Duty to Promote the Success of the Company - Assignment Example

?Law Business Associations Table of Contents Introduction 3 Deficiency of Company Law Is Its Failure to Provide Any Effective Restraints on the Ability of Company Directors to Reward Themselves Excessive Remuneration and Benefits 6 Duties Imposed On Directors’ That Restrict Them From Deriving Benefits For Themselves Taking Into Account The Role Of Shareholders And Other Stakeholders In Account 12 Duty to Act within Powers 12 Duty to Promote the Success of the Company 12 Duty to Exercise Independent Judgement 13 Duty to Exercise Reasonable Care, Skill and Diligence 14 Duty to Avoid Conflict Of Interest 14 Duty to Accept Benefits from the Third Parties 14 Duty to Declare the Interests in Proposed Transaction with the Company 15 Conclusion 16 References 18 Introduction The Companies Act 2006 (c.46) clearly addresses the problems associated with director’ Remuneration. This particular Act provides comprehensive regulations of the United Kingdom based company’s law. The Act includes certain common principles related to the directors’ duties. Directors’ remuneration’ has occupied a vital position in usual discussions in recent years. This happens primarily owing to the fact that often there lays a huge difference between the remuneration of the directors and the employees. In accordance with a news report presented by Wcbn (2011), the latest trends in directors’ remuneration have been demarcated from the review made by PricewaterhouseCoopers (PwC). It depicts that remuneration levels usually depend upon the industry within which the company is operating and the company size1. In accordance with a report presented by KPMG UK, it is ascertained that the scenario related to directors’ remuneration in the year 2013 has gone through certain decisive changes. The report states that in the modern day scenario for designing the salary structure, a shift of focus from the market median to the linkage between pay along with performance has been made. The latest trends in the remuneration structure can be best understood by following the pictorial representation given below2. Source:2 Companies Act 2006 provides a detailed understanding of the appointment and removal of directors. The Act states that initial appointment of the directors are done by ‘subscribers’ to the memorandum’. Furthermore, the Act also states that ‘article of association’ determines the appointment of directors. In accordance with article 17 of the new model, it states that directors are selected by the members of the annual general meeting and by the Board of Directors. The appointment regulations state that a person must be willing to act as a director. Whereas, s167 (2b) CA 2006 states that “consent by that person, to act in that capacity” must be informed to the companies house3. According to a report presented by Ernst & Young, the changing landscape pertaining to directors’ remuneration has been revealed. The observations reveal that the United Kingdom’s recovery pertaining to the global recession is slower. This is resulting in a decrease in consumer spending and business confidence. The latest trends related to the shareholders’ voting rights with regard to the new remuneration structure has highlighted that companies have been compelled to make transparent communication regarding directors’ remuneration4. Correspondingly, director’s remuneration has accelerated at an alarming rate. In nations such as the UK, all the companies that are listed are required to comply with company law, as directed in the Companies Act, 1985. Subsequently, in 2002, certain reforms had been made to the set out Companies Act 1985 with regard to the enhancement of accountability and transparency for the companies that are listed. In terms of a crucial directive, under the requirement of company law, listed organisations will be necessitated to publish a report relating to directors’ remuneration within annual reporting cycle. Despite such reforms the company law has remained noticeably ineffective to establish specific restraints on directors’ from amassing unabated remuneration packages3. This study intends to discuss the failure of the company law in restricting the directors’ from rewarding themselves excessive remuneration and benefits. Moreover, the study will also focus on the duties of the directors that will impose restriction on their ability of obtaining benefits for themselves. The duties imposed on the directors that restrict them from obtaining excessive benefits are significantly affected by the decisive roles played by shareholders and other stakeholders. Deficiency of Company Law Is Its Failure to Provide Any Effective Restraints on the Ability of Company Directors to Reward Themselves Excessive Remuneration and Benefits In order to decide upon the structure of directors’ pay, numerous committees are involved. In accordance with the context in D, 2 of ‘UK Corporate Governance Code’, it has been stated that there must be a formal procedure to decide upon the policies related to the directors’ remuneration. This formal procedure must maintain transparency and is usually named as the remuneration committee. It has been mentioned in the governance code that no individual director is allowed to decide upon their own remuneration package. The principle lay down in D.2.1 states about the involvement of committee membership for directors’ remuneration. These two members are highly accountable for the decision-making process of directors’ remuneration package5. In the modern day scenario, the vast difference between the directors’ pay and the compensation of the employees reflects the failure of the company law. In this regard, the failure of the company law is associated with the restriction on the directors’ excessive remuneration along with benefits. It has been affirmed that regulations pertaining to directors’ remuneration mainly arise responding to the market failure related to corporate governance. According to agency theory, it reflects the relationship, where the company’s shareholders delegate their power and management to the directors’. In this context, it is observed that this particular separation of ownership and management has given space to the directors’ to perform activities in order to suffice self-interest and benefits. Furthermore, in accordance with the failure of company law, it has been comprehended that the ‘principal-agent theory’ essentially reflects directors’ remuneration as a vital mechanism in reducing the agency cost6. From an in-depth analysis, it has been determined that wherever the shareholders’ do not levy their control over the remuneration of the directors, there is a likely chance of deriving benefits for own-self by the directors. The report of the Department for Business Innovation and Skills discusses the linkage between pay and performance of the directors7. It has been revealed that the Chief Executive Officer’s (CEO’s) remuneration pertaining to the UK’s top companies have accelerated to greater heights in the past few decades. Precisely, this aspect has given rise to a level of discomfort amid the shareholders and the stakeholders. The growth of CEO’s remuneration in the UK when compared with the remuneration packages of other CEO’s of companies operating in different nations reveals a wide gap. Additionally, the executive pay structure in the UK executes under new regulations. It has been observed that the introduction of the directors’ remuneration report has become a necessary requirement in the company’s operating within the UK. Moreover, all the registered companies operating within the UK has also been subjected to the remunerations reports. In comparison with the scenario of directors’ remuneration in the UK, the other countries have readily implemented measures to improve the level of transparency associated with directors’ remuneration 5. In accordance with recent news, it is recognised that the Dutch government has strictly outlined rules on bank bonuses in Europe. The new rules state about the bankers’ bonuses being curtailed to 20% of the salary of employees. Bankers’ bonuses have raised significant controversies in recent times owing to the financial crisis that affected Netherlands around five years ago. The global financial crisis has been assumed to be partly associated with the remuneration policies within the financial institutions. It has been also assumed that the pay structures of the banks are greatly responsible for the critical financial crisis. Therefore, Dutch government has laid down such rules against bankers’ bonuses8;9 The case studies of Disney, AT&T and Verizon have in common the remuneration fluctuations of the CEOs of the companies within the year 1991-2002. It has been apparently observed that the remuneration pertaining to the company’s CEOs is negatively associated with their job competencies. It has been noted that Disney’s CEO Michael Eisner has been paid around US$38 million i.e. above the industry standard. Furthermore, in relation to this aspect, Michael Eisner received his compensation within three years out of the six years even when the performance of the company was in the deteriorating stage. With regard to an in-depth analysis of a report presented by Stanford Business, in the year 1992, the average pay that CEO of S&P 500 firm derived amounted to US$2.7 million. Furthermore, with the passage of time, the average rate of the directors’ remuneration has also accelerated10. The case study of Northern Rock Bank of the UK can be another pertinent example of failure of corporate governance under company law. This firm was the first ever UK based bank that suffered a huge loss pertaining to directors’ remuneration. This case occurred only after the decision taken by the state ownership on directors’ remuneration strategies. The wordings of the state ownership demarcated that the performance of a company primarily depends upon the contributions made by the individual directors. The wordings further incorporated that the policy related to directors’ remuneration has been designed to impart transparency. Nevertheless, contrary to these policies the executive directors’ of Northern Rock Bank used to derive compensation of around ?6.2 million even when the company was almost about to collapse. This shows the loopholes within the corporate governance policies mandated under company law11. Precisely, these new rules that have been established have failed to combat against the criticism that has been levied on the directors. In order to mitigate the disparities taking place with respect to directors’ remuneration, The Financial Services Authority (FSA) has developed a remuneration code. This particular code came into reconvening in the year 2010. At the initial stage, this code has been levied upon the FSA’s banks and the broker dealers among others. In accordance with the remuneration code, it states that it is necessary for the firms to establish, maintain and implement the remuneration policies effectively. In the present day context, the remuneration packages of the directors have become more complex7. Under the section 994 pertaining to the Companies Act 2006, it has been stated that the company’s shareholders endure the right of issuing proceedings against the company management if they feel that the company is involved in any kind of unfair practices that might hamper the shareholders interest. In keeping with the case of Maidment v Attwood and Ors [2012] EWCA Civ 998, it has been decided by the High Court that Attwood’s remuneration was readily excessive. However, High Court affirms that excessive remuneration of Attwood was justified and not unfair. The High Court justified the statement by stating that pay package has been clearly disclosed in the books of accounts. The court further stated that Maidment could have challenged the remuneration package before also. Correspondingly, the Court of Appeal overruled the decisions of High Court. According to the Court of Appeal, the decisions made by the High Court were incorrect as it dismissed Maidment’s petition. Rather High Court could have suspended the Maidment’s petition for additional hearing. This would have provided an opportunity for determining the actual reasons of liquidation. According to the Court of Appeal, the company’s directors had breached the fiduciary duties, thereby failing to protect the interest of the company12. In accordance with the compensation package, there exist a positive and a negative side. In terms of the positive side of executive compensation, if designed properly and effectively, it can become a vital mechanism of the corporate governance strategies. Moreover, positive compensation of the executives has also the potential to align the incentive packages of the managers to that of the shareholders in order to make certain important financial decisions along with investment. On further in-depth analysis, it has been noted that the management compensation packages incorporate bonuses and stocks among others. However, the dark side of the management compensation entails that incentive alignment might direct towards value creation. It has been further noted that false compensation plans might lead to value destruction. Furthermore, disproportionate management compensation pay might lead to the overvaluation of the firm13. As a matter of fact, directors’ remuneration must be under strict supervision. Therefore, it can be ascertained that the failure of corporate governance incorporates the duties of the directors, auditing, directors’ remuneration, risk management and quality pertaining to the financial reporting among others. The directors’ remuneration scheme is rather not transparent and upon this aspect any consequences cannot be measured. It is required to improve the transparency level of the directors’ remuneration to mitigate the salary disparity problem at the earliest. Furthermore, it has been recognised that the massive failures pertaining to the executive remuneration has forced the government to implement measures for regulating the payment structure. The governmental decision to bring stability within the financial system reflects its goals and objectives14. Duties Imposed On Directors’ That Restrict Them From Deriving Benefits For Themselves Taking Into Account The Role Of Shareholders And Other Stakeholders In Account Directors’ duties incorporate the fiduciary and general duties. In accordance with the Companies Act 2006, it has been noted that the directors’ duties were replaced by new rules and regulations. However, the responsibilities have been implemented in the similar manner as in case of the common rules. According to the Companies Act 2006, there are seven statutory duties levied upon the business institutions and the directors’ that have been briefly explained below11. Duty to Act within Powers In case of a director, it becomes necessary for them to act according to the instructions given by the constitution of the company. Moreover, it is their duty to exercise their power for the benefit of the organisation and the employees. This particular duty of the directors replaces the common law that describes the execution of their activities pertaining to the articles along with memorandums. In light of the Companies Act 2006, it does not design the proper purpose of the directors’ duties and thereby such matters have been greatly determined in the previously implemented case laws11. Duty to Promote the Success of the Company This particular duty of the director also replaces the fiduciary duty in order to mitigate and fulfil the best interests pertaining to the company. In-depth analysis of the directors’ duties reveals that the statute is rather more prescriptive in comparison with the common law. In-fact, it sets out a line of factors that must be taken into consideration by the director while planning for the business success and growth. It is the responsibility of the director to incorporate statute factors during the decision-making process pertaining to the company’s benefit. The relevant factor that must be considered by the directors during decision-making process entails the consequences pertaining to the decisions with respect to the long-term sustainability. The next factor reflects the interest of the employees working within the company. The following factor focuses on the need for developing a relationship amidst the business institution and the stakeholders. Another important factor that must be considered by the director is the impact of the business operations upon the environment along with the community. Furthermore, the desirability of the business in maintaining a reputation pertaining to the higher standards also frames a factor that must be taken under concern by the directors. It is necessary for the director to act in a manner that will reflect a fair delivery of activities amidst the employees of the companies. It is important on part of the directors to check on the minutes of board meetings that must reflect correct deliberations being undertaken11. Duty to Exercise Independent Judgement In relation to this particular duty of the directors, it codifies the standard principles pertaining to the law. In this regard, it basically reflects about the principles to which the directors’ are bind to execute their powers quit independently11. Duty to Exercise Reasonable Care, Skill and Diligence In accordance with the Companies Act 2006, it mainly states that it is essential for the directors to execute their skills and powers with diligence and care. Precisely, it states that directors are required to perform their duty with care but if they endure further subjective knowledge then their standard will be heighten on basis of this particular accountability11. Duty to Avoid Conflict Of Interest The aforementioned duty mainly replaces the rule that reflect no-conflict for directors. In accordance with the rule of this particular duty, it has become a crucial deliberation on part of the directors’ to avoid any kind of conflicts that might arise between the personal interests and their duties. In this regard, this rule states that the independent board members might authorise the director to exploit interest that might come in conflict with the company’s interest but with an objective of success. This type of right mainly requires shareholders’ approval and must be included in the articles11. Duty to Accept Benefits from the Third Parties The Companies Act 2006 reflects that the directors must not exploit their power and position for benefiting themselves pertaining to the third parties. However, it has been further noted that the directors can receive benefit to a certain extent that must not breach their duties in correspondence with the corporate hospitality11. Duty to Declare the Interests in Proposed Transaction with the Company It is necessary for the directors to derive consent from the company before entering the contractual transaction that might include directors’ self-interest. Precisely, it is necessary for the director to enclose the details in front of the company pertaining to the proposed transaction11. When law is implemented on the directors, there are strict regulations that affirm consequences related to the breach of duty. It has been observed that on breach of any duty by the directors, it is the company that is liable to levy charges or take actions against the directors. In certain cases, the shareholders are also levied the right to take actions against the directors, if they feel that they are receiving an unfair treatment15. In accordance with the UK Corporate Governance Code, it mainly puts its focus on the company directors. This is because their shares have been traded upon the stock exchange. There exists an optimistic relationship amongst the corporate governance code and directors’ remuneration. It reflects that in the presence of better corporate governance measures, the directors’ remuneration being designed must be capable enough to retain and attract the individuals enduring the related skill and competencies. It has been further observed that the remuneration package of an individual must be in such a form that will motivate the individual to attain the desired objectives. Even though under the purview of the corporate governance code, high salaries are fixed for the directors, the core issue of concern remains the linkage between the pay and the performance. In usual cases, the remuneration package entails a performance based pay. If the directors successfully achieve their level of the performance, they are liable to receive the reward accordingly. This performance-based pay for the directors encourages them to achieve their standard targets. Therefore, in order to restrict the directors’ from deriving excessive remuneration from the company, it is necessary to impose duties that will protect the interests of the shareholders and the stakeholders’16. Conclusion From the overall evaluation, it is ascertained that the failure of the company law in restricting the directors to derive excessive remuneration as benefits has been a key factor for variations in the pay received by the directors and the general employees. The study has revealed the picture that directors’ pay is designed under the corporate governance code that comes under the purview of the Companies Act 2006. Furthermore, the study also reveals that excessive directors’ remuneration might lead to unfair conducts. Consequently, it is the responsibility of the company to scrutinise the directors’ remuneration to mitigate the disparity related issue. Furthermore, the study also focuses on the accelerated rate of CEO’s remuneration in the companies of the UK in comparison with other countries. The drawback of the Companies Act 2006 has also been backed up by few real life examples. The case of Maidment v Attwood and Others has highlighted that a shareholder i.e. Maidment has filed a case against the director of the concerned company i.e. Attwood. In his petition, he revealed levied charges against the director of having received excessive remuneration even when the company was in the phase of insolvency. This shows the loopholes within the strategies designed by the corporate governance code. In order to mitigate this issue pertaining to directors’ remuneration, certain duties are required to be strictly levied upon the directors in order to protect the interest of the companies and the stakeholders. The duties levied upon the directors are required to be enacted in accordance with their power. The duties include promotional strategies pertaining to the success of the company. Moreover, the duties also entail independent judgement, use of diligence, care and competencies. Conclusively, it incorporates avoiding of conflicts and fulfilment of any kind of personal interests. Thus, the study reveals the problem and also provides an insight on the duties of the directors’ that limit them from availing unabated benefits. The directors in the present day scenario are required to ensure that they are avoiding any undue benefits which can be detrimental for the organisation at large. References Jennifer Adams, ‘Expert Guide: Directors’ Appointments, Registrations And Removals’ [2010] (Home) accessed 01 January 2014. Bis, ‘Shareholder Votes On Directors’ Remuneration’ [2012] (Uploads) accessed 19 December 2013. BIS, ‘Executive Remuneration’ [2011] (Discussion Paper) accessed 19 December 2013. Bloomberg Finance L.P, ‘Executive Remuneration: The Age Of Excess’ [2013] (Law Reports) accessed 19 December 2013. Charles Russell, ‘Directors' Responsibilities’ [n.d.] (The Duties of Directors) accessed 19 December 2013. Ernst & Young LLP, ‘Changing Landscape of Executive Remuneration: A summary’ [2012] (The remuneration Environment) < http://www.ey.com/Publication/vwLUAssets/Changing-landscape-of-executive-remuneration-2012/$File/1263469_In_Focus_2012_EXEC_SUMM_MASTER_CLIENT_VER_01.pdf> accessed 19 December 2013. Paul Gregg, Sarah Jewell and Ian Tonks, Executive Pay and Performance: Did Bankers’ Bonuses Cause the Crisis? [2011] (University of Bath) accessed 19 January 2014. ICSA, ‘Directors’ Remuneration’ [2009] (Chapter 9) accessed 19 December 2013. Joel Wolpert, ‘Corporate Governance and The 2008 Financial Crisis’ [2009] (FCMA FCIS) accessed 19 December 2013. KPMG LLP, ‘KPMG’s Guide to Directors’ Remuneration 2013’ [2013] (The Remuneration Landscape) accessed 19 December 2013. Michael Faulkender, Dalida Kadyrzhanova, N. Prabhala and Lemma Senbet, ‘Executive Compensation: An Overview of Research on Corporate Practices and Proposed Reforms’ [2010] (Journal of Applied Corporate Finance) accessed 19 December 2013. Maidment v Attwood & Ors [2012] EWCA CIV 998. Pinsent Masons LLP, ‘Deciding Directors' Remuneration Packages (And the Influence of Institutional Investors)’ [2010] (Corporate) accessed 19 December 2013. Stanford Graduate School of Business, ‘CEO Skill and Excessive Pay: A Breakdown in Corporate Governance?’ [2005] (Research) accessed 19 December 2013. The Amsterdam Herald, ‘Dutch Government Unveils 'Strictest Rules in Europe' On Bank Bonuses’ [2013] accessed 19 January 2014. Wcbn, ‘08 Jul 2011: Changing Remuneration Trends’ [2011] (Daily News) accessed 19 December 2013. Read More