Directors Duties to include Corporate Social Responsibility

Introduction

It is established that the role of directors and officers under the Corporations Act [1] are to discharge their duties and power to act on behalf of shareholders and to run the daily business practices of a company. [2] In other words, they are expected to exercise their duties in the best interests of shareholders and to maximise wealth. However, recent disputes have surfaced as to whether the law needs to be clarified and to require directors’ duties to incorporate responsibilities that go beyond the shareholder interest responsibility. That is, whether the law should require directors to take into account wider responsibilities in regards to stakeholders such as suppliers, customers, environment and the broader community when making decisions. [3]

It has been argued by legal critics that the existing laws should remain unchanged as there is already sufficient flexibility within case law that permits directors and officers to consider the interests of shareholders and other stakeholders when making decisions that are the long-term interests of the company. [4] A legislative amendment to oblige directors to take into account stakeholder interests as part of a statutory duty to the company could have adverse consequences in confusing the primary role of directors, creativity in work practices, and therefore is unfeasible, unnecessary and could have detrimental effect on the decisions made by directors. [5]

Additionally, many non-shareholder activities in regards to suppliers and customers and the community are perceived as a means to further the organisation’s image and prestige. [6] Moreover, the activities of stakeholders are seen as opposing and contrary to the best interests of the corporation, that is, the prime interests of shareholders. [7] However, this is not the case as it can actually improve the company’s overall value and image towards prospective shareholders. [8] Additionally, taking into account stakeholder interests should not be seen as a compliance approach or through a “narrow” lens as one legal commentator proposed but recognising it as part of what is best interest for the company in the long run. [9]

Furthermore, it is suggested by most legal commentators that corporations should take the ‘stakeholder-oriented’ approach to corporate governance. [10] This allows directors to make corporate decisions whilst incorporating stakeholder interests at their own discretion and should ultimately be left to the company and its own integral governance arrangements, as oppose to complying with external regulations. By mandating directors’ duties to take into account stakeholder interests will not necessarily result in promising outcomes, as the requirements in addition to the current legal framework will force directors to take the “tick the box” approach, that is, the only motivation they would have is to conform with the law instead of genuinely care for the interests of stakeholders. [11]

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Current framework on Directors’ Duties: The existing legal framework does not constrain directors from taking into account stakeholder interests when making decisions.

The recent calls for reform to the Corporations Act resulted from the growing belief that directors should have a social awareness and consideration for the wider community and to behave decently by taking into account stakeholder interests. [12] With firms such as Nike having issues in regards to workplace conditions in their many sweatshops in third world countries, they had to swiftly defend themselves against damaging criticisms towards their company from both shareholders and stakeholders (especially customers) as they had failed to meet both ethical and environmental standards in relation to work practices. [13] Additionally, with the decisions made by the controversial company, James Hardie, has proved that these sorts of issues in regards to directors being negligent are slowly changing. Due to James Hardie under-funding its asbestos victims and instead protecting its shareholders and disregarding the overall interests of the victims, caused them to have reputational costs, as well as financial decreases in share prices. [14] As a result of this, James Hardie’s later decision has proved to be a beneficial one to the survival of the company by recognising the interests of its stakeholders (the asbestos victims) in joining up with the NSW Government and the ACTU, which in turn have boosted the company’s share price and overall financial stability. [15] This therefore has benefited the overall best interests of the company and its shareholders. As a result of the James Hardie’s crisis as well as the Nike Company crisis in conjunction with current laws to corporate governance has deterred companies from excluding stakeholder interests and instead they are encouraged to foster relationships with stakeholders and taking on the belief that they are also an important factor in having efficient performance.

As stated above, companies already have sufficient laws that guard them in regards to stakeholders when making corporate decisions. In particular, listed companies in Australia are required to conform with the Australian Stock Exchange (ASX) Corporate Governance Principles and Recommendations, which requires companies and directors to disclose and produce an annual report of the ways in which they have conformed to the recommendations during a particular period. [16] Additionally, companies are required to have in place on their website outlining ways they would deal with stakeholder interests under a ‘Code of Conduct’ and ‘Ethics’. A Code of Conduct, which involves setting out the values and important policies of the company, can help directors take into account the interests of stakeholders when making decisions as well as to assist in weighing out the company’s risks management practices. [17]

In regards to the 28 Recommendations established by the ASX of ‘Good Corporate Governance Principles’, Principal 10 seems to have the most regard for stakeholders as it dictates that in order to have good corporate governance, companies need to “recognise the legitimate interests of stakeholders”. [18] It further suggests that directors also have the duty to establish ‘tone and standards’ for the company and also keeping adequate watch on these standards. [19]

Not only do listed companies in Australia has to conform with corporate governance standards, but non-listed companies such as government departments and not-for-profit organisations, under Standards Australia are required to develop effective corporate governance procedures. [20] In 2003, the Australian Standard created a non-rigid guidance called the ‘AS 8003’, which sets out the elements guided to implementing and achieving effective Corporate Social Responsibility. [21] The purpose of the standard is for companies to maintain a culture of corporate social responsibility through having a self-regulatory approach that can be monitored and assessed within the company. [22] Additionally, in order for companies to meet legal obligations, Standards Australia has also developed other standards to assist companies in implementing an effective corporate governance in regards to risk management, Occupational Health and Safety (OH&S), and environmental management just to name a few. [23]

Furthermore, in conjunction with the standards and regulations discussed above, there are other regulations in regards to corporate governance, which requires directors to show a social conscience, in regards to stakeholder interests. [24] Under Section 181 of the Corporations Act outlines the duties of directors to act in the best interests of the corporation. [25] According to Section 180, clause 1 of the Corporations Act states “that a director or other officer of the corporation must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise they were a director of a corporation in the corporation’s circumstances.” [26] Additionally, under Section 181; “a director or other officer of the corporation must exercise their powers and discharge their duties in good faith in the best interests of the corporation and for a proper purpose.” [27]

In regards to director’s fiduciary duties with the corporation, companies are also required to obey with other range of Commonwealth, State and Territory laws in regards to health and safety, anti-discrimination laws, industrial relations, equal opportunity and environmental impact laws. [28] In particular, environmental impact laws such as the Environment Protection and Biodiversity Conservation Act [29] , which provides a framework to protect and manage matters of national environmental significance. [30] Additionally, in 2009, a company Rocky Lamattina and Sons Pty Ltd were fined $220,000 for clearing trees that were likely nesting habitat for the endangered south-eastern red-tailed black cockatoo. It was held by Justice Mansfield: “…it was appropriate to fix an amount that would have a strong deterrent effect and demonstrate that such conduct was seriously regarded by the community and would not be tolerated by the court.” [31] Therefore, in carrying out their duties, directors’ should do so with care, skill and diligence, as it is vital to act in the interests of the company as a whole as well as reflecting the wider community expectations, in particular, paying more attention to the environment to the ways in which it is utilised and maintained as this is an integral part of the company in the long-term growth and sustainability, especially if the environment is part of the survival of a company. [32]

Moreover, Ian Ramsay, in his article Directors’ Duties and Stakeholder Interests, has articulated that ‘Australian courts have done enough to adopt the law where appropriate, in particular increasing the standard of care and diligence … and that the existing laws already allows directors to consider stakeholders, not just shareholders’. [33] He then shifts the focus by depicting:

“A fundamentally important issue is how directors balance the interests of various stakeholders in the company and the role of the law in this process ….” [34]

In summary, with both the current statutory obligations and industry standards in place that encourages directors to have regard for stakeholder interests as well as shareholders, there is no need for a reform to the Corporations Act in order to formally oblige directors to take into account stakeholder interests, because as previously discussed, corporate decision makers are not constrained by existing legal framework. [35] The law does not hinder the abilities of companies from considering the interests of various stakeholders as directors’ views are now slowly shifting towards building relationships. These sorts of initiatives may possibly bring better business performance and higher returns for shareholders. [36]

Over-regulating could damage the objective of ‘Best interests of the corporation’.

In further discussing whether the Corporations Act should be clarified and revised to require directors to uphold the interests of specific classes of stakeholders when making corporate decisions, it is vital to discuss the main objective of a company, which is to act in the best interests of the corporation, in other words, its shareholders. [37] As their duty is to act in interests of the company, directors must consider both existing and future shareholders; this requires them to maintain both the short-term and long-term growth and corporate governance of the company. As Ford, Austin and Ramsay noted: “Although there may be no direct obligations in company law on directors to take extraneous interests into account, it does not follow that directors cannot choose to do so … Management … may be justifiably concerned to ensure that the company is a good corporate citizen” [38]

In the discussion by Australian Banker’s Association (ABA), they articulated that directors should make decisions in good faith and for the proper purpose that benefits the community, consumers and environment. [39] It is noted in the report that where there is a lack of attention paid to the shareholders of a company, this could be considered as breach of the duties to the Board of the company. However, where the interests of stakeholders are defective, this would be considered not to be acting in good faith and the best interests of the corporation, thus it could expose the company to risks and drastic consequences. [40]

Recognising the significance of stakeholder interests and communicating it towards the employees and shareholders will ultimately benefit the company in the long run as well as improving corporate image and growth. [41] This notion is supported by Rick Sarre in his article, Responding to Corporate Collapses: Is there a role for Corporate Social Responsibility? Where he claims:

“There are some critics who say that business involvement in the community-social matters detracts from the main aim of creating shareholder value. I think the opposite – I believe that it builds shareholder value … It has [business] acquired greater responsibilities as a result of being given greater freedom…” [42]

Additionally, in the article by James McConvill, he contends that companies should not approach stakeholder responsibility through a “narrow lens” that is, it should not be seen as an ‘end’ but acknowledging their interests as part of what is best for the company, both in the short-term as well as long-term corporate sustainability. [43]

“Not only will the shareholders and other investors benefit, but the company will continue to offer jobs to employees and serve the community in various ways.” [44]

Moreover, it is argued by the ABA in the CAMAC discussion paper by amending the Corporations Act [45] to contain a provision to mandate a directors’ duty to consider stakeholders may stifle the way in which business decisions are made and lead to inefficient decisions, this could have detrimental effect on both shareholders and stakeholders, thus, impacts on the overall duty of directors to act in the best interests of the corporation and ultimately, shareholders. [46] As further pointed out by the ABA, the Corporations Act, specifically under Section 181(1) covers enough to authorize directors to take into account shareholder interests and other stakeholders, and conveys enough instructions for a director to act in good faith and in the best interests of the corporation and for the proper purposes. [47] This further supports the argument that company law already allows for directors to have regard for stakeholder interests. Therefore, by amending the Corporations Act to further oblige directors will unlikely change the corporate behaviour of directors to consider the interests of stakeholders. [48]

In addition, by conforming to legal requirements to take stakeholder interests into consideration when making decisions would create risks on the decisions made by the Board as the company may be intervened by the interests of subsidiary groups which do not correspond with the overall best interests of the corporation. [49] Additionally, in the quest to satisfy legal requirements, directors may become distracted by court proceedings and other legal actions in order to conform with the laws that in turn there could be a shift in focus of the Board of directors and management, which could result in not fulfilling their duties and responsibility of acting in the best interests of the shareholders. [50] As a result, this could have detrimental effect on both the shareholders and the broad stakeholders.

“To require directors to sacrifice their primary obligations would be to further stifle the entrepreneurial spirit that is seriously in danger of being extinguished as a result of over-regulation.” [51]

To further elaborate on the argument above, with the implementation of a mandatory provision requiring directors to consider stakeholder interests would most likely to turn companies in taking a compliance system to corporate social responsibility, that is, a ‘tick the box’ approach, which does not follow the concept of corporate social responsibility. [52]

Self-regulation and Imposed Law

Companies are slowly deterred from excluding stakeholder interests and are now moving towards building relationships and upholding stakeholder interests when making corporate decisions. [53] This proves that directors will gradually engage with stakeholders without rigorous imposition of laws. It has been argued by many legal critics, that these requirements and regulations should be dealt with solely by the company. [54]

As stated in the Corporations Act, a director is to act in good faith and the best interests of the corporation, therefore, it is in their authority and a matter for the Board to decide, when, and what stakeholders should be taken into account. They should have the flexibility and ability to make decisions and balance competing interests in good time. [55] As previously discussed above, the issue with James Hardie, and their subsequent decision to take into account asbestos victims was not done on the imposition of law but was at their own discretion in wanting to further stabilise their company. As articulated by the Senate Standing Committee as to whether a mandatory provision is necessary in regards to directors’ duties:

“If company law were to impose new and, at times, contradictory duties … directors’ fiduciary duties could be weakened, perhaps to the point where they would be essentially meaningless.” [56]

Additionally, better outcomes would result if companies were given the flexibility to implement stakeholder oriented approach as a central part of their decision making process instead of replacing it with a mandatory provision under imposed law. [57] Moreover, by implementing the mandatory provision forcing directors’ to comply would have adverse results, that is, directors would not appreciate stakeholder interests and would only comply with the regulations due to the consequences of sanctions and threats. [58] Therefore, it is suggested that forming a corporate culture, which involves stakeholder oriented approach, and incorporating the company’s long term object would encourage directors and employees to uphold stakeholder interests. [59] This would have a better result on the performance of the company rather than complying with imposed laws. Moreover, companies should create statements of vision and strategy that would encourage directors to achieve the objective to improve the company’s image and growth. [60]

Moreover, instead of prescribed regulations, companies should implement ‘norms of best practice’ that would involve all the key players of the organisation; the Board, and executives. [61] This supports the notion that it is unnecessary for formal rules as the company, at its own discretion, can create and achieve its own ‘self-regulatory objectives’. [62] As noted in the Cooney Committee “Self-regulation, if it works, in many aspects is better than regulation imposed by law.” [63]

An example of an industry that develops its own ‘stakeholder oriented approach’ is the Banking industry. [64] The banking industry develops programs as a way to engage with its stakeholders and making it part of their corporate social responsibility. Some of their day-to-day programs in engaging with the broad stakeholders include customer research; this is to help them understand the needs and wants of customers. Additionally, they also have employee consultations as well as stakeholder forums to manage and meet concerns and expectations. [65] Other programs include community service principles such as financial literacy and taking part in philanthropic activities (i.e. sponsoring cultural events). In particular, St George’s Bank employs a section on its website catering to customer service called ‘Customer relations/complaint handling’, which allows customers to freely voice their opinions or concerns directly to the bank, either via phone or internet. [66] Additionally, they also developed under the Australian Banker’s Association a Code of Banking, which guides its employees on ways to improve banker/customer relationship in committing to particular standards developed by the bank. [67] Thus, St George Bank does employ CSR regulations within its day-to-day business practices which regulate the relationship between its stakeholders and the company and therefore, does not require the imposition of laws to restrict its day-to-day practices on how it should consider stakeholders.

Conclusion

Overall, due to the existing legal framework in Australia, as outlined in the Corporations Act as well as the ASX Listing rules; these have shown to be sufficiently effective enough in detailing the overriding duties of directors to take into account stakeholder interests. [68] Additionally, by not excluding the interests of stakeholder in the overall best interests of the corporation could benefit the company in both short-term and long-term sustainability and profitability. By building healthy relationships and developing corporate strategies without imposition of laws would allow directors to freely act instead of taking the ‘tick the box’ approach. [69] Thus, a rigorous law would only have adverse consequences by decreasing directors’ abilities to make efficient decisions for the best interests of the corporation. [70] For the reasons outlined above, the Corporations Act should not be revised or clarified to add another provision as it would only stifle the originality of companies in making decisions and balancing the interests of stakeholders. [71]