As a business owner, you know that the success of your company depends on the actions of its directors. In the UK, director duties are the primary regulations in which the behavioural expectations are laid out. If directors fail to meet these expectations, they can be held personally responsible for any resulting harm.
There is an ongoing debate about whether the interests of shareholders should be the top priority or if they should be balanced with the interests of other stakeholders, such as employees and customers. Shareholder primacy argues that shareholders should always come first, while pluralism believes that all stakeholders’ interests should be considered equally.
In response to growing pressure to modernise UK company law, the Companies Act 2006 introduced the concept of enlightened shareholder value. This new approach replaced the previous duty of directors to act in the best interests of the company with a “duty to promote the success of the company.” This means that directors are required to focus on the long-term growth and success of the company, rather than just short-term financial gains for shareholders.
Importantly, the Act recognises the interests of non-shareholder groups, such as employees and the community, and requires directors to consider these groups when making decisions. This marked the first deviation from shareholder primacy, although it was made abundantly clear that the shareholders’ interests are considered to be superior to those of other constituencies.
This blog will first examine the historical context to assess whether pluralism has any legal basis, and then the practical implications of enlightened shareholder value will be examined to assess whether this introduction was obsolete or a helpful stepping stone.
The Historical Context
For the longest time, the UK company law has embodied the notion of shareholder primacy which is essentially based on the assumption that shareholders are ‘owners’ of the company. By virtue of this assumption, those supporting shareholder primacy believe that shareholders should have control and residual interest rights in ‘the company’ as per the fundamental principles of property law. This leads us to beg the question of whether pluralism is even possible under the current legal understanding of the relationship between the company and shareholders. The debate as to whether this is the case has been exacerbated by the illusive legal nature of the share as it does not easily fit into a ‘normal legal category.’ Despite this, this blog submits that there is justification for a pluralism approach.
The crux of the matter is hidden within the development of company law in the UK. Both the creation of the concept of separate legal entities (borne out of joint stock companies) and the evolution of the stock market have vastly changed the role of shareholders becoming increasingly passive. The Companies Act 1862 codified this change holding that companies were now ‘formed’ by the shareholders, rather than shareholders ‘forming themselves’ into companies. Logically, this detachment of shareholders saw a handing-over of power and it could, therefore, correctly be seen that shareholders’ definite ‘ownership’ rights had been diminished, in return for a ‘set of indefinite expectations.’
Despite this, courts have repeatedly failed to take companies’ separate legal personalities seriously enough in this context still viewing shareholders as the automatic interest holders. The UK is a paradoxical stance which seems to purport to view the modern company as an entirely separate legal personality, whilst vesting significant rights which can be likened to property rights in the shareholders.
Enlightened shareholder value is an attempt to address this paradox and find a middle ground between shareholder primacy and pluralism that hopefully pleases both parties, the question is – did it?
Enlightened Shareholder Value
In 2005, the government announced plans to include the concept of Enlightened Shareholder Value in the Companies Act 2006 stating it would:
“embed in statute the concept of Enlightened Shareholder Value by making clear that shareholders must promote the success of the company for the benefit of its shareholders, and this can only be achieved by taking due account of both the long-term and short-term, and wider factors such as employees, effects on the environment, suppliers and customers”.
This aims to encourage directors to prioritize long-term success and the interests of other groups, not just shareholders. The Companies Act 2006 codified this intention replacing the common law duty for the director to act in good faith in the best interests of the company, with a ‘duty a promote the success of the company.’ This new duty includes specific attention to employees, customers, and the environment. However, critics argue that the Act still prioritizes shareholders’ interests and that the 2006 Act has had no meaningful impact on the rights of non-shareholder constituencies. Ultimately, the Act is seen by some as ‘at most an accessible restatement of the [current] law: a clearer exposition of the law for the directors whose behaviour it regulates.’
2.2 Shortcomings of ESV and its Implementation
Indistinguishable from the Shareholder Value Approach
Enlightened shareholder value (ESV) tries to strike a balance between putting shareholders first and considering other interests, but in practice, it doesn’t change much. Directors are still mainly focused on shareholder value, and the interests of non-shareholder groups are not any better protected than before. Directors were already considering these interests when it made business sense for shareholders, and ESV, in its current form, doesn’t change that. The original shareholder value approach as understood at common law and the new enlightened shareholder value approach has suitably been described by the courts as “[coming] to the same thing with the modern formulation giving a more readily understood definition of the scope of the duty”. There are not only criticisms in respect of ESV itself but also in the government’s implementation of the theory.
Subjective & Difficult to Prove
One issue with the enlightened shareholder value approach is that the required standard of care from directors is quite low and subjective. According to s 172(1), as long as a director acted in good faith, they won’t be considered to have breached their duty. This is mainly a subjective test, which means it can be difficult to prove if a breach has occurred. This is a step back from the common law duty for directors to act in good faith in the best interests of the company, which had an objective element. The Act does consider existing common law rules, but as it would have been easy to incorporate the test used in Charterbridge Corp Ltd v Lloyds Bank Ltd, where a director could be challenged if they were considered to be something which no intelligent and reasonable man could have reasonably considered to be in the company’s interest. The purposeful exclusion of this test suggests that the Act intended to create a subjective standard. At the very least, it creates ambiguity and could make it difficult to hold directors accountable.
No Claim for Constituencies
One major flaw of enlightened shareholder value, as set out in the Companies Act 2006, is that only shareholders can take legal action for breaches. This means that other parties affected by the company’s actions, like employees or customers, can’t take legal action. This is because companies have their own legal identity, and only the company or someone appointed by the law can represent it in court. So, if a company breaches its duty to consider the interests of non-shareholder groups, there’s no way for those groups to hold the company accountable. This makes the new additions to the law ineffective, as there’s no way to enforce them.
As a result, some argue that the idea of shareholder primacy still dominates. Directors are left to self-regulate their behavior, but it’s unclear whether self-regulation is effective. While it can encourage some to follow the rules, there’s no real punishment for those who don’t. As such, self-regulation has crucially been identified as “lack[ing] effective sanctions, broad public accountability and a specified commitment to monitoring and reviewing the scheme”, preventing it from enabling any change in corporate behaviour. Thus, self-regulation, albeit in the context of international internet regulation, has been described as “lip-service” for matters that are “not considered to be important enough to merit more than encouragement towards self-regulation”. It’s argued that ESV in its current form should be viewed from this perspective, noting the legislature’s hesitance to give non-shareholder constituents any real rights to hold directors accountable.
No Real Impact
Despite the introduction of enlightened shareholder value (ESV) in the UK, studies have shown that it hasn’t made much of a practical difference. In fact, Keay and Iqbal when studying large supermarkets/retailers found that many companies (e.g. Sainsbury’s) may have already been doing what ESV requires because it simply makes good business sense and those who weren’t doing it before, are still not doing it now (e.g. Next).
Similarly, individual directors don’t seem to be paying much attention to ESV either. In a study conducted by Infogroup/ORC International, only 11% of directors were aware of changes to the role of directors and related provisions under the Companies Act 2006, and only 17% reported any changes in their behavior. This lack of impact could be due to the fact that companies were already taking into account the interests of different groups before ESV was introduced. But even when asked directly, only 22% of directors said that ESV had influenced the way they discharged their duties.
These findings have been confirmed by other studies conducted by the UK Department for Business, Innovation and Skills and the Association of Chartered Certified Accountants. All in all, it seems that the changes introduced by the Companies Act 2006 haven’t resulted in significant changes in corporate behavior.
The introduction of Enlightened Shareholder Value in the Companies Act 2006 aimed to balance the interests of shareholders with other stakeholder groups, marking a significant shift in the philosophy underpinning UK company law. However, in practice, the impact has been minimal, with many directors and corporations continuing business as usual, still prioritizing shareholder interests. The persistent dominance of shareholder primacy, combined with a lack of enforceable rights for other stakeholders, suggests that a more comprehensive approach may be necessary to genuinely promote long-term, holistic corporate success.
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