Arguments for and against Corporate Governance

In seeking to critically examine the arguments for and against the regulation of corporate governance around the world, this essay will first look to discuss why there was a need for the increasing development of the regulation of corporate governance frameworks internationally in view of the recent financial crisis and its ongoing impact upon corporate enterprise globally. However, it will then be recognised the development of an effective system has not been helped by the fact that there are a number of different theories of corporate governance illustrated by the way in which those working in this field have dealt with what they consider to be the key element for a corporate governance system. This is illustrative of the fact that there is arguably a lack of consistency in the approach taken by jurisdictions around the world which can only serve to further complicate matters for multinational corporations. On this basis, this study will then seek to focus in upon the development of the law in relation to corporate governance in the UK with a view to providing for further arguments for and against its improved regulation. Finally, this essay will look to conclude with a summary of the key points derived from this discussion in relation to the arguments for and against the regulation of corporate governance around the world.

To better understand why there is a need to better regulate corporate governance frameworks, the system previously promoted by North Atlantic states until more recent years failed because of a high degree of over-speculation on the part of those operating within it without sufficient regulation through key economic entities like those found on Wall Street heavily relied upon by economies globally. [1] However, although it has usually been argued problems arose due to a lack of a sufficiently regulated corporate governance framework to be adopted by corporations uniformly, the real reason for financial systems failures globally arose from out of the fact US sub-prime mortgages had been converted into traded securities with complex structures [2] purchased by European banks believing this diversified their portfolios without appreciating the risks involved. [3] But, despite the real reasons recognised for the recent world economic crisis, it was only a matter of time before problems arose in practice and the need for more effective systems of corporate and financial regulation became paramount. [4] 

With this in mind, effectively developed corporate governance frameworks need to be put in place for making those administering companies’ activities more watchful by making directors and management more accountable through an effective system of regulation. To achieve this companies themselves have recognised the need to develop more effective corporate governance systems because it was believed this would have a positive effect on performance by making their activities more transparent and accountable. [5] The corporate governance of companies is focussed upon separating both ownership and management of any company [6] regarding the full and efficient use of their assets. It is incumbent upon company owners to introduce corporate governance mechanisms to guarantee the effective regulation of any company’s activities through the moderation of agency problems arising from out of a separation of control and ownership. [7] This is because, in determining the value of principles of corporate governance to the development of jurisprudential theories of juristic personality regarding corporate law, ostensibly, corporate governance looks to mitigate and/or resolve the agency problems experienced by all corporations fashioned by the partition of ownership and control within a company and the lack of sufficient monitoring regarding the activities of both directors and management.

For agency theorists, systems of corporate governance can be more effective in both their monitoring and management roles where every boardroom looks to include many more independent directors from outside the general day-to-day administration of a company. This means they are non-employees with no significant business relationship with the companies they involve themselves with to limit any conflicts of interest arising. [8] However, managerial hegemony theorists have looked to place much greater emphasis upon the view that there is a recognised need to utilise the role of NEDs [9] despite the fact they have proved quite ineffective in monitoring the performance of executive management if the Chief Executive Officer plays the main role in the nomination of their company’s board members to control the administration of a company's affairs. [10] Nevertheless, resource dependence theorists have looked to focus upon the role of a company’s board of directors as resource providers between companies and their working environments, whilst also emphasising the role of individual board members as being quite critical to their ability to carry out effective monitoring under a given system of corporate governance. [11] Such a view is then further supported by the fact corporate governance has focussed upon the structure and role of companies’ boards of directors to strengthen their accountability [12] . Therefore, a more effective regulatory system of corporate governance may be effectively expressed as a regime focussed upon “a set of relationships between a company’s management, its board, its shareholders and other stakeholders … through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined" [13] .

Interestingly, however, the UK has previously sought to limit the possibility of corporate collapses with the development of a more effectively regulated corporate governance framework since the problems that arose with Enron in the US in view of the unscrupulous activities of the directors that ran the company without sufficient redress. [14] This is because events such as these were considered to be indicative of the culture prevailing at the time that valued 'deal-making' and money above all else. Therefore, the need for a more effective regulatory system was marked by the fact corporate governance at this time was little more “a weak check and balance" that “historically relied on reasonably honest and honourable managers and directors" within what fundamentally developed into a “financial and moral corruption machine". [15] However, it was only when things went into decline that people became truly aware of the importance of the US' position to the ongoing development and maintenance of the world economy [16] so that policy makers needed to look to exercise much greater regulatory control. [17] 

Unfortunately, the reality has proved more difficult in practice. The reason for this is that, despite the attempts to provide more effective regulation, [18] many have argued “corporate governance is fundamentally a weak check and balances approach" that trapped “a trusting or negligent board, shaped the corporate culture and ethical climate, and ensnared the auditors, the external attorneys, and … politicians and regulators" [19] . Nevertheless, many academics still believe the principles involved with formulating an effective system of corporate governance are as much about industrial organisation [20] , politics [21] , ideology [22] , and historical accident [23] , as they are about the investors . [24] On this basis, an effective system may develop through the establishment of an effective internal monitoring system to limit director’s self-serving behaviour beyond the merely administrative principles of the Companies Acts of 1985 and 1989 in the UK. For example, the recognition of company directors' fiduciary duties has previously proved somewhat controversial in looking to fully recognise the liabilities allied to their position with their duty to act in the best interest of their companies having largely been recognised as being arguably a directors' most significant duty. [25] The reality, however, is that this has proved to be something of a misnomer in relation to the understanding of directors' fiduciary duties in relation to acting in the 'best interests' of their companies since this is understood as company directors' main nominate duty. Nevertheless, by serving their own personal interests, company directors could be said to have failed to be acting in their company's ‘best interests’ by, for example, forming a new company that 'siphons' off the best parts for the new organisation to the detriment of the ‘original’ company and their fellow company directors exclusion from participating in the new corporate entity. [26] 

Nevertheless, company directors' fiduciary duties are not directly concerned with their decisions relative merits - it is only actually concerned with whether a decision is compromised by a conflict or a potential personal benefit. [27] As a result, the ‘proper purpose rule’ is also a fiduciary duty because the exercising of a power to secure a personal benefit is but one of a number of possible improper purposes potentially perpetrated by a director. [28] But this would still only appear to fit within the concept of directors exceeding their authority because directorial liability for fiduciary wrongdoing has been largely subsumed within the framework developed to regulate other fiduciaries behaviour. [29] Therefore, company directors must not exploit their company’s property for their personal profit because there is no leeway to consider whether a company has been harmed by the fiduciary - except to avoid a conflict of duty and interest [30] - since liability for breach is strict and the director will be held liable as a constructive trustee; [31] even though the conflict between personal interest and duty is nothing more than a mere possibility. [32] But, whilst the ‘best interest’ and ‘proper purpose’ rules may appear fiduciary, when the judiciary uncritically labels the two thus, they serve to offend the rules regarding practical application. [33] 

However, the importance of recognising company directors duties has been emphasised in this area of the law under the Companies Act (CA) 2006. Sections 155-161 codified director’s duties previously largely found in the ongoing development of the common law to both clarify the law and also make it more accessible for those it applies to, whilst sections 170-175 of the Act have also emphasised the significance of company director’s duties. But company directors' powers are limited under sections 41-42 so only two resolutions can now be made (since an extraordinary resolution can no longer be passed) and the procedure is very strict so any acceptance cannot be revoked. [34] In addition, company directors are duty bound [35] to act to promote the success of the company in their shareholders' interests. [36] Therefore, company law now seeks to provide a framework of rules to limit and even eliminate director’s abuse of their powers whilst also seeking to preserve the remit of these powers for the good of the company. As a result, the CA 2006 has served to 'freeze' the law regarding the recognition of company directors’ duties and impend its development as section 170(4) has recognised its general duties have served to replace the common law principles on which they are based.

However, whilst company directors owe duties to both their company under section 170(1) of the CA 2006 and to individual shareholders under the common law, the common law also generally says that company directors owe duties to shareholders individually. [37] But, in view of the ongoing developments in the law, where a company director is accused of breaching a duty related to their company, the allegation has to be identified in one or more of the general duties set out in the statute - except where the statutory statement preserves the common law duties. Moreover, section 170(5) of the CA 2006 also included statutory general duties “shall be interpreted and applied in the same way as the common law duties or equitable principles" so the existing case-law would remain relevant to interpreting the new statutory duties because “regard shall be had to the corresponding common law rules and equitable principles in interpreting and applying the general principles". But, where there is a breach of a director's duties, there is a need to draw attention to the fact the law is now somewhat inconsistent because section 178 of the CA 2006 simply states that the civil consequences of breaches of the statutory duties are to be the same as under the common law. There is also a duty on company directors not to allow for a conflict of interest if the matter has been authorised by the directors under sections 175(4) and (5) of the CA 2006 and authorisation cannot be given retrospectively and applies only to the conflict situation under section 176.

Powers had previously been granted to companies shareholders to limit abuses of powers by directors in carrying out activities on behalf of their companies because the shareholders’ franchise is the foundation “upon which the legitimacy of the director’s managerial power rests". [38] For example, under section 459 of the Companies Act 1985, company shareholders could seek an order from the court because they believe their “company’s affairs are being or have been conducted in a manner which is unfairly prejudicial to the interests of its members generally or of some part of its members ... or than any actual or proposed act or omission of the company ... is or would be so prejudicial." Therefore, due to unfair prejudice, a court could give relief so Foss v. Harbottle [39] limited the exceptions so the judiciary were now becoming more flexible and innovative in recognising unfairly prejudicial conduct including – (i) excluding directors from management without an offer being made to purchase the petitioner’s shares fairly; [40] (ii) diverting business; [41] (ii) awarding themselves excessive financial benefits; [42] (iv) abuses of power and breaches of the company's Articles of Association; [43] and (v) the destruction of their relationship with the company. [44] 

Now, however, under section 168 of the CA 2006, where company directors do not act in ‘good faith’ this allows shareholders to remove a director (or even the whole board) through the use of an ordinary resolution – although they must also be warned the removal of any company directors from the board may lead to claims of unfair dismissal and further litigation regarding their employment where compensation is sought that may prove costly to the company as a whole. [45] Nevertheless, the UK system of corporate governance is currently undergoing some significant changes to make the framework more effective for regulating company directors activities. In addition, the enlightened shareholder value concept seems to perpetuate shareholder primacy, whilst directors are duty bound under section 172 of the CA 2006 to promote their companies success. [46] Therefore, one of the most significant purposes behind the ongoing development of corporate governance in the UK has been to maintain equilibrium between restricting directors from misusing their powers and preserving a strong management body when seeking to implement the CA 2006 to clarify directors' key duties and obligations regarding the running of their corporations in the best interests of their shareholders by accounting for the following principles - (i) transparency; (ii) accountability; (iii) fairness; (iv) responsibility; (v) rules; (vi) non-legislative codes; (vii) an appreciation of best practices; and (viii) self-regulation. [47] 

However, the CA 2006 does not reveal which case decisions previously decided under the common law it will confirm and which it will depart from. [48] Problems have previously arisen when directors start to act beyond their powers and even abuse them so, to limit company directors' abuse of their powers, there is a need to encourage companies to include as many independent directors as possible to improve the conflict monitoring function. [49] That this has proved to be the case is despite the argument non-executive/independent directors are ineffective in this role due to their lack of day-to-day involvement with a given company due to their other work [50] since companies boards of directors are generally resource providers [51] even though recent corporate governance developments seem to have centred upon making boards of directors more accountable. [52] 

Prior to the CA 2006's enactment policy makers domestically began an extensive process of review to determine whether changes were necessary to make the system of corporate governance more effective and efficient. [53] In addition, the Company Law Review Steering Group [54] sought to establish rules regarding directors’ duties whilst the Cadbury Report 1992 [55] reviewed the control and reporting functions of the companies’ boards along with shareholder rights and the Greenbury Report of 1995 [56] dealt with remuneration, before the Hampel Report of 1998 [57] instigated a draft of the Combined Code of Corporate Governance in bot 2003 and 2006. Specifically, the Combined Code of Corporate Governance 2006 recognised at paragraph E1 “Institutional shareholders should enter into a dialogue with companies based on the mutual understanding of objectives" as a reflection of the 2001 Myners Review on ‘Institutional Investment in the UK’. This Review then considered whether there were any factors that distorted “the investment decision-making of institutions", whilst also encouraging institutional shareholders to consider their responsibilities as company owners and how they should exercise their rights on behalf of beneficiaries. Moreover, section 1 of the Combined Code of Corporate Governance 2003 looked to detail the values considered pertinent to the governance of UK listed companies regarding the statements required for transparency by companies [58] and reports by shareholders. [59] Section 2 of the Code also included the recognition of principles regarding institutional shareholders’ role in monitoring and ensuring the proper governance of companies [60] - although they are really merely just another facet of the process for developing a more practical corporate governance framework in the UK. [61] 

However, the reforms provided by the CA 2006 to advance the regulation of corporate governance in the UK also explained where the law does not match up with contemporary practice. [62] This is because the application of such principles means company directors must act in ‘good faith’ and loyalty [63] without allowing personal interests to colour decisions they are meant to make on behalf of their companies or risk being held personally liable. [64] Such a view has arisen because it was recognised in Charterbridge Corp Ltd v. Lloyds Bank Ltd [65] the proper test for whether a company director was acting in ‘good faith’ is based on whether someone in the same position could “have reasonably believed that the transactions were for the benefit of the company". In the interests of transparency it was incumbent upon company directors to report voluntarily whenever there was a suspicion their personal interests may conflict with their companies [66] and should seek their shareholders’ approval without there being an actual conflict. [67] This is because the recognition of directors' fiduciary duties means they must act bona fide in their company's best interests; [68] exercise their powers for a proper purpose; [69] not allow a conflict of interest to arise; [70] and must not make a ‘secret profit’ [71] or risk being held personally accountable.

Then, allied to the recognition of director’s fiduciary duties under the common law, all company directors within the UK's jurisdiction must also adhere to a recognised duty of care and skill. The remit of such a duty was then summarised by Justice Romer in Re City Equitable Fire Assurance Co [72] where he stated - (i) company directors must exhibit a degree of skill reasonably expected of someone with their knowledge and experience; (ii) but they are not bound to attend continuously; and, (iii) are justified in trusting others to perform their duties honestly where it is permitted. [73] However, these obligations are somewhat vague [74] and the elements of the test are out of date and not robust enough for the protection of companies interests in modern times. [75] Therefore, there was a need for policy makers domestically to codify director’s duties under the CA 2006 at sections 155-161 to clarify the law and make it more accessible for those it applies to. In addition, the CA 2006 established companies’ constitutions under section 17 also re-emphasised the significance of a company's Articles of Association under sections 18-20, [76] whilst the practical validity of the actions of any company will not be founded upon the issue of their capacity under section 39 since company directors can bind their company in ‘good faith’ [77] subject to any limitations [78] not affecting their liability or shareholders’ ability to act. [79] 

In addition, along with the aforementioned Combined Codes of Corporate Governance of 2003 and 2006, there is also a need to consider more recent developments in the forms of Sir David Walker's Review on Corporate Governance ('Walker Review') published in 2009 along with the Review of the Combined Code of Corporate Governance regarding the development of a more effective corporate governance framework. [80] The Walker Review was undertaken to report jointly to the Chancellor of the Exchequer, the Secretary of State for Business, Enterprise & Regulatory Reform and the Financial Services Secretary to the Treasury by examining corporate governance in the banking industry domestically to improve the available corporate governance framework. [81] To this effect, the Chancellor of the Exchequer recognised “corporate governance should have been far more effective in holding bank executives to account" in the wake of the problems experienced domestically as a result of the 'global economic meltdown'. [82] Therefore, the Walker Review stressed the importance of companies domestically needing to recognise – (a) the effectiveness of risk management at board level; (b) the balancing of skills, experience and independence required on banking institutions boards of directors; (c) the effectiveness of board practices and the performance of audit, risk, remuneration and nomination committees; (d) institutional shareholders roles in engaging with companies and the monitoring of boards of directors; and also (e) whether the domestic approach is consistent with international practice. [83] This is because it was believed such recommendation would establish a unilateral framework for safeguarding companies interests against their management over-speculating without sufficient means of redress. [84] 

Walker also recommended substantial changes to the way both banks and other major financial institutions' boards of directors’ function by boosting the role of non-executive directors to provide greater regulation. [85] The Walker Review also recommended strengthening banks' boards of directors and making rigorous challenges in company boardrooms to encourage institutional shareholders play a more active role as engaged owners to create a more effective system of corporate governance. [86] This is achieved through proposals including - (i) board level risk committees being chaired by a non-executive; (ii) risk committees having the power to scrutinise and block large transactions; (iii) implementing greater powers for remuneration committees to scrutinise salaries; (iv) remuneration committees overseeing the payment of high-paid executives not on boards of directors; (v) increased public disclosure about high-paid executives salaries; (vi) non-executives being required to spend 50% more time at work and face tougher scrutiny; and the (viii) Financial Services Authority monitoring conformity and disclosure by fund managers. [87] 

Then, to further enhance the corporate governance framework domestically, a report was published regarding the findings of the Financial Reporting Council's (FRC) review of the Combined Code of Corporate Governance. [88] On this basis, a call for evidence was issued inviting views regarding the resolution of matters relating to companies governance including (a) Which parts of the Code have worked well? (b) Do any aspects of the Code need further reinforcement? (c) Have any parts of the Code inadvertently reduced the effectiveness of the board? (d) Are there any aspects of good governance practice not currently addressed by the Code or its related guidance that should be? and (e) Is the ‘comply or explain’ mechanism operating effectively and how might its operation be improved? [89] Additionally, this report also established the actions the FRC was going to take that then led to a consultation period regarding proposed revisions to the Combined Code of Corporate Governance to produce a new Combined Code of Corporate Governance in May 2010. This led to the creation of a unilateral framework implementing some of the recommendations made as part of the Walker Review [90] the FRC considers should apply to all listed companies. [91] However, there is still no specifically tailored legislation for the purpose of corporate governance in the UK beyond the guidance that has already been provided for by the aforementioned Combined Codes of Corporate Governance. Therefore, it seems to be effectively a case of making do to then achieve some order as an indication of the UK's more flexible approach tailored towards market forces so such steps then permit policy makers to develop their own corporate governance frameworks.