Corporate governance
How do Ethical Principles apply?
Aims of the lecture
Establish links between corporate governance and ethical conduct
Understand the roles of directors and shareholders in companies
Assess critically the shareholder-versus-stakeholder approaches to corporate governance
Relate CSR and ethical theories to corporate governance
Corporate governance in an ethical context
The company as part of society; ethical context influences
corporate governance
Directors are accountable to shareholders, but what are their
ethical obligations?
Accountability to stakeholders recognised in law and on
ethical grounds
Issues such as excessive executive pay, while legally
approved by the company, are perceived as unethical
Roles in public and private companies
In a private company owners, directors and managers overlap; personal relations matter
more than corporate structures
In the public company separation between investors, directors and managers
Directors are entrusted with safeguarding the best interests of the company as a whole;
accountable to shareholders
Private v. public company
Foundations of shareholder primacy model
(economic model)
Property theory: The shareholder does not own the company the way a person
owns an object but has limited, defined rights, e.g. right to vote (possibly) and right
to receive dividend (if declared), but note…
Debtholders or creditors: they are stakeholders, and possibly in a stronger position
than shareholders, e.g. right to interest
Hence, property theory is inaccurate to describe the role of the shareholder
Agency theory
Based on principal-agent model of the company
Views the shareholder as principal, but they are not principals in agency law; they
are ‘owners’ in only the most restricted sense, and do not constitute a legal entity
Views managers as agents of shareholders, and holds that their interests should be
aligned with shareholders - hence equity-based compensation - but managers in law
owe duties to the company as a whole
Hence, agency theory inaccurately reflects corporate roles
How agency works
Directors and managers
Directors include both executive and non-executive (who take no part in day-to-
day running)
All directors have duties of oversight of the company’s best interests
Senior directors are both directors and employees of the company
Managers are employees only, employed by the company as a legal entity
Single-tier Board of Directors
Shareholder Primacy and Business Ethics
Mistaken, but ingrained, idea that there is a legal duty to increase shareholder
wealth…
This idea of the company rests on a utilitarian view of human nature as material
self-interest only – overlooking the pro-social dimension
Friedman’s dictum that the purpose of business is to increase profits; but top wage
earners often disagree
Financial crisis dented the economic model
Change of culture called for: directors and boards
Directors’ Duties – The US
Duty to obey the law and take into account ethical considerations. Also…
‘business judgment rule’ – what is best for the company v. personal interests
(including shareholders’)
Constituency statutes – in many US states, recognize stakeholder rights; concern
over takeovers
Problem of the dual share structure: weighted voting maintains control of insiders
in a public company
Directors’ duties - the UK
Duty to promote the success of the company
Interpreted as ‘enlightened shareholder value’ - can take stakeholders into account, but…
Generally interpreted as duty to maximize shareholder value
UK corporate governance guidelines contained in a code, allowing flexibility. Allows for
balance between executive and non-executive directors - both liable in law for directors’
duty of good faith to the company
Stakeholder approaches to Corporate Governance
The two-tier board of directors: supervisory board and management board
Stakeholder representation on the supervisory board, e.g. Germany’s co-
determination
Criticisms of the 2-tier board: strong particular interests and a weak sense of the
best for the company as a whole
Swedish emphasis on supporting social values, but boards dominated by two large
holding companies
Asian structures overshadowed by the importance of personal relations
Executive pay
Market-based remuneration (e.g. stock options) based
on agency theory; saw soaring executive pay…but
what checks?
Say on pay in the US AGMs not binding
UK: FTSE 100 CEOs earnings rose 266% in 13 years,
v. 46% rise for ordinary worker
Role of public opinion: huge rewards for bankers
despite their banks failing; there is now a binding vote
on executive pay in the UK
EU move to restrict bonuses for bankers
CSR, ethics and corporate governance
Corporate governance structures and shareholder focus take little account of ethics
and CSR
CSR comes into the enlightened shareholder view but as a business concern, rather
than ethical
Business reputation leads companies to focus more on ethics, e.g. in supply chains
Ethical codes, often rule-based, tend to focus on behaviour; but encourage the
attitude of abiding by the letter, rather than the spirit
Conclusions
Corporate governance structures and processes tend to benefit insiders and
executives but undervalue stakeholders and ethical concerns
Reforming structures can help to restore public confidence, but still encourages a
‘box-ticking’ mentality…and has led to a decline in the number of public
companies
Legislation and case law support CSR and ethical considerations, but executives
have been slow to wake up to the weaknesses of the economic model
