, 58, 149, 150, 152–3, 155–60, 163, 270, 277 Biggs, Norman, 107 Bilateral safeguards: collective bargaining, 126 employment, 126–7 firm-specific investment, 127

firm-specific risk, 119, 126–7 Black, B.S., 199–200 Blair, Margaret M., 127, 130 Blair, Tony, 107, 194 Blecher, M., 95, 98, 99 Blockholders, share ownership, 270, 275, 278 Boards: boardroom behaviour, 243 directors, see Directors interlocking, 276 monitoring, see Monitoring non-executives, see Non-executive directors supervision, see Supervisory boards two-tiers, see Two-tier board system see also Managers Bondholders: shareholders compared, 149 veto, 118, 126 Booth, Albert, 79 Boothby, Robert, 40 Bowden, Sue, 14, 15, 175–94 Branson, Douglas, 142 Bratton, William, 142 British Institute of Managers, 250, 251, 252 British Leyland, 181, 182 Brougham, Henry Peter, 31 Bullock Committee (1976): 2x+y formula, 77, 106 co-determination, 76 Conservative Party attitudes, 78 industrial democracy, 10, 42, 54, 76–80, 104–7, 253 internal company structures, 6 Labour Party attitudes, 8, 76–80 majority report, 77, 105 membership, 76 minority report, 78, 106 proposals defeated, 43, 52–3, 79–80, 106 supervisory boards, 78, 106, 107 terms of reference, 76, 78 Trade Union Congress (TUC), 105 two-tier board system, 77, 106, 107 worker directors, 77–8, 253 Cadbury Code: chief executives (CEO), 256 compliance, 236, 256, 258 non-executive directors, 17, 256, 258 review, 257 self-regulation, 17, 44, 45 see also Codes of practice Cadbury Committee, 17, 107, 255–6 Californian Public Employees’ Retirement System (CalPers), 46, 198–9, 229, 230 Callaghan, James, 76, 80, 181 Callard, Sir Jack, 107 Campbell, David, 162, 163

Index 291 Canal companies, 29–30 Capital markets: efficiency, 161–2 Germany, 6, 85–90 globalisation, 180, 186 institutional shareholders, 178 joint stock companies, 146, 147 managers, 153, 156, 157, 269 reputation, 269 source of finance, 164, 269, 274 see also Stock exchanges Capitalism: collective capitalists, 3 corporate bureaucracy, 36 Crosland’s analysis, 152 disintegration of property, 169, 170 employment, 28–9 entrepreneurial capitalism, 27, 28 individualism, 152 market pressure, 153 Marxist analysis, 3, 35 moral basis eroded, 170 People’s Capitalism, 159 twentieth century dominance, 4, 21 Charkham, Jonathan, 251, 254, 256 Chayes, Abram, 151, 158 Chief executives (CEO): Cadbury Code, 256 malpractice, 236 non-executive directors, 245, 259 removal, 245 United States, 245, 280, 284 Christman, John, 168 Citrine, Walter McLennan, 61 Civil servants, government intervention, 188–9 Clift, Ben, 7, 51–81 Coase, Ronald, 116, 157, 158 Cobden, Richard, 32 Codes of practice: Cadbury, see Cadbury Code Combined, see Combined Code compliance, 45, 236, 256, 258, 262 continuing role, 261–2 flexibility, 262 good practice, 45 Greenbury, see Greenbury Code Hampel, see Hampel Code Listing Rules, 45, 236, 257 market pressure, 236 sector-wide initiatives, 235–6 shareholder value, 45 stakeholders, 44 takeovers, 15, 184 see also Self-regulation Co-determination: Bullock Committee (1976), 76 consensus, 134 deadlock avoided, 132

directors, see Worker directors Germany, 9, 76, 91, 104, 132, 134, 280, 285 innovation, 104 Japan, 281 participation limited, 9, 134 pluralism, 134 veto, 72 see also Industrial democracy Coffee, J.C., 195, 198 Cohen Committee (1945): conservative results, 65 evidence, 61–2 Industrial Boards, 63 Labour Party attitudes, 8, 41, 53, 54, 60–4 nominee shareholders, 62, 63 subsidiary companies, 63 Trade Union Congress (TUC), 62–3 Cole, G.D.H., 54, 57–8, 59 Collective bargaining: bilateral safeguards, 126 industrial democracy, 72, 73, 74, 79 Japan, 281 socialism, 70 trade unions, 41, 53, 67, 69, 73, 74 Collective capitalists, 3 Collison, Lord, 69 Combined Code: Company Law Review Steering Group, 17–18, 261–2 compliance, 236, 258, 262 disclosure, 262 Listing Rules, 45, 236, 257 non-executive directors, 259, 260, 261–2 revision, 262 self-regulation, 17, 44 see also Codes of practice Commitment: external fund managers, 230–1 family companies, 274 Japan, 280 liquidity compared, 273–4 Companies: acquisitions and mergers, see Takeovers administrative coordination, 28 anti-political writing, 21 common features, 1 contractual model, see Contractual theories creation of state, 143 diversity of form, 22, 26 embeddedness in social structures, 267, 274 fraudulent promotion, 30, 247 game theory, 266 legislative creation, 29–30 market coordination, 28 members: insurance companies, 205 registration, see Registered holders separation, 147

292 Index Companies (cont.): members (cont.): shares, see Share ownership; Shareholders wider participation, 151 moral basis, 13, 26–9, 170 political parties, 38–42 politics, 21–49 professional organisation, 55, 56 public-private axis, 142–5, 168–73 “republics”, 26, 34, 36, 45 subsidiaries, see Subsidiary companies theoretical literature, 1–2 Companies and Securities Advisory Committee (CASAC), 217 Company law: 1975 Bill, 75 agency costs, 277–8 contractual theories, 171 control rights, 275–6, 277–8 Germany, 275–6 Japan, 275 joint stock companies, 145–6, 169 Labour Party policy, 7–8, 15, 41, 51–81 licence, see Licence to operate licence to operate, 22–3, 27 “Magna Carta”, 33 monopolies and mergers, 38 non-executive directors, 17 personality, see Legal personality United States, 276 Company Law Review Steering Group: Combined Code, 17–18, 261–2 contractual theories, 141 non-executive directors, 260 pluralism, 12, 141 shareholder value, 12, 141, 160 shareholders’ rights, 12 two-tier board system, 260 Competition: external fund managers voting, 225, 228, 239 liberalism, 4 monopolies and mergers, 38 public interest, 44 public policy, 5 see also Market pressure Competition Commission, 48 Complementarities, institutions, 280, 284–5 Compliance: codes of practice, 45, 236, 256, 258, 262 legal compliance, 5 negotiated compliance, 48 Confederation of British Industry (CBI), 252, 253 Conflict of interest: external fund managers voting, 196, 220 institutional shareholders, 239 labour/capital, 42 worker directors, 69

Conservative Party: authoritarianism, 39 Bullock Committee (1976), 78 companies, adversarial conception, 66 co-partnership, 40 corporate economy, 38 Employee Share Ownership Plans (ESOPs), 46 entrepreneurial economy, 39 industrial democracy, 40 industrial relations, 39–40 joint stock companies, 39 landowners, 38 managers, 39 non-executive directors, 251 One Nation Conservatism, 41 owner-manager ideal, 39 private associations, 44 property rights, 38–9, 44 self-regulation, 41, 43–4, 73 shareholders’ rights, 44 see also Political parties Constitutional structures: Germany, 5, 6, 90, 275 legitimacy, 66 pluralism, 47 public responsibilities, 27, 55, 56 Consultation: consensual negotiation, 10 European Commission, 109–10 social dialogue, 101–2, 103, 104 trade unions, 66 UK companies, 108 Contract of employment: continuity guaranteed, 118 indeterminate nature, 279 master and servant, 29 Contracts: external fund managers, 202, 219, 229 implicit, 118, 136 incentives, 269 incomplete, 121, 125, 130, 167, 268 nexus, see under Contractual theories Contractual theories: assets, 119–20, 128 classical contracts, 128 classical/spot markets, 119 company law, 171 Company Law Review Steering Group, 141 crystallisation, 142 distortions, 18 efficiency, 122, 142, 162, 233, 237 equity, 120 ex ante safeguards, 118 factors of production, 164–5, 166 firm non-existent, 164 incomplete contracts, 121, 125, 130, 167, 268 intervention, 18

Index 293 joint stock companies, 144 legitimacy, 142, 163 leveraged buy-outs (LBO), 159–60 market failure, 245 monitoring, 18 nexus of contracts: agency, 142, 165, 268 authority, 165–6 conceptual foundations, 115–19 corporate evolution, 233 customers/suppliers, 128 efficiency, 142, 233 metaphor, 163 pluralism, 125 non-executive directors, 17 ownership, 14, 163–4, 167 politics, 142 post-contractual opportunism, 118 public non-interference, 168 relational contracts, 128 risk, 116 safeguards, 121, 123, 125, 131 shareholders’ rights: fiduciary duty, 44 justifications, 116–21, 144–5, 160–1 pre-defined rights, 14 priority, 13 stakeholders, 163, 172 theoretical fantasy, 162–3 total wealth creation, 130, 131 transaction costs, 119–21, 126, 128 United Kingdom, 141–2 United States, 142 veto, 118, 119, 126 Control: boards, see Directors financial autonomy, 274–5 management, see Managers market, see Market for corporate control ownership, see Ownership stabilisation, 136 stakeholders, 132 supervision, see Supervisory boards takeovers, see Takeovers two-tier, see Two-tier board system Co-operative Movement, 62 Corporate capitalism, twentieth century dominance, 4, 21 Corporate evolution: efficiency, 18, 233, 237–8 market pressure, 238 monitoring, 237–46 non-executive directors, 17, 233–63 politics, 21, 22 public interest, 22 technological change, 22 Corporate governance: accountability, see Accountability

activism, see Activism agency, see Agency codes, see Codes of practice hierarchies, 279–81 institutions, see Institutional shareholders long-run issues, 177–80 market pressure, 18, 245–6, 270 national models, 284–7 pluralism, see Pluralism politics, 14–15, 175–94 public policy, 14, 175–94 shareholders, see Shareholders’ rights sociology, 18, 265–87 votes, see Voting Corporate performance: activism, 15–16, 199–201 monitoring, 241 non-executive directors, 17, 243, 244, 258–9 worst performing companies, 259 Corporate restructuring, social consequences, 10 Corporate trustees: accessorial liability, 216 beneficiaries, 203–4, 210, 215–16 breach of duty, 216 directors, 215–16 fiduciary duty, 210, 215–16 pension funds, 202, 203–4, 210, 215–16 subsidiary companies, 202 see also Pension fund trustees Co-specialisation: employment, 124, 130 stakeholders, 126 suppliers, 131 Costs: activism, 183, 184, 224, 239 agency costs, see under Agency social choice, 132, 135 see also Transaction costs Crosland, Charles Anthony Raven (Tony), 13, 152 Custodians: institutional shareholders, 201–8 insurance companies, 205 investment trusts, 207 open-ended investment companies (OEICs), 208 pension funds, 203, 204 share ownership, 201–8 unit trusts, 206 Cyert, Richard M., 19 Dalton, Hugh, 58–9, 60, 61 Decision-making: coalitions, 19, 281, 283 Germany, 9, 104, 283 managers, 281–4

294 Index Decision-making: organisational goals, 281–2 routines and interactions, 282 satisficing, 281 social choice costs, 132, 135 veto, 118, 119, 126 works councils, 104 see also Co-determination Dell, Edmund, 79 Demsetz, Harold, 153, 157, 165, 166 Department of Economic Affairs (DEA), 41, 53, 190, 193 Department of Trade and Industry (DTI): see also Company Law Review Steering Group government intervention, 188–9 investigations, 15 pluralism, 12 Dicey, Albert Venn, 39 Directors: accountability, 4, 51 agency, 142 board monitoring, see Monitoring CEOs, see Chief executives chairmen, 250, 256 corporate trustees, 215–16 crony networks, 179 interests, disclosure, 63 Laski’s proposals, 56 nomination committees, 256, 259 non-executive, see Non-executive directors remuneration committees, 259 Table A, 248 titled/public figures, 247, 248 workforce, see Worker directors see also Managers Directors’ duties: corporate objectives, 133 inclusiveness, 12 insurance companies, 220–1 investment trusts, 223 monitoring, 260–1 non-executive directors, 261 shareholder value, 44 shareholders’ rights, 11, 34 stakeholders, 5, 43, 47 understanding, 191 worker directors, 77 see also Fiduciary duty Disclosure: avoidance, 64 Combined Code, 262 directors’ interests, 63 industrial democracy, 72 nominee shareholders, 64 share ownership, 65 shareholders’ rights, 46 voting, 227–8

Dividends: Germany, 85 institutional shareholders, 177, 178 joint stock companies, 173 short-termism, 179 Dodd, E. Merrick, 148, 149, 150, 158 Donnelly, Shawn, 8, 9, 83–100 Donovan Commission (1967), 69 Drucker, Peter, 151 East India Company, 28, 30 Easterbrook, Frank H., 132, 153 E-commerce, challenges, 10 Economic power: concentration, 3 Germany, 34 limited liability, 34 pension funds, 46 public interest, 57, 58 sophisticated sociability, 152 United States, 34 Economics: complementarities, 284–5 entrepreneurship, see Entrepreneurial economy neo-classical analysis, 157, 162 transaction costs, see Transaction costs webs of relationships, 114–15 EETPU, 68 Efficiency: a priori, 161–3 agency, 18, 116, 162, 277 allocation: resources, 155, 162 rights, 144 assumed outcomes, 14 competing goals, 14, 162, 171 complementarities, 285 contractual theories, 122, 142, 162, 233, 237 corporate evolution, 18, 233, 237 entrepreneurial economy, 29 government intervention, 44 institutions, 19, 266 market for corporate control, 162 organisational form, 21, 158, 166 ownership, 3, 30 pluralism, 11, 12, 114, 132 politics, 266 public interest, 28 regulation, 234 rent-sharing, 129 risk, 113, 117 shareholder value, 5 shareholders’ rights, 13, 44, 113, 115, 171 stakeholders, 172 takeovers, 161, 240 Employee Share Ownership Plans (ESOPs): agency costs, 282

Index 295 Conservative Party, 46 equity, 135 Germany, 110, 282, 283 Japan, 282 pluralism, 135–6 productivity, 135 social welfare, 135 Sweden, 110 total wealth creation, 135 United States, 46, 110, 136, 281 Employment: agency theory, 266, 278, 279 bilateral safeguards, 126–7 capitalism, 28–9 co-determination, see Co-determination contracts, see Contract of employment co-specialisation, 124, 130 deferred remuneration, 118 employee voice, 266 factors of production, 279 firm-specific risk, 123–7 firm-specific skills, 121, 123–4, 127 flexibility, 43 generic skills, 119, 121 government intervention, 189 hierarchies, 279–81 hire and fire policies, 43 human resource management, 102, 108 life-time employment, 19, 280–1 redeployment, 119, 121 rent, 124–5, 130 residual payments, 125 transaction costs, 121, 126 unions, see Trade unions worker participation, see Industrial democracy see also Master and servant Enforcement: market pressure, 236, 262 shareholders, activism, 191, 226 Enlightened managerialism: self-regulation, 44–5 shareholder value, 12, 45, 141 stakeholders, 45, 47 Entity theory: assets, 145–8 radical entity theory, 148–52 Entrepreneurial economy: capitalism, 27, 28 Conservative Party, 39 efficiency, 29 Environmental protection: European Union, 43, 97 Germany, see under Germany public interest, 5 Sweden, 97 United Kingdom, 97 Equal opportunities:

Germany, 6, 84, 93 public interest, 5 Equal pay, Germany, 92–3 Equity: contractual theories, 120 Employee Share Ownership Plans (ESOPs), 135 firm-specific risk, 116, 127 institutional shareholders, 178 joint stock companies, 146 property rights, 146, 147, 185 see also Shares European Commission: consultation, 109–10 European Company Statute (draft), 43, 71, 75, 109, 253 supervisory boards, 71, 75 two-tier board system, 71, 253 European Union: environmental protection, 43, 97 Gyllenhammar Report (1998), 10, 103–4 harmonisation, 43 industrial democracy, 10, 109 insider trading, 88 regulation, 48 subsidiarity, 110 works councils, 11, 71, 75–6, 109 Evolutionary theory, see Corporate evolution Exit: full disposal, 185, 186 institutional shareholders, 14, 154, 183–4 liquidity, 273 partial disposal, 185, 186 pension funds, 213–14 public buyout, 182 public ownership threatened, 183–4 public policy, 185 readiness, 154, 175, 184, 268 shareholders, 14, 38, 154, 175, 182, 183–4 takeover threat, 185, 186, 270 underpriced shares, 38 External fund managers: activism: commitment, 230–1 costs, 239 disincentives, 195–6, 227 institutional shareholders, 16, 195–7 insurance companies, 206, 221 investment trusts, 207, 208, 223 liabilities, 16 obligations, 16 pension funds: agency, 196, 217, 218, 229 contracts, 202, 219, 229 delegated duties, 204, 211 duty of loyalty, 220 duty to consider, 218–19 fiduciary duty, 198, 217, 218, 220

296 Index External fund managers (cont.): pension funds (cont.): investment managers, 211, 217–20 management agreements, 204, 209, 224–5, 229 monitoring, 219, 230 United States, 198, 226–7 External fund managers voting: box-ticking, 226 breach of duty, 219 conflict of interest, 196, 220 contentious issues, 219, 225 costs, 224 disclosure, 227–8 exercise, 204, 209, 211, 219, 224–5, 228 financial conglomerates, 220, 227 instructions/directions, 202, 204, 219, 228 insurance companies, 206, 220–1 investment trusts, 208, 223 Labour Party policy, 227 management agreements, 204, 209, 224–5, 229 market pressure, 225, 228, 239 monitoring/supervision, 219, 230 pension funds, 196, 198, 202, 204, 209, 211, 219, 220, 224–5, 227–31 policies, 209, 228, 229–30 proportionate influence, 225–6 United States, 198, 219, 226–7, 228 window-dressing, 226, 227 Fabian Society, Working Party on Industrial Democracy, 74, 107 Faccio, M., 201 Factors of production: contractual theories, 164–5, 166 employees, 279 ownership, 164–5, 166, 268 Fama, Eugene, 165 Fiduciary duty: accessorial liability, 216 awareness, 191 contractual theories, 44 corporate trustees, 210, 215–16 insurance companies, 220 managers, 37, 119, 133–4, 149 multi-constituency, 133 open-ended investment companies (OEICs), 223 pension funds: investment managers, 198, 217, 218, 220 trustees, 210, 215–16 United States, 198 pluralism, 133–4 shareholder value, 44 unit trusts, 221–2 see also Directors’ duties

Finance: autonomy, 274–5 financial conglomerates, 220, 227 financial/strategic interests, 271–3, 274 markets, see Capital markets politics, 159 regulation, 277 Financial Reporting Council, 255 Financial Services Authority, 207, 223, 257, 262 Finn, P.D., 218 Firm-specific risk, see under Risk Fischel, Daniel R., 132, 153 Ford, H.A.J., 219 Foreign investors, institutional shareholders, 197–9 France: enterprise committees, 104 institutional shareholders, 271, 272 société en commandité, 31 Franks, Julian, 161, 201, 258, 259 Fraud: fraudulent promotion, 30, 247 managers, 35, 268, 280 Free-riders, activism, 183, 184, 239, 268 Fund managers, see External fund managers Galbraith, John Kenneth, 152, 159 Gamble, Andrew, 1–20, 21–49, 51–81 Game theory, companies, 266 Germany: accounting practice, 85 Aktiengesetz (AktG), 86 Arbeitsdirektor, 283 banks, 83, 84, 86, 270, 271, 275, 277 blockholders, 270 Bundesbank, 86 capital markets, 6, 85–90 collegiate principle, 283, 284 company law, 275–6 constitutional structures, 5, 6, 90, 275 corporate responsibility, 90–9 decision-making, 9, 104, 283 Deutsche Terminbörse, 87 dividends, 85 economic power, 34 Employee Share Ownership Plans (ESOPs), 110, 282, 283 environment: BUND, 98 causal principle, 94 certification, 97, 98 Chambers of Industry and Commerce, 98 cooperation principle, 94 criminal sanctions, 95 damages, 96 eco-audits, 97, 98 EMAS, 97 emissions, 95

Index 297 environmental officers, 94–5, 96–7 hazardous materials, 95 impact statements, 94 information requirements, 94, 96 IOW, 98 packaging, 96 precautionary principle, 94 protection, 6, 9–10, 84, 94–9 standards, 98 strict liability, 95–6 testing, 97 Umweltbundesamt (UBA), 94 waste disposal, 95 water management, 95 equal opportunities, 6, 84, 93 equal pay, 92–3 family companies, 271, 276 futures and options, 87 Geregelter Markt, 87 Gründerkrise (1873), 84 industrial democracy, 6, 9, 19, 66, 280, 286 information technology, 91, 92 insider trading, 88–9 institutional shareholders, 9, 85, 271, 272 insurance companies, 83, 85, 86 investment, 9, 43, 83, 85, 86–7 Konzern, 276 lay-off protection, 91 managers, 84–6, 283 maternity rights, 93 network structures, 276, 277 Neuer Markt, 87 pension funds, 90 political choice, 48 prospectuses, 88 public interest, 8–9, 83–100, 276 public policy, 176 regulation, 58 reunification, 83, 86, 92 shareholders’ rights, 84–5 specialists, 283 stakeholders, 283 stock exchanges, 43, 87–8 supervisory boards (Aufsichtsrat): co-determination, 9, 76, 91, 104, 132, 280, 285 committees, 9, 92 composition, 92 constitutionalisation, 91, 275 formal constraints, 45 introduction, 6, 8, 84, 275 monitoring, 275–6, 283 new importance, 83 stakeholders, 283 two-tier board system, 6, 8, 47, 61, 66, 106, 276 UK reform proposals, 47, 61, 78, 106 takeovers, 9, 86, 89–90

taxation, 9 unemployment, 86, 91 Weimar Republic, 90, 91 worker directors, 280, 283 works councils: collective bargaining, 93 company policies, 83, 91, 280 constraints, 45 decline, 9, 83, 92 discrimination, 9 harassment, 9 health and safety, 9, 91, 93 introduction, 90–1 mobbing incidents, 91 UK reform proposals, 66 Gilson, R.J., 195 Gladstone, William Ewart, 32 Globalisation: capital markets, 180, 186 challenges, 10 market pressure, 172 public policy, 11, 108 GMWU, 78 Goldsmith, 185 Governance, political economy, 4 Government intervention: balance of payments, 189 civil servants, 188–9 efficiency, 44 employment, 189 fears, threats and phobias, 181–4 industrial malaise, 179, 180, 253 IRC, see Industrial Reorganisation Corporation lame ducks, 181 managers, 179–80 nationalisation, 181–2 non-executive directors, 252–3 non-interference, 168 regional policy, 179, 180 regulation, see Regulation right people/right thing, 180, 191 share ownership, 189, 190, 191–2 takeovers, 14, 15, 185, 187–8 see also Public policy Gower, Laurence C.B., 13, 151 Goyder, George, 151 Gray, Kevin, 169 Greenbury Code: self-regulation, 44, 45 see also Codes of practice Greenbury Committee, 107 Greene Committee (1928), 57 Grey, Thomas, 169, 170 Guild Socialists, 53 Gyllenhammar Report (1998), 10, 103–4 Hammond, Eric, 68

298 Index Hampel Code: compliance, 236 non-executive directors, 17 self-regulation, 44, 45 see also Codes of practice Hampel Committee, 17, 107, 257 Harris, Michael, 7, 51–81 Hart, Oliver, 167, 168 Hayek, Friedrich August von, 24 Heath, Barrie, 107 Heath, Edward, 70 Heffer, Eric, 70, 77 Henwoood, Doug, 160 Hermes LENS Asset Management, 230 Hierarchies, corporate governance, 279–81 Hodgson, Sir Edward, 60–1 Holland, J., 195 Holland, Stuart, 70 Honoré, A.M., 13, 146, 148 Hostage-taking, transaction costs, 126–7 Human resource management, 102, 108 Incentives: ESOPs, see Employee Share Ownership Plans firm-specific investment, 131, 135 managers, 269, 282 market pressure, 246 non-executive directors, 242 Incorporation: joint stock companies, 28, 145–6 legislation, 51 shareholder value, 37 Independence: investment trusts, 207 non-executives, see Non-executive directors trade unions, 41, 54, 66, 67, 69, 77, 106 Industrial democracy: collective bargaining, 72, 73, 74, 79 Conservative Party, 40 co-partnership, 40, 67 democratic imperative, 113 directors, see Worker directors disclosure, 72 European Union, 10, 109 Germany, 6, 9, 19, 66, 280, 286 Industrial Boards, 63 Japan, 19, 285–6 Labour Party policy, see under Labour Party managers, 70, 278 nationalisation, 66, 67–8, 73 productivity/profitability, 10, 111–12 public ownership, 253 representation gap, 11 self-management, 70 self-regulation, 70 shareholders’ rights, 278 shop stewards, 72

social cohesion, 10 Trade Union Congress (TUC), 69, 71, 74, 78 trade unions, 8, 66–7, 68, 71 trust, 10 United States, 19, 281 White Paper (1978), 80, 106 works committees, 72 zero-sum, 278, 280 see also Co-determination Industrial Democracy Commission, 78 Industrial relations: Conservative Party, 39–40 hierarchies, 279–81 Labour Party policy, 41, 42 unions, see Trade unions Industrial Reorganisation Corporation (IRC): expert managers, 15, 187–8 monitoring, 187–8 stakeholding, 190 takeover market, 14–15, 185, 187 Information requirements: Germany, environment, 94, 96 non-executive directors, 241 pension fund trustees, 214, 225 takeovers, 240, 241 Information technology: challenges, 10 Germany, 91, 92 surveillance, 102 work organisation, 102 Insider trading: avoidance, 235, 241 Germany, 88–9 justification, 154–5 Institute for Workers’ Control (IWC), 70 Institutional investors, open-ended investment companies (OEICs), 16, 208–9, 223 Institutional shareholders: accountability, 16, 46 activism: conflict of interest, 239 contemporary form, 160 corporate performance, 15–16, 199–201 costs, 183, 184, 224, 239 enforcement, 191, 226 exceptional circumstances, 239–40 exit threat, 154 free-riders, 183, 184, 239, 268 incentives lacking, 195–6, 215, 227 increasing power, 159 radical compact, 195 visible/invisible, 200 voice, 183, 274 voting, 16, 198, 201, 210, 224–8 capital markets, 178 dividends, 177, 178 exit, 14, 154, 183–4

Index 299 foreign investors, 197–9 France, 271, 272 fund managers, see External fund managers Germany, 9, 85, 271, 272 insurers, see Insurance companies investment trusts, see Investment trusts Japan, 271, 272 legal obligations, 197–201, 209–23 lobbying, 224 nationalisation, 14, 183–4 non-executive directors, 195, 252, 255, 258 occupational pensions, 202–4 pensions, see Pension funds predefined index strategies, 273 responsibilities, 15, 195–231 share ownership: asset values, 178 beneficial owners, 202, 203–4, 205, 206, 207, 208, 222 custodians, 201–8 equity, 178 extent, 15, 239, 271, 272 growth, 238–9 interest-holders, 201–2 liquidity, 239 nominees, 160, 184, 201, 203 property rights, 178 registered holders, 201, 203, 205, 206, 207, 208 risk, 239 structure, 201–9 trusts, 201, 202 United States, 154, 197–9, 271, 272 short-termism, 178–9 unit trusts, see Unit trusts United States: competition, 160 non-executive directors, 195 UK holdings, 197–9 US holdings, 154, 271, 272 voting, 16, 198, 226–7, 228, 229 voting: activism, 16, 198, 201, 224–8 compulsory, 224–8 fund managers, see under External fund managers voting holder of rights, 202, 204, 205–6, 207–8, 209 insurance companies, 205–6, 220–1 investment trusts, 207, 223 open-ended investment companies (OEICs), 209, 223 pension funds, see under Pension fund trustees proxy advisory services, 17, 225, 230 regulation, 209, 210, 224–8 unit trusts, 206–7, 209, 221, 222 United States, 16, 198

Institutional Shareholders’ Committee (ISC), 252, 255, 256 Institutions: complementarities, 280, 284–5 efficiency, 19, 266 Insurance companies: accountability, 16 assets, 205 bare trusts, 205 beneficial owners, 205 custodians, 205 directors’ duties, 220–1 external fund managers, 206, 221 fiduciary duty, 220 Germany, 83, 85, 86 growth, 177 institutional shareholders, 177, 178, 183–4, 204–6 limited liability, 205 members, 205 mutuals, 205 nationalisation, 183 ownership, 205 partnerships, 30 policyholders, 205 registered holders, 205 subsidiary companies, 205, 206 voting, 205–6, 220–1 Investment: agency costs, 269 bank-firm ties, 269 co-specialisation, 126 firm-specific: bilateral safeguards, 127 contractual safeguards, 125, 130, 131 incentives, 131, 135 pluralism, 132 rent, 136 skills, 121, 123–4, 127 takeovers, 136 Germany, 9, 43, 83, 85, 86–7 Japan, 43 National Investment Board (NIB), 60 pension fund management, 202–3, 217–20 relation-specific, 129 short-termism, 43 sunk investment, 11 Investment trusts: accountability, 16 beneficial owners, 207 custodians, 207 directors’ duties, 223 external fund managers, 207, 208, 223 independence, 207 institutional shareholders, 178, 184, 207–8, 223 public companies, 207 registered holders, 207

300 Index Investment trusts (cont.): shareholders, 207, 223 share-trading, 185–6 voting, 207–8, 223 Investors: foreign investors, 197–9 institutional, see Institutional shareholders shareholders, 150–1, 155, 156 Ireland, Paddy, 12, 13, 14, 141–73 Jackson, Gregory, 18, 19, 265–87 Japan: banks, 270, 271, 272–3, 275, 277 blockholders, 270 co-determination, 281 collective bargaining, 281 commitment, 280 company law, 275 complementarities, 285 cross-shareholdings, 272, 276–7 decentralisation, 283 Employee Share Ownership Plans (ESOPs), 282 family companies, 285, 286 industrial democracy, 19, 285–6 institutional shareholders, 271, 272 investment, 43 keiretsu groups, 272 life-time employment, 19, 280–1 managers, 283–4 network structures, 276–7 politics, 43, 48 property rights, 275 public policy, 176 share ownership, 270, 271, 272, 273, 275, 276–7 stakeholders, 43 trade unions, 280–1 zaibatsu, 285 Jenkins, Clive, 67 Jenkins Committee (1962): conservative results, 65 Labour Party attitudes, 8, 41, 64–5 lack of radicalism, 152 membership, 64 remit, 189–90 Jensen, Michael C., 153, 157, 159–60, 164 Joint stock companies: advantages/disadvantages, 32–3, 35 banks, 31 capital markets, 146, 147 company law, 145–6, 169 Conservative Party, 39 contractual theories, 144 corporate bureaucracy, 36 dispersal of rights, 29, 57, 247, 248 dividends, 173 equity, 146

family companies, 247, 248 fidelity/zeal, 33 financial needs, 28 Gladstonian company, 38 impersonal authority, 39 incorporation, 28, 145–6 industrial capital, 35 legal personality, 13, 28 legitimacy, 36 liberalism, 39 limited liability, 28, 29 managers, 40 money capital, 35 ownership, 146 Parliamentary Committee (1844), 31–2 partnerships, 145–6, 147 political choice, 169 political hostility, 29, 30 property rights, 169 Royal Charter, 30 Scotland, 30 shareholders, 146 shareholders’ rights, 146 social character of production, 3, 173 transparency, 33 unincorporated, 146 Jones, Jack, 68, 75, 78 Kahn-Freund, Otto, 69 Katz, Wilbur, 157, 158, 162 Kay, John, 115, 129 Kelly, Gavin, 1–20, 21–49, 113–39 Knowledge industries, pluralism, 12 Kohl, Helmut, 86, 88, 89, 93, 94, 96, 99 Kohlberg Kravis Roberts, 160 Kraakman, R., 195 Labour Party: alternate organisational forms, 53 companies: adversarial conception, 42, 53, 65 lack of interest, 7–8, 41, 52, 64 law reform, 7–8, 15, 41, 51–81 thinking, 54–8 Companies Commission proposed, 73, 74 Company Law Working Party, 70–1, 73 Department of Economic Affairs (DEA), 41, 53, 190, 193 Finance and Trade Committee (FTC), 59–60 industrial democracy: ambivalence, 8, 42, 52 Bullock Committee, see Bullock Committee (1976) law reform, 65–76 public ownership, 253 social contract, 105–6 industrial relations, 41, 42 Labour Research Department, 62, 68

Index 301 Legal Advisory Panel, 60 licence to operate, 8 monopolies, 64 National Investment Board (NIB), 60 nationalisation, 8, 52, 54, 59, 66, 182, 183 New Labour, 186–94 non-executive directors, 15, 252–3 policy documents, 59–60 private associations, 8, 41–2 public ownership, 8, 59, 253 Reorganisation of Industry subcommittee, 67 social contract, 74, 79, 105 stakeholders, 15, 186–94 supervisory boards, 73 trade unions, 41–2, 66 voting: external fund managers, 227 pension fund trustees, 210 worker directors, 42 Working Party on Industrial Democracy, 68 see also Political parties Laissez-faire: limited liability, 7, 31, 32, 33, 34 market for corporate control, 38 property rights, 44 shareholders’ rights, 37 Lasfer, M.A., 201 Laski, Harold, 54, 55–6, 59, 66 Lazonick, William, 166 Legal personality: joint stock companies, 13, 28 legislation, 26, 28, 51 private associations, 26 Legitimacy: constitutional structures, 66 contractual theories, 142, 163 joint stock companies, 36 managers, 279 property rights, 37, 39, 114 public interest, 28 rentiers, 171 LENS Inc, 230 Leveraged buy-outs (LBO), 159–60 Leverhulme Trust, 1 Liberal Industrial Inquiry (1928), 249 Liberal Party: corporate organisation, 41 Lib-Lab pact, 80 Liberal Yellow Book, 53 Liberalism: competition, 4 joint stock companies, 39 political economy, 3–4, 7 public interest, 25 Lib-Lab pact, 80 Licence to operate: company law, 22–3, 27

Labour Party policy, 8 politics, 8, 21, 22–3, 27 public responsibilities, 27 Limited liability: contingent privilege, 55 economic power, 34 individual responsibility, 7 insurance companies, 205 joint stock companies, 28, 29 laissez-faire, 7, 31, 32, 33, 34 legislation, 51 opposition, 31, 39 politics, 29–34 privilege, 34, 55, 61 public interest, 33, 34, 61 social betterment, 32 Limited partnerships, 31, 32 Lindley, Nathaniel, 147 Liquidity, share ownership, 239, 273–4 Lohnro, 185 London Stock Exchange: All-Share Index companies, 258 Financial Reporting Council, 255 Listing Rules, 45, 236, 257 merger, 43 non-executive directors, 252 Lowe, Robert, 32, 34 MacAvoy, Paul W., 243, 244 McCulloch, John Ramsay, 31 Macey, Jonathan M., 118, 126 Macmillan, Harold, 40, 41 Managers: accountability, 45, 106, 149, 280 agency: non-shareholders, 117–18, 247–8 shareholders, see under Agency autonomy, 4, 37, 152, 282 capital markets, 153, 156, 157, 269 careers: labour markets, 282 professional training/expertise, 179, 282 reputation, 269 coalitions, 19, 281, 282, 283 Conservative Party, 39 decisions: decision-making, 281–4 veto, 72, 118, 119, 126 enlightened managerialism, 12, 44–5, 47 entrenchment, 235 fiduciary duty, 37, 119, 133–4, 149 fraud, 35, 268, 280 Germany, 84–6, 283 government intervention, 179–80 human resource management, 102, 108 ideas, 282 incentives, 269, 282 industrial democracy, 70, 278

302 Index Managers (cont.): inefficient/underperforming: agency costs, 235 market for corporate control, 38, 154, 161 non-executive directors, 17, 244–5, 251, 258–9 shirking, 268, 281 Japan, 283–4 joint stock companies, 40 legitimacy, 279 leveraged buy-outs (LBOs), 159–60 malpractice, 17, 35, 236, 268, 280 market pressure, 246 opportunism, 19, 268, 269, 281 ownership, 30, 36, 39, 40, 175, 177 performance: ex post review, 235, 260 targets, 195 public interest, 28, 59 public responsibilities, 150, 153 removal/replacement: difficulties, 17, 241 employee influence, 280 ex post review, 235 hostile takeovers, 240 non-executive directors, 244–5, 258–9 price system, 180 resistance, 235 salaried experts, 59 self-interest, 17 shareholder value, 12, 45, 160 shareholders, 175 social world, 281–4 supervision by shareholders, 15 trusteeship, 40, 45 unit trusts, 206–7, 209, 221–2 United States, 284 see also Directors Mandak, G., 95 Manne, Henry, 153–7, 161, 162, 164 Mannesmann, 9 Manning, Bayless, 151, 157, 158 March, James G., 19 Market for corporate control: agency, 44, 162, 270 effective market, 37–8, 44 efficiency, 162 inefficient managers, 38, 154, 161 laissez-faire, 38 leveraged buy-outs (LBOs), 159–60 short-termism, 161 takeovers, 38, 44, 136, 154, 161, 270 United States, 280 voting, 154 Market pressure: capitalism, 153 codes of practice, 236 corporate evolution, 238, 245–6

corporate governance, 18, 270 enforcement, 236, 262 external fund managers voting, 225, 228, 239 globalisation, 172 incentives, 246 managers, 246 market turbulence, 246 monitoring, 237, 258 public responsibilities, 153 see also Competition Markets: capital, see Capital markets classical/spot markets, 119 market coordination, 28 market failure, 245–6 takeovers, see Market for corporate control Marshall, Alfred, 35 Marx, Karl Friedrich, 3, 35, 36, 173 Mason, Edward, 151 Mass production, 102 Master and servant: contract of employment, 29 social order, 39 Max-Planck-Institut für Gesellschaftsforschung, 2 Mayer, Colin, 161, 201, 258, 259 Maynard, Joyce, 70 Meacher, Michael, 70 Means, Gardiner C., 4, 36, 40, 58, 153, 155, 156, 157, 158, 160, 270, 277 Meckling, William H., 116, 157, 163 Members, companies, see under Companies Mergers, see Takeovers Mikardo, Ian, 68 Mill, John Stuart, 32–3, 36 Miller, Geoffrey P., 118, 126 Millon, David, 142, 143, 144 Millstein, Ira M., 243, 244 Mirror Group Newspapers, 209, 224 Mitsubishi Heavy Industries, 281 Monitoring: activism, see Activism boards: alternative mechanisms, 238–41 banks, 270 contractual theories, 18 corporate evolution, 237–46 corporate performance, 241 directors’ duties, 260–1 endogeneity, 244 further intervention, 257–62 Germany, 275–6, 283 historical development, 246–57 Industrial Reorganisation Corporation (IRC), 187–8 market failure, 245–6 market pressure, 237, 258

Index 303 non-executive directors, 17, 188, 235, 237, 240, 241–5, 258–61 shareholders, 268 strengthened role, 258–61 strong/weak hypothesis, 244 employee voice, 266 external fund managers, 219, 230 see also Accountability Monopolies: company law, 38 Labour Party policy, 64 price system, 180, 185 Morgan, Kenneth, 76, 79 Multinational companies, socialisation of production, 172–3 Nationalisation: banks, 183 favourable buyout, 14, 182 government intervention, 181–2 industrial democracy, 66, 67–8, 73 institutional shareholders, 14, 183–4 insurance companies, 183 Labour Party policy, 8, 52, 54, 59, 66, 182, 183 price leadership, 182 public ownership threatened, 182–4 socialism, 3 trade unions, 67 underperformance, 181, 182 Nedelsky, Jennifer, 168 Negligence, non-executive directors, 247 Newbold Committee (1999), 199, 210, 211 Nexus of contracts, see under Contractual theories Nominee shareholders: bare trusts, 201 Cohen Committee (1945), 62, 63 designated nominee system, 203 disclosure, 64 institutional shareholders, 160, 184, 201, 203 omnibus account, 203 pension funds, 203 pooled nominee system, 203 share-trading, 185–6 Non-executive directors: accountability, 17, 253, 257 appointment, 17, 191, 250, 254, 259 Bank of England: inefficient managers, 17, 244–5, 251, 258–9 reform pressure, 236–7, 252 survey results, 254, 255 best practice, 255 British Institute of Managers, 250, 251, 252 Cadbury Code, 17, 256, 258 Combined Code, 259, 260, 261–2 company law, 17 Company Law Review Steering Group, 260

Conservative Party, 251 contractual theories, 17 corporate performance, 17, 243, 244, 258–9 directors’ duties, 261 evolution and policy, 17, 233–63 government intervention, 252–3 Hampel Code, 17 incentives, 242 independence: effectiveness, 242, 255, 256, 259 evolving role, 249–51 performance, 243–4 theoretical case, 243 information requirements, 241 institutional shareholders, 195, 252, 255, 258 Labour Party policy, 15, 252–3 London Stock Exchange, 252 minority position, 17, 260 modern era, 250–7 monitoring, 17, 188, 235, 237, 240, 241–5, 258–61 negligence, 247 nineteenth century, 246–9 powers, 260 PRO NED, 254, 256 professional advisors, 249, 250, 259 retired executives, 250 shareholders, 260 survey results, 250, 254, 255 two-tier board system, 260 United States, 17, 195, 243, 258, 284 White Paper (1973), 252 White Paper (1977), 252 see also Directors NUPE, 74 Obligations: external fund managers, 16 institutional shareholders, 197–201, 209–23 pension funds, 210–21 public interest, 6 Open-ended investment companies (OEICs): accountability, 16 Authorised Corporate Director (ACD), 208, 209, 223 bare trusts, 208, 223 beneficial owners, 208 custodians, 208 depositary, 208, 223 fiduciary duty, 223 registered holders, 208 shareholders, 208, 223 voting, 209, 223 Organisation for Economic Cooperation and Development (OECD), 102–3, 271, 272 Ownership: agency, 163–8 antecedent rights, 114, 115

304 Index Ownership (cont.): assets, 29, 147, 148, 164, 167 beneficial, see Beneficial owners bundle of rights, 29, 170, 171 central concept, 3, 4 conflict, 35 contractual theories, 14, 163–4, 167 control and ownership: antecedent rights, 114, 115 circular arguments, 115, 168 division, 4, 36, 175, 270 efficiency, 30 factors of production, 268 legal rights, 275–6, 277–8 managers, 30, 36, 175, 177 politics, 30, 34–8 reexamination, 268–78 residual control, 167, 168 corporate economy, 29 efficiency, 3, 30 factors of production, 164–5, 166, 268 functions, 54–5 incidents of ownership, 13, 148 institutions, see Institutional shareholders insurance companies, 205 joint stock companies, 146 legal title, 4, 115 managers, 30, 36, 39, 40, 175, 177 means of production, 3, 35, 53 OECD countries, 271, 272 ownership myth, 13, 148, 168–73 patterns explained, 277–8 rights, see Property rights shares, see Share ownership social citizenship, 3 social purpose, 54–5 sociology, 271–7 see also Shareholders’ rights Parkinson, John, 1–20, 113–39, 162, 163, 233–63 Partnerships: Board of Trade review, 31 co-partnership, 40, 67, 147 insurance companies, 30 joint stock companies, 145–6, 147 limited partnerships, 31, 32 social partnership, 110, 111 Peel, Sir Robert, 31 Pension fund trustees: beneficial interests, 203–4 corporate, see Corporate trustees duties: breach of duty, 214, 215, 216, 219 controlling interests, 212–13 delegation, 204, 211 efficient management, 211–13 exercise of powers, 214–15

fiduciary duty, 210, 215–16 general duties, 210–11 genuine consideration, 214–15 good faith, 213, 215 information requirements, 214 loyalty, 213–14 standard of care, 211–12 takeovers, 214 legal obligations, 210–16 reasons, 214–15 replacement, 215 statement of investment principles, 209, 228 voting: breach of trust, 219 contentious/non-contentious issues, 214 delegated, see External fund managers voting directions/instructions, 204, 219, 228 information requirements, 214, 225 Labour Party policy, 210 non-voting policy, 219 policies, 209, 219, 229–30 rights retained, 204, 229 self-help, 229 trust deeds, 209 United States, 16, 198, 219, 226–7, 229 Pension funds: accountability, 16, 46 agency, 196, 217, 218, 229 Australia, 217, 229–30 bare trusts, 204 beneficiaries: beneficial owners, 203–4 corporate trustees, 215 interests, 213 investment managers, 217, 218 Californian Public Employees’ Retirement System (CalPers), 46, 198–9, 229, 230 custodians, 203, 204 economic power, 46 exit, 213–14 financial interests, 271 Germany, 90 governance, 46 growth, 177 investments: fund managers, see External fund managers management, 202–3, 217–20 statement of principles, 209, 228 legal obligations, 210–21 management agreements, 204, 209, 224–5, 229 nominee shareholders, 203 pooled superannuation trusts (PST), 218 registered holders, 203, 204 share ownership, 203–4, 271–2 subsidiary companies, 202

Index 305 trust deeds, 209 United States, 16, 46, 198, 226–7, 229, 281 see also Institutional shareholders Pension Investment Research Consultants (PIRC), 46, 203 Pluralism: authoritarianism, 4 co-determination, 134 Company Law Review Steering Group, 12, 141 conceptual foundations, 113–39 conclusions, 136–9 constitutional structures, 47 corporate objectives, 130–1 co-specialisation, 124, 126, 130 Department of Trade and Industry (DTI), 12 efficiency, 11, 12, 114, 132 Employee Share Ownership Plans (ESOPs), 135–6 fiduciary duty, 133–4 governance structures, 131–6 implications of model, 130–6 knowledge industries, 12 participatory mechanisms, 134–5 pluralist critique, 121–9 risk, 114, 122, 123–9 social welfare, 122 stakeholders, 47, 132 total wealth creation, 130 United Kingdom, 12 Political economy: agency, 2 classical conception of firm, 27–8 common themes, 2 entrepreneurial capitalism, 27 governance, 4 laissez-faire, see Laissez-faire liberalism, 3–4, 7 organising concepts, 3 public interest, 27 public policy, 2–3 socialism, 3, 35 Political Economy Research Centre (PERC), 1, 2 Political parties: companies, 38–42 Conservative, see Conservative Party Labour, see Labour Party Liberal Party, 41, 80 private associations, 8, 38, 41–2, 44, 47–8 Politics: actor-centred institutionalism, 266 agency costs, 277 companies, 21–49 contractual theories, 142 corporate evolution, 21, 22 corporate governance, 14–15, 175–94 efficiency, 266

finance, 159 Japan, 43, 48 licence to operate, 8, 21, 22–3, 27 limited liability, 29–34 moral basis of companies, 26–9 private interest, 23–4 public interest, 7, 23–6 regulation, 123 Private associations: Conservative Party, 44 Labour Party policy, 8, 41–2 legal personality, 26 opposed interests, 8 politics, 8, 38, 41–2, 44, 47–8 public character resisted, 7 public interest, 6, 27 regulation, 5, 6, 27, 37, 122 shareholders’ rights, 34 trade unions, 41–2 United Kingdom, 5, 6, 7, 8, 27 Private interest: politics, 23–4 public interest, 24, 25, 26 Privy Council, 30 PRO NED, 254, 256 Profit, public interest, 57 Property Defence League, 38 Property rights: agency, 155 bundle of rights, 29, 170, 171 collective force, 173 Conservative Party, 38–9, 44 dilution, 274 equity, 146, 147, 185 institutional shareholders, 178 Japan, 275 joint stock companies, 169 laissez-faire, 44 legitimacy, 37, 39, 114 market products, 166 residual control, 167, 168 shares, 13, 147, 151, 178 thing-ownership, 170 United States, 149 see also Ownership Proxies, see under Voting Public companies: joint stock, see Joint stock companies public-private axis, 142–5, 168–73 reprivatisation, 13, 152–7, 163 Public goods, regulation, 5 Public interest: aggregate, private interests, 24, 25, 26 altruism, 24, 25 competition, 44 corporate evolution, 22 disputed concept, 23 economic power, 57, 58

306 Index Public interest (cont.): efficiency, 28 empirical theory, 23, 25 environmental protection, 5 equal opportunities, 5 Germany, 8–9, 83–100, 276 industrial organisation, 55 legitimacy, 28 liberalism, 25 liberty, 24 limited liability, 33, 34, 61 managers, 28, 59 normative theory, 23 obligations, 6 political economy, 27 politics, 7, 23–6 private associations, 6, 27 profit, 57 public discourse, 25–6 public good, 24, 25 realism, 23–4 regulation, 5, 66 shareholders’ rights, 34 socialism, 35 stakeholders, 45 Public ownership: favourable buyout, 14, 182 industrial democracy, 253 industrial interest, 192 Labour Party policy, 8, 59, 253 nationalisation, see Nationalisation salaried experts, 59 share ownership, 189, 190, 191–2 threat, exit, 183–4 Treasury, 192, 193 see also Government intervention Public policy: competition, 5 corporate governance, 14, 175–94 exit, 185 Germany, 176 globalisation, 11, 108 Japan, 176 political economy, 2–3 takeovers, 185 United States, 176 Public responsibilities: constitutional structures, 27, 55, 56 Germany, 90–9 licence to operate, 27 managers, 150, 153 market pressure, 153 Public-private axis, 142–5, 168–73 Quarrell, John, 217 Radice, Giles, 74, 75 Railway companies:

legislative creation, 29, 31 shareholders, 146 speculation, 32 Ramelson, Bert, 70 Registered holders: company membership, 201 institutional shareholders, 201, 203, 205, 206, 207, 208 insurance companies, 205 investment trusts, 207 open-ended investment companies (OEICs), 208 pension funds, 203, 204 unit trusts, 206 Regulation: efficiency, 234 European Union, 48 financial system, 277 Germany, 58 legal compliance, 5 politics, 123 private associations, 5, 6, 27, 37, 122 public goods, 5 public interest, 5, 66 self-regulation, 5 stable framework, 42 United States, 277 voting, 209, 210, 224–8 Renneboog, Luc, 201, 258, 259 Rent: employment, 124–5, 130 firm-specific investment, 136 opportunistic division, 124–5, 131 project rent, 124–5 rent-sharing, 129 Rentiers: activism, 160 externalisation, 154 functionless, 12, 147, 171 genuine investors compared, 156, 164 irrelevance, 151 legitimacy, 171 power, 159 profit share, 160 shareholder value, 160 shareholders’ rights, 145, 171 title to revenue, 164 wealth maximisation, 172 Reprivatisation, public companies, 13 Reputation, managers, 269 Residual risk: non-shareholders, 11, 114 shareholders: agency, 267, 279 beneficiaries, 11 efficiency, 122 fiduciary duty, 11, 44 no contractual protection, 113

Index 307 Responsibilities: institutions, see Institutional shareholders public, see Public responsibilities shareholders, 15, 192–3, 195–231 Rhys Williams, Sir Brandon, 251 Risk: allocation, 122 contractual theories, 116 efficiency, 113, 117 existing debt, 118 firm-specific risk: bilateral safeguards, 119, 126–7 contractual safeguards, 121, 123, 125, 131 customer-suppliers, 127–9 employment, 123–7 equity, 116, 127 transaction costs, 120, 126 market value, 155 pluralism, 114, 122, 123–9 shareholders: diversified portfolio, 116–17, 239 institutions, 239 residual, see Residual risk residual income, 116, 117 stakeholders, 11, 131 underperformance, 116 Roe, Mark J., 135, 277 Rolls Royce, 181 Romano, Roberta, 200, 244, 245 Royal Commission on Mercantile Law (1854), 32 Scandinavia, worker rights, 102 Scanlon, Hugh, 79 Scargill, Arthur, 70 Schmidt, Helmut, 76 Schröder, Gerhard, 89, 90, 94 Schumpeter, Joseph, 36 Scientific management, 102 Scotland, unincorporated trading companies, 30 Scott, Kenneth, 164 Self-interest, see Private interest Self-regulation: codes, see Codes of practice Conservative Party, 41, 43–4, 73 culture/rules, 5 enlightened managerialism, 44–5 industrial democracy, 70 negotiated compliance, 48 takeovers, 184 Share ownership: blockholders, 270, 275, 278 custodians, see Custodians dilution, 274 disclosure, 65 diversification, 116–17, 239, 273 ESOPs, see Employee Share Ownership Plans

families: commitment, 274 disadvantages, 274 Germany, 271, 276 Japan, 285, 286 joint stock companies, 247, 248 financial autonomy/dependence, 274–5 financial/strategic interests, 271–3, 274 fragmentation, 4, 6, 37, 268, 270, 274, 278 incidents of ownership, 13, 148 institutions, see under Institutional shareholders Japan, 270, 271, 272, 273, 275, 276–7 liquidity/commitment, 273–4 network structures, 276–7 pension funds, 203–4, 271–2 public ownership, 189, 190, 191–2 registered, see Registered holders title to revenue, 147, 164, 169 wider share ownership, 46 Shareholder value: cash flow, 269 codes of practice, 45 Company Law Review Steering Group, 12, 141, 160 directors’ duties, 44 efficiency, 5 enlightened managerialism, 12, 45, 141 fiduciary duty, 44 incorporation, 37 managers, 12, 45, 160 rentiers, 160 stakeholders, 5, 43 Shareholders: activism: institutions, see Institutional shareholders rentiers, 160 rights, 45–6 United States, 153 agency, see Agency bondholders compared, 149 capital provision, 116, 156, 164, 166, 171 Cole’s proposals, 58 company of shareholders, 13 co-partnership, 147 cross holdings, 135 directors’ duties, 11 ESOPs, see Employee Share Ownership Plans exit, see Exit institutional, see Institutional shareholders investment trusts, 207, 223 investors, 150–1, 155, 156 joint stock companies, 146 Laski’s proposals, 56 legal title, 4 managers, 175 marginalisation, 34

308 Index Shareholders (cont.): monitoring, 268 nominees, see Nominee shareholders non-executive directors, 260 non-voting shares, 64, 65, 73–4, 158, 190 open-ended investment companies (OEICs), 208, 223 ownership, 13, 14, 147, 148, 150–1 passivity, 15, 35, 58, 64, 147, 155, 160 railway companies, 146 rentiers, see Rentiers residual risk, see Residual risk responsibilities, 15, 192–3 risk, see under Risk secured creditors compared, 152 shareholdings, see Share ownership supervision of management, 15 suppliers, 135 supremacy, 11, 13 United States, 13, 153, 276 Shareholders’ rights: accountability, 36, 46 activism, 45–6 Company Law Review Steering Group, 12 Conservative Party, 44 contracts, see Contractual theories directors’ duties, 11, 34 efficiency, 13, 44, 113, 115, 171 exclusivity, justification, 114–21 Germany, 84–5 historical distortions, 155–6 industrial democracy, 278 information/disclosure, 46, 241 joint stock companies, 146 laissez-faire, 37 overriding importance, 113 ownership, see Ownership private associations, 34 public interest, 34 rentiers, 145, 171 residual control, 167, 168 residual income, 116, 117, 118–19, 163, 166 shareholder democracy, 37, 45, 151, 154 voice, 37, 38, 185 votes, see Voting Shares: beneficiaries, see Beneficial owners compulsory amortisation, 151–2 ESOPs, see Employee Share Ownership Plans exit, see Exit holders, see Registered holders holdings, see Share ownership insider dealing, see Insider trading institutions, see Institutional shareholders intangible property, 13, 147 non-voting, 64, 65, 73–4, 158, 190 ownership, see Share ownership

prices: financial interests, 272 leadership, 182 price system, 180 takeovers, 38, 153–4, 180, 200, 241 under-priced, 38, 153–4, 180 property rights, 13, 147, 151, 178 public ownership, 189, 190, 191–2 structure of ownership, 201–9 Shonfield, Andrew, 69 Short-termism: dividends, 179 institutional shareholders, 178–9 investment, 43 market for corporate control, 161 takeovers, 15 Silberston, Aubrey, 129 Slater, 185 Smith, Adam, 30, 32, 33, 35, 36 Social choice costs, 132, 135 Social citizenship, ownership, 3 Social justice, redistribution, 53 Social welfare: corporate objectives, 130–1 Employee Share Ownership Plans (ESOPs), 135 pluralism, 122 Socialism: collective bargaining, 70 nationalisation, 3 political economy, 3, 35 public interest, 35 Sociology: corporate governance, 18, 265–87 ownership, 271–7 societal effect, 285 South Sea Company, 29, 30 Stakeholders: activism, 47 codes of practice, 44 contractual theories, 163, 172 control, 132 co-specialisation, 126 directors’ duties, 5, 43, 47 efficiency, 172 enlightened managerialism, 45, 47 Germany, 283 Japan, 43 Labour Party policy, 15 pluralism, 47, 132 public interest, 45 risk, 11, 131 shareholder value, 5, 43 stakeholder debate, 43 sunk investment, 11 theories, 142 United States, 43 Stanley, Oliver, 40

Index 309 Stapledon, Geof P., 15, 16, 195–231 Stock exchanges: Germany, 43, 87–8 listing rules, 45, 236, 257, 284 London, see London Stock Exchange New York, 284 see also Capital markets Sträter, M., 95 Subsidiarity, European Union, 110 Subsidiary companies: Cohen Committee (1945), 63 corporate trustees, 202 insurance companies, 205, 206 pension funds, 202 Supervisory boards: Bullock Committee (1976), 78, 106, 107 European Commission, 71, 75 Germany, see under Germany Labour Party policy, 73 trade unions, 71, 72, 74 see also Two-tier board system Suppliers: assets, 128 co-specialisation, 131 customer-supplier relationships, 127–9, 135 firm-specific risk, 127–9 shareholders, 135 Sweden: Employee Share Ownership Plans (ESOPs), 110 environmental protection, 97 Sykes, A., 195 Takeovers: activism, substitute, 240 bid premium, 240, 241 codes of practice, 15, 184 defences, 89, 200 duties, 214 economies of scale, 185, 187 efficiency, 161, 240 exit mechanism, 185, 186, 270 firm-specific investment, 136 Germany, 9, 86, 89–90 government intervention, 14, 15, 185, 187–8 hostile bids, 38, 136, 161, 240 implicit contracts, 118, 136 inefficient managers, 38, 154, 161, 180, 240–1 information requirements, 240, 241 international finance, 185–6 IRC, see Industrial Reorganisation Corporation market for corporate control, 38, 44, 136, 154, 161, 270 poison pills, 89, 276 public policy, 185 self-regulation, 184 share prices, 38, 153–4, 180, 200, 241

short-termism, 15 total wealth creation, 136 transaction costs, 240, 241 United Kingdom, 14–15, 161, 184–6 United States, 276 Tawney, Richard Henry, 54–5, 56, 57, 59, 158 Taxation, Germany, 9 Taylor, Frederick Winslow, 102 Taylor, Robert, 10, 11, 101–12 Technology, organisational form, 22 TGWU, 68, 78 Thatcher, Margaret, 42, 181 Total wealth creation: contractual theories, 130, 131 Employee Share Ownership Plans (ESOPs), 135 takeovers, 136 Trade Union Congress (TUC): Bullock Committee (1976), 105 Cohen Committee (1945), 62–3 Economic Committee, 62, 66 flexibility/productivity, 110 industrial democracy, 69, 71, 74, 77, 78 Industrial Democracy Working Party, 70, 71 Jenkins Committee (1962), 64–5 Trade unions: collective bargaining, 41, 53, 67, 69, 73, 74 consultative bodies, 66 independence, 41, 54, 66, 67, 69, 77, 106 industrial democracy, 8, 66–7, 68, 71 Japan, 280–1 Labour Party policy, 41, 66 nationalisation, 67 private associations, 41–2 recognition, 103 social partnership, 110, 111 supervisory boards, 71, 72, 74 worker directors, 73, 77, 78 Transaction costs: contractual theories, 119–21, 126 employment, 121, 126 hostage-taking, 126–7 institutional economics, 158 suppliers, 128 takeovers, 240, 241 Transparency: joint stock companies, 33 United Kingdom, 6 United States, 46 voluntarism, 107 Treasury: devaluation (1967), 188, 193 public ownership, 192, 193 Trustees: corporate, 202, 203–4, 215–16 pension funds, see Pension fund trustees unit trusts, 206, 221 voting, 204, 209–10, 214

310 Index Two-tier board system: Bullock Committee (1976), 77, 106, 107 Company Law Review Steering Group, 260 European Commission, 71, 253 Germany, 6, 8, 45, 47, 61, 66, 276 non-executive directors, 260 see also Supervisory boards UK Active Value, 230 Unemployment, Germany, 86 Unit trusts: accountability, 16 Australia, 221–2 authorised, 206–7 beneficial owners, 206, 222 custodians, 206 fiduciary duty, 221–2 institutional shareholders, 178, 184, 206–7 managers, 206–7, 209, 221–2 registered holders, 206 share-trading, 185–6 trustees, 206, 221 voting, 206–7, 209, 221, 222 United Airlines, 281 United Kingdom: contractual theories, 141–2 environmental protection, 97 pluralism, 12 private associations, 5, 6, 7, 8, 27 takeovers, 14–15, 161, 184–6 transparency, 6 United States: activism, 153, 198–201, 226–7, 229 banks, 159, 271, 277 Californian Public Employees’ Retirement System (CalPers), 46, 198–9, 229, 230 chief executives (CEO), 245, 280, 284 company law, 276 contractual theories, 142 Department of Labor, 198, 226 economic power, 34 Employee Share Ownership Plans (ESOPs), 46, 110, 136, 281 essentialist debates, 143 firm-specific skills, 127 independent directors, 17 industrial democracy, 19, 281 Institutions, see Institutional shareholders managers, 284 market for corporate control, 280 market-based control, 270 non-executive (independent) directors, 17, 195, 243, 258, 284 pension funds, 16, 46, 198, 226–7, 229, 281 political choice, 48 property rights, 149 public policy, 176 regulation, 277

shareholders, 13, 153, 276 stakeholders, 43 takeovers, 276 theories of the corporation, 142–3 transparency, 46 voting, 16, 151, 198, 219, 226–7, 228, 229 Veblen, Thorstein, 149, 158 Virginia School, public choice theory, 25 Vodafone, 9 Voice: civil servants, 188 employees, 266 institutional shareholders, 183, 274 shareholders’ rights, 37, 38, 185 Voting: collective action, 38 compulsory, 224–7 contentious/non-contentious issues, 214, 219, 225 fund managers, see External fund managers voting holder of rights, 202, 204, 205–6, 207–8, 209 institutions, see under Institutional shareholders insurance companies, 205–6, 220–1 investment trusts, 207–8, 223 Labour Party policy, 210, 227 market for corporate control, 154 non-voting shares, 64, 65, 73–4, 158, 190 open-ended investment companies (OEICs), 209, 223 pension funds: delegated, see under External fund managers voting trustees, see under Pension fund trustees proportionate influence, 225–6 proxies: appointment, 204 fiduciary duty, 222 proxy advisory services, 17, 225, 230 United States, 226 regulation, 209, 210, 224–8 trustees, 204, 209 unit trusts, 206–7, 209, 221, 222 United States, 16, 151, 198, 219, 226–7, 228, 229 see also Activism Watkinson Committee (1973), 251–2 Webb, Sindey, 54, 57 Wedderburn, Kenneth W., 77, 152 Wigham, Eric, 69 Williams, Shirley, 79 Williamson, Oliver E., 119, 126, 131, 157, 158 Wilson, Harold, 15, 72, 181, 187, 194 Winter of discontent, 80 Wintour, Patrick, 72

Index 311 Wise, Audrey, 70 Wolfe, Alan, 163 Wood, Franklin, 149 Woodcock, George, 69 Worker directors: Bullock Committee (1976), 77–8, 253 conflict of interest, 69 directors’ duties, 77 dual loyalty, 280, 283 elections, 77, 78 Germany, 280, 283 Labour Party policy, 42 trade unions, 73, 77, 78 see also Co-determination; Industrial democracy Worker rights: annual reports, 103

commercial success, 108 employment relations surveys, 108 flexibility, 102–3, 111 negotiation, 101, 102 participation, see Industrial democracy Scandinavia, 102 self-interest, 108–9 social dialogue, 101–2, 103, 104 social pacts, 111 unequal relationship, 101 Works councils: competitive advantage, 103 decision-making, 104 European Union, 11, 71, 75–6, 109 Germany, see under Germany social dialogue, 101–2 social plans, 134