Stakeholder engagement and directors’ duties under company law

image of businessman with tablet showing survey results, representing stakeholder engagementWe have written often, and at length, about the imperative of taking a holistic approach to Corporate Governance, and that balancing the interests of primary stakeholders in formulating the Goal of the organisation is key to this. In UK company law, we can see that this is now effectively explicit in the statutory duties of directors.


Importance of stakeholder engagement

Over two years ago we made the case for regular stakeholder surveys as a more effective way to expose the existence of bad practices in an organisation than whistleblowing, mentioning the experiences of GlaxoSmithKline and Foxconn in China, Olympus in Japan and Bernie Madoff in the US. We also talked about the exhortations of William Dudley, President and CEO of the Federal Reserve Bank of New York for the financial services industry to improve its ethical standards and suggesting the use of regular surveys to highlight customer and employee concerns about culture, and quoting the examples of J P Morgan and the London Whale, BNP Paribas and Sanction violations and the failings in the UK’s National Health Service, among others.

Read: Regular business surveys are better than whistleblowing

Since then there have several huge scandals of improper corporate behaviour, which this website has commented on, including Wells Fargo whose drive for growth through cross-selling led to the mass creation of fake customer accounts and five thousand staff being sacked, VW where defeat devices allowed diesel engined cars to cheat emissions tests for regulatory approval, and UK’s largest grocer, Tesco, having to declare that it cheated on its profit forecasts through special contracts with suppliers that allowed it to manipulate revenue recognition.

In each of these cases, we have argued that engaging with key stakeholders on a regular basis would have brought these failings out into the open without the need for whistleblowers and nipped these scandals in the bud, saving these organisations huge sums of money. The proviso, of course, is that there was transparency and proper accountability, as we’ll come back to later.

Directors’ duties under the UK Companies Act 2006

The UK government, just prior to pressing the Article 50 button to commence negotiations to leave the EU, and then precipitating a General Election before the consequences start to emerge, released a Green Paper on Corporate Governance Reform. This document limited itself to asking opinions on three matters: a) executive pay, b) strengthening the employee, customer and wider stakeholder voice and c) corporate governance in large, privately held businesses. What happens to this initiative after the election and with Brexit preoccupying the government remains to be seen, but it prompted us to look at the legal background to the element that interested us most in the Green Paper, namely stakeholder engagement.

When we look at the relevant parts of the applicable Companies Act 2006, we are looking at the sections relating to Directors’ Duties. The background to this is that under Common Law, directors’ duties fell under three headings:

  • their fiduciary duty to the company
  • a duty of skill and care
  • their statutory duties

By fiduciary duty, it was mandated that they act in good faith in the interests of the person they represent, that is, the company.

The duty of skill and care followed this in that the shareholders, as owners who had entrusted the running of their business to the directors, and the creditors who were restricted by the limited liability of the shareholders to claims against the net assets in their company, were both exposed to risk, and the duty of skill and care was introduced to reduce the risk both parties bore.

The lawyers tasked with drawing up the 2006 Act were mindful of changes in social attitudes towards the limited liability company, particularly regarding the primacy of the interest of the shareholders. In weighing up the relative merits of what was described as Enlightened Shareholder Value (accepting that a company’s ultimate goal was to maximise its value for shareholders) and the Pluralist approach (which argued that directors should be accountable to other stakeholders as well as the owners), it decided that the more practical approach was to adopt ESV, but to make it clear that directors, in deciding what was in the best interests of the company, should take into account the interests of other stakeholders.

So the 2006 Companies Act, in Section 172, addresses directors’ duties to promote the success of the company for the benefit of its members, but lists some of the most important things directors have to take into account in this process. Specifically:

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, and

(f) the need to act fairly as between members of the company.

(Useful source of info: ACCA Guide to the Companies Act 2006)

Now this, of course, requires what we at ACG have always advocated, which is a holistic approach to determining a goal for the company which balances the interests of the main stakeholders. In fact, it is the merest common sense that if the interests of customers, employees and owners aren’t adequately aligned, the business will be unsuccessful. Hence our continual puzzlement with the widespread (but diminishing) belief in the over-riding primacy of shareholder value in running businesses.

However, the Act goes further in providing for communication with stakeholders on the company’s performance in carrying out this Enlightened Shareholder Value approach, as prescribed in Section 172 above. In a Statutory Instrument published in 2013, it mandates an annual report to be published by all larger companies. The purpose of this Strategic Report 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)

The Statutory Instrument then lists the required content of this report including:

information about—

(i) environmental matters (including the impact of the company’s business on the environment),

(ii) the company’s employees, and

(iii) social, community and human rights issues, including information about any policies of the company in relation to those matters and the effectiveness of those policies.

Now, how is this information to be gathered? Logically, it can most reliably be gathered by stakeholder engagement, leading us to the ACG recommended practice of regular surveys of key stakeholder groups.

However, we can take this to a further stage to achieve an even better result.

Stakeholder engagement and surveys

At ACG, we have always promoted the use of regular surveys, conducted independently of the company and reporting at the highest level, to ensure that the views of the key stakeholders regarding the company’s corporate governance are known to the board members.

With the growth of social media, it is now possible to create an open stakeholder engagement platform which can provide a continuous feedback to companies. Indeed, a whole industry has grown up around Reputation Management, which “listens” for all social media noise and allows filtering of the noise. It is therefore now feasible to set up a channel providing what we call Dynamic Stakeholder Engagement, which is a permanently open channel for a company providing a social media like engagement opportunity with all its stakeholders (and non-stakeholders). This channel would gather views on a continuous basis, which would have to be assessed by a data analytics process to sort the wheat from the chaff and provide a regular report to the board. This report would highlight worrying issues in regard to the key stakeholders on a continuing basis, but also ideas and opportunities for innovative new products and opportunities for productivity and profit improvements.

The legal background is provided in the UK by the demands of the Companies Act 2006 regarding Enlightened Shareholder Value and the Strategic Report it mandates to report on the board’s performance in fulfilling its duties to further the success of the business, taking into account the broad interests of the key stakeholders.

We would tune the analytics process to contribute to a stakeholder-congruent goal derived holistically and informing on the ethical culture of the business.

So provisos/caveats/rules include the following:

  • the thrust of the analysis has to be to focus on the company’s goal, holistically conceived through congruence of the aims of the key stakeholders, and throwing light on the ethical culture (or otherwise) in which the goal is being pursued; this is a very important focus which current efforts in compliance and softer systems like CSR do NOT do, and is a critical differentiator for our ACG approach
  • it has to be run externally to avoid capture by the company’s internal organisation
  • there has to be a mechanism in place to ensure the chairman and the board treat the report with the attention it requires, possibly through a special board committee

Finally, there is a case for giving the industry regulator access to the report.

Benefits of dynamic stakeholder engagement

In summary, there is a clear link between the legal demands on directors spelled out by the UK Companies Act 2006, the Green Paper of 2016/17 and the solutions provided by the ACG approach to corporate governance, with its dynamic engagement with stakeholders.

The benefits to directors of assisting them in this way are that they are informed by a forward-looking, predictive set of tools that equips them to fulfil their fiduciary duty towards the company which employs them, and empowers them to exercise the “duty to exercise independent judgement” (section 173) and “reasonable care, skill and diligence” (section 174) which the Companies Act demands of them.

Additionally, if at some stage disaffected shareholders, or even a liquidator, challenge the directors with not fulfilling their duty under section 172 to promote the success of the company, taking into account the interests of the wider group of stakeholders, they will be able to defend themselves much more easily if they can point to the shareholder engagement channel as evidence that they did their reasonable best to comply with the law. And since the standards expected of directors are tightening all the time, and their indemnity insurers are scrutinising behaviour much more closely before paying claims, adopting the ACG approach can only be in their best interests.

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