From the TUC

Corporate governance: What it’s about, why it matters

24 Jul 2014, by Guest in Economics

The TUC’s new pamphlet on “corporate governance” is made up of contributions from 17 expert authors including academics, businesspeople, former government advisors and trades unionists. NPI shared the editorial duties. But why should anyone whose immediate concern is with low pay, poor housing or cuts to services care about a subject seemingly so obscure?

Here’s why.

Those at the top of large corporations may lead lives that are remote from those of ordinary people but the decisions they take can have far reaching effects. The effects of those decisions – not accidentally, not just here or there, but systematically – have become harmful to the wider economy and society at large. Helping to explain why we are now in an era of low investment, poor productivity and seemingly endless cuts is what makes the obscure relevant.

This begs the question: whose interests should the people who sit atop the pinnacle of the large corporations serve? According to the doctrine of ‘shareholder primacy’, the answer is “the shareholders”.

Many may think this is no more than common sense: shareholders own the company’s shares, don’t they? But the doctrine has only been prominent (in the UK and the US) for three decades at most. If it now reigns supreme, it has only done so for far less time than that.

The decision-making rule that follows from the doctrine is that the directors should run the company so as to maximise “shareholder value”. Most of the damaging effects of any decisions can be traced back to this “rule”, which leads to five interrelated problems.

  • A stifling of innovation and a chronic low level of investment.
  • This holds back growth, productivity, earnings and therefore living standards.
  • Much greater earnings inequality (with especially high rewards at the very top) follows.
  • An economy-wide imbalance – in the form of chronic corporate savings –emerges as the partner of a chronic public sector deficit.
  • Wider interests – of the communities in which companies are based, the environment, supplier firms, the national interest – are harmed by this focused pursuit of shareholder value.

The diagnoses of these problems are broadly divided into two groups, according to whether “maximising shareholder value” is seen as being wrong in principle or just flawed in the way it has been implemented.

The responses can also be broadly grouped under two headings: “representation” and “institutional framework”. The first group propose changing the people who make the decisions within the company. “Workers on the board” is the most striking of these, but far from the only one. The second group propose things like changes to rates of corporation tax – e.g. to encourage investment – or the taking of a longer term view.

Two things struck us in editing the contributions to this pamphlet. The first is that looked at in the round, it is a collection in which some of the big problems besetting our economy and society are put down not to the faults of the poor and the weak but rather to those of the rich and the powerful.

The second is the use of telling, concrete examples. None is more so than the one used by John Kay to show how thinking about corporate governance changed at some point between 20 and 30 years ago. His example contrasts two versions of the mission statement of ICI, arguably Britain’s greatest 20th century company, in 1987 and then again in 1994.

In 1987:

ICI aims to be the world’s leading chemical company, serving customers internationally through the innovative and responsible application of chemistry and related science. Through achievement of our aim, we will enhance the wealth and well-being of our shareholders, our employees, our customers and the communities which we serve and in which we operate.

Whereas seven years later:

Our objective is to maximise value for our shareholders by focusing on businesses where we have market leadership, a technological edge and a world competitive cost base.

Between these statements, Kay points out three differences. In 1987, operations (the application of chemistry and science) came first and finance (enhancing wealth) second. By 1994, they were the other way round.

1987 looked forward (innovation) whereas 1994 emphasised existing market leadership.1987 talked about employees, customers and communities as well as shareholders. By 1994 all but the last had disappeared. By 2007, ICI itself had disappeared.

Besides summing up the change in values that took place, showing that companies once thought they should behave otherwise gives hope: how it is now – just a recent phenomenon – is not how it has to be.

Download the full book “Beyond Shareholder Value” as a pdf file