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144 Critical company law

these companies is woefully poor: ‘even the largest investment companies tend to have small monitoring sta s’.123 And such sta as there are are poorly trained and ill prepared to take on the required task of active monitoring despite their huge and international portfolios. Conflicts of interests both legal and in terms of reputation are another barrier to coalitions. Loach posits the example of a fund manager who will have connections with banking firms who in turn will have connections to many companies who may be a liated to the company which the fund manager wishes to confront. He may therefore decline to do so as ‘fund managers who develop an anti-manager reputation will lose business and find it harder to attract new clients’.124

Loach identifies the third barrier to activism as being the desire of institutional investors for ‘soft information’, that is information which the managers supply to them rather than to the general public, and presumably doesn’t constitute insider dealing. Loach maintains that ‘if an institution is in possession of truly material non-public information, then it can make abnormal returns even in an e cient market.’125 The fourth barrier Loach terms ‘behind the scenes activism’, and refers to the exchange which takes place between managers and institutional investors. If the latter made public their concerns it may trigger a rush to sell shares and a corresponding loss to share value, so to avoid this, managers will attend to the grievances of their institutional investors behind the scenes. This latter barrier does, of course, denote institutional investor activism and perhaps does demonstrate a reconnection of ownership to control; however, the other three barriers do not and instead indicate clear advantages to institutional investors in remaining passive. Indeed, Loach notes that the more recent attempts at institutional investor activity which have centred on high executive remuneration have resulted in unexpected and negative outcomes. For example, when the institutional investors of GlaxoSmithKline discovered that its CEO Jean-Paul Garnier was about to be awarded an £11 m remuneration package, they successfully campaigned to persuade shareholders to reject the proposal. However, Loach maintains that the non-institutional investors were spurred on by their success with Garnier to set their sights on the executives of Aviva, Standard Life and Prudential, the institutional investors themselves!

Thus it can be seen that while institutional investors hold a large proportion of British shares, they are traditionally inactive or at least publicly inactive. The reasons for this are partly sta ng policies which are not geared up for high-level monitoring. However, the overwhelming evidence suggests that their self-interest is better served by operating privately, making their views known to the executive and benefiting from non-public information. A

123Roach, L, ‘CEOs, chairmen and fat cats: the institutions are watching you’ (2006) Company Lawyer 27, p 299.

124Ibid, p 300.

125Ibid.

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flexible understanding between institutional investors and managers is much more mutually advantageous than a long-drawn-out and public battle over pay, the amounts of which are tiny when compared with company profits. In these ways institutional investors do not di er from economic owners and further evidence the argument that no separation between ownership and control exists outside that experienced by the small investor.

THE THIRD WAY, COMPANY REFORM AND ‘ENLIGHTENED SHAREHOLDER VALUE’

In this section it will be argued that the politics of New Labour have greatly a ected the orientation of contemporary corporate governance perspectives. It will be argued that while the politics of New Labour is primarily committed to a market economy, it shies from the rhetoric of the free market, preferring instead the rhetoric of inclusion. The political perspective of New Labour is best demonstrated by outlining the thoughts of the authors of the three influential books on the subject. These are, in descending importance, Anthony Gidden’s The Third Way,126 Will Hutton’s The State We’re In 127 and Charles Leadbetter’s Living On Thin Air.128

The ‘third way’ politics of New Labour may be understood as the outcome of a reaction against old-style socialism (a broad umbrella containing the ‘far left’ and the Labour Party of the 1970s) and the neo-liberal politics of Thatcherism. The generally acknowledged architect of the political notion of ‘the third way’ is Anthony Giddens in his influential book of the same name. Here he described third way politics as an attempt to connect the social welfare principles of socialism with a strong national market operating in a global context. Giddens constructed this model through a critique of socialism and neo-liberalism and concluded that while both schools of thought were flawed, modern society and the consciousness of the populace generally remained entrenched in certain elements of both. For example, he argued, the individualism of the 1980s had left a residual aversion to many of the activities of the welfare state. During this decade, in particular, the welfare state had been criticised by the right for being undemocratic and for suppressing personal liberty, criticisms that had a powerful appeal because they were, in part, true. Giddens himself described the welfare state as being ‘bureaucratic, alienating and ine cient’.129

However, he notes, these tenacious notions of individualism have not led to a corresponding aversion to the making of welfare claims. Neither has it

1261998, Polity Press.

1271996, London: Jonathan Cape.

1281999, Viking Press.

129Op. cit., Giddens, p 113.

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a ected the population’s moral a nity to the ‘socialist’ principle of providing for the vulnerable. At first blush, he argued it might appear that these two perspectives, individualism and socialism, were incompatible. However, third way politics could encapsulate both perspectives and these two seemingly irreconcilable positions could cohabit in a world where increased individual liberty was coupled with increased individual responsibility. ‘Having abandoned collectivism, third way politics looks for a new relationship between the individual and the community, a redefinition of rights and obligations.’130

Expanding individualism would mean expanding individual obligations. Thus, he argued, a consciousness must be nurtured which allowed for a responsible, mature individualism. So, in respect of the welfare state, ‘third way politics sees these problems not as a signal to dismantle the welfare state, but as part of the reason to reconstruct it’.131

Third way politics identified the role of the state, not in the minimalist style of the neo-liberal’s Hayekian vision, nor in the intervention vision of the socialists. Instead, the role of the state was to promote the market while maintaining a more generalised prosperity through some limited government intervention in its activities:

Classical social democracy thought of wealth creation as almost incidental to its basic concerns with economic security and redistribution. The neoliberals placed competition and the generating of wealth much more to the forefront. Third way politics also gives very strong emphasis to these qualities, which have an urgent importance given the nature of the global market place. They will not be developed, however, if individuals are abandoned to sink or swim in an economic whirlpool. Government has an essential role to play in investing in the human resources and infrastructure needed to develop an entrepreneurial culture.132

Third way politics deployed a ‘social investment state’, which aimed to create a ‘new mixed economy’ that would comprise a ‘synergy between public and private sectors, utilising the dynamism of markets but with the public interest in mind’.133

In third way politics, the balanced combination of public and private sectors was important for a number of reasons. An overly dominant market tended to perpetuate inequality, as evidenced by the great di erentials in meritocratic societies such as the USA, the UK and New Zealand. However, an overly public, welfare economy tended to create a ‘dependency culture’. In third way politics, the key to moving toward greater equality in a modern

130Ibid, p 64.

131Ibid, p 113.

132Ibid, p 99.

133Ibid, p 100.

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society was the elimination of social exclusion. Third way politics viewed ‘equality as inclusion and inequality as exclusion’.134

Inclusion refers in its broadest sense to citizenship, to the civil and political rights and obligations that all members of a society should have, not just formally, but as a reality of their lives. It also refers to opportunities and to involvement in public space. In a society where work remains central to self-esteem and standard of living, access to work is one main context of opportunity. Education is another, and would be so even if it weren’t so important for the employment possibilities to which it is relevant.135

In order to counteract the many forms of social exclusion which perpetuated inequality, third way politics would construct an ‘inclusive society’, utilising the ingredients of ‘equality as inclusion, limited meritocracy, renewal of public space (civic liberalism) beyond the work society, positive welfare and a social investment state’.136 The trend towards a socially excluding society could be reversed through a ‘civic liberalism’ which encouraged a political and economic commitment from the richer elements of society to the poorer. Furthermore, a private solution could be found to public welfare programmes if the middle classes possessed a self-interest in maintaining the welfare state. This self-interest could be satisfied by improving the services o ered by the welfare state, elevating welfare from a ‘safety net’ for the poor into a series of high-quality services, which all classes could enjoy. Indeed, he argued, ‘where “welfare” assumes only a negative connotation and it is targeted largely at the poor, as has tended to happen in the US, the results are divisive’.137

Thus, third way politics seeks to encourage the market economy, while ensuring that its tendency towards social division is tempered by some limited state intervention to encourage socially responsible and community-sensitive commerce. In this way, third way politics accommodates aspirations for individual freedom by making that freedom dependent on a commitment to certain social obligations. In the context of the welfare state, the freedom of individuals to enjoy its benefits should be tempered by their obligation to pay for its continual improvement, and to limit personal claims to state benefits, education and healthcare by taking a more responsible attitude to work, childcare and healthy living. In the context of artificial legal individuals, such as the company, the individual freedom to operate in the market must be tempered with social obligations to communities and the environment.

134Ibid, p 102.

135Ibid, p 103.

136Ibid, p 105.

137Ibid, p 108.

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The notion of the ‘socially responsible business’ was also discussed at length by another writer with the ear of New Labour, Will Hutton, former editor of The Observer newspaper. His version of third way politics was discussed under the concept of ‘stakeholder capitalism’ in his briefly important book, The State We’re In.138 In this treatise he argued for the encouragement of the socially responsible corporation in which the interests of all ‘stakeholders’ were negotiated. These ‘stakeholders’ would include consumers, employees, creditors and local communities, as well as the well-established interests of shareholders. This approach would encourage a commitment from all those concerned with the corporation and would give them a reason to pursue the prosperity of the business, an outcome clearly popular with business owners. Hutton’s more radical message, however, was that business should not be run purely for the purpose of creating profit. The interest of shareholders’ dividends was only one of the interests that business should pursue. Shareholders were just one among many types of stakeholder and should take their place among a number of other priorities.

Hutton’s socially responsive business held clear socialist undertones, yet in spite of this, ‘stakeholder capitalism’ remained a buzz phrase of New Labour for many years, although the policies were not pursued. In contrast, third way notions have retained their popularity with the policies of New Labour coupled with the occasional ideological garnish such as that presented by Charles Leadbeater in his book, Living on Thin Air: The New Economy.139

Like Giddens, Leadbetter argued that the old class system had disappeared and, with it, traditional methods of retaining social order. However, unlike Giddens, Leadbetter attempts to understand this in terms of the material basis of social order. The economy, he argued, has shifted from industrial production to a ‘knowledge-based economy’, but has done so while attempting to retain the institutions of social order that maintained and described the older economy. So, despite moving into a knowledge-based economy with all its potential democratic and safe connotations, individuals were experiencing their life as fraught with increasing anxiety. However, he argued, this sense of anxiety and powerlessness was not a personal failing but an institutional failing. While the economy has undergone huge changes, the institutions that contained and sustained the economy had not. Indeed, the institutions that exist today were, in all their major characteristics, institutions designed to meet the needs of industrial Victorian England.

The nineteenth century was revolutionary because the Victorians matched their scientific and technological innovations with radical institutional innovations: the extension of democracy, the creation of local govern-

138Op. cit., Hutton.

139Op. cit., Leadbeater.

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ment, the birth of modern savings and insurance schemes, the development of a professional civil service, the rise of trade unions and the emergence of the research based university. We live with the institutions the nineteenth century handed down to us. Our highly uneven capacity for innovation is the fundamental source of our unease. We are scientific and technological revolutionaries, but political and institutional conservatives.140

The ‘new economy’, which to a greater extent is viewed as developing naturally and organically, required new institutions to be artificially created through government policy. Thus, the market itself demands third way politics in order that it may continue to prosper. New Labour’s attempt to reorganise welfare, work and social order is not so much autonomous political policy as a sensitive response to the requirements of the new ‘knowledgebased economy’. Little wonder then that Tony Blair is cited on the back cover as saying: ‘Charles Leadbetter is an extraordinarily interesting thinker. His book raises critical questions for Britain’s future. I know it will be widely read and debated.’141

The stated challenge of the New Labour Government was to reconstruct a social order appropriate to the demands of a new economy. The question was, would it reflect Gidden’s third way or Hutton’s stakeholding? These two possible directions for company law reform were assessed in some detail in the CLR’s consultation document in 1999.142 The third way approach was reflected under the heading of ‘enlightened shareholder value’ while the stakeholder approach was reflected under the heading ‘pluralist approaches’.

Enlightened shareholder value

The enlightened shareholder value approach advocates the continuation of a company law which promotes the interests of shareholders by acknowledging that this may be best achieved by taking account of the interests of others connected with the company.

Exclusive focus on the short-term financial bottom line, in the erroneous belief that this equates to shareholder value, will often be incompatible with the cultivation of co-operative relationships, which are likely to involve short-term costs but to bring greater benefits in the longer term.

140Ibid, preface.

141Ibid, cover page.

142‘Modern company law for a competitive economy: the strategic framework’, consultation document, February 1999.

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Thus the law as currently expressed and understood fails to deliver the necessary inclusive approach.143

The CLR noted that the practical advantage of adopting the enlightened shareholder value approach is that it would not involve a fundamental change in the orientation of company law which is concerned to maximise shareholder wealth. It would, however, involve a little modification. The CLR maintained that the law as it was expressed tended to ‘lead to an undue focus on the short term and the narrow interest of members at the expense of what is in the broader and longer term sense of the enterprise’.144 This, the CLR suggested, could be addressed by reformulating directors’ duties to give e ect to the enlightened shareholder value approach. The current law, with its emphasis on a director acting in the interests of members as a whole including future members and its restraints on a director improperly using his power, enabled directors to take account of broader enlightened shareholder value concerns. Instead, however, directors tended to pursue short-term narrow ends and the law tended to support this. The CLR stated that ‘it is in our view clear, as a matter of policy, that in many circumstances directors should adopt the broader and longer term (inclusive) view of their role.’145 The reason they did, they proposed, was because of a lack of knowledge and understanding of the law. The aim of law reform, from this perspective, would be to clarify the position in law, creating clear signposts for directors which would enable them to steer the company in the interests of wider concerns. Importantly, this approach would not entail a radical reform of the law. Instead it would express the law in such a way as to allow directors to take an enlightened shareholder value approach.

However enlightened shareholder value is a third way policy and as such it attempts to construe the market’s usual pursuit of profit as something that is first desirable and second something which is best achieved by considering the interests of all. A seemingly inclusive approach rather than an exclusive approach, it locates the achievement of this inclusive approach in the polishing up of the status quo and relies more upon wishful thinking than rigorous analysis. Its assumption that the failures arise because people need more advice, more education, more codes of practice in order to do the right thing is typical of contemporary policy making. For as the CLR notes, the law already exists to enable an enlightened shareholder value approach and yet directors don’t take his route. Is it because of ignorance? Yes, say enlightened shareholder value advocates. Or is it that the market measures success by profitability which is achieved by specifically ignoring the interests of other

143Ibid, p 37.

144Ibid, p 39.

145Ibid, p 40.

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players such as employees and suppliers? A company achieves profitability if the capital it spends on production is less than it gains on the sale of its products. Thus, arguably, greater profit is achieved by reducing its wage and supply costs.

The pluralist approach

The pluralist approach as characterised by the CLR would shift the orientation of directors’ duties away from shareholders only, to include shareholders and all other persons concerned with the company including employees, suppliers, creditors, consumers and the wider public (other stakeholders). It promotes this radical approach because:

the present law in making shareholders’ interests ultimately overriding, may create, or reinforce, an environment in which relationships are dif- ficult to sustain. This increases the level of ine cient risk between those managing companies and employees, suppliers and others, on whom the company depends for factors of production and who depend in turn on the company for a secure environment within which to make the commitments necessary to provide them.146

In order to create this conducive environment all the many parts of the Companies Act that give shareholders control would have to be replaced with provisions which balanced these powers between all stakeholders. This radical reformulation of company law and the way in which it would a ect business culture, argued the CLR, would be unpopular. Furthermore, directors would be unclear as to whom they were accountable and this would, according to the CLR, ‘dangerously distract management into a political balancing style at the expense of economic growth and international competitiveness’.147

As the pluralist’s stakeholding premise assumes a convergence of selfinterest between all stakeholders which should be reflected in governance structures such as board representation, the CLR presented a number of objections to the assertion that this approach would be better for profitability. These are well founded. As the empirical evidence presented by Roe illustrates, systems which enhance employee/stakeholder interests are not as profitable as those that promote shareholder interests. Stakeholding, as presented by the CLR, although in contrast to Hutton’s approach, presents a new model of the socialised corporation which is di erent from the post-war model discussed earlier in that it is promoted as something that will increase

146Ibid, p 42.

147Ibid, p 44.

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profitability. It promotes a social institution as something which is in fact a superior market institution. This is not only wrong, it misses the point of the social corporation. It was never supposed that a social approach to corporate governance would enhance shareholder value, quite the opposite. It was supposed that it would create a fairer and more socialised society which provided safe and well-paid positions for employees, good inexpensive products for consumers and would address environmental and community issues. The price for these social goods was profitability and it was a price worth paying. This is more in line with Hutton’s stakeholding notion and one which would have seriously radicalised both the law and society as a whole.

However, in contemporary society the notion that a company should operate non-profit goals is seen as eccentric at best. And while a bald neo-liberal approach is considered too stark, too individualistic, too greedy, the aims of neo-liberalism, the enhancement of private ownership are unquestioned. It is a matter of style. Profit-maximise, but call it inclusion. This ‘have your cake and eat it’ approach of both the enlightened shareholder value and pluralist approach is more palatable in the former hue because it does not require the structural changes and loss of profit-making potential which the pluralist threatens. And so the CLR later abandoned stakeholding’s pluralism and its possible connotations of the social corporations in favour of enlightened shareholder value. The subsequent legalisation closely reflects this.

The Companies Act 2006 in respect of governance issues is best comprehended as an ideological creature of its time. It is a point in the process of corporate governance discussions. In its preferment of the free market with the rhetoric of socialism, it concurs with the abandonment of non-profit- orientated goals but reconstructs the social corporation. Unlike Dodd’s social corporation it does so in words only, requiring directors to only consider the interests of other stakeholders and only when in honest pursuit of the promotion of the success of the company for the benefit of its members. The dominant ideology in legal scholarship contractarianism gave enlightened shareholder value some intellectual credibility. Furthermore, it enabled the reform process to reformulate the power relations within the company as bargains between company players, borrowing the assumptions of equality and fairness of contractual agreements. But companies are the structures within which the wealth of society is organised and enlightened shareholder value organises this wealth for the benefit of shareholders – and that isn’t equal or fair.