Shareholder Primacy, Enlightened Shareholder Value - Essay Example

Part This section of the essay will examine the relationship between the two concepts and how they relate to the modern world of business and ascertain whether the concept of enhanced shareholder value principle is a completely different and advance restatement of corporate governance or a refutation that abolishes the concept of shareholder primacy. Shareholder Primacy Shareholder primacy is the notion that shareholder interest should be assigned first priority in a firm. It is the idea that the nation needs to adopt a policy where non-shareholders are treated as second-class citizens of a company through codified laws1. In the case of Re: Smith and Fawcett Ltd2 Lord Greene stated that directors may act in a way they consider in the best interest of the country, not what the courts may consider to be the best interest of the company. In the UKs corporate law, directors of companies have a duty of being loyal to their “companies as a whole”3. The concept of “company as a whole” is not set in stone since it is not well defined. Traditionally, the fundamental duty of directors of companies are owed to present and future shareholders4. Thus the approach of directors increasing the profits for shareholders is described as the theory of shareholder primacy5. Since shareholders pool their resources to form a company with the view of making profits, it is logical to assume that shareholder primacy refers to making profits and optimum profits. This implies that in assessing a good team of directors, their ability to make profits and declare the highest levels of dividends is the main yardstick for defining their success. Enlightened Shareholder Value The enlightened shareholder value concept evolved over the years as the concept of corporate governance evolved. This grew out of the discussions of what directors actually need to do in a given company. There were two schools of thought. One school of thought suggested that directors need to satisfy the shareholders who put them in power as a means of proving shareholder primacy. Another school of thought advocated for the need to concentrate on other different interest groups or stakeholders. The enhanced shareholder value concept sought to enhance stakeholder engagement and create a long-term business culture which involved the provision of the interests of the different people who affect and are affected by the companys activities6. The enhanced shareholder value involves an attempt to eliminate the agency problem and also create a system where the best interest of a business is sought by its directors and the people charged with its governance. It is obvious that a company cannot maximise its long term market value if it fails to treat its important constituents right7. Michael Jensen who proposed the “enlightened stakeholder theory” argued that a company cannot create value unless it maintains good relationships with customers, employees, financial backers, suppliers, regulators, communities and so on8. This implies that the people charged with governance will have to look beyond the mainstream idea of creating the highest possible profits in the short run. The business must look beyond just the short-term and seek to attain the best interest of the firm in the medium and long-term timeframe of its existence. The concept of enlightened shareholder value is integrated into the UK legal system and recognised by the Companies Act, 2006. Section 172 of the Act states that the duty of the directors is to promote the success of the company for the benefit of its members. This clearly means that the best idea of the corporate governance and directorship is to ensure that the position and the needs of shareholders are met9. The qualification of the concept with the word “enlightened” connotes some degree of an improved system of conduct. This involves the identification of better ways and means of dealing with problems and issues that come with creating value for shareholders. Enlightenment comes with the need to seek the optimal and the best interest of the shareholders by fulfilling some conditions other than the mere idea of attaining profitability with little concern for other factors and matters that are relevant to the quest. This need for enlightenment is steeped in the fact that failure to do so will cause some degree of adverse reactions for the firm and the company. This is because the stakeholders are important for the longer term survival and continuous attainment of profits. Hence, there is the need for some degree of temperance in order to ensure that the firm operates in a way and manner that is enlightened in seeking profits for a given period. Shareholder Primacy Versus Enlightened Shareholder Value: Critical Analysis So far, it has been established that shareholders are at the centre of the creation and operation of a company. Shareholders appoint directors who are bound by law to seek the best interest of the company. Thus, the directors are by law required to seek shareholder primacy. The enlightened shareholder value concept requires the directors to focus on all areas of the business and ensure that they seek the best interest of the firm in a long term interest. Thus, in contrast between the two concepts, one needs to ascertain whether they are compatible or synonymous or two separate and distinct concepts. This can be examined from several lenses. Corporate Governance Shareholder primacy implies that directors are required to work within the rules of the agency theory in order to carry out their fiduciary duties to the company. However, from the current legal position and the integration of the conventions of corporate governance, there are rules and principles that binds the directors in their discharge of their operations in order to meet shareholder primacy. The Cadbury Report, Hampl Report and the Combined Code of Corporate governance provides a formal and semi-legal set of rules which requires the directors of a company to assume certain responsibilities. This sets out the main body of rules of corporate governance. Corporate governance is defined by Stephen Bottomley to involve implicit and explicit relationships between the corporation and its employees, creditors, suppliers, customers, host communities and relationships around these constituencies10. This implies that corporate governance rules make it imperative for the directors of a firm to seek shareholder interest through the attainment of a set of objectives that are due to external stakeholders. Thus, there is the need for directors to act in an enlightened perspective of considering stakeholder perspectives as a means of meeting shareholder needs. Legal Obligations Corporate governance principles in the UK are mainly conventional and do not have a strong demand for compliance. Directors are required to comply by the principles but they have to account for departures. However, in other instances, directors have no other choice but to fulfil some obligations as part of a legal requirement. Thus, for instance, a business needs to pay taxes, otherwise, the veil of incorporation will be removed and the directors could be tried for their failure to pay taxes. Thus, it imperative and demanded by law that firms look at the legal needs of stakeholders like tax authorities. In other situations, case law makes it imperative for directors to comply by a stakeholder-oriented system11. Thus for instance, the ruling of Re: Horsley and Weight Ltd12 it was held that that in period of financial difficulties, directors need to be sensitive to the creditors and other stakeholders before they consider other things like dividends. This places some kind of caveat on directors in their quest to meet the pure profit motive of dealing with shareholder needs in their activities. Sustainable Profits Section 417 of the Companies Act 2006 states that the directors of a firm must provide an explanatory narrative that would enable investors to make more sense of the financial report and to gain an understanding of the companys business performance and future prospects13. This implies that directors are required to guarantee the going concern of the firm. This is because sustainable profitability is important and vital. Hence, the directors are tasked to ensure that they keep their relationship with their stakeholders in an appropriate framework and even report on it. This is evidence that shareholder primacy is not just about making profits over the short-term but it encompasses making profits over a sustained period of time. Conclusion The doctrine of enlightened shareholder value involves the blending of shareholder primacy with stakeholder pluralism14. This need to blend shareholder primacy with stakeholder responsibility is borne out of the principles of corporate governance, legal obligations and the need to ensure the sustained growth of a company. These three factors make it imperative for directors to run businesses in a way that they seek the interest of stakeholders alongside the interest of stakeholder that they affect and are affected by in running the business. Hence, the principle of shareholder primacy in the 21st Century is synonymous with the enlightened shareholder value and it is not possible to seek shareholder interest without being sensitive to the interest of other stakeholders. Part 2 This section is an advise to Han, a director of Jedi Tea Ltd who has come under pressure of being removed as a director due to a conduct that has been deemed by his fellow directors to be wrong. In doing this, the main issues of the case will be analysed and from there, the relevant rules in corporate law will be applied in order to draw conclusions on an advise to Han. Issues The main issue that needs to be dealt with in order to provide a good advise to Han are as follows: 1. Whether the failure to disclose his interest in Star Choccies constitute a breach of his fiduciary duties to Jedi Tea Ltd or not. 2. Whether the decision to sell Belgian chocolates from Star Choccies Ltd with high costs and lower profits was an issue relating to conflict of interest or not. 3. Whether Luke and Chewbacca can jointly take a decision to remove Han as a director and stop issuing dividends and increase their own director compensation or not. Rules The primary principle that guides the actions of directors in running companies is the fiduciary duty. The fiduciary principle indicates that a director needs to act in the best interest of the owners of the company or the shareholders15. This is a general and broad principle which requires directors to work in ways that puts the interest of the shareholders ahead of their own personal and selfish interests. This is at the solution of the agency problem which is an issue which arises from the need of directors to act as the proper agents of the shareholders who appoint them. Therefore, a binding duty is placed upon the directors in order to ensure that they use the firms resources and their privileges, which span over discussions about the veil of incorporation which protects them as directors. Hence, directors need to make the best of the privileges that they attain as a result of their position as the agents of shareholders. Aside the general fiduciary duty that comes as a result of being a director, there are other issues and matters that are relevant to this discussion. This include things like Conflict of Interest, Independent Judgement and Duty of Care which can define the boundaries of the actions of a given director. Conflict of Interest In Bray V Ford16, it was held that a person holding more than one positions or more than one set of interest within an organisation could potentially have an issue with conflict of interest. This is because when a person has some power, he could abuse that power and extend his reach to attain other benefits because of the authority he wields. In the case, Ford was serving as the vice chairman of the team of governors and at the same time offering his services as a solicitor. It was held that such a situation could lead to conflict of interest. The case of Percival v Wright17 it was held that although a director owed duties generally to shareholders and was to show loyalty to the company at all times, a director did not owe direct duties to individual shareholders. Hence, a director can act for the best interest of the company at any point in time. These principles in common law relating to conflict of interest have been codified in the Companies Act 2006. Section 175 of the Companies Act states that directors must avoid conflict between their personal interest and the companys interest. This implies that the directors will have to put aside their personal interest and do what is in the best interest of the company at all times. The current statute reflects the elements of the House of Lords ruling in the case of Re: Aberdeen V Blaikie Bros18 where they stated that no director or agent of a company is allowed to engage in an activity of personal interests which conflict with the activities of a company. Hence, there is the need for conflicts of interests to be kept out of the normal activities of a director. Section 175 (5) of the Companies Act 2006 states that it is the duty of independent directors to authorise conflict of interest issues. This means that the independent directors will have to always monitor activities of directors and create an avenue where they can report conflict of interest issues. Independent Judgement Section 173 of the Companies Act 2006 imposes duties on directors of companies to exercise independent judgement. This means that the director will have the right to exercise judgement and the judgement must be exercised independently19. Thus, the right and the privileges of a director includes the right to make decisions and act where necessary. This implies that the managers can take decisions and the decisions are binding on both active and dormant directors of the company20. Duty of Care In exercising their fiduciary duty, directors ought to carry out their activities with a duty of care. In City Equitable Insurance Company21 it was held that in exercising duties as a director, one ought to have the average level of skills and this is determined by a subjective test. Another case involving Dorchester Finance V Stabbing22 it was held that the subjective test for duty of care relates to skills and not to diligence. Section 174 of the Companies Act 2006 however made it clear that both skills and diligence should be objectively tested. Removal of Directors A company can remove a director through one of three main ways. The first way is to get an ordinary resolution under Section 168 of the Companies Act. Subsection 1 of Section 168 allows the removal of a director by ordinary resolution on any matter or situation. Subsection 2 makes it imperative for notice to be given to the director in question. Subsection 5 requires providing all the compensation and payments due to the director and the satisfaction of all relevant clauses that protects the director. The second way is through the invocation of the agreed methods of removing a director as per the articles of association. The third way is the disqualification under some breaches of the law. However, in this case, the most applicable method is the first method. This method can however be limited by the Bushell v Faith clause which normally gives a director three votes per share in matters relating to his removal. Declaration of Dividends Sections 827 – 853 of the Companies Act 2006 states that dividends can be declared by ordinary resolution and this is done when the directors make a recommendation of the limit. Application In this case, it appears that Han owed a fiduciary duty to Jedi Tea Ltd. In this vein, he has a duty to seek the best interest of the company at all time. In cases where there is a conflict of interest, he has a duty to declare it and get it resolved. That is the best way to act in good faith. However, in this case, Han did not have anyone to report to and there was no precedence of who to report such matters to. Thus, although it can be said he had shares in the supplying company, there was no procedure for the declaration of the conflict of interest. Secondly, he owes the fiduciary duty to the company as a whole and not to the individual directors. Hence, there was the need for the company to come up with rules on how to deal with disclosures on the basis of conflict of interest. Since there was none, he can argue that he had no one to report to. The second element is that Han can argue that he acted in good faith. This is because, the only alternative to importing from Belgium was an online company. He can show objective facts that indicate that importing from Star Choccies Ltd was a better option than the online company. He can cite incidents like the potential for fraud and the potential for paying higher. This will show that he truly exercised a duty of care. Concerning his removal, there is the need for due process to be followed. Luke and Chewbacca cannot just remove him. They need a resolution on that. And since Han is a director, he can stand against it and argue his case out with the two pointers above (acting in good faith and the lack of a procedure for reporting conflicts of interest). Additionally, if there is a Bushell V Faith Clause, then he can use his shares which will be 87% (28% x 3). This will prevent the resolution that will remove him. In terms of refusing to declare dividends, there is the need for an ordinary resolution. And in this situation, Han can argue against it, but there might be little he can do about this since the two other directors have the required power to block the dividends. On the other hand, he can make demands for salaries and all payments that is due him under the Companies Act section 829. And in future, his pay as director will have to be given to him as it is guaranteed by the Act. Bibliography Books A Keay. Company Directors Responsibilities to Creditors. (2nd Edn, London: Routledge, 2010). A Keay. Enlightened Shareholder value Principle and Corporate Governance (2nd Ed, London: Routledge, 2012). B Hannigan, Company Law (OUP, 3rd edn 2012) B Horrigan. Corporate Social Responsibilities in the 21st Century (2nd Edn, Surrey: Edward Elgar Publishing, 2010) C Turner. Corporate Governance: A Practical Guide for Accountants (3rd Edn, London: Butterworth-Heinemann, 2012) J Loughrey. Directors Duties and Shareholder Litigation in the Financial Crisis (2nd Edn, Surrey, Edward Elgar, 2010). J Lowry and A Reisberg. Pettet’s Company Law: Company and Corporate Finance (Pearson, 4th edn 2012) M McElroy and M Van Engelen. Corporate Sustainability Management: The Art and Science of Managing (2nd Edn, London: Routledge, 2012). P Davies and S Worthington Gower: The Principles of Modern Company Law (Sweet & Maxwell, 9th edn 2012) P Lyndon Davies. Introduction to Company Law (1st Edn, Oxford: Oxford University Press, 2010). S. Bottomley. The Constitutional Corporation: Rethinking Corporate Governance. (2nd Edn: Surrey: Ashgate Publishing, 2007) Cases Bray V Ford [1896] AC 44 Dorchester Finance V Stabbing [1989] BCC 498 Mutinational Gas and Petrochemical Company V Multinational Gas and Petrochemical Services Ltd [1983] Ch 258 Percivel V Wright [1902] 2 Ch 401 Re: Aberdeen V Blaikie Bros (1854) 1 Macq 46 Re: City Equitable Insurance Company [1925] Ch 407 Re: DKG Contractors Ltd [1990] BCC 903 Re: Horsley and Weight Ltd [1982] 3 All ER 1045 Secretary of State for Trade and Industry V Taylor [1997] Statutes Companies Act, 2006 Read More