Banking Commission challenges shareholder primacy
I have blogged before about the flaws of shareholder primacy, and the TUC has long argued that directors’ duties should require directors to promote the long-term success of the company, rather than prioritising shareholder interests as at present.
Now the Parliamentary Commission on Banking has picked up this theme in its recent Report, arguing:
The obligations of directors to shareholders in accordance with the provisions of the Companies Act 2006 create a particular tension between duties to shareholders and financial safety and soundness in the case of banks.
Other Government-sponsored responses to the financial crisis, notably the Walker Review of Bank Governance, have also acknowledged the weaknesses of shareholder engagement and its impact on poor decision making in the financial sector. However, the Walker Review did not challenge the notion of shareholder primacy but limited itself to recommendations to make it work better, the most significant of which has led to the Stewardship Code for Institutional Investors. What is particularly significant is about the Banking Commission is that their recommendations open the door to more fundamental reform:
The Commission recommends that the Government consult on a proposal to amend section 172 of the Companies Act 2006 to remove shareholder primacy in respect of banks, requiring directors of banks to ensure the financial safety and soundness of the company ahead of the interests of its members.
This begs the question, however – why just the banks? While the consequences of bank failures have been particularly stark, there is no reason why shareholder primacy should work well for every part of the economy except for the banks. Shareholder primacy does not operate in a different ways depending on the sector of a company. If it contributed to bank failure by distorting the priorities of board decision making and encouraging short-termism and a lack of proper regard for risk, then there is every reason to suppose that it contributes to failure across other sectors of the economy, with a negative, if less dramatic, impact on company economic and social performance.
The Financial Reporting Council, responsible for the Corporate Governance Code and the Stewardship Code, has commented that:
The equity markets play a most important role in our economy. When credit is short as in 2008/9 that role can be vital. An amendment to the Companies Act to remove shareholder primacy could have a profound bearing on investors’ willingness to commit capital and might set precedents for other sectors…The FRC is not convinced that disenfranchising shareholders is the right solution. If shareholder primacy is removed it may affect the ability of banks to attract future capital.
In reality, as demonstrated clearly by the Kay Review of Equity Markets, the stock market is very rarely a source of new capital for companies and is largely a market in second hand shares. Stock market movements and share price are watched closely by company boards because a low share price makes a company vulnerable to hostile takeover and often leads to lower pay for company directors, not because they reflect the ability of the company to attract new capital for investment.
The Banking Commission may have felt that as their remit was limited to the banking sector, their recommendations should be limited to the banking sector, but their report opens up an important opportunity to argue for wider reform of directors’ duties.