Print
E-MailDavid Kershaw is Professor of Law at London School of Economics and Edmund‐Philipp Schuster is an Associate Professor of corporate law at London School of Economics. This post is based on their recent paper.
In December of 2018 a potentially transformative event occurred within UK corporate law and corporate governance. In the course of its latest revision, the UK Corporate Governance Code has introduced the idea that establishing a “company purpose” is essential for the effective functioning of corporations. This may not, at first glance, seem all too revolutionary—especially to a US corporate lawyer. Within the context of UK law, however, the Code’s new requirement for the board to “establish the company’s purpose, values and strategy and satisfy itself that these and its culture are aligned”, raises a number of foundational questions about companies and the nature of their relationships with shareholders and other stakeholders.
In our paper The Purposive Transformation of the Company Law we try to unpack these questions. We explore the meaning and regulatory implications of the Code’s use of the term “company’s purpose”, which is not defined in the Code itself—a problematic omission given that “company purpose” already has several meanings in UK company law. We argue that “company’s purpose” in the Code must refer to an animated idea of why a company exists; its mission-purpose, such as to revolutionise transportation, organize the world’s information, or to eradicate cash payments. Companies with a clear mission purpose are increasingly presented as essential for a dynamic economy. The Big Innovation Centre’s Purposeful Company Project, for example, argues that “purpose is key to corporate and economic success” and estimates losses to the UK economy of not taking purpose seriously to be in the region of £100 billion a year. Moreover, such purposeful companies are also thought to be a means of generating wealth through a more inclusive form of capitalism, as a purposeful focus drives a reordering of corporate priorities, away from the immediate and ever-present priority for shareholders characterising UK company law, and (variably) towards employees, customers, suppliers and other stakeholders. This notion of purpose is aligned not only with modern management theory and corporate think-tank policy papers, but also with the pronouncement of some of the most important members of the investment community. The CEO of Blackrock, one of the world’s largest fund management companies, recently observed, for example, that “without a sense of purpose, no company either public or private can achieve its full potential”. As such, although aspirational, the idea is relatively uncontroversial. Its adoption by the UK’s Governance Code reflects this purposive consensus. From a legal and regulatory perspective, however, purpose portends controversy in UK corporate law and regulation; its formal recognition in the Code may prove to be a Trojan horse with the potential to challenge the UK’s longstanding and, importantly, mandatory shareholder primacy election.
There are two components of this challenge to the legal and regulatory status quo which the paper explores. First, UK company law’s default instruction to directors in section 172(1) of the UK Companies Act is to always prioritize shareholder interests, whereas a meaningful mission-purpose orientation, where purpose comes first, will invariably lead to at least an occasional demotion of shareholder interests. On the face of it, the two concepts are clearly incompatible: an ever-present duty for honest directors to prioritise shareholder interests compromises a commitment to purpose. But the paper takes the exploration of this problem a step further. It asks whether it is possible, consistent with section 172(1), to re-fashion a matrix of stakeholder interests which demotes shareholder interests through a “reject money to make money purpose” or through re-characterising the nature of shareholders’ interests when the company benefits from purposeful shareholders who affirm the company’s purposeful focus. As both these workarounds are found wanting, the paper then explores the opt-out provided by UK company law (through section 172(2) of the Companies Act 2006) to redefine the company’s interests in a non-shareholder focused way. However, given the stickiness of defaults and the perception that this option was made available only for non-commercial companies, the paper concludes it is unlikely, without legislative intervention, to be used in practice. Accordingly, the first reason that the Corporate Governance Code’s purposeful instruction is a regulatory Trojan horse is that to enable the commitment to purpose the Code calls for, and for it to be more than window dressing, requires legal reform to nudge companies to consider redesigning their matrix of stakeholder interests
The second component of the challenge to UK corporate law and regulation that the adoption of purpose poses relates to what the paper calls the legal ecology of purposeful companies. Purposeful companies require a purposive ecology, without which firms are incapable of internally and externally making credible commitments to their mission purpose, thus rendering corporate purpose an empty marketing slogan in practice. There are different ways in which such a purposeful ecology can be provided. Perhaps the simplest route to creating such an ecology is the presence of a purposeful controlling shareholder. However, in the absence of such shareholders, the paper argues, the ecology of a purposeful company must provide managers with a zone of insulation from immediate shareholder pressures which can compromise purpose. Such a zone of insulation can be provided by non-legal means, such as the status and perceived importance of senior management. But in the absence of non-legal forms of insulation, corporate law matters and it can either cradle and fertilise, or undermine and destroy, purposive aspiration. A central problem for establishing purposeful companies in the UK, however, is that the UK’s legal ecology supports and fosters shareholder value pressures and, accordingly, is likely in practice to override, undermine and inhibit any meaningful commitment to company purpose. Thus, the second reason that the Corporate Governance Code purposeful instruction is a regulatory Trojan horse is that to enable mission-purpose to be taken seriously by companies, it challenges them to creatively explore the ways in which UK corporate law can be legally engineered to provide a purposive legal ecology and, to the extent that it cannot, it challenges the existing legal and regulatory status quo.
Although invariable presented as a shareholder primacy jurisdiction, there is a surprising degree of optionality available within UK company law. The paper shows how in theory UK corporate law’s ostensibly mandatory and pro-shareholder rules can be dismantled and engineered to create a purposive zone of insulation quite at odds with the traditional perception of UK company law. But theory and practice clearly diverge. In practice UK companies do not deploy this latent optionality. Neither investors, from traditional fund managers to hedge funds, nor the experts to whom many funds outsource their governance decisions, have incentives which enable them to carefully assess tailored purposeful governance arrangements, and the risks associated with departing from the ostensible mandatory rules (including the “bad smell problem” and re-characterisation risk) mean that such legal engineering is rarely worth the candle. Accordingly, to provide for a purposive legal ecology, the paper argues that legal change is required to legitimate and enable the use of this latent optionality.
Such changes, however, run up against a wall of theoretical, political and empirical objections. In short, a “zone of insulation” can readily be re-characterized as “a zone of managerial abuse”. The paper engages with these challenges directly. It shows that the theoretical and empirical case for and against rules that create a zone of insulation remains unequivocally equivocal. Such equivocation offers only one logical and sensible conclusion: don’t tell companies what type of legal ecology they have to have, rather enable them to build a legal and regulatory ecology that in their view is adapted to their purposive, or indeed non-purposive, needs. That is, the one lesson we can take, and which the UK needs to learn, from our discipline’s longstanding theoretical and empirical conflict about appropriate governance arrangements is that one size never fits all and so lawmakers should never offer one size. The only credible objection to this philosophy is a familiar one: that optionality will be abused by those who pay attention to the detriment of those who do not. The paper considers these concerns and rejects them. At each stage of the investment process there is little reason to be concerned about this problem anymore; today this concern exists only in the historical imagination of corporate commentators and regulators.
The complete paper is available here.
