Boards must strike a balance to ensure shareholders receive value while the interests of other stakeholders are safeguarded, says prominent academic.
The debate about the purpose of organisations has heightened in Australia and overseas this year. At its core, it is about whether corporations exist to maximise profits and serve shareholders, or have broader stakeholder responsibilities, or both.
The Assistant Minister to the Prime Minister, Ben Morton, this month criticised business for pandering to activist groups and “noisy elites” who push social agendas. He called for business to focus on providing the best product or service, and maximising profit, within the law.
Business Council of Australia CEO, Jennifer Westacott, reportedly said days later that business should “make a virtue of being profitable companies”, seemingly supporting the Federal Government’s view that business should avoid supporting “fashionable social causes”.
In the United States, the Business Roundtable, an organisation for CEOs of large companies, made headlines in August with its revised Statement on the Purpose of a Corporation. Signed by 181 CEOs, the Statement calls for companies to serve all stakeholders.
Critics of the Statement see it as a major shift from shareholder primacy to a greater focus on “stakeholder capitalism”, where organisations serve a range of stakeholders (including shareholders) and boards govern for them.
The Council of Institutional Investors in the US, a corporate governance advocate, criticised the Business Roundtable Statement: “CII believes boards and managers need to sustain a focus on long-term shareholder value. To achieve long-term shareholder value, it is critical to respect stakeholders, but also to have clear accountability to company owners. Accountability to everyone means accountability to no one.”
In a statement, CII added: “Much of the discussion on ‘stakeholder’ governance focuses on individual companies, and seems to downplay or ignore the role of markets. Shareholders have a very particular role in allocating (and re-allocating) equity capital.
The Governance Leadership Centre asked Professor Pamela Hanrahan, Professor of Commercial Law and Regulation, and Deputy Head of School (Research) at UNSW Business School, for her view on the debate between shareholder and stakeholder capitalism (and governance). Hanrahan is one of Australia’s leading authorities on financial-services law and regulation.
GLC: Pamela, how do you define “stakeholder capitalism” and why is it in vogue again?
Pamela Hanrahan: It’s a term that has been around since the late 1990s. It is often associated with R. Edward Freeman. He would define it as a system in which corporations are seen as vehicles through which all stakeholders – including equity and debt providers, employees, suppliers, customers, and communities – pursue their joint interests. These corporations might tailor their governance arrangements to include all stakeholders and to engage more formally with the interests of each group and with their joint concerns.
On this model, directors have duties to all stakeholders and managers are seen as the agents of multiple principals. It is predicated on the assumption that if corporate strategy disproportionately privileges one group of stakeholders over others, it won’t work.
It’s a political notion, not a legal one. It comes back into vogue in times when the community thinks the benefits and costs of business are not being shared appropriately, and there is no trust in the political system to address perceived inequalities and long-term societal challenges. I think we are in that environment now.
GLC: Do you believe stakeholder capitalism is the way forward for boards?
PH: It is a tempting slogan, but I wouldn’t call it the way forward for boards. I think Australian company law already allows for all the perceived benefits of this approach – giving the board as a collective decision-maker responsibility for setting the goals and values for the corporation and for recognising and balancing the interests of different stakeholders.
Investors who provide equity capital expect a return for the risk they take, and boards must ensure the company is properly and responsibly managed to deliver that return. What it means to manage the company ‘properly and responsibly’ evolves as circumstances change, and boards must be sensitive to that in setting the strategic direction and in explaining clearly to investors where the value will come from into the future.
Good boards recognise that delivering value to investors over the medium to long term requires them to get the balancing of stakeholder interests right.
GLC: Should the board’s responsibility to stakeholders, via directors’ duties, be enshrined in Australian law, as is the case in the UK through section 172 of The Corporations Act 2006 (UK)?
PH. No, I am not in favour of a section 172 type provision in Australia. Australian law requires individual directors to exercise their powers and discretions in the best interest of the corporation – that’s not the same as saying they owe a duty to maximise shareholder returns. It is a stronger provision than UK section 172, which in some respects pays lip service to these other interests but may actually embed shareholder primacy. It is not clear that the UK’s section 172 requires UK directors to do anything other than put some motherhood statements in the minutes, so I would challenge your question that it enshrines responsibility to stakeholders.
Australian directors must balance different stakeholder concerns to arrive at a considered decision about what is best for the corporation. That is their job – it is not always easy and it involves judgement calls.
GLC: What are the risks of embedding a responsibility to stakeholders into directors’ duties?
PH: Directors already face significant legal risk if they are perceived to have got that stakeholder balancing wrong. Look at James Hardie. Perhaps the parent company could have done what other asbestos businesses did globally and just put the subsidiary into liquidation and walked away. Instead, the directors tried to establish a mechanism for compensation – they got it wrong and ended up being sued for a defective stock exchange announcement. That’s the reality – whatever the law says.
That said, it’s interesting to compare the duty in section166 of the new Indian Companies Act – it is that directors must ‘act in good faith in order to promote the objects of the company for the benefit of its members as a whole, AND in the best interests of the company, its employees, the shareholders, the community and for the protection of the environment’. Note the AND in the Indian law.
GLC: Can boards adequately assess the needs of employees, customers, the community, suppliers and regulators in the traditional governance model? Or will we need to see changes in board composition or structure?
PH: This is about the purpose of boards. Our model works on the basis that, in a private-sector organisation, having a group of (hopefully) reputable, experienced people who must deliberate and arrive at decisions collaboratively, who bring different histories and perspectives to the discussion, knowing they are legally obliged to put the corporation’s interests first, is the best approach. A board is not a parliament. Employee-elected directors and two-tiered boards were floated in the UK but rejected, I think for good reason. In the Australian debate there is a real misunderstanding about two-tier boards and what the supervisory board actually does and why its members are chosen the way they are. They do not run the business.
Can boards adequately assess the different interests? It is already the directors’ job to think about how business decisions are impacting different stakeholders. That is a given. It is important to get the right non-financial information from management and to communicate openly with all stakeholders – including investors – about where they propose to strike the balance on these issues. This determines where the board will position the company on a whole range of important questions from employee rights to climate impact to data governance.
Board skills is an interesting question. I think the case for diversity of thinking and approach is obvious in any group decision-making body. It is every director’s responsibility to engage with the issues and challenges the business faces. But at the end of the day, you are running a business. If the board needs to hear from advocates for particular interests, they should make sure they do, and if they ignore what they hear in their decision-making, they do so at their peril.
Most boards focus on what will benefit their medium- to long-term investors. It’s rarely a question of one group having ‘priority’ over another – it is about how you bring those interests into alignment over the longer term.
GLC: What does stakeholder capitalism mean for shareholders and is it right that they might have lower priority than other stakeholders (who don’t contribute equity capital) in some board decisions?
PH: Shareholders are a diverse group. Long-term investors don’t want the same thing as traders. Most boards focus on what will benefit their medium- to long-term investors. It’s rarely a question of one group having ‘priority’ over another – it is about how you bring those interests into alignment over the longer term. Commissioner Hayne (in the Financial Services Royal Commission) took the view that eventually interests converge. That is not always the case, but it is worth reflecting on. Even in a business that won’t exist in 10 years, it’s about how to come to a landing that takes account of all legitimate concerns and doesn’t buckle to vested interests or political pressure.
Remember, many businesses – fund managers and listed law practices are good examples – already operate on the basis that the interests of beneficiaries or clients must be preferred over the company’s interests and this affects all board decisions. If the government wants to pass a law that says corporate interests must be subordinated to other interests in a particular area it is always open to it to do so, and directors will adjust.
GLC: How do you see the issue of stakeholder capitalism evolving in Australia over the next 10 years?
PH: These things run in cycles. As a lawyer, I am not convinced this latest thought bubble adds much. That said, the idea that boards must consider and balance the impact of corporate decisions on all stakeholders is now accepted, even by the US Business Roundtable, and it is unlikely that will change at least for listed entities. To me, the more significant issue is about corporate short-termism and that is a discussion that must involve investors and governments, not just boards.
There is a broader discussion we need to have about what is happening politically and how society conceptualises regulation and the relationship between the government, corporations and citizens. I am profoundly concerned about the anti-democratic implications of trying to resolve questions of political and social justice through corporate law.
GLC: Is Australia lagging other countries on stakeholder capitalism?
PH: No. If you believe that, think about the recent history of Deutsche Bank, and how quickly (former British Prime Minister) Theresa May’s stump speech about reforming capitalism disappeared.
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