Ready for more of the same? The Green
Paper published by the Commission on corporate governance for European
Companies was published yesterday.
This paper aims to address three key issues... (stop me if you have heard this before)
1. Board of directors - Non-executives are needed with more skills,
diversity and experience and invest sufficient time in the board
2. Shareholder monitoring - Apparently, evidence shows the majority
of shareholders are apathetic and focused on short-term goals. The review
wants to try and get more shareholders involved and promote long-term returns
3. How to apply 'comply or explain' - Companies are not providing
sufficient explanations for diverging from the Code
Well, point 3 is perhaps an area which needs looking at. The Combined Code in
the UK has increasingly seen more and more adherence to it - see for example
Grant Thornton's Corporate
Governance Review -, even leading up to the crash in 2008. Despite no
"one size fits all" approach there seems to be evidence of firms
converging to the same model. A deeper understanding is needed of why do people
adhere to the Combined Code or generally corporate governance codes around the
EU? One would hypothesise that it is because it attracts investors; but is that
really enough to blindly walk in to complying with the Code? I am of no doubt
that there is a stronger thought process before deciding on internal governance
but a review is needed.
As to boards of directors this could potentially be interesting. The first
point may be for at least UK companies is that non-executives are generally
experienced and knowledgeable according to a 2009 review by Grant
With non-executives becoming more involved does this change the structure of
the board and does it affect our understanding of the firm?
It would seem points one and two of the Green Paper go hand in hand. Monitoring
is difficult for shareholders and so boards become a market-induced body to
monitor executive management. However, if non-executives become more involved
then this may incur problems at least from an agency theory perspective.
Shareholders will then have to monitor the boards more rigourously and in truth
are likely to incur higher agency costs to ensure they do not incur conflicts
of interest or shirk responsibilities.
However, I like many others, are not a strong believer of agency
theory. For one agency theory often makes the common mistake of seeing the
firm as a nexus of contracts. Law however, makes it clear this is not the case.
A corporation is its own legal entity with objectives generally decided by the
With the board becoming more involved we seem to be converging away from
agency theory, closer to stewardship theory and resource dependency
theory. It seems the biggest and boldest move would be to confirm the
status of the company and the board as the principal according to agency
theory with executive management as the agents.
Shareholders are not well placed to monitor who generally spread risk by having
a diverse portfolio of investments and are not concerned enough to monitor any
one individual firm. Instead of getting shareholders more involved we should be
looking for ways to keep them investing whilst removing levels of direct involvement.
This could be done through higher shareholder representation on the board for
One issue that needs to be rigorously addressed will be fiduciary law no
matter what changes take place. Fiduciary law itself can be explained by agency
theory and thus may be problematic if different economic theory such as
stewardship can explain the firm.
With non-executives increasing their involvement how will this impact on their
liability? Will it be necessary to have clearly defined duties depending on the
type of director you are? Increased liability of course, is met with
significant opposition and their resistance is usually enough to deter any
Non-executives themselves are often executives of other companies. With
suggestions of increased time commitment this may have an impact on the people
capable of taking directorships. It may also cause stronger friction in
multiple directorships or more severe or common breaches of the duty of care
with directors spreading themselves too thin.
However, fiduciary law is flexible and based on fundamental principles of
loyalty and care by the agent to the principal. As long as the director adheres
to these principles owed to the company there should not be a pressing
issue, more so for executive members of the board at least.
It seems safe to say the EC needs to think long and hard about the implications
of involving shareholders and non-executives more in the company. Under
the current structure non-executives should not become more involved without
some sort of increased monitoring of them, which is a cost shareholders are
unlikely willing to bare. But if directors and the company can be seen as the
principal then it may go a long way to improving corporate governance as
directors are more attached to the company, capable of understanding the
company's needs, and objectives.
For more commentary on directors' duties and
shareholder litigation, visit Gibbs: Law and Life, a blog centering on directors' duties
and company law, particularly on interpretation and practicality of directors'
duties in the 21st Century.
For more information about LexisNexis
products and solutions connect with us through our corporate site.