A Public Limited Company

Introduction

A public limited company is a popular business model for many corporate governance reasons. Corporate governance can be defined as ‘the system of laws, rules and factors that control operations of a company.’ This essay will address these points and show the issues over ownership and control which interested parties in a business face and possible remedies.

The corporate governance debate originated from a series of serious business failures due to fraud in the late 1980’s to early 1990’s such as that of Blue Arrow, Polly Peck and Coloroll (similar cases to the infamous Enron in the USA). In these cases directors had too much power and were able to abuse it. Shareholders, as the primary source of investment need to be able to exercise their control, however can they in reality?

The Fabian Society argues that although companies are dominant over society, they are ‘largely untrammelled by effective public regulation or accountability,’ and even say that ‘intervention is unfashionable.’

It could be argued that the regulatory problems began when Margaret Thatcher followed the free market forces theory of Friedrich Hayek and allowed companies to effectively regulate themselves. This Conservative government believed in a laissez fair approach to intervention and so leaving the shareholders at risk of director dominance. The Labour government then introduced a white paper to develop a better regulatory system of corporate governance, manifesting into the Companies Act 2006, which still leaves much to be desired. This is because it is largely a consolidation of the existing rules, hence why previous case law may still be relevant, meaning very little change was actually brought about.

The issues to cover will be split into three areas of study; shareholders, directors and the combined code.

Shareholders

Shareholders are members of the company and are interested in returns on their investments. The articles of association contains their rights and powers over the company, expressed through general meetings (of which there must be at least one a year) and through the passing of resolutions. Although delegation to directors is important in order to assist in the everyday running of the business, not all things can since assent may be necessary, such as with s.190. This makes the assistance of shareholders resolutions vital. However, Morse asks if whether expression through resolutions actually means they have control over the board of directors or ‘are they just a rubber stamp?’ Enforcing this argument is the fact that many shareholders fail to attend the meetings and the shares are in fact in ‘dead hands.’ Morse suggests this is because many company issues are complex and require expert knowledge which the directors may have but the ordinary shareholder doesn’t.

Also, many investors hold shares through an intermediary and so do not have a direct relationship with the company. Allowing a person to engage with the company despite having no direct link would be too difficult and costly to implement, but must be done if corporate governance over the area is to be fair and effective. To enable shareholders to have more control over their investments, information needs to be made more accessible; something the combined code (which will be looked at shortly) encourages.

Hannigan points out the further issue of the shareholders lack of unity and their disparity giving them very little influence over directors. In other words, ‘ownership of the company has become divorced from its control.’ Technically the purchase of shares should divide the risk of investment but in reality, although shareholders can contribute to the management of the company, much is delegated to directors.

To benefit shareholders, decisions can be made without a resolution or even a meeting so long as there is unanimous consent among the members, appearing to be a fair method of decision making. This is because the courts realise that shareholders don’t always follow the correct formalities, but that doesn’t mean their decisions should be ignored. However this is conditional on there being evidence of a full and proper discussion. Alternatively assent to a decision can, in certain circumstances, be given by the directors, a method which may seem less fair for the shareholders. In fact, taking this further, it has been known for just one member to make a decision; a highly undemocratic and odd allowance.

Shareholder democracy can work but is difficult in large public companies where shareholders have a tiny portion of the total shares and, are unlikely to be very involved in the company as it would take time, effort and money; preferring instead to sit back and allow others to control it for them. If the company is not profitable enough then instead of attempting to exercise their power, many prefer to simply exit. This can impact directors since bailing investors will lower the company value, but overall, the odd shareholder leaving is unlikely to have too great an impact and would have to be on a large scale.

When deciding the voting method at meetings, polls seem the most democratic but, unfortunately, would not be beneficial for minorities and the two majority shareholders always choose the method. A minority shareholder would prefer a show of hands which involves one person one vote, as opposed to a poll which is one share one vote. The chair can pick unless they choose a show of hands, in which case two members can object. This lack of consistency and allowing the most powerful to choose a form which benefits them even further would seem highly undemocratic and leads to a loss of control from the smaller, already disadvantaged, shareholders.

Institutional shareholders can also cause difficulties since they will possess a higher number of shares and so gain the influence that goes with it; leading to long term over short term values being implemented; meaning many of the minority shareholders will be left unheard. Especially, as many are known for their ‘continuing passivity.’

Having said all this, a new feature in English law is the shareholder’s ability to override directors through court action under derivative claims. This was introduced with a view to assisting vulnerable investors.

By following the aggregate theory the shareholder has primary interest and their needs should be followed first. Many of the points covered seem to be against this theory. A view that will be reinforced when looking at directors control.

Directors

The role of directors is to run the company in the interests of its shareholders. However this role is compromised by the lack of accountability they face, and in turn the directors struggle to hold the executives to account. Ensuring they act on behalf of the shareholders and not in their own interests is difficult since the CA06 mentions very little on the subject.

Although the shareholders have some say at annual board meetings, it’s the directors who have more of an impact on the management and control of the business. Morse contends directors own the majority of shareholdings and so they ‘could ratify their own acts and prevent any opposition.’ The only current protection other shareholders have to this is the minimal rights found in cases such as Foss v Harbottle.

However directors aren’t untouchable; they can be removed by ordinary resolution and unlike with private companies, PLCs are governed by the UKLA’s Listing Rules which provide an element of democracy to the directors system. Shareholders can vote with a system of one vote per share to elect the board. Having said this, in practice, the board’s nominees get elected the majority of the time; this leads to the reasoning for a nomination committee required by the combined code. Also if there has been a major loss of capital then directors will be required to hold a general meeting to explain why and they may be held accountable.

Directors must also follow s.172 and ensure they always promote the success of the company, and not their own interests. This wide provision includes protection for those ranging from employees to the environment and community at large.

There is also the reinforcement of shareholder protection found in Quin, which limits the power of a single person by establishing that some transactions need consent from all directors. Gramophone appeared to be able to clarify by saying that ‘the directors are not servants to obey directions given by the shareholders as individuals: they are agents appointed by and bound to serve the shareholders as their principals.’ Shaw however stated that permanent directors cannot be overruled like ordinary directors by shareholder resolution, meaning the directors regain the power. Affirmation that the directors are indeed in control is found in Cuninghame.

It is important to have a mixture of executive and non executive directors in play as they both bring different advantages to the company. Executive directors duties focus on their widespread management powers. Non executives however tend to look at general management strategies and policies, as well as very importantly, scrutinising executives. However, the quest for non executive directors in order to prevent the domination of the executives must focus on quality rather than quantity, since appointing many ‘token’ directors can be somewhat futile.

Another aspect here is that the audit committee, influenced by the Smith Report 2003, must publish their work showing their protection of shareholders interests in the annual accounts and so encouraging companies to prioritise these interests. However, directors still hold power over shareholders in that they can refuse to register a transfer of shares if it is not in the interests of the company or even if the person is simply undesirable.

At the end of the day, decisions must be made quickly and competently by directors. ‘Corporations cannot be run by consensus.’ For this reason, directors need more control, yet safeguards need to be in place and the combined code goes towards achieving the right balance of power.

Combined Code

This all lead to the need for several non governmental committees (and so possibly bias), namely; the Greenbury Committee 1995, the Hampel Committee 1998 and, the one which in many opinions was the most productive, the Cadbury Committee 1992, which enhanced the status of the Combined Code .

The Hampel committee drafted the Combined Code on corporate governance following the Higgs report which focused on the importance of non executive directors. However, it is not binding and so had very little impact until the Cadbury Committee introduced a ‘comply or explain’ approach which led to high cooperation among the FTSE 100 companies.

They also promoted the concept of companies incorporating their own codes. Again, these recommendations are not legally binding, but the London Stock Exchange does require companies annual reports to outline the extent to which they have complied with them. This is more advanced than that of France or the Netherlands which has no such requirement. In fact, the code being voluntary and flexible could be to its advantage since it is ‘more likely to be complied with fully, in spirit as well as letter.’

The theory behind the code was that all companies should have an effective board structure in place, one which is collectively responsible for the running of the company. To achieve this it placed a strong emphasis on the need for everyone to be fully informed through regular meetings. By following the code a business can ensure that they have genuine internal control which will protect shareholders from directors control.

Beyond looking at a director level, it also states the need to keep the roles of chairman and CEO separate. The chairman needs to be completely independent to ensure that all parties with an interest are treated equally and given a voice. Again, its voluntary nature is shown by Marks and Spencer’s flouting of this rule.

Overall, the code places emphasis on ‘integrity, openness and accountability.’ Although it needs development, it is certainly a step in the right direction. Riley suggests the next stage would be to introduce a general duty of good faith into the contractual relationship. If more firms can be encouraged to follow the code then the corporate governance problem will not be so great.

Conclusion

Overall, one of the greatest issues shareholders are faced with is their distance from the everyday running of the company, making it difficult to control management, a problem which appears to have no solution. But, Hannigan states that ‘the current range of matters which require shareholder approval is an appropriate balance.’ However, based on the powers directors have this would seem an odd conclusion. In fact there currently appears, according to Dignam, to be a system of ‘negotiated regulation’ in place. But this has led to not just the ‘inmates running the asylum’ but ‘asking the inmates to design, build and run the asylum.’ In effect, self-regulation.

Monks and Minnow say that ‘the price we all pay for the benefits of the corporate structure is our loss of control.’ Brandeis believes that the government didn’t want this lack of regulation, they merely saw it as ‘futile to insist’ due to the influence foreign companies.

In conclusion the current system of corporate governance does not appear suitable to solve the issues faced in businesses, especially from the aspect of shareholders and their lack of control over the business. Ultimately the ‘corporate standards have not kept pace with corporate power’ and in the words of the Fabian Society, ‘it’s a business world. The company is king.’