CSR in a company law context. Legal duties of directors. Some relevant questions. Key question: Does the pursuit of stakeholders’ interests clash with managerial duties under company law? What are the legal duties of managers /directors under company law?
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CSR in a company law context Legal duties of directors
Some relevant questions Key question: Does the pursuit of stakeholders’ interests clash with managerial duties under company law? • What are the legal duties of managers/directors under company law? • Whose interests do these duties protect? • How are these managerial duties enforced?
2 main managerial duties Duty of Care - requires “some level of attentiveness, some process for (and actual) acquisition or possession of relevant information, some reasoned deliberationin performing services, and exercise of some conscious (but virtually unrestricted) judgmentabout acceptable levels of return per unit of risk or other measure of enhancing stockholder well-being.” Duty of Loyalty - no self-dealing (self-interest of directors)
Legal formulations of duties UK: “we do not accept that there is anything in the present law of directors’ duties which requires them to take an unduly narrow or short-term view of their functions... There is nevertheless considerable evidence that the effect of the law is not well recognised and understood.”(UK Company Law Review Steering Group) Pay attention to: • Whose interests (shareholders, company itself, stakeholders) • Short-term v. long-term perspective
OECD ‘Board members should act on a fully informed basis, in good faith, with due diligence and care, and in the best interest of the company and the shareholders.’ (Principles of Corporate Governance 2004) “Generating economic profit so as to enhance shareholdervalue in the long term, by competing effectively, is the primary objective of corporations in market economies. Corporate governance must acknowledge this objective while simultaneously fulfilling broader economic, social and other national objectives. This multiplicity of functions is complex but necessary to the perpetuation of the corporation and the market system.” (Millstein Report)
UK “(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 company’s employees, (c) the need to foster the company’s business relationships with suppliers, customers and others, (d) the impact of the company’s operations on the community and the environment, (e) the desirability of the company maintaining a reputation for high standards of business conduct...” (Art. 172, Companies Act 2006)
US Director to act “in a manner [the director] reasonably believes to be in the best interests of the corporation.” (Model Business Corporation Act ann. (1996) para. 8.30(a).) Directors have a general duty to act with care and in the best interests of the corporation and its stockholders. (Delaware law) “‘The best interests of the corporation’ are generally understood to coincide with the best long-term interests of the shareholders.” (US author)
Germany Two-tier board system: management board (senior executives) and supervisory board (appoints, supervises and advises MB; 1/3 -1/2 worker reps). Pre 2010 version of Code • Management Board “is responsible for independently managing the enterprise. In doing so, it is obliged to act in the enterprise’s best interests and undertakes to increase the sustainable value of the enterprise.” • Supervisory Board: “The representatives elected by the shareholders and the representatives of the employees are equally obliged to act in the enterprise’s best interests.” (Corporate Governance Code) 2010 Code ‘The representatives elected by the shareholders and the representatives of the employees are equally obliged to act in the enterprise's best interests.’ The Code ‘clarifies the obligation of the Management Board and the Supervisory Board to ensure the continued existence of the enterprise and its sustainable creation of value in conformity with the principles of the social market economy (interest of the enterprise).’ German Corporate Governance Code (2010) http://www.ecgi.org/codes/documents/cg_code_germany_may2010_en.pdf
France “In his business relations with other partners… the manager may undertake all managerial decisions in the interest of the company.”(Article 13, the 1966 Company Law) The interest of the company “May be understood as the over-riding claim of the company considered as a separate economic agent, pursuing its own objectives which are distinct from those of shareholders, employees, creditors including the internal revenue authorities, suppliers and customers.”(Vienot Report I, 1995) “The common interest of all of these persons… is for the company to remain in business and prosper; is not the sum of conflicting interests.”(Vienot Report I, 1995)
Conclusion: Interests promoted by CL Company laws re. the interests of shareholders: • Qualifies them with varying terms (‘collective’, ‘long-term’ or ‘common’ interests of shareholders); • Replaces them by the ‘interest of the company’; • Refers explicitly to the interests of stakeholders (employees, creditors including the internal revenue authorities, suppliers and customers, the community and the environment, even the market system).
Judicial enforcement of … 1. Duty of Care Weak judicial enforcement due to the ‘business judgment rule’ (BJR) – managers have to be grossly negligent, not merely ordinarily negligent 2. Duty of Loyalty Strong judicial enforcement – self-dealing not allowed
Ford Model T http://en.wikipedia.org/wiki/Ford_Model_T http://www.youtube.com/watch?v=0k7YXc8G8-s
Dodge v. Ford Motor Co (1919) (1) Ford’s decisions: • Limit dividends to 5%, but for what reason? Henry Ford: future dividends would be limited to five percent monthly while the remaining profits would be used for business expansion, and also “to employ still more men, to spread the benefits of this industrial system to the greatest possible number, to help them build up their lives and their homes.” Minority shareholders complain and go to court
Dodge v. Ford Motor Co (2) Court: “There should be no confusion ... of the duties which Mr. Ford conceives that he and the stockholders owe to the general public and the duties which in law he and his codirectors owe to protesting, minority stockholders. A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end and does not extend to a change in the end itself, to the reduction of profits or to the nondistribution of profits among stockholders in order to devote them to other purposes.”
Dodge v. Ford Motor Co (3) HOWEVER, Ford wins: the court applies the BJR: “We are not, however, persuaded that we should interfere with the proposed expansion of the business of the Ford Motor Company. In view of the fact that the selling price of products may be increased at any time, the ultimate results of the larger business cannot be certainly estimated. The judges are not business experts. It is recognized that plans must often be made for a long future, for expected competition, for a continuing as well as an immediately profitable venture.”
Shlensky v. Wrigley (1968) (1) Wrigley’s decision: refused to schedule baseball games at night (as all other baseball clubs were doing) Minority shareholders complain of lost business opportunities (reduced profitability), and go to court. They claim: Wrigley has refused to install lights, not because of interest in the welfare of the corporation but because of his personal opinions that baseball is a ‘daytime sport’ and that the installation of lights and night baseball games will have a deteriorating effect upon the surrounding neighborhood.
Shlensky v. Wrigley (1968) (2) Complaint of minority shareholders: Directors were acting for a reason or reasons contrary and wholly unrelated to the business interests of the corporation; such arbitrary and capricious acts constitute mismanagement and waste of corporate assets, and the directors have been negligent in failing to exercise reasonable care and prudence in the management of the corporate affairs.
Shlensky v. Wrigley (3) HOWEVER, Wrigleywins: the court applies the BJR: ‘By these thoughts we do not mean to say that we have decided that the decision of the directors was a correct one. That is beyond our jurisdiction and ability. We are merely saying that the decision is one properly before directors and the motives alleged in the amended complaint showed no fraud, illegality or conflict of interest in their making of that decision.’
Business judgement rule (BJR) Standard of review ref duty of care: only when managers were grossly negligent, not merely ordinarily negligent • Stated explicitly in laws (‘business judgment rule’ - BJR) • Implicitly, a matter of judicial self-restraint BJR: A special standard of culpability (greater fault than ordinary negligence) • gross negligence standard • The process-versus-substance distinction: judicialreview of the process of decision-making is tighter than the review of the decision arrived at through that process (American Law Institute’s Principles of Corporate Governance)
Judicial enforcement of Duty of Care Bottom-line: When minority shareholders challenge top management with breach of duty of care in pursuing the profitability of the company, Courts are unwilling to second-guess management Why: ‘The institutional incompetence of courts to pass upon the wisdom of business decisions.” BJR ‘protects from substantive review for wisdom.’ Rationale: in a risky business environment, managers should be able to take risky business decisions without constant fear of lawsuits affecting their professional judgment. Business executives will not be held liable simply for a bad business decision.
Company Law & Managerial discretion Bottom-line on CL - “Directors have fiduciary responsibilities to shareholders which, while allowing directors to give consideration to the interests of others, compel them to find some reasonable relationship to the long-term interests of shareholders when so doing.” (American Bar Association’s Committee on Corporate Laws)
CL & the managerial duty of care Bottom-line CL protects – through the BJR – the discretion of management against overbearing shareholders (-> opening for CSR) CL cannot force managers – through litigation – to exercise due care (-> pointless to try to modify duties of managers under CL to promote CSR)
Corporate governance system Protection of shareholders’ intereststhrough: • Managerial duties and litigation • Powers and rightsof shareholders under CL • elect directors • amend the constitutive of the company • approve the distribution of dividends • approve external auditors • approve annual accounts • approve new share issues • approve extraordinary transactions (mergers, take-overs). • Transparency laws – material information for shareholders to understand the performance and prospects of the company • Capital markets– impersonal valuations of company performance (markets elevate “exit” over “voice”: shareholders sell and invest elsewhere) • Institutional shareholders– large size -> no easy ‘exit’ from market -> engage and pressure the management (‘voice’) • ‘Market for corporate control’ – ‘hostile takeovers’ (new owners sack top management), especially in the 1980s.
Some relevant questions Questions: • Whose information needs can be satisfied through reporting regulations in corporate governance? • Is it less controversial to refer to stakeholders in reporting regulations instead of in the legal duties of managers/directors? Recent developments in • UK • EU
1. UK: the Business Review 2006 (1) “purpose of the business review is to inform members of the company and help them assess how the directors have performed their duty under section 172 (duty to promote the success of the company).” (Article 417 (2))
UK: the Business Review (2) For quoted companies, the business review must include, ‘to the extent necessary’ (to comply with the objective of BR), “(a) the main trends and factors likely to affect the future development, performance and position of the company’s business; and (b) information about (i) environmental matters (including the impact of the company’s business on the environment), (ii) the company’s employees, and (iii) social and community issues, including information about any policies of the company in relation to those matters and the effectiveness of those policies; and (c) subject to subsection (11), information about persons with whom the company has contractual or other arrangements which are essential to the business of the company.” Art. 417 (5), Companies Act 2006
UK: the Business Review (3) “social and community issues” = For ex, employee health and safety; social risks existing in the supply chain (e.g. child labour and ‘fair wages’); and indigenous and human right issues relating to local communities in overseas operations. (UK Accounting Standards Board)
Objective of BR (former OFR) “pivotal role [of the proposed OFR] in improving understanding of business performance and prospects, as well as promoting accountability and encouraging responsiveness and high standards of business practice.” “Directors are addressing the OFR to shareholders. The purpose of the OFR is to assist shareholders assess a company’s strategies and the potential for them to succeed... Information in the OFR will also be of interest to other stakeholders, including: employees, suppliers, customers, regulators and other users of reports and accounts such as those particularly interested in the environment and broader community.”
Objective of BR (former OFR) “Our approach is that the document is not financial in the narrow sense; as the title indicates, it is a qualitative, as well as a financial, evaluation of performance and trends and intentions. On the other hand it is an analysis and description of the business as an operational and commercial entity prepared by the directors from their perspective as managers of the business.”
2. EU Accounting Directives (2014) Applies to large companies based on no. of employees (500), total assets (EUR 20 million) and turnover (EUR 40 million) Report contains a non-financial statement with info ‘relating to at least environmental, social and employee matters, respect for human rights, anti-corruption and bribery matters, including: (i) a description of the policy pursued by the company in relation to these matters; (ii) the results of these policies; (iii) the risks related to these matters and how the company manages those risks.’ http://eur-lex.europa.eu/legal-content/EN/ALL/;jsessionid=n7LLT79Gj8yHP6v9tKtqrJxKYSTmRL2TG07rr8RvzvK8k9Q15VTs!206856764?uri=CELEX:52013PC0207
EU Accounting Directives (2014) Regulatory options considered by the EC • strengthening the existing requirement (annual report contains some CSR info) • new requirements for detailed reporting • setting up an EU Standard The annual report: ‘The annual report shall include a fair review of the development and performance of the company's business and of its position, together with a description of the principal risks and uncertainties that it faces. The review shall be a balanced and comprehensive analysis of the development and performance of the company's business and of its position, consistent with the size and complexity of the business.’ http://eur-lex.europa.eu/legal-content/EN/ALL/;jsessionid=n7LLT79Gj8yHP6v9tKtqrJxKYSTmRL2TG07rr8RvzvK8k9Q15VTs!206856764?uri=CELEX:52013PC0207
EU Accounting Directives (2014) “a flexible and non-intrusive approach” ‘Companies may use existing national or international reporting frameworks and will retain their margin of manoeuvreto define the content of their policies, and flexibility to disclose information in a useful and relevant way. When companies consider that some policy areas are not relevant for them, they will be allowed to explain why this is the case, rather than being forced to produce a policy.’ • ‘In providing such information the company may rely on national, EU-based or international frameworks and, if so, shall specify which frameworks it has relied upon.’ (->UN Global Compact, the UNGPs, the OECD Guidelines for MNEs, ISO 26000, the ILO Tripartite Declaration, and the Global Reporting Initiative) • ‘Where a company does not pursue policies in relation to one or more of these matters, it shall provide an explanation for not doing so.’ (‘comply or explain’ approach) http://eur-lex.europa.eu/legal-content/EN/ALL/;jsessionid=n7LLT79Gj8yHP6v9tKtqrJxKYSTmRL2TG07rr8RvzvK8k9Q15VTs!206856764?uri=CELEX:52013PC0207
EU Accounting Directives (2014) Why regulate and make reporting mandatory? The Commission ‘identified both a market and regulatory failure: … market incentives appear insufficient or uneven. Despite the increase in demand for non-financial information, the benefits related to non-financial disclosure are perceived by some stakeholders as long-term and difficult to quantify in a precise manner, while short-term costs are more apparent and easily measurable.’ Reasons • ‘overall performance of companies’ (‘help companies to better manage non-financial risks and opportunities’ –> long term success of company) • Accountability (non-financial info is used by NGOs and local communities to assess the impact and risks) • ‘ability of investors to assess and factor appropriately and timely all relevant information’ (‘allows investors to take better account of sustainability considerations and long term performance’) • ‘efficiencyof the EU financial markets’ http://eur-lex.europa.eu/legal-content/EN/ALL/;jsessionid=n7LLT79Gj8yHP6v9tKtqrJxKYSTmRL2TG07rr8RvzvK8k9Q15VTs!206856764?uri=CELEX:52013PC0207
3. France: New Economic Regulations (2001) The report [of the board or executive board] ’contains information … about the way the company takes into account the social and environmental consequences of its activity.’ It should indicate the importance of sub-contracting, how the company promotes to its subcontractors the provisions stipulated by the fundamental conventions of the ILO and how the company makes sure its subsidiaries abide by them. It should indicate furthermore the way the foreign subsidiaries of the company take into account the impact of their activities on the regional development and neighbourhood populations.
4. Corporate governance codes: “comply or explain” provisions Corporate governance codes:Soft law, later backed by transparency regulations – first in UK in 1990s, spread throughout Europe. • Combined Code on Corporate Governance (UK) – board of directors to review the effectiveness of the system of internal controls, including risk management systems, and to report to shareholders. • London Stock Exchange’ Listing Rules – listed companies include in annual report a statement of how they applied the Combined Code: “(a) a narrative statement of how it has applied the principles…; (b) a statement as to whether or not it has complied… with the Code provisions... A company that has not complied with the Code provisions… must specify the Code provisions with which it has not complied … and give reasons for any non-compliance.”
Some relevant questions Questions: Whose information needs can be satisfied through reporting regulations in corporate governance? Is it less controversial to refer to stakeholders in reporting regulations instead of legal duties of managers/directors? Yes! Overlap between the needs of shareholders and stakeholders for information. Visible through the lenses of risk-management.
Transparency laws Reporting in itself does not require any change in corporate conduct. How do these laws count? • Strengthens the ability of stakeholders to act against the company, • Company goes through an internal process of finding, analysing and reporting information, • Places a topic on the public agenda (legitimising force) and opens the way for more stringent law/policy. • Enforcement – both private and public • Codification– bothpublic and private • Dangers: ”boiler-platereporting”, ”paper compliance”, meaninglessreporting, burrying the readers in information