Essay written in 2020 for the course “International Corporate and Financial Law”, held by prof. Thomas Bachner at WU – Wirtschaft Universitat Wien. Evaluated with highest honors
In this essay, after an analysis of both the “pluralist approach” and the “shareholders’ primacy”, it will appear evident that the role of directors is well-considered in the former, but sometimes overlooked in the latter. Indeed, it is of crucial importance for a better understanding of both, and should be taken into due account for a meaningful discussion of any of those models. Furthermore, I will also explain why the role of directors may be used as the starting point for solving the “shareholder” versus “stakeholder” debate by finding a balanced approach that makes the best of both worlds.
Starting with authors dealing with the pluralist approach, it is clear how much the role of directors in weighing up all the interests involved is stressed: think about the content of “interest of the company” in Dutch law (as “filled up” by Verdam, 2014). But why is it necessary that directors operate this weighing of interests? The answer is that companies actually use a variety of inputs to carry on their activities: not only equity capital, but also the workforce, infrastructures, creditors’ loans etc., and if all those interested groups are not taken into due consideration the company will suffer in the long-term. The pluralist approach is thus very concerned with the aim of enhancing directors’ behaviour towards sustainability (Johnston, 2014), and since sustainability and high-commitment work practices often lead to higher profitability of companies, even in financial terms, in the long-term (Clarke, 2014), the fact that the role of directors is taken into such a big account is certainly valuable for shareholders as well! Directors’ role in this respect is also considered for instance by the practice of developing remuneration arrangements based on sustainability objectives, in order to align directors’ interests with those of the several stakeholders – if directors do not understand at first sight that shareholders too would be pleased by a socially responsible approach. The threats of Corporate Social Responsibility (CSR), of reputational sanctions, or of directors’ companies being excluded by big investment funds (Halvorssen, 2014) have also the same effect of enhancing directors’ behaviour towards a balancing of all relevant interests. Furthermore, the pluralist model also takes into consideration directors’ duties: for instance, in the vicinity of insolvency, such duties shall be modified as creditor-regarding (Davies, 2006), because of creditors’ newly acquired position – displacing shareholders – of “residual claimants” – creditors being obvious stakeholders – and this again stresses the importance of directors for this model. Finally, in many countries adopting this approach – e.g., many continental countries – there are usually companies that face a type of principal-agent conflict that UK and other shareholders-oriented countries rarely face – due to the dispersed-ownership structure of their companies (Bachner, 2009) – : the conflict between minority and majority shareholders. Directors sitting on the supervisory board therefore play the role (Gerner-Beuerle and Schuster, 2014) of monitoring management’s consideration of minorities.
It appears, on the other hand, that sometimes the different shareholders-oriented approach does not take into due consideration the role of directors. However some may argue, that this lack of consideration would not be a bad thing. Proponents of this view might reasonably make four arguments to support it.
First, aligning directors’ interests with those of the shareholders does not in fact automatically lead to positive financial outcomes, when we are faced with the presence of different cathegories of shareholders with different time horizon concerns, within the same company. A board’s strategy that may be seen favourably by a “buy&sell” investor, could therefore be opposed by a “buy&hold” investor. This is also the reason why stock-options – and, in general, equity-based remuneration arrangements – may unfortunately lead to abuses (e.g. Enron, Armour & Skeel, 2007) if a director seeks to maximize shares’ value in the short-term without considering the long-term as well. Secondly, fiduciary duties in situation of near-insolvency may lead to inefficient risk-taking by directors accountable to shareholders (Davies, 2006), only benefiting from the upsides without suffering from the downsides of a risky project. Thirdly, directors’ duty of care is not well-enforced in shareholders-oriented countries like the UK because of the lack of an efficient “protection” to directors’ discretionality (Gerner-Beuerle and Schuster), again showing the fact that directors are sometimes overlooked in those systems. Fourthly, civil enforcement of directors’ duties by minority shareholders through means of a derivative action (Gerner-Beuerle and Schuster), is still much less frequent than the administrative “disqualification of directors” or criminal liability substitutes, due to the collective action and free-rider problems faced by UK companies with dispersed shareownership, that inhibit shareholders’ activism and lead to – too much high, since not well-controlled – directorial independence.
However, this view of directors not being of core importance in the shareholders-system has a key weakness: if the role of directors was not of core importance in this system too, we would not have provisions, in the UK CGC, trying to enhance shareholders’ engagement in decision-making – e.g. rules 3-4, providing for the chair taking into due consideration shareholders’ view on, inter alia, governance and board resolutions – and outlining a very preminent role of independent non-executive directors (NEDs) and their committees – rules nnrr. 17, 24, 25, 32 – in a much more specific manner than their continental counterparts – e.g. AT CGC’s definition of independence, rule 53, is much narrower than UK CGC rule nr. 10. In fact, NEDs play a key-role in mitigating the collective action problem in dispersed shareholders companies by removing executive directors (rule 13 UK CGC) who do not act in their principals’ best interest (breaking sec. 172 UK CA), thus rendering them more accountable to shareholders. Furthermore, the fact that directors should have a stronger role in the shareholders-oriented model can also be inferred from Verdam, p. 3, in regard to the second pillar of the “enlightened shareholders value” (ESV) theory, trying to find a balance between shareholders’ and other stakeholders’ needs. In fact the second pillar – necessary for the ESV theory to work, and now disappeared by withdrawal of the OFR-legislation – provided for directors’ key role in social accounting in order to find a balance between the two theories mentioned above.
In conclusion, the role of directors is very well-considered in the stakeholders-oriented approach but less in the shareholder-oriented. This is a particularly serious omission because the role of directors in the “shareholder” versus “stakeholders” debate is of key importance to understand how to deal with the main issues of both systems. Conversely, the argument contrary to this view has been shown to be not credible. Furthermore, the role of directors is also useful to find the golden solution of a balance between the two above mentioned-approach, to build a modern sustainable company.