Corporate governance has traditionally been viewed as a way to reduce agency costs between shareholders and managers in the context of private ordering. Laws and regulations pertaining to corporate governance have, therefore, typically aimed to enhance long-term wealth for shareholders.
Governments have in recent years, however, discovered a new use for corporate governance: advancing the public interest. This has been done by promoting everything from environmental causes to gender diversity to humanitarian aid. In the United Kingdom, the government has been explicit in advocating this view of corporate governance. Prime Minister Theresa May has expressly noted that corporate governance should be used to ensure that corporations work towards providing a “fairer economy” or an economy that “works for all.” A review body working under the government has been even more forthcoming in describing corporate governance as a replacement for national regulation in employment issues. Yet the UK is not alone in its views. India is relying on corporate governance rules to hold corporations accountable to the public, China is using it to promote “social harmony,” and in the U.S., the Securities and Exchange Commission has used corporate governance rules to “promote peace and security” and “combat global corruption”.
While governments undoubtedly have broad discretion in using regulations to achieve public policy goals, we question whether corporate governance rules with a public focus are an appropriate and efficient means for doing so. This is because the practice suffers from two main shortcomings: requiring corporations to pursue public objectives at the expense of other goals and discouraging governments from using more effective forms of regulation.
As to the first shortcoming, the starting point for our critique is the corporate purpose. Because we find that the corporate purpose lies somewhere between exclusive shareholder wealth maximization and the pursuance of public interests, governmentally mandated corporate-governance rules may justifiably include public goals. Yet, we argue that such rules must reflect a balanced corporate purpose and promote governance that serves multi-faceted corporate aims. This is not to say that corporate governance rules must necessarily promote public and shareholder interests equally, but rather that the overall effects of a particular governance mechanism should be balanced and, as much as possible, be directed at benefitting the full range of corporate stakeholders. This suggests that when corporate governance mechanisms address social issues they should not promote public over shareholder interests as the aim should remain to benefit the corporation in a holistic manner.
Moreover, in some instances, public-oriented corporate governance has been designed primarily to further the interests of one set of stakeholders. This creates problems when it disadvantages the interests of other stakeholders. As an example, corporate governance rules designed to promote humanitarian aid may divert funds from corporate activities supporting employees or the local community. In these instances, the furthering of one stakeholder group’s interest may impinge on competing stakeholder interests and risks hampering the long-term interests of the corporation.
The second problem is that public-oriented corporate governance rules tend to focus only on indirectly regulating corporate conduct. For instance, the rules encourage corporations to disclose their executives’ pay, the number of women on their boards, or their efforts to reduce greenhouse gas emissions rather than direct them to do so. Of course, direct and indirect regulation each has its benefits and costs and only by weighing them can a government determine the optimal combination. However, in the case of public-oriented corporate governance, there is a marked preference for indirect regulation. The entire model of corporate governance in the UK, for example, is premised on a “comply or explain” model, meaning that corporations can choose to comply with corporate governance practices or explain why they have chosen not to do so.
Indirect regulation can be an appropriate compromise between those that view over-regulation as inefficient and those that view under-regulation as ineffective. Nevertheless, indirect regulation is only effective if reinforced by traditional forms of regulatory fiat where regulatory delegation fails. In the area of public-oriented corporate governance, failure of regulatory delegation is apparent in a number of areas. Most notably, a recent UK study found that, despite countless attempts by the government to indirectly regulate executive compensation through corporate governance, the pay gap between CEOs and employees has not narrowed, and the relationship between executive compensation and firm performance has not improved.
To address these shortcomings, we suggest several reforms. To avoid unduly privileging specific stakeholders, we argue that governments should try to balance the overall effects of public-oriented corporate governance rules and, as much as possible, aim to benefit the full range of corporate stakeholders. Where this is not possible, it may well be that using corporate governance is the wrong approach to solving that specific public problem.
Indeed, if governments are truly seeking to regulate and change corporate conduct towards public policy issues, they must complement current approaches with more direct ones. While we do not necessarily advocate an interventionist approach in all areas, we do find that it is both more effective and justifiable to address legitimate public goals directly rather than relying (exclusively) on the shaming and nudging techniques of indirect regulation often found in corporate governance mechanisms with public aims.
Overall, public-oriented corporate governance should not be used as a one-stop shop to fix the ills of society. Where appropriate, it should be used strategically and form part of a concerted, multifaceted effort to address the root of the public policy issue.
This post comes to us from professors Barnali Choudhury and Martin Petrin at University College London, Faculty of Laws. It is based on their recent article, “Corporate Governance that ‘Works for Everyone’: Promoting Public Policies Through Corporate Governance Mechanisms,” available here.