Theresa May on Corporate Governance: A misguided approach?

When last I wrote, I rose some preliminary objections to the idea of employee representation on corporate boards in the UK. I am not against strengthening the position of employees because I do not believe the current 'normative consensus' espoused by Hansmann and Kraakman: that the best way to achieve aggregate social welfare is through running the company in the collective interests of shareholders.

However, I noted that giving employees a voice on the board would be nothing more than a palatable political response because of the legal structure in companies it probably would not change the way companies operate. An employee representative would be under the same duties as any other director and it may cause new conflicts of interest or raise questions as to their independent judgement.

Now, fortunately, her government appears to have rowed back from this position and it is being reported instead that the proposed reforms will include:

1. Introduce corporate governance codes to private companies
2. Require companies to publish pay ratio between CEO chief executive and average employee
3. Improve effectiveness of remuneration committees and the extent to which they should consult shareholders and the wider company
4. Introduce binding votes on executive pay packages

The reasons behind this reform are, supposedly, to 'increase public trust in business in the face of the rise in anti-globalisation and anti-business sentiment'.

In response to this, the common objection is dusted off that more controls on business and boards will lead to some sort of mass exodus of top management talent from the country, just as there was a mass exodus from Britain after Brexit and America after Trump... as if the only thing tying management to this country is whether or not shareholders have a binding say on their pay.

Yet, what I object to under these proposals is the government's inability to think outside the box. Everytime, there is a scandal we hear the same story: "More shareholder power", that is the answer, despite seemingly ignoring considerable evidence that shows increasing shareholder power does not improve business.

There is the work from Cheffins that shows increase in investor confidence often comes from essentially soft forms of control rather than granting shareholders more rights.

There is work from Armour, Siems et al that shows increasing shareholder power in some cases decreases prosperity as it significantly relates to reduced public listings.

We must also consider some of the seminal work on agency theory by the likes of Fama, who highlighted matters such as portfolio theory. Shareholders diversify their risk and have little incentive to monitor one company. There is also the problem of information asymmetries between company and shareholder, that even if they did have the incentive they may not be properly informed to make good or fully informed decisions.

There is also the fact the government point to other countries' practices, such as the US, France, and Australia, but ignore work by Tubner that highlights the impact of developing legal systems by analogy or legal transplant can result in legal irritants as laws operate out of context. Not to mention using Australia as an analogy for legal development of strengthening shareholder power ignores there own reforms of removing the 100-member rule that allows 100 shareholders to table resolutions at annual general meetings.

Then you have my own current work (forthcoming, so don't want to give too much away just yet) that shows even if shareholders tried to legally enforce anything against the company, the courts are parsimonious in allowing shareholders to enforce the company's rights due to restrictions on locus standi.

So, I am not sure the case is really made out, that the way to improve public confidence in business is to give shareholders more power. It is built on a faulty premise that: (1) we trust shareholders to make the right decision, or any decision at all; and (2) the faulty premise that the best way to achieve aggregate social welfare is to run companies for the shareholders' collective interest.

This begs the question, of course, what should we do? Now, I have many angles I could take on this, but I draw attention to Cheffins' work on whether law matters, and I also draw inspiration from Schynder's recent paper on why should law matter.

It would appear that the objective of reforming the law, i.e. why should law matter, is to improve public confidence. It does appear there are other objectives, such as deterrence, but confidence appears to be the main concern. The reasons for this are highlighted in the news article such as 'good governance helps companies take better decisions, for their own long-term benefit and the economy overall'; and 'businesses are a pillar of our society, creating employment opportunities and contributing significantly to funding our country's public services'. Seemingly if we are confident in what businesses are doing we can rely on them and we as the public and consumers become more confident in the market and continue to spend.

Cheffins points to the different ways investor confidence is improved, noting this is not achieved through increasing their rights. Factors such as financial intermediaries and the stock exchange are better at achieving this.  One must stress that this looked at increasing investor confidence, so one must be careful in drawing an analogy between investor and public confidence. But from this observation our working hypothesis could be increased shareholder rights will reduce public confidence in business.

It is taken from this that increasing shareholder rights we would observe a decrease in public confidence in business. While I said it was a danger to draw analogies with investor confidence as to whether increased rights would reduce public confidence, the hypothesis can be supported by the idea that shareholders, with their lack of incentives, will fail to monitor the company properly to increase confidence; those that do monitor the company will only do so to increase their own personal wealth; and when things do turn sour shareholders will lack the appropriate legal mechanisms to enforce the desired standards through the courts or company resolution.

If we want to increase public confidence we need more imaginative ways of doing that. Now, I am openly in favour of good regulation of business. I am not necessarily going to say what regulation that should be, as I do not think it is a matter for company law, nor is there the space or time to do so here. But, for example, employment law could be strengthened to support the statement above. That we rely on business for employment opportunities. We are not going to be confident in business if we feel they can remove us from our role in favour of short-sighted profit. So getting the balance of employment law right can help increase confidence. Yet, this Conservative government has gone about restricting employment rights.

This then boils down to what I said previously, these reforms are nothing more than palatable political responses.