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Chartered Director

Governance Perspective: an IoD member's response

14 Apr 2021

Lord Justice Mummery in the Court of Appeal is quoted as saying, “A director of a company is appointed to direct its affairs. In doing so, it is his duty to use his position in the company to promote its success and to protect its interests”. As one might hope from one of Britain’s best legal brains, this quote covers everything a board should do – it sets direction, promotes success, and protects the interests of the company on behalf of the shareholders who constitute the company. I would observe that many boards, probably the majority, fail to do this in some respects – and in some cases, the company prospers in spite of the board rather than because of it. The pressures of public opinion, of news media, and of regulators can easily take up the majority of a board’s attention, leaving it little time to consider how to run the business efficiently.

A board can be dysfunctional in many ways, but some of the most common are mistaking the interest of the executives for those of the owners, mistaking pension fund and institutional investment managers for representatives of shareholders, mistaking growth in sales for growth in profits, and mistaking the world of accounting for the real world. The well-intended proposals put forward by the Better Business Act coalition are, in my view, likely to make business governance worse rather than better.

As we all know, the road to hell is paved with good intentions. The board has a fiduciary responsibility to the shareholders for a very good reason: It is the shareholders who have put up the money and are taking the risks. The idea that a board should legally be able to act against the interests of these people is worrying. It has always been the case that directors should take into account the long-term interests of the company, and this clearly means behaving in a responsible manner and making sure that the reputation of the company for good behaviour is maintained. That is absolutely not saying that their objective should be to do anything other than promote the success of the company.

The idea that a company should regard saving the planet or looking after the wider population in other ways as their objective is a crowd pleasing “acceptable face of capitalism” suggestion. But in practice, it would potentially lead to welfare losses and inefficient resource utilisation. The simple job of every company is to deliver the maximum profit over the long-term, which means providing the best service for its customers with the lowest use of resources. If it does this, it will be saving the planet, and it will be looking after the wider population. 

Adam Smith explained this principle years ago, and no one has effectively questioned it since. If there was ever any doubt, the record of China in taking a billion people out of poverty simply by adopting the Adam Smith model over the last 25 years should have removed them. The Adam Smith thesis is that if there are social objectives to be achieved, then the government is responsible for taking the appropriate action or passing the appropriate laws. The more profits are made by shareholders, the more they can contribute to society as a whole via the tax system. If there are external dis-economies, then the tax system can be used to deal with them.

The proposals from the Better Business Campaign totally confuse the job of the government and the job of individual enterprises and would make both significantly less efficient if they were ever put into effect. We have a supervisory system for governmental actions, which to a greater or lesser extent can juggle priorities and measure success. If social objectives were delegated to the private sector, controls over appropriate resource allocation between competing claims and any measures of efficiency would be entirely lost. What economists refer to as the “Agency Problem” would be multiplied many times over should company managers be allowed to explicitly and legally ignore the interests of their owners.

Making boards more accountable is always a good idea, but one which unfortunately is often completely misinterpreted. Making a board accountable does not mean having 100-page annual reports, which today very few people read. It does not mean producing large numbers of returns to regulators, and it above all does not mean suggesting in the accounts provided that the company exists to serve wider society rather than those who have got together to set the company up (or in quoted companies, their successors in title). Shareholders’ rights are easily ignored, and every rule and regulation that is imposed makes it easier for the board to ignore the people they are meant to represent. 

The net effect of measures to make boards more accountable has been to raise the average size of companies well above that where it would be without the burden of detailed reporting and regulation. The cost of maintaining a stock exchange quote is about the same whether the company has a turnover of £10 million or £10 billion. The costs of compliance & the costs of accounting all fall as a proportion of turnover for larger companies. The efficiency of the business does not increase, and in many cases, it falls. This means more resources are used to achieve the same output, and those who truly wish to protect the natural environment and save the planet should be looking for the most efficient use of resources possible. The best way we have of doing this is by encouraging competition and profit maximisation, and on occasion, cutting regulatory burdens.

An organisation such as the Institute of Directors could be influential in this debate and should be out there trying to make business more efficient and promoting the removal of unnecessary regulation and reporting. That way, society would be better off, and all the desirable objectives which the Better Business Act Campaign says it wants to achieve would be much more achievable. The division between government, which is there to achieve the objectives of society as a whole (including saving the planet), and individual enterprises, which are there to act in the interests of their shareholders, is a useful distinction which we should keep. The planet and everyone on it would suffer if these proposals were enacted.

Marcus W Johnson is Director for Kirly Ltd and Kirly group companies, and wrote this piece in response to the Governance Perspective published on in March 2021.

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