‘Only a crisis - actual or perceived - produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are lying around’ (Milton Friedman). In his Foreword to the British Academy’s report last year - ‘Principles for Purposeful Business’ - the President of the Academy cited this quote. He commented that in 2019 there was a ‘growing sense of crisis and many were looking for new ways to do business’. Now, in 2020, directors and shareholders face real governance challenges in addressing new societal challenges as well as the environmental challenges on the horizon.
The report proposes that the role of company in society be reframed as ‘to profitably solve the problems of people and planet, and not profit from causing problems.’ A business should also articulate its own individual purpose such as to 'drive change to fight diabetes' (Novo Nordisk). This sits together with the concept that businesses should demonstrate sound 'Environmental, Social and Governance' ('ESG') credentials. The report and other articles (see Profit with a Purpose - the new Norm) explain why these concepts are key to ensuring long term success. In this article I set out how the law already requires sound ESG adherence and legal change is on the horizon.
Director and Shareholder responsibility at law - where are we now?
The primary duty of the directors is to promote the company's success for the benefit of its shareholders, which has at its core a profit making purpose. Nevertheless, the duty recognises ESG principles. In exercising their duties, directors must consider other factors, including the environment, business relationships with customers, suppliers and employees. This concept, known as ‘enlightened shareholder value’, recognises other stakeholder interests, although they have no rights to enforce their interests against directors. The duty is owed to the company, which has the primary right to enforce it, although shareholders can remove directors, restrain them from acting in certain situations; and (in limited circumstances) step into the company’s shoes to bring a ‘derivative claim’.
Shareholders, on the other hand, have few responsibilities, being able to act in their own individual interests. However, a company's articles may place additional responsibilities on them, for example by binding the shareholders (and the directors) to a more extensive corporate 'purpose'. Companies that are accredited as B Corps (see It's B Corp business but it is personal) do so, for example. The effect should not be to expose directors and shareholders to greater claims from external stakeholders, but to bind and permit them to pursue environmental and social goals. Furthermore, investors in public markets are under pressure to act responsibly in their engagement with investee companies. The revised Financial Reporting Council stewardship code and UN's Principles for Responsible Investment, both for example, operate as a call to action for responsible investment, embodying sound principles of ESG.
Transparency and Reporting obligations
Varying degrees of ESG reporting are also required, depending on the company's size and any market on which it is quoted. These requirements span, for example, reporting in their annual report (and in some cases on a website) on:
- how 'enlightened shareholder value' factors have been taken into account in the board's decisions in a financial year and how the company engages with stakeholders;
- reporting on the company's purpose and how the board has ensured the company's strategy and culture are aligned with that purpose; and
- many other aspects of ESG such as board diversity, director remuneration, gender pay, carbon efficiency, modern slavery and the company’s payment practices.
These requirements are extensive and many apply to large private companies as well as quoted companies. Other companies, such as those who have chosen to become B Corps, also undertake ESG reporting voluntarily.
The agenda for reform
Some are calling for a reframing of directors' duties to embed 'corporate purpose' in the duty to promote the success of the company – this would set out that the company's purpose is not only to benefit its members, but also wider society and the environment and reduce harm with the goal of eliminating that harm or costs. As yet, there has been no Government announcement proposing this change. It raises the question of who should enforce this new duty – should it continue to be only the shareholders or should other stakeholders have rights of action? Care is needed to preserve the concept of the company as a separate legal entity. Employees and external stakeholders may already have contractual and other remedies against the company.
It looks more likely in the mid-term that we will see a fortified regime for audit of corporate reporting. In the Queens' speech the Government announced that it would follow up on reports such as the Kingman and Brydon reports into the Financial Reporting Council (FRC) and Future of Audit. We therefore expect the FRC to be recreated as the 'Audit, Reporting and Governance Authority' ('ARGA') and given stronger powers, including to investigate companies' governance and reporting and to fine directors for reporting failures. Furthermore, ARGA is likely to be mandated with acting as the 'midwife' to a new corporate audit profession – covering not only audit of financial statements, but also other reporting including ESG information.
As yet, how far and when the law will be reformed to drive greater accountability for companies to adhere to a sound purpose is uncertain. However, the British Academy's Principles for Purposeful Business, sets out a challenge to business to find solutions in the meantime. The ideas that are 'lying around' in that report relate not only to Governance, but also how to measure and value ESG performance and employ new partnerships and structures. What is clear from the current crisis is that boards and shareholders will give greater prominence than ever to risk management. However, they should also look to ensure that their corporate purpose remains relevant and that their culture and strategy are aligned. Those companies who achieve this balancing act will be well positioned for the new normal to come.