The Legal Relevance of the Enlightened Shareholder Concept - Assignment Example

School: CRITICALLY DISCUSS THE LEGAL RELEVANCE OF THE ENLIGHTENED SHAREHOLDER CONCEPT Lecturer: CRITICALLY DISCUSS THE LEGAL RELEVANCE OF THE ENLIGHTENED SHAREHOLDER CONCEPT Introduction The internal functions and processes that take place within various companies in the United Kingdom (UK) greatly affect the overall output of the labour, economic and business environment of the country (Kraakman, et al. 2004). Because of this, there continues to be efforts made by all stakeholders, especially those in the law making sectors of the Arms of Governance to ensure that there are national legislations that guide the way things are done within these companies. The UK company law has been on such legislation that have regulated the way and manner in which companies are expected to undertake their internal governance. In 1998, there were several calls by various agencies and stakeholders for the UK company law to be reviewed as it was considered to be overly based on common law (Lowry and Dignam, 2006). This call was mainly led by the Department of Trade and Industry which put forward a proposal, which was later considered by the Company Law Review Steering Group (CLRSG). Going into parliament in November 2005 as the Company Law Reform Bill, there was a passage into what is now known as the Company Law Act 2006. Even though enshrined with several provisions and regulations, one aspect of the Company Law Act 2006 that has generated a lot of public, academic and professional debate and discourse is S 172 CA 2006, which touches on the duties of directors. Theoretically, S 172 CA 2006 has been said to promote what is now known as enlightened shareholder (Kraakman et al., 2009). This paper there seeks to critically discuss the legal relevance of the enlightened shareholder concept in relation to what used to exist before the S 172 CA 2006. Principles of the Enlightened Shareholder Concept The concept of enlightened shareholder became part of public, academic and business discourse starting from the passage of the Company Law Act 2006 (Lowry and Dignam, 2009). Since then, there have been various interpretations for the term. In a much generalised framework of discourse, the enlightened shareholder concept can be said to be an approach to corporate governance whereby the role and place of the shareholder has been redefined in a more elaborate and expanded manner (Sealy and Worthington, 2010). By the use of the term approach, reference is being made to the fact that the enlightened shareholder concept has become a way of corporate life which entails a set of conduct and actions that must be exhibited or put up to justify the execution of the concept (Micklethwait and Adrian, 2003). Most commonly, the enlightened shareholder concept is said to an expansion on what constitute the interest of the shareholder, whereby issues of environment, employees and local communities are all seen as very crucial determinants for the creation of long-term shareholder wealth (Lord, 2010). In effect, the enlightened shareholder is one whose long-term wealth is generated by paying frantic attention to corporate stakeholders and the way they are treated. By and large, the enlightened shareholder concept is never achieved until such a time that the environment, employees and local communities are all seen to be playing a role towards the protection of the wealth of the shareholder. It was in the light of this that Wong (2011) argued that the enlightened shareholder is a consensus building venture where the ambitions of the shareholder is lessened as a result of shared responsibility from other corporate stakeholders. S 172 CA 2006 as a Reflection of Enlightened Shareholder Concept As it has been indicated earlier, the enlightened shareholder concept came to existence with the passage of the Company Law Act 2006 (Collison, et al, 2011). This means that there should certainly be a place for the concept in the Act. Indeed, 2 172 CA 2006 has been noted to take care of the enlightened shareholder concept as it fully reflects the principles of concept. In a very general sense, the S 172 CA 2006 does not make exact mention of the term enlightened shareholder. Rather, it defines the duties of directors of companies in a way that clearly reflects the principles of enlightened shareholder as elaborated above. For example, the S 172 provides that (1) A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to- (a) the likely consequences of any decision in the long term, (b) the interests of the companys employees, (c) the need to foster the companys business relationships with suppliers, customers (d) the impact of the companys operations on the community and the environment, (e) the desirability of the company maintaining a reputation for high standards of business conduct, and (f) the need to act fairly as between members of the company (U.K. Companies Act of 2006 S 172). Even though the part of the law stated above may not be seen to have made direct reference to the shareholder, it is important to note that under the Company Act, directors are mandated to remain directly accountable to shareholders and shareholders alone (Lowry and Dignam, 2006). By implication, the fiduciary duties of the director specified above are in the direct context of how the director is expected to recognise or approach the interest of the shareholder. By making reference to the various corporate stakeholders, one would therefore appreciate the important that the Act places on the attention that has to be given to the corporate stakeholders in generating the said interest of the shareholder which the director is expected to protect. In effect, the Company Act 2006 enshrines directors to be concerned about the company’s success and thus the shareholders success in a manner that does not sorely place emphasis on the shareholder’s interest (Clarke and dela Rama, 2008). Rather, the principle of the enlightened shareholder is to be achieved by taking into critical account the interest of other stakeholders, thereby making the enlightened shareholder concept as shared responsibility. The Shareholder before the Company Act 2006 There are two major approaches to corporate governance. These were the shareholder value approach and stakeholder value approach. Before the coming of the Company Act 2006 however, the shareholder value approach was what was functional in most UK companies. As the name implies, the shareholder value approach emphasised on shareholder primacy whereby the shareholder was considered the owner of the company and thus the person whose interest had to be protected (Lockyer v Buckhurst [1964]). Even though the shareholder is still considered the owner of the company after the Company Act 2006, a lot more has been added to this and much has been changed from the shareholder value approach. For example, regardless of the fact that the shareholder is considered the owner of the company, there is now a pluralist approach to the shareholder value approach whereby the interest of the shareholder must be met by equally meeting the interest of other stakeholders. This concept of shareholder value approach was found to be weak in a lot of ways and from a lot of perspectives. Firstly, there were those who argued that there was lack of fairness for the other stakeholders as their interests were hardly respected and recognised (Graham et al, 2004). It has been said that even though the other stakeholders such as employees and customers have not stopped performing their roles in the way they used to do before, there is now a better definition of the motivation by which they must do this (Kershaw, 2009). This motivation is identified as the need to do it for their own good and not merely for the good of the shareholder. There are actually critics of the shareholder value approach who have identified deliberate legal provisions that were created in times past in the UK to enforce or popularise the shareholder value approach (Lowry and Dignam, 2006). Most commonly, the Insolvency Act 1986 and Companies Act 1985 are quoted as examples of laws that were enacted in promotion of the shareholder value approach (Davies, 2008). In those times, there used to several arguments in support of the shareholder value approach. For example, it was argued that this approach took powers away from a group of fewer people namely the directors into the hands of the major, which were the shareholders. There were also some who argued that the shareholder value approach was actually very necessary in serving as a motivation for the shareholder to do more in terms of investing in the company, knowing that it was his interests that were rightly being met (Topham, 1978). What is more, some commentators believed that with the shareholder value approach, real value was created for the larger company because since the shareholder was the financier of the company, empowering the shareholder’s interest to lead to more financial growth for the shareholder meant that it was the larger company that was experiencing growth. With the coming of the enlightened shareholder concept, there have been major weaknesses associated with the shareholder value approach. Firstly, the approach has been found only to promote short term gains for the companies rather than focusing on sustainability (Berle, 2009). This is because most shareholders existed only for a short time and expected their short term gains. Again, it discouraged other stakeholders from approaching their roles in a manner that meant that they were working for themselves. Consequently, the other stakeholders were discouraged from also investing in the companies, even though some of these stakeholders like employees and customers gave long term assurance of existence to the company (Clarke, 2007). Legal Merits of Enlightened Shareholder Apart from the numerous legal relevance given to the enlightened shareholder concept above, there are very specific legal merits that can be associated with the concept. The first of these is the legal implication of the enlightened shareholder concept to the UK Corporate Governance Code. As noted by Garrett (2007), the UK Corporate Governance Code applies only to listed companies in the UK. By implication, any or all the provisions made in the code by way of the six major principles apply to only a small segment of companies listed (Kershaw, 2002). Meanwhile, Davies (2003) found that the annual contributions made by non-listed companies and most other companies in the non-formal sector contributed to a greater share of gross domestic product when compared to listed companies. If the corporate governance code is anything to go by in terms of helping to develop businesses in the UK, then it can be said that the lack of sufficient coverage for the code has directly affected the rate of growth of the business sector in UK. With the enlightened shareholder concept, which has rightly been enshrined in the Company Act 2006, there is now as much expansion in terms of coverage as never before. From a legal perspective, there is now a common code by which all companies in the UK can be guided on their governance and ways of regulation so as to ensure that there is fair practice aimed at growth (McGaughey, 2011). What is more soothing is the fact that with the backing of the Company Act 2006, the enlightened shareholder concept has now received a statutory legal backing for enforcement (Berle, 2009). Apart from the coverage, it can be said that there is a unique legal relevance in the way and manner in which the enlightened shareholder concept has come to combine two important corporate theories that used to be practiced as separate or different theories. These theories are the shareholder value and stakeholder value (Susan, 2005). A lot has been said about the shareholder value already. The stakeholder value was also practiced in some quarters as an independent approach to corporate governance whereby emphasis was taken away from the shareholder to other non-shareholder stakeholders (Dobbin, 2010). Unfortunately, this situation resulted in several legal challenges as shareholders thought they were being unfairly treated (Hillman and Keim, 2001). Today, with the enlightened shareholder concept, such instances of legal battles between shareholders and directors for unfair treatment will become a thing of the past. This is because the enlightened shareholder concept serves as a paradigm that bridges the gap and thus brings the two theories together (Jensen and Meckling, 2006). Through the enlightened shareholder concept, the only way to ensure that the shareholder’s value is created is by first creating value for the other stakeholders. At the end of the day therefore, it is not just the shareholder or the stakeholder whose interests are protected but that of the company in general, as reflected in the interest of both parties (Lazonick and OSullivan, 2010). There are a lot of commentators who have also said that the combination of the two theories have made room for there to be an unprecedented moment of accountability as never existed before. This is because there has been an internal check and balance situation between the shareholder and the stakeholder (Masouros, 2012). Consequently, there has also been a fair ground for these two parties to operate, knowing that the interest of one person must be shared in a collective manner to promote that of the other person (Rappaport, 2008). Conclusion The discussions above have so far shared much light on the enlightened shareholder concept and explained how relevant the Company Law 2006 has been in fostering the continual realisation of the enlightened shareholder concept. Most importantly, the comparisons made between the era before the Company Law 2006 came into existence and the time thereafter makes it valid to conclude that U.K. is now experiencing a better corporate and business atmosphere where it does not have to take only the values that the shareholder wants to create to make the larger company functional. Rather, the shareholder has been enlightened by creating the awareness and realisation that the shareholder cannot effectively have what he seeks to gain from the company when the interests of other stakeholders including customers, employees, the environment, the larger society is not taken into consideration. This era of stakeholder emancipation has also carried a lot of legal relevance and significance. For instance, there has been wider coverage for the interests of companies to be protected. This is because unlike the provisions made in the UK Corporate Governance Code, which only emphasised on listed companies, there is now an awakening for the interest of all other companies, both medium and small scale to benefit from the legal provisions of the Company Law. If for nothing at all, the UK can now be said to be experiencing a dispensation where all companies are considered equal and same. 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