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Horrigan, Bryan --- "Directors' Duties: Anglo-Australian Reform of CSR" [2005] ALRCRefJl 22; (2005) 87 Australian Law Reform Commission Reform Journal 17


Reform Issue 87 Summer 2005/06

This article appeared on pages 17 – 21 of the original journal.

Directors’ duties: Anglo-Australian reform of CSR

By Bryan Horrigan *

Australia and the UK are at the forefront of major reviews of the law and policy surrounding corporate social responsibility (CSR).1

Many businesses claim to be profitable, sustainable, and socially responsible. Can they really maximise their performance on all of these dimensions simultaneously, or must increased shareholder value always come at the expense of non-shareholder interests? Moreover, why is there so much public, academic, and business division over CSR’s meaning and legitimacy, let alone its implications for the responsibility of corporate directors?

Current Australian inquiries

The Corporations and Markets Advisory Committee (CAMAC) is investigating whether and how CSR should be regulated in terms of the duties and reporting of directors. CAMAC’s Discussion Paper on this topic was released in November 2005.

Similarly, the federal Parliamentary Joint Committee on Corporations and Financial Services (PJCCFS) is investigating CSR’s impact on directors and ‘triple bottom line’ reporting.

Both Terms of Reference can be interpreted narrowly in terms of focusing only or mainly on links between directors’ duties and stakeholder interests, or more broadly in terms of wider aspects of corporate responsibility in civil society that impact upon (but are not directly reducible to) directors’ duties. As current laws or reviews on protection of employee entitlements, socio-ethical factors in investment product decisions, directors’ annual reporting requirements, and long-tail corporate liabilities all demonstrate, corporate law provides many possible intersections between corporate responsibility and social responsibility.

Both Terms of Reference require a full investigation of the case for and against CSR and its regulatory options. They address that topic ‘head on’ and therefore make it difficult to ‘duck’ fundamental conceptual questions about corporate responsibility generally, or to sit on the fence about CSR in particular. After all, CSR either has a coherent and worthwhile meaning or not, and either it should be supported in the law or not. Among other things, the CAMAC Terms of Reference ask, ‘Should the Corporations Act be revised to clarify the extent to which directors may take into account the interests of specific classes of stakeholders or the broader community when making corporate decisions?’, and ‘Should the Corporations Act be revised to require directors to take into account the interests of specific classes of stakeholders or the broader community when making corporate decisions?’ (emphasis added). Similarly, the PJCCFS Terms of Reference inquire into ‘the extent to which organisational decision makers should have regard for the interests of stakeholders other than shareholders, and the broader community’, and also ask ‘(w)hether revisions to the legal framework, particularly to the Corporations Act, are required to enable or encourage incorporated entities or directors to have regard for the interests of stakeholders other than shareholders, and the broader community’ (emphasis added).

Nobody needs to subscribe to CSR to think that directors can and should consider non-shareholder interests when the interests of the shareholders require it. Similarly, a company can subscribe to socially responsible business practices consistently with the directors’ responsibilities to the company without subscribing to the full gamut of CSR options as part of their core corporate responsibilities. The relationship between stakeholder interests and decision making by directors can take different forms, only one of which might be a direct legal duty owed by directors to stakeholders including shareholders. The overriding problem in requiring directors to run companies in the interests of all stakeholders lies not only in allowing directors ‘to play poker with someone else’s money’, but also in the inability of stakeholder theory so far to explain satisfactorily ‘how conflicts between different stakeholders are to be resolved’.2

A coherent approach to policy making, law making, regulation, and business practice concerning CSR presupposes an underlying conceptual framework for corporate responsibility. That framework inevitably must be cross-disciplinary and multi-dimensional. It requires attention to the status and legitimacy of corporations, and their relationship to civil society, from a range of political, legal, and other standpoints. Indeed, it might take a distinct and cross-disciplinary body of business theory about the place of corporations in civil society to address such questions about corporate responsibility fully.3

We therefore need to decide the relationship between corporate responsibility and social responsibility before we can decide what that means for decision making by corporate directors and managers. Anything less risks putting the cart before the horse. The relationship of corporations with civil society drives conclusions about their legitimacy and responsibility. Answers about the legitimacy and responsibility of corporations then drive conclusions about what best serves the interests of corporations. Answers about what best serves the interests of corporations then drive conclusions about what corporate directors can and must do in fulfilling their duties and obligations to corporations.

Many of the more than 100 public submissions to the PJCCFS inquiry are predictable in their bottom lines. Those who identify more with a shareholder-focused view of business caution against radical changes to the current law. Conversely, those who identify more with social justice emphasise stakeholder-sensitive corporate responsibility. Nor is the current corporate law neutral in its underlying ideology. According to two leading international corporate law experts, ‘the recent dominance of a shareholder-centred ideology of corporate law among the business, government, and legal elites in key commercial jurisdictions’ means that ‘(t)here is no longer any serious competitor to the view that corporate law should principally strive to increase long-term shareholder value’, with consequences for reform of corporate governance and corporate law.4 Even viewed as a normative claim and not just as a descriptive statement, that conclusion still turns on what is really involved in producing ‘long-term shareholder value’. All of this affects how those conducting these inquiries frame them and their outcomes.

Australian and UK inquiries and models

The PJCCFS inquiry includes assessing ‘whether regulatory, legislative, or other policy approaches in other countries could be adopted or adapted for Australia’. Recent UK proposals to incorporate the notion of ‘enlightened shareholder value’ in the law regulating directors’ duties offer an immediate model for comparison. The UK Company Law Reform Bill 2005 proposes law reform in the following terms:

‘Duty to promote the success of the company

(1) 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.

(2) Where or to the extent that the purposes of the company consist of or include purposes other than the benefit of its members, his duty is to act in the way he considers, in good faith, would be most likely to achieve those purposes.

(3) In fulfilling the duty imposed by this section a director must (so far as reasonably practicable) have regard 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.

(4) The duty imposed by this section has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company.’

Note the following features of this UK model. It rests on a particular view of the relationship between shareholders, other stakeholders, and corporate responsibility. It completely identifies ‘the success of the company’ with ‘the benefit of its members as a whole’, in a way that conflates those two things to the exclusion of other aspects of the relation between corporate responsibility and civil society. It retains shareholder primacy, and all of its stakeholder-inclusive elements must be read subject to that overriding norm. It compels directors to consider particular non-shareholder interests where necessary, as distinct from merely clarifying that they are entitled to do so, but it does not illuminate anything about when and how this might be ‘reasonably practicable’. In other words, it is directed at requirements to consider interests but not the process for considering them or any outcomes. An obligation to take non-shareholder interests into account in corporate decision making falls way short of an obligation to protect or give effect to those interests. Stripped of its mandatory commands, it contains elements of what directors are probably entitled to do already under Australian law, in terms of being entitled to consider non-shareholder interests where necessary to meet their corporate obligations. It presumes but makes no contribution towards measures for assessing and deciding between different shareholder and non-shareholder interests. Many of these features are problematic.5 It is no answer here to say that such changes in the law could be supplemented and worked out by other forms of regulatory guidance, without building that connection more forcefully into the legislative framework.

Democratic responsibility of public officials in policy and law reform

These CSR inquiries also raise a fundamental point about their wider democratic responsibility. What are Australians entitled to expect from these inquiries, given that their outcomes go to fundamental questions about corporate responsibility in civil society and possible redirections of course in corporate regulation? Here, I can only suggest the possibility of a conception of the policy process within a constitutional democracy whose government is answerable to the people that shape how this democratic responsibility is approached.

The best outcome for Australian society lies in these inquiries producing material that fully and transparently canvasses, informs, and opens up all necessary dimensions of the public debate about corporate responsibility reform, to facilitate the best possible public discussion of which way corporate law and practice should now turn. Doing so enables the people to have sufficient material to respond properly to the outcomes of each inquiry in the next stages of the policy-making and law-reforming process. In turn, this enhances the people’s engagement with government in those avenues for it under our system. It also amounts to discharging responsibly the formal task assigned to each inquiry by those who represent the people. This is better than foreclosing debate through an unduly narrow interpretation of the Terms of Reference, giving a less than full account of CSR debates and options, or unjustifiably limiting the scope of these inquiries.

While the absence of any evidence of an impediment to corporate consideration of stakeholder interests under existing law is relevant, for example, it is not determinative and cannot alone justify deciding that no further inquiry or reform is needed. That evidence itself needs contextualising, especially from the perspective that it emerges from a pre-existing business and regulatory culture embodying a particular conception of the shareholder primacy norm. Rightly or wrongly, that conception marginalises stakeholder interests, or subjugates them completely to shareholder interests.

Reframing thinking about shareholder/ stakeholder interests

We need to transcend the unproductive focus in much public debate about shareholder and stakeholder interests trumping one another in a zero-sum way. Clearly, a business is not a charity, a business has responsibility to its owners as well as others, a business needs to make money to survive, and the directors of a business corporation cannot have a blank cheque to sacrifice shareholder interests to non-shareholder interests. However, all of that is the start and not the end of a full account of corporate responsibility. Moreover, acting primarily in the interests of shareholders without regard to, or even at the expense of, the interests of other stakeholders, including those who might have contributed something directly to the prosperity of the corporation (such as employees, creditors, and people using the corporation’s products), must be justified within a coherent conceptual and regulatory framework of corporate relationships and the responsible exercise of corporate power.

‘Few trends could so thoroughly undermine the very foundation of our free society as the acceptance by corporate officials of a social responsibility other than to make as much money for their stockholders as possible’, argued Milton Friedman more than 40 years ago in his landmark book, Capitalism and Freedom.6 Nothing in Friedman’s statement means that corporations and their directors can pursue that objective with absolute freedom, unhindered by any legal, ethical, or other constraints. Admittedly, Friedman himself originally conceived of boundaries on profit making narrowly rather than broadly, in terms of how a corporation ‘stays within the rules of the game, which is to say, engages in open competition, without deception or fraud’,7 and not in terms of broader stakeholder-focused concerns grounded in the place of corporations in civil society. Friedman’s later formulation of his grand claim in his landmark 1970 New York Times Magazine article on this topic expressly contemplated constraints upon business grounded both in law and business ethics, in terms of a corporate executive’s responsibility to the corporation’s owners ‘to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom’.8 By 2005, Friedman was arguing that his statement that ‘the social responsibility of business [is] to increase its profits’ is equivalent to the statement that ‘the enlightened corporation should try to create value for all of its constituencies’ (original emphasis).9 All of this shows that the issue of corporate responsibility is complex and not fully captured in one-dimensional clichés about ‘shareholder primacy’ and ‘shareholder value’, at one extreme, or embracing the ‘triple bottom line’, at the other.

Australian law frames a corporate director’s duty as one owed to the company, and not one owed to the shareholders or other stakeholders directly. One problem is that shareholders and stakeholders can have conflicting or even incommensurable interests. So, expecting directors to serve both shareholder and non-shareholder interest is problematic, at least in terms of legally enforceable duties to both.

Moreover, the mono-dimensional equation of a corporation’s best interests with its shareholders’ interests breaks down if pushed too far. Shareholders do not equate to the company for all purposes, as a duty to the company as a sustainable enterprise over the long term is different from a duty to those current shareholders who want to maximise share prices for short-term trading. Recent cases at the highest Australian level confirm important limitations on the capacity of shareholders to excuse anyone from abusing corporate power, including their inability to ratify what would otherwise be a breach by directors of their statutory duties.

Even from an economic standpoint alone, modern corporate governance appreciates that maximising shareholder value requires multi-dimensional attention and responses to corporate opportunities and risks from a variety of politico-regulatory, socio-economic, and environmental sources in the surrounding business climate. Shareholder and stakeholder interests are therefore relational and interdependent. Corporate law scholarship is still unable to decide conclusively whether these relationships are best viewed in terms of a compact between a company and its members, communitarian views of a company’s social ‘license to operate’, a middle ground between contractarianism and communitarianism,10 an account of corporate decision making within what some call a ‘team production’ model of mediating hierarchies of corporate interests,11 or something else.

What approaches and outcomes are best?

In terms of fulfilling the brief set for the CAMAC and PJCCFS inquiries, my main point is a two-fold one about their democratic responsibility and what kind of conceptual framework of corporate responsibility we need before we can make decisions either way about reform in this area. If the current form of the ‘stakeholder primacy’ orientation of Australian corporate law is right, then it should be possible to justify its largely unaltered continuance in terms of a viable conception of corporate responsibility, which illuminates the complex balance between civil society, corporations, and their shareholders and other stakeholders.

In terms of outcomes, I do not favour drastic changes to current directors’ duties as an immediate first step, even if the current corporate regulatory regime is fundamentally flawed in checking corporate irresponsibility towards non-shareholders. Putting the spotlight just on directors’ duties is too narrow a focus on corporate responsibility. Changing them meaningfully risks introducing too much change too quickly, given the current state of corporate law and both regulatory and business practice based upon it. Other options are in play. Both the business sector and the civic sector have a role in suggesting and developing forms of CSR regulation beyond what the government might legislate into law. As the national and international ground on CSR moves beneath us, a new cooperative regulatory focus by the public, private, and civic sectors is needed from the outset, not least in integrating new CSR initiatives and co-regulatory measures with existing corporate governance reforms. That is one reason why, whatever the outcomes of these inquiries, I favour further amplification of the main Australian Stock Exchange Corporate Governance Council principle concerning stakeholders (that is, Principle 10’s injunction to ‘recognise the legitimate interests of stakeholders’), which still has much work to do in developing stakeholder-focused guidelines for corporate decision makers.

Some corporate law experts suggest that the current law adequately permits directors to consider stakeholder interests where necessary, and that stakeholder-focused concerns are best managed within our evolving corporate governance regime and practice, and not by dramatic changes to the law on directors’ duties.12 Others point to the advantage of enhancing the trend towards CSR reporting and disclosure over any changes to the law that ‘allow or require directors to prioritise non-shareholder interests over the interests of shareholders’.13 Some submissions to the PJCCFS inquiry mention the core concern of enhancing consideration by corporate decision makers of potential adverse consequences of their decisions for various constituencies affected by them, akin to the UK model. I have detailed elsewhere some of the main arguments for and against some reforms, and potential flow-on implications for other areas of corporate law and enforcement, as well as my own preference for a multi-pronged approach attacking this problem on a number of fronts at once, without crippling either business or civil society.14 Certainly, whatever the outcome of these inquiries, much more can be done in finding ways of incorporating CSR concerns within ordinary business, investment, and rating practices and standard-setting.

We are yet to have the kind of open and structured CSR debate we need, including debate about a variety of options and mechanisms for enhancing the connection between corporate responsibility and social responsibility. Hopefully, these inquiries will produce material for public discussion to infuse that debate richly.

* Professor Bryan Horrigan is the Associate Dean (Research), Division of Law, Macquarie University; Visiting Scholar, Wharton Business School, University of Pennsylvania; and a consultant with Allens Arthur Robinson.

Endnotes

1. This article uses and expands upon ideas in B Horrigan ‘Cleaning Up Their Act?: Current Government Inquiries’ (2005) 70 Precedent 10; and B Horrigan, ‘Comparative Corporate Governance Developments—Key Ongoing Challenges from Anglo-American Perspectives’, in S Tully (ed) Research Handbook on Corporate Legal Responsibility (2005).

2. M Jensen, A Theory of the Firm (2000), 2.

3. I am indebted to Eric Orts from the Wharton Business School on these points and ideas about business theory.

4. H Hansmann and R Kraakman, ‘The End of History for Corporate Law’ (2002) 89 Geo LJ 439.

5. On some of these criticisms, see also I Ramsay, ‘Public Show and Tell is the Way to Incentivise Directors and Their Companies to Behave Nicely’ The Age, 21 July 2005; and Mallesons Stephen Jacques, Submission to PJCCFS Inquiry into Corporate Responsibility (2005).

6. M Friedman, Capitalism and Freedom (1962), 133.

7. Ibid.

8. M Friedman, ‘The Social Responsibility of Business is to Increase Its Profits’, New York Times Magazine, 13 September 1970.

9. M Friedman, ‘Making Philanthropy Out of Obscenity’ (2005) 37:5 Reason 32.

10. S Bottomley, ‘From Contractualism to Constitutionalism: A Framework for Corporate Governance’ (1997) SydLRev 17.

11. M Blair and L Stout, ‘A Team Production Theory of Corporate Law’ (1999) 85 Virginia Law Review 247; M Blair and L Stout, ‘Director Accountability and the Mediating Role of the Corporate Board’ (2001) 79 Washington University Law Quarterly 403.

12. J McConvill, ‘Directors’ Duties to Stakeholders: A Reform Proposal Based on Three False Assumptions’ (2005) 18 Australian Journal of Corporate Law 88.

13. I Ramsay, ‘Public Show and Tell is the Way to Incentivise Directors and Their Companies to Behave Nicely’ The Age, 21 July 2005.

14. B Horrigan, ‘Cleaning Up Their Act?: Current Government Inquiries’ (2005) 70 Precedent 10. Corporate Governance Developments—Key Ongoing Challenges from Anglo-American Perspectives’, in S Tully (ed) Research Handbook on Corporate Legal Responsibility (2005).


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