Ethical Performance
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the Companies Act and the stakeholder question

June 2001

The UK company law review will publish its final report next month. EP talked to the chairman of the sub-group that considered ways in which the balance of power between shareholders and other stakeholders might be changed

The Labour Party’s manifesto declared that a second-term Companies Act would ‘modernize company law to promote transparency, reduce burdens on small companies and promote long-term economic success.’

A Companies Bill would be based largely on the company law review, which will publish its final report next month. The review will recommend that social and environmental responsibilities be introduced into the law.

This ‘stakeholder question’ was at the centre of the review’s three years of deliberations. The review has concluded that directors should be encouraged – but not required – to take a broader and longer-term view of their responsibilities.

Bristol University’s professor John Parkinson chaired the sub-group considering the stakeholder question. He said there were two elements to the recommendations in this area: restating directors’ duties and reporting requirements.

The review team quickly rejected what it had described as a ‘pluralist’ approach which would have required directors to recognize interests of employees and other stakeholders, even when these conflicted with the interests of shareholders. Instead the team concluded that shareholder interests should continue to predominate, although calling for an ‘inclusive’ approach.

Parkinson explained that the pluralist approach simply would not work in law, for two reasons: the problem of identifying specific stakeholders for the purpose of bringing an action against a company, and of how a court could make a judgement.

‘A pluralist statement of directors’ duties could be no more than declaratory, saying we want directors to weigh the issues and that shareholders’ interests wouldn’t necessarily take precedence,’ the law professor said. ‘A duty of that kind simply can’t be enforced. A court would have to sit in judgement on the way in which the company had made a decision. What criteria could the court use?’

The proposed statement of directors’ duties therefore merely clarifies current law, but stresses that long-term considerations must be taken into account.

Reporting is proposed as the second way of addressing the stakeholder question, and this will introduce considerable changes. Listed companies and large private businesses will be required by law to publish an expanded version of the current operating and financial review (OFR) in their annual reports.

Parkinson believes this should be a powerful influence for change. ‘If companies disclose their record on the environment, that is a kind of discipline. The availability of more information can affect the set of pressures which companies face.’

But the review team decided against mandatory reporting on social and environmental issues, except ‘where these are relevant to an understanding of the performance of the business’.

Parkinson said he was concerned that forcing companies to respond to a checklist of issues would have resulted in empty statements.

‘Requiring disclosure in all cases might just produce meaningless boilerplate reporting. The objective is to ensure meaningful disclosure and encourage transparency’, he explained. ‘Reporting in these areas is at a very early stage of development, so it would not be appropriate to crystallize in law rules which are still developing’.

Critics charge that the proposals have been watered down: the review team decided that these elements of the OFR will not have to be audited. Auditors will review only the process of preparing the OFR.

Parkinson argued that directors must decide what is material for their business, and auditors should not be asked to second-guess those judgements. But auditors should examine whether the board had gone through a meaningful process in preparing the OFR.

Assuming, as is likely, that the review’s proposals are broadly incorporated in a new Companies Act, large private companies and most public companies will have to address social and environmental issues.

If directors do not, they will have to show the auditors – and others such as campaigners and investment analysts who ask the question – that they have thought through all the issues and have proper processes for judging what is material, and what is not.

The review might not have been as radical as some corporate governance activists wanted, but its effect will be that more companies will report in greater detail on their ethical performance.


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