On November 29, 2016, the UK Government published a Green Paper on Corporate Governance Reform, which sets out a series of options aimed at strengthening – once again – the UK corporate governance framework.
This is nothing fundamentally surprising, since the regulatory frameworks for corporate governance have resembled permanent construction sites in most Western countries since the 1990s. Indeed, corporate governance regulation seems to be subject to cycles of reforms and crises: Regulatory reforms are undertaken to address certain perceived pressing problems. New scandals or crises then still take place, which then in turn causes regulators to reform the framework again. In the UK, this process started with the famous Cadbury Report of 1992. Since then, various versions of the UK Corporate Governance Code have aimed at ‘improving’ the code-based UK corporate governance regulatory system.
The nature of the perceived pressing problems has change over time, of course. In the 1980s and 1990s, corporate governance reforms mainly focused on aligning top executives’ interests with those of shareholders in order to reduce the perceived managerial risk aversion that was held responsible for relatively sluggish rates of return for investors (see for the academic rationale behind this thinking the important article by Amihud and Lev 1981). The purpose of corporate governance reforms was hence to improve corporate performance (measure as the creation of shareholder value).
After the financial crisis of 2008, the focus shifted towards corporate governance structures that would guarantee appropriate ‘risk management’ rather than encouraging managerial risk-taking.
The new Government Green Paper, now, zeros in on two key issues, which have gained increased prominence over the past years. Namely, the appropriateness of executive pay – not just in relation with firm performance, but increasingly also compared to worker pay – and the question of the influence of other stakeholders than shareholders on corporate decision-making.
The Green Paper can hence be seen as the continuation of a well-known pattern of permanent CG reform. What is surprising about the new CG reform, however, is the much more challenging task that the Government hopes corporate governance regulations can achieve, namely: saving free-market capitalism from itself!
Indeed, the introductory letter to the Green Paper by the Prime Minister contains the following rather astounding passage:
But for people to retain faith in capitalism and free markets, big business must earn and keep the trust and confidence of their customers, employees and the wider public. For many ordinary working people – who work hard and have paid into the system all their lives - it’s not always clear that business is playing by the same rules as they are. And when individual businesses lose the confidence of the public, faith in the business community as a whole diminishes – to the detriment of all. It is clear that in recent years, the behaviour of a limited few has damaged the reputation of the many. It is clear that something has to change.
What has to change – so the PM’s argument seems to run – is corporate governance regulations. Corporate governance has hence moved from a relatively limited affair concerning managers and shareholders alone – as posited by the still dominant agency theory of corporate governance – to a much more fundamental element, crucial to the legitimacy of the capitalist system.
Corporate governance reform thus seems to be a crucial instrument for the May Government to achieve its ambition – stated in the opening sentence of the PM’s introduction to the Green Paper – to “[…] build an economy that works for everyone, not just the privileged few.”
This statement (which – incidentally – is remarkably close to the title of Robert Reich’s most recent book) and the above quoted paragraph on faith in capitalism are remarkable, because they seem to constitute an acknowledgement that the current economic model in place in the UK is on the verge of a major crisis in the form of a public backlash against ‘free markets’ and capitalism in general. That a right-wing government would acknowledge such a crisis situation is remarkable.
The problem is, however, that the body of the Green Paper then focuses mainly on rather timid proposals in the area of executive pay and of stakeholder influence over corporate decision-making. Some of these proposals may certainly constitute an improvement on the current situation, e.g. in terms of stakeholder interests. However, they clearly fall short of what would be needed to achieve the Government’s more fundamental goal of restoring trust in the existing capitalist system. This is the argument we make in a response to the government consultation on the Green Paper that I wrote together with my colleagues Dionysia Katelouzou from the Dickson Poon School of Law and Aditi Gupta from the KCL School of Management & Business. We argue that if the Government is serious about its very ambitious goal for Corporate Governance reform, it will need to adopt reform proposals that have more teeth than what is currently being proposed. The full response can be found on SSRN.