Enlightened Shareholder Value - Essay Example

?Advanced Company Law Module Module Number: Academic Year: Seminar Essay Question: The enlightened shareholder value principle is a sophisticated restatement rather than a refutation of the principle of shareholder primacy. Student Number: Question # 1: Enlightened Shareholder Value Introduction Enlightened shareholder value is an important aspect of English Company Act 2006. The determination of the goals of a big traded company brings to fore two main concepts that are applicable in various commonwealth jurisdictions: the ides of the value of the shareholders, and the value for the stakeholders. The concept of shareholder value holds that company directors must tailor their policies to be in line with the interests of the shareholders of the company1. Directors are therefore expected to steer the operations of the company with the maximization of the shareholder’s interests as the main priority. The United Kingdom established the Company Law Review Steering Group (CLRSG) in late 1990s and mandated it to come up with a detailed review of English company law. At the end of its exercise, the CLRSG noted that the country’s legal system, like other Western jurisdictions, prefers shareholder value. The CLRSG indicated that the current legal system reflects the reality that business organizations are run in such a way that the shareholders often benefit. That is, the legal system confers upon shareholders absolute powers in the management of the local companies, such that the mandate of the directors is basically to exercise delegated power. Additionally, the CLRSG stated that the crucial goal of business organizations is to create maximum gains for the investors in the short term as opposed to long-term goals2. This paper examines the argument that the enlightened shareholder value principle is a sophisticated restatement rather than a refutation of the principle of shareholder primacy. Various English statutory provisions and case laws will also be analysed to establish the facts surrounding the primacy of shareholders. Shareholder Primacy English company law has consistently developed since 1850s. Whereas several alterations have been done to the body of law, the larger part of the primary legal structure and a number of the provisions established in the Companies Act 1862 remain in place to date. This is especially true even after the latest repeals to the body of law as envisaged in the Companies Act 2006. It is arguable that, unlike the largely fair structures of company law, English case law has consistently reaffirmed the primacy of shareholders. The courts have traditionally held that any public business organization should be managed to the advantage of the membership or shareholders3. However, the CLRSG has recommended a change of tack. To this end, the reviewing body supported the implementation of the principle of enlightened shareholder value (ESV)4. Section 172(1) of the Companies Act 2006 mainly captures the provision for the ESV. The provision reaffirms the management of every company should be done with respect to the interests of the shareholders. The section basically upholds the principle of shareholder value, but limits the formerly absolute benefits of the group by introducing the rule and the need for due respect for the interests of other stakeholders5. This is arguably a proposal for a new doctrine in the English law, in the sense that section 172(1) conditionally supports the primacy of the interests of the shareholder. The requirement, which could be interpreted as the enlightened aspect of the shareholder value, underscores the doctrine of due attention to the value of non-share-holders as well. The latest law has brought about far-reaching legal implications in the understanding of the provision. Responses to the new clause among legal opinions may be divided into two categories: supporters and detractors of the enlightened shareholder value rule. It can be argued that section 172(1) is actually a modest but well thought-out principle that will balance the interests of various parties to a company. However, the eventual enforcement of stakeholder theory, which considers the appropriate management of a company as that which factors in the interest of all relevant parties, is far from being realised. The ESV rule could be viewed as too unclear to cushion non-shareholding stakeholders from ceding their due interests. Pitfalls in the Shareholder Primacy Shareholder primacy is widely believed to be a common norm, regardless of the stakeholder approach to company law. The question, however, revolves around whether or not the doctrine is stipulated in statutory law and or prominent in case laws. In the United States, corporate governance regulations tend to favour shareholder value. In England, company executives and directors have adhered to shareholder-first policy. In light of this, the Institute of Directors carried out a study in 1999, which established that many directors understood that they were expected to adopt strategies that would culminate in maximum shareholder gains in the short-term as opposed to sustainable development of the company for long-term growth and the realization of the general interests6. Shareholder primacy can be exercised in their right to vote and install new directors7. Section 303 of the Company’s Act 1985 entitles the shareholders to remove directors from office. Though limited in scope, these rights grant the shareholders the authority to make decisions on critical changes to the governing body of a company, such as amendments to the internal regulations provided for in the articles of association. Conversely, the decision on who should become directors and who quits such positions cannot be easily executed in public corporate bodies with a broad ownership of the shares. In such cases, legal and technical challenges normally overcome the essence of voting rights as an important aspect of ESV. In most cases, the discretion to vote on behalf of the shareholders who have not showed up normally rests with the board chairman. The chairman can exercise this power through proxies, a development that normally witnesses the holders of the office remaining put against the wishes of the shareholders. This is normally the case, spare for closely-held corporate bodies where a shareholders’ influence of the voting patterns (individually) as a way of exercising the enlightened value is almost nil. As to whether shareholders have adequate voting rights to ratify the changes in the way the company is run, they only get the chance to vote on such matters when the relevant the meeting(s) are called by the board. This sense of curtailed shareholder power lends credence to the argument that votes of shareholders is akin to a fake or just ceremoniously created to grace the legality of managerial influence8. Additionally, Section 459 of the Companies Act 1985 confers upon the shareholders, the power to petition against the leadership of a company that is being managed inappropriately and in gross violation of the shareholders’ entitlements. The provision has been invoked severally in dealing with private companies; in which case, a member proves that he or she was entitled to particular legitimate benefits during their association with the company, but which have been unfairly disregarded. However, with public corporate organizations, where parties tend to be members without being assured of any future benefits by directors or key executives, the issue does not arise. To this end, there are isolated cases where shareholders may sue the directors in individual capacity. This is allowed by law, especially against directors who have undertaken fraudulent deals upon a smaller group or a single shareholder. Notably, though, such derivative legal proceedings may be preferred only where the conduct of directors meets the thresholds for a violation of the fiduciary duty and the outcome unfairly affects the minority interests. Interestingly, shareholders normally enjoy exclusive special entitlements, but this is mainly theoretical9. In light of this, in case shareholders begin derivative court case against directors with questionable competence, whose actions are prejudicial to the due interests of the concerned shareholders, any damages and or costs that the legal action may attract will be the burden of the entire organization including the plaintiff-shareholders. Similarly, in case shareholders exercise their rights to dismiss a director whose actions are contrary to the duty of the holder of the office as specified in the Articles, then the whole company will stand to gain. In light of the limited scope of the powers of shareholders in deciding how they want the company managed, it can be argued that enlightened shareholder primacy is not as clear as it should be in written law. Conversely, various examples of case law have supported the concept that enlightened shareholder value exists. Authorities on shareholder primacy The first case law in support of shareholder primacy was evident in the court verdict on Hutton v West Cork Railway Co [1883] 23 CHD 654. In the English case involving company law, the powers of the director to use company finances for his own benefit at the expense of non-shareholders were severely curtailed by court. The court’s decision was influenced by the employees’ interest in the wake of the company's insolvency10. In another related case, Re Halt Garage (1964) Ltd [1982] 3 All ER 1016 involved the reduction of company capital and employee remuneration in the wake of a company placed on receivership. In the ruling, the court ordered the return the money because the pay had a substantial impact on the capital, and that the pay could not be regarded as salary. Unlike the rulings on the first two cases which upheld the enlightened shareholder value, the third case, Regentcrest v. Cohen [2001] 2 BCLC 80 empowers company directors to act in good faith without fear of meddling by court. The court ruled that by enforcing the principle of ‘subjective test,' the directors’ actions was executed in good faith because it stemmed the impending nasty legal battle that could have ensued within the company board11. As such, decisions made by directors whether faulty or otherwise should need to meet the conditions of the bona-fide rule in order to be declared as fit and within the fiduciary responsibility12. In light of the ruling, the English Courts have shown their reluctance to review corporate policies implemented by directors. Lord Wilberforce made it clear in the last case, Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821 that any shareholder and or other stakeholders should refrain from using the courts as a platform for reviewing managerial policies. The judge added that it would be grossly unfair if courts of law assumed the responsibility of supervising boards of directors over bona-fide managerial decisions aimed at advancing business goals13. Case study # 2 Generally, company directors are debarred from realizing gains where their individual interests and their fiduciary responsibility conflict14. By Han’s retaining his position as director in Jedi Tea Ltd and his shareholding in Star Choccies Ltd, his conduct qualifies as one that is embroiled in major conflict of interest. This is especially true considering his abuse of a director’s office by ordering for chocolate supplies from his family-owned company at inflated prices. The roles and responsibilities of directors regarding conflicts of interest place them above reproach15. In light of this, Luke and Chewbacca are likely to point out in court that Han has failed to rein in his conflict of interest as a director of Jedi Tea Ltd by: compromising his fiduciary responsibility; making a personal gain by virtue of being a director of Jedi Tea, and; appropriating for himself gains through diversionary means to another company in which his wife and himself own substantial shares. Han has allotted Star Choccies the supplier contract to impair business goals which Jedi Tea Ltd is vigorously pursuing in its new expansion program. In this case, Han’s conflict of interest occurs because of his: failing to reveal interests in the supply contracts with Star Choccies Ltd. Han’s co-directors may argue that by virtue of his position, he could have already shared confidential company information with his wife-managed Star Choccies Ltd. As such the two directors may argue that he has benefited unfairly in two ways: a) from the business opportunities that such confidential information brought about; b) as the main architect of inflated costs of supplies above the market rates. Conversely, Han could argue that Luke and Chewbacca did not follow the due process of the law in relieving him of his fiduciary duties and entitlements as director. Han may cite the lack of any agreement among the three directors, and the missing link of the shareholder primacy in his removal from the office. Moreover, his co-directors’ eventual denial of his dividends is also in breach of the rules regulating the activities of a limited company, which entitles shareholders to the amount of gains limited to the percentage of their investment. Han may use the concept of a limited company as defence against his association with Star Choccies Ltd. He could then argue that Star Choccies is a separate legal body whose management, operations and liability does not involve its members, shareholders, directors, and promoters among other stakeholders. In light of this argument, the contract for the supply of chocolates between the two limited companies was executed at the company level16. The possible use of limited liability by Han as defence may be derived from the ruling on the Salomon v Salomon & Company Ltd [1897] AC 2 case. The verdict of the House of Lords held that in most companies where the membership enjoys limited liability, they cannot be held personally accountable for the debts incurred by the company. Under the principle of Limited liability the proprietors of a company are not liable for the undertakings of the separate legal entity17. The only exception is that the shareholders are answerable for the value of their unremitted entitlements as opposed to any other duties to the company18: therefore, Han’s case in not an exception. He could argue that his family ties and shareholder entitlements in Star Choccies Ltd have no basis in law. Possible Court verdict Possible rulings on the case could be as follows: firstly, as to whether Han acted inappropriately as a director of Jedi Tea Limited in his engagement in the activities of Star Choccies Ltd, the court is likely to establish that Han indeed failed the fiduciary test set out in Section 29 of the Companies Act 199019. The provision requires company directors to obtaining the approval their dealings from the other shareholders. Secondly, as to whether a conflict of interest exists in Han’s dealings with another company where his wife is a director and he owns reasonable shares amounting to 30%, his conduct is likely to be established as tantamount to a conflict of interest as spelt out in the provision. This is especially true because he retains his role as director of Jedi Tea Limited and retains the inflated returns on goods supplied in a milieu of conflict of interest. Luke and Chewbacca are also likely to be found to have acted in breach of Section 186 and 187 of the Companies Act 1963 by arbitrarily increasing the salaries of the directors20. They also denied Mr Han his due payments upon his ouster from office. Possible Reliefs The court is likely to suggest that even though Mr Han has breached the fiduciary role by failing to reveal his associations with another company in kind, Luke and Chewbacca acted unfairly in Mr Han’s dismissal and subsequent denial of his due shares in Jedi Tea Ltd. As a result, the court could order a rescission of the contract for the supply of chocolates by Star Choccies; order that Han be paid his dues by Jedi Tea; and reinstated as director-shareholder of Jedi Tea. Han could also be ordered to settle the damages arising from the inflated costs of the chocolate supplies incurred by Jedi. Generally, one mistake of a director may lead to other breaches of the company law, hence the need to be vigilant in handling legal complications in a company. Bibliography Ashraf, Tahir, ‘Directors' duties with a particular focus on the Companies Act 2006’ [2012] 54 IJLM125-140. Benson et al, ‘Deviations from Expected Stakeholder Management, Firm Value, and Corporate Governance’ [2011] 40 FM 39-81. Benson, Bradley W., and Davidson, Wallace N., ‘The Relation between Stakeholder Management, Firm Value, and CEO Compensation: A Test of Enlightened Value Maximization’ [2010] 39 FM 929-996. 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