{"id":1881,"date":"2018-02-02T08:40:44","date_gmt":"2018-02-02T08:40:44","guid":{"rendered":""},"modified":"2019-08-06T09:31:41","modified_gmt":"2019-08-06T09:31:41","slug":"the-origination-and-development-of-esv-business-law-essay","status":"publish","type":"post","link":"https:\/\/www.lawteacher.net\/free-law-essays\/business-law\/the-origination-and-development-of-esv-business-law-essay.php","title":{"rendered":"The Enlightened Shareholder Value Approach (ESV)"},"content":{"rendered":"

It can be seen obviously from the previous chapter that despite that fact that stakeholder theory requires directors to balance the interests of all stakeholders, the balancing of conflicts interests seems impossible to be achieved as it is a tricky issue. [180<\/a>]<\/span>\u00a0Further, as noted in chapter one, within company law it is difficult to find a strong support for the notion of shareholder primacy. As such, that the two primary theories that establish what should be the proper purpose of corporations suffer from their shortcomings.<\/p>\n

ESV as a new approach of determining for whose interests companies should be run will be assessed in this section. In order to make the evaluation of the ESV approach clearly, there are two issues worth analysing here: the origination and development of ESV and the assessment of the s.172 CA2006.<\/p>\n

3.1 The origination and development of ESV<\/h2>\n

Despite the fact that directors\u2019 duties form one of the central issues in company law, there was no company\u2019s legislation to formally prescribe the role of directors before the CA 2006. Although in common law, the shareholder primacy and stakeholder theories have defined for whom the companies should be run through different views, as proved in previous two chapters they both have numerous strengths and weaknesses in different degrees. Considering that, the UK has develop a \u201cthird way” namely ESV in companies legislation that merges the ingredients of these two theories and requires that companies should run business for long-term benefit and extend their considerations to stakeholder constituencies.\u00a0[181<\/a>]<\/span>\u00a0The ESV approach is based on the notion that long-term benefit maximisation cannot occur unless fostering the co-operative relationships with other stakeholders. It thinks that trust is an indispensable element of long-term financial well-being.\u00a0[182<\/a>]<\/span><\/p>\n

In 1998, the Department of Trade and Industry set up CLRSG for the purpose of reviewing the UK company law.\u00a0[183<\/a>]<\/span>\u00a0The objective of CLRSG was established in the first consultation document that is \u201cto provide straightforward, cost-effective and fair regulation which balances the interests of business with those of shareholders, creditors and others”.\u00a0[184<\/a>]<\/span>\u00a0As a part of the objective, determining in whose interests companies should be run has become a noteworthy issue. CLRSG believed that it is necessary to formulate the purpose of companies in company law, as it has been the subject of robust debate for a long period time.\u00a0[185<\/a>]<\/span>\u00a0CLRSG identified that there are two leading theories of defining the objective of companies in common law, so-called the shareholder primacy and the pluralist theory (known as stakeholder theories), which could be applied by companies\u2019 legislation to address the issues of ascertaining the corporate purpose. It was also concerned that the shareholders\u2019 interests can only be enhanced if other stakeholders\u2019 values are also catered for.\u00a0[186<\/a>]<\/span>\u00a0Therefore, there was an intension of introducing some element of stakeholder theory into the UK company law. Consequently, in order to be consistent with the present law which reflects that companies should be run for maximising shareholders\u2019 interests, and achieve a better goal of benefiting of all, CLRSG established ESV approach which is based on the shareholder primacy theory but explicitly advocates long-term profit maximisation,\u00a0[187<\/a>]<\/span>\u00a0and requires directors not only performing in the best interests of shareholders but also taking account to other stakeholders\u2019 interests.\u00a0[188<\/a>]<\/span>\u00a0In contrast, the pluralist theory was rejected, not only because it requires the law modification of directors\u2019 duties,\u00a0[189<\/a>]<\/span>\u00a0but also CLRSG regarded that this theory is unworkable and undesirable in the UK.\u00a0[190<\/a>]<\/span>\u00a0Thus, in 2001, CLRSG stated ESV approach in the Final Report.<\/p>\n

In July 2002, a White Paper was published by the government as a response to CLRSG\u2019s report. The government agreed with the logic of CLRSG that providing the objective of companies in the law and the concept of ESV. As a result of this, clause 19 of the draft Companies Bill as a part of the White Paper stated the duties of directors. There are four things need to be noticed in this draft Bill: first, directors\u2019 duties is clarified. Directors are required to run companies in good faith and \u201cwould be the most likely to promote the success of the company for the benefit of its members as a whole.”\u00a0[191<\/a>]<\/span>\u00a0Second, the material factors are concerned. The definition of material factors was \u201c(a) The likely consequences (short and long term) of the actions open to the director, as far as a person of care and skill would consider then relevant; and (b) All such factors as a person of care and skill would consider them relevant\u2026”.\u00a0[192<\/a>]<\/span>\u00a0This means that this provision built a reference to the fact that \u201cdirectors are to consider the factors that a person of care and skill would consider relevant.”\u00a0[193<\/a>]<\/span>\u00a0Third, the Bill included a provision of the Operating and Financial Review (\u201cOFR”).\u00a0[194<\/a>]<\/span>\u00a0This requires companies, no matter being listed on the London Stock Exchange or New York Stock Exchange, if they are British-Based companies, an annual OFR have to be publish to the public, which including the identification of material social and environmental risks made by companies and the disclosure information of those risks.\u00a0[195<\/a>]<\/span><\/p>\n

Three year later, in March 2005, the government published the second White Paper with some interesting changes as comparing to the CLRSG\u2019s report and first White Paper. In order to promote the success of companies for benefiting the members as a whole, the consideration factors which involves the interests of employees, suppliers, customers, the relationships with community and environment, and a high standard of operation were listed in clause B3 (3) of the draft Company Law Reform Bill.\u00a0[196<\/a>]<\/span>\u00a0It is worth noting that the phrase of \u201cso far as a person of care and skill would consider them relevant” was removed by the government without any explanation, which means the standard of directors\u2019 consideration was omitted. Although the draft Bill did not state how directors regard these factors, it seems a hierarchical approach that suggests directors giving more attention on the former than the latter.\u00a0[197<\/a>]<\/span>\u00a0The reason for saying that is CLRSG supported a hierarchy of obligation that is allowing directors to increase shareholders\u2019 interests preferentially.\u00a0[198<\/a>]<\/span>\u00a0Another change appeared in the Bill is that a long-term performance was dictated for the first time. Apart from that, the Bill has not only obliged directors to balance the divergent interests between the members fairly, but also required directors to regard creditors\u2019 interests when companies is insolvent or is approaching to insolvency.\u00a0[199<\/a>]<\/span><\/p>\n

The Company Law Reform Bill finally came out on 1 November 2005. The Bill provided the directors\u2019 duties in clause 156(1) and (3) which is slightly different from the clause B3 (3) of the draft Bill. The clause 156 (1) provided that \u201cA director of a company must act in a way that he considers, in good faith, would be most likely to promote the success of the company for the benefit of the members as a whole.” The objective of companies was defined by the provision that is directors should operate companies for the interests of shareholders. Besides, the clause 156(3) laid down a requirement to directors that is when they make the regard for fulfilling their duties, their considerations must be reasonably practicable. Another exciting change from the draft bill is that the Bill took short-term consequences out of the provision only left long-term results. After all these changes, it has to be admitted that clause 156 as a milestone in the UK law that makes the purpose of companies clear which is to run companies for shareholders\u2019 interests.<\/p>\n

Before enacting the s.172 CA 2006, the House of Lords made final emendations of the clause 156. As a result of that, the clause 156 became to clause 158: clause 158 (1) mixes the content of clause 156(1) and (3) together and 158 (2) shows that benefiting shareholders\u2019 interests is the critical goal of companies. The 158 (1) neglects the expression \u201cso far as is reasonable practice”, which means there is no requirements of directors\u2019 consideration and directors obtains an unfettered discretion of the concern.\u00a0[200<\/a>]<\/span>\u00a0In addition, the statement of OFR was changed from the detailed and strict provision in the 2002 White Paper to the sketchy and loose term therein. As such, that the quoted companies are not required to file an OFR.\u00a0[201<\/a>]<\/span><\/p>\n

After a decade of consultation, the s.172 CA 2006 became fully operative in October 2009. The concept of ESV approach with a list of non-exhaustive factors that directors should take responsibilities to promote the success of the company for the members is incorporated in the s.172. This means that directors have twofold duties, first is to promote the success of the company for the benefit of members in long-term results, which seems that ESV determines to finish the debate between \u201cthe company” and \u201cthe interests of the company”,\u00a0[202<\/a>]<\/span>\u00a0as it requires directors to run the business for members\u2019 interests not for the interests of companies; and second is to take account of the matters which are listed in the provision, which means that directors are required to consider a broad variety of interests rather than those of shareholders.\u00a0[203<\/a>]<\/span><\/p>\n

3.2 The assessment of the s.172 CA 2006<\/h2>\n

Having presented the evolution of the ESV approach, now we turn to assess whether s.172 CA 2006 adopted the right approach in defining in whose interests companies should be run, as this issue is the importance of the provision.\u00a0[204<\/a>]<\/span><\/p>\n

3.2.1 Enforcement issue<\/h2>\n

According to the list of non-exhaustive factors provided in s.172, directors are required to consider wider range of stakeholder\u2019s interests during the decision-making process. But under the provision there is no right given to non-shareholder stakeholders to against directors where directors fail to take account their interests when making decisions. It has been said that except members, those stakeholders who listed in s.172 are \u201ctoothless against the directors”.\u00a0[205<\/a>]<\/span>\u00a0Furthermore, even if these stakeholders had rights to take a legal action, it might not be easy to prove that directors breached their duties. This problem has been demonstrated in section 309 of the Companies Act 1985. Under the provision, directors were required to concern employees\u2019 interests in ensuring what is in the best of companies\u2019 interests. However, the provision is recognised as useless term, because it is extremely difficult to find a case law on this section.\u00a0[206<\/a>]<\/span>\u00a0As a result of that, it is believed that \u201ca right without a remedy is worthless.”\u00a0[207<\/a>]<\/span>\u00a0Probably, it has been said that the constituencies involved in the list of s.172(1) could apply for an injunctive relief which is used to stop directors doing something when they have breached the duty of consideration of relevant matters.\u00a0[208<\/a>]<\/span>\u00a0Nevertheless, the problem with this action is that it is uncertain whether the courts would accept a non-shareholder stakeholders\u2019 application or not. Even though the courts did, it would be far from easy to provide the evidences that prove directors had intention of not taking account to listed constituencies.<\/p>\n

As discussed in earlier chapters, under CA 2006, shareholders are the only group of stakeholder who can exercise derivative activities to against the directors if they fail to promote the success of the company for benefiting members or do not treat members\u2019 interests fairly (s.172(1)(f)). But this situation rarely occurred as it is on the bottom of the list, which means the directors are allowed to pay the least consideration to \u201cact fairly between the members of the company”. This also shows that shareholders are not so likely to trigger this action if directors fail to take account to other factors listed in s.172 (1) (a)-(e), because it is costly claim to shareholders. Even if shareholders are willing to bring a derivative claim for other stakeholders, it still has a problem of proving the breach. The reason of saying that is s.172 gives a free discretion to directors, which means that directors are able to justify the considerations which they made is to promote the success of the company for benefiting members. Also, the courts have announced that the hindsight will not be used when evaluating directors\u2019 actions.\u00a0[209<\/a>]<\/span>\u00a0Thus, it will be very difficult to prove that directors have not regarded the relevant matters when making decision.<\/p>\n

Apart from the enforcement issue discussed above, the most notable problem of enforcement of s.172 is that there is no criminal or civil sanctions are introduced for penalising directors who have breached the duties. This means that if directors are in the breach of the duty, they may escape from justice easily as there is no penalty to them.<\/p>\n

All of this shows that while s.172 appears to provide more leverage to the stakeholders who are listed in the provision, the reality is that except shareholders, most of them would not have legal remedy to against directors where they are in the breach of the duty in the section. In other words, the non-shareholder stakeholders\u2019 interests are not protected.<\/p>\n

3.2.2 Guidance of ESV<\/h2>\n

The guidance contained in s.172 seems to strike a balance the shareholder primacy and stakeholder theory, as it requires directors to consider the factors listed in the provision for the benefit of members. This direction is one step beyond the shareholder primacy because it adds considerations of stakeholders\u2019 interests as a part of directors\u2019 duty. However, it differs from the stakeholder theory, especially when there is a conflict of interests between shareholders and non-shareholder stakeholders,\u00a0[210<\/a>]<\/span>\u00a0the former states that the shareholder’s interests should prevail, and the latter argues that the directors should balance conflicting interests among stakeholders, without giving automatic priority to the shareholders.\u00a0[211<\/a>]<\/span>\u00a0It can be seen clear form the section that if an action which only benefits a range of stakeholders but shareholders, the directors will not act upon it.\u00a0[212<\/a>]<\/span>\u00a0Thus, under the s.172 other constituency interests are only instruments to be used for promoting shareholders\u2019 value, they are not treated as ends. Accordingly, as the section still emphasises the significance of the interests of members, it is said that s.172 does not go far enough towards solving the problem of the protection of other stakeholders\u2019 interests.\u00a0[213<\/a>]<\/span><\/p>\n

Besides, s.172 produces a lower standard to guide directors to act in practice.\u00a0[214<\/a>]<\/span>\u00a0Although the section establishes a list of non-shareholders stakeholders\u2019 interests to which directors are to have regard, it does not give an answer to directors how to regard these interests if they are competing interests. Under this uncertainty, directors may ignore the consideration of other stakeholders and only focus on benefitting shareholders\u2019 interests, because ESV is a \u201cshareholder-centered” approach. In addition, ESV has no definite or objective test which can be used to evaluate directors\u2019 action, so it is quite hard to judge whether the directors are in the good faith to prosecute their responsibilities effectively. Hence, it is most likely to happen that directors will take personal reasons not professional views to favour one group over anther listed therein. In other words, instead of making a reasonable concern of the listed matters, directors may do lip service, which is inconsistent with the Guidance to the Key Clauses.\u00a0[215<\/a>]<\/span><\/p>\n

On the other hand, some commentators argued that s.172 is the guidance for CSR.\u00a0[216<\/a>]<\/span>\u00a0It is believed that ESV will benefit the future of corporate governance potentially, because it encourages directors to start taking the view that taking account of the listed factors is essential element of their general duty.\u00a0[217<\/a>]<\/span>\u00a0Arguably the purpose of not setting out any guidance under the section is to accord with the demands of modern commercial practices.\u00a0[218<\/a>]<\/span>\u00a0It is true that no company has exact same operation model and challenge, so some argued that it is impossible establish a fixed task in provision and order directors to achieve it. Thus, it is said that ESV as a flexible approach leaves the unfettered discretion to directors themselves to determine how to regard stakeholders\u2019 interests depending on the circumstances of the case.\u00a0[219<\/a>]<\/span>\u00a0But it is quite unpersuasive, as discussed in previous paragraphs that no criterion is available to evaluate directors\u2019 behaviour, they may take advantage of increasing their own interests.<\/p>\n

Undoubtedly, ESV has realised that modern corporations are made from different group of stakeholders who contribute special-firm investments to companies, so it extends the interests of corporations from shareholders to all stakeholders and requires directors to consider the listed factors for the success of the company. Nevertheless, because the absent of guidance of examining directors\u2019 actions under the s.172, the interests of stakeholders is hardly to be protected. As a result of that, ESV fails to enforce CSR into corporations\u2019 operations.<\/p>\n

3.2.3 The absence of consideration of creditors\u2019 interests<\/h2>\n

Notably, even though creditors are normally recognised as one of the most important constituencies in companies, they are not included in the list of stakeholders\u2019 interests in s.172(1). Someone suggested that the interests of creditors might be contained by the word \u201cothers” in s.172(1)(c): \u201cthe need to foster the company\u2019s business relationship with supplier, customers and others,”.\u00a0[220<\/a>]<\/span>\u00a0However, if this suggestion is accepted then it will be very strange. The word \u201cothers” are generally used in text for describing something which is not necessary, but it is not the same case here. The reason of saying that is, it is well-known that creditors are a group of people who carry a big weight in corporations, so their interests are important enough to be referenced separately. Another suggestion of not mention creditors in s.172(1) is that their interests are protected by s.172(3), which states that directors are required to consider creditors\u2019 interests when a company is insolvent or near insolvent. This provision can be understood that if the company is solvent, the interests of creditors will not be considered as their interests are not included in the list.<\/p>\n

Another drawback of this provision is that it fails to achieve the objective of statutory formulation.\u00a0[221<\/a>]<\/span>\u00a0The one of main purposes of establishing the directors\u2019 duties in companies\u2019 legislation though the statutory formulation is to clarify such duties and make it more accessible to outsiders. Nevertheless, as there is no indication to creditors under s.172(1), people will believe that directors have no duties to them. Therefore, the interest of creditors may be harmed.<\/p>\n

3.3 Conclusion<\/h2>\n

This chapter has rehearsed the origination and development of ESV and assessed s.172. After evaluating issues of ESV previously, the initial question can be responded reasonable. I would suggest that although s.172 introduces the consideration of non-shareholder stakeholders\u2019 interests into directors\u2019 duties when promoting the success of the company, it fails to ensure that directors discharge their stewardship of these considerations and in accord with the purpose of companies as the statement of s.172 is less clear.\u00a0[222<\/a>]<\/span>\u00a0Thus, the answer to the question would be that s.172 failed to adopt a right way in defining in whose interests companies should be run.<\/p>\n

S.172 requires directors to promote the success of the company for the benefit of its members as a whole, which means that like shareholder primacy, the section agrees that shareholders\u2019 interests are still paramount and other stakeholders\u2019 interests are wholly subordinate to shareholders. Yet, the notion of giving primacy to shareholders\u2019 interests in s.172 has challenged its origins in the concept of CSR. As a result of that, the interests of those stakeholders may be ignored or harmed as directors have no duty to them under ESV. Notwithstanding s.172 also requires directors to consider other stakeholders\u2019 interests during the making-decision process of promoting the success of the company for the benefit of its member as a whole, it is extremely hard to be exercised in practice. Reasoning that:<\/p>\n

First, under the section it is clear that if there is the divergent interest between shareholders and other stakeholders, directors will drop the latter interests.\u00a0[223<\/a>]<\/span>\u00a0This reflects that other stakeholders\u2019 interests seem to be subordinate interests. Second, there is no explanation of how directors to regard the listed interests. Thus, stakeholders\u2019 interests may only be considered when it promotes the interests of shareholders.\u00a0[224<\/a>]<\/span>\u00a0This means that ESV treats stakeholders\u2019 interests as instrument to benefit shareholders\u2019 interests. Third, ESV does not provide any standard which can be used to measure directors\u2019 good faith. This makes directors\u2019 position \u201cvirtually unassailable”,\u00a0[225<\/a>]<\/span>\u00a0which means that directors are free to favour any stakeholder group as it is subjective discretion. Accordingly, instead of regarding stakeholders\u2019 interests, directors may look for their own benefit. Fourth, except shareholders, other stakeholders have little or none legal remedy which can be applied to against directors where they have breached the duty of s.172. Considering shareholders are the merely group of people who have a statutory right to trigger derivate proceedings in companies, directors are likely to take the risk of \u201ctechnical breach” of the regard list than not promoting the interests of companies.\u00a0[226<\/a>]<\/span>\u00a0The purpose of doing that is to avoid legal action taken by shareholders. So the interests of other stakeholders are harmed. Lastly, s.172 does not clarify the consideration of creditors\u2019 interests plainly in condition that companies are solvent.<\/p>\n

To sum up, all the facts described above demonstrate that ESV fails to adopt a right approach in define the objective of companies, because it does not pay close attention to the importance of non-shareholder stakeholders\u2019 interests. The section fails to guarantee that the interests of non-shareholder stakeholders are considered by directors under s.172. Therefore, ESV is an unfair approach which will destroy the trust and co-operation relationships between companies and stakeholders.<\/p>\n

<\/p>\n","protected":false},"excerpt":{"rendered":"

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