It is obvious that the formal corporate legal skeleton covers only a very small part of how the corporation actually operates to carry out its business and continually adapts to its business environment. In Bernard Black’s terms, most of the legal rules concerning the corporation’s operations are “trivial,”20 in the sense that the rules are important only if they are ignored despite how easy they are to satisfy. The rest and obviously most important part of the governance structure—the dark matter of corporate governance—is the realm of reporting relationships, organizational charts, compensation arrangements, information gathering, and internal controls and monitoring, all largely non-legally dictated policies, practices, and procedures that do not appear in the corporate statute or the corporation’s charter or bylaws. (The Oxford Handbook of Corporate Law and Governance, 2018). The history of corporate governance can be traced since the introduction of large corporations (like East India Company, The Hudson’s Bay etc)(Cheffins, 2012).
Corporate Law & Corporate Governance
What should be the line of demarcation between the corporate law & corporate governance, it is possibly one of the most difficult questions. Last five decades, Corporate Law jurists are giving due importance to corporate governance over the corporate law. Jensen & Meckling calls corporate form as a legal fiction (Theory of the Firm: Managerial Behavior, Agency Costs and the Theory of the Firm). In Bernard Black’s words, most of the legal rules concerning how a corporation operates might seem simple and unimportant (trivial). However, they become significant when they are ignored, despite being easy to follow. The truly crucial aspect of corporate governance involves various things like reporting relationships, organizational charts, how employees are paid, gathering information, and the systems for internal control and monitoring. These elements are not strictly dictated by the law; they may be within the ambit of the company’s own policies and practices that are not found in the official laws or the company’s formal documents. It’s important to understand that these non-legal governance processes can become legal requirements if the government decides that the company’s internal rules aren’t sufficient to protect the interests of society. A clear example of this is when, after the Enron/WorldCom accounting scandals, the government introduced the Sarbanes-Oxley Act, which forced companies to follow specific governance requirements for their financial reporting. This included having external monitors for their internal controls, setting up specific board committees, and assigning mandatory responsibilities to officers. However, generally, it is up to the company to figure out how to implement compliance, even when the board has a responsibility to ensure it. (See also, Bernard Black, “Is Corporate Law Trivial? (1990). In other words, it can be said that corporate governance is the operating system of the company which may involve the policies and procedures which may not be strictly provided by the company legislation. ‘Corporate governance is the system by which companies are directed and controlled‘ (Cadbury Committee, 1992). This is notable, the definition of corporate governance as provided in the Cadbury committee report on corporate governance still holds good.
The readers should make the note of the economists’ contributions in the academic part of corporate law & corporate governance. For the last four decades, economics began making important inroads into corporate law scholarship, a significant amount of academic, not judicial, attention is still directed at devising the right model of corporate law and governance.
Advanced economies follow a fundamental tenet to operate their capital markets and business practices. Significant changes have been made to the corporate structure, which now exhibits a high level of consistency. It may be possible for these techniques to converge even more. Such convergence requires the existence of an accepted standard. It is widely accepted that business executives should put the company’s financial interests, including those of minority shareholders, first. The shortcomings of competing models (management-oriented model as it was prevalent in United States or labour-oriented model as prevalent in Germany) led to the widespread use of the shareholder-oriented business model. Further, elites from the worlds of academia, business, and government have undergone a noticeable shift in recent years in significant jurisdictions. On a number of important corporate issues, they have come to a common understanding. The main tenet of this consensus is that the shareholder class should have ultimate control over the corporation. Corporate executives should be accountable for running the business in a way that supports the interests of its shareholders. This consensus also emphasizes that other corporate stakeholders, such as creditors, employees, suppliers, and customers, should have their interests protected through contractual and regulatory frameworks rather than participating directly in corporate governance. Strong protection is also necessary for noncontrolling shareholders against any potential exploitation by controlling shareholders. The market value of shareholders’ shares in the company is the primary metric used to assess the interests of shareholders in publicly traded corporations, i.e. creation of the value for the shareholders. This consensus among various powerful groups represents a significant advancement in the viewpoints of corporate governance. (Hansmann & Kraakman, THE END OF HISTORY FOR CORPORATE LAW (p. 3)).
Alternative Models to Shareholders’ Primacy
The Manager-Oriented Model – Between 1930s and the 1960s, a significant normative school of thought developed in the United States that praised a higher degree of discretions to be given to the executives and managers of large corporate enterprises. The managerialist model’s appeal from a normative standpoint was significantly reduced by the decline of the conglomerate movement during the 1970s and 1980s. Even when managers have the best of intentions, it is now generally acknowledged that giving them a lot of discretion over corporate investment policies frequently causes them to put their own interests first. However, this particular model has been found to be more effectively dealing with the interest of non-shareholders within the corporate set up (see, Hansmann & Kraakman, THE END OF HISTORY FOR CORPORATE LAW (p. 5)).
The Labor-Oriented Model – The Labour Law jurisprudence rests upon the notion that the general provisions of the Law of Contracts are unable to protect the interest of the Labourer. In this respect, it is pertinent to note that Germany rule of codetermination provided that labour unions’ representatives are appointed in the upper layer board. Although involving employees directly in corporate decision-making can help reduce certain inefficiencies that may arise in labor contracting, the diverse interests within the typical workforce make it challenging for them to function effectively as a governing body. This difficulty becomes even more pronounced in codetermined firms where employees must share governance responsibilities with investors.
The term “labor-oriented” refers to a corporate governance model that gives special consideration to the rights and interests of employees or labor unions within a company. As stated, this model, which peaked in German co-determination, prioritizes employee participation in decision-making and seeks to uphold their rights and welfare. The shareholder-oriented model, which emphasizes the economic interests of shareholders, including noncontrolling shareholders, and has taken the lead as the prevailing theory in corporate law, has eclipsed the labor-oriented model.
The State-Oriented Model – In corporatist economies, the primary means of state control over corporate matters have typically resided beyond the realm of corporate law. These methods involve granting significant authority to government bureaucrats for tasks such as determining credit allocation, handling foreign exchange, issuing licenses, and providing exemptions from anticompetition regulations, among others. At one time, it became very popular in the countries like France & Japan. The state-oriented model, however, has also lost a lot of its appeal. State socialism’s declining acceptance as a dominant intellectual and political ideology is one of the causes of this shift.
The Stakeholder Model – An alternative viewpoint to the conventional shareholder-focused view of corporations is offered by stakeholder models in corporate governance and corporate law. These models emphasize the significance of taking into account the interests and welfare of various stakeholders, such as employees, clients, suppliers, and the community, in addition to those of shareholders. Stakeholder perspectives, according to proponents, can help corporations make decisions that are fairer and more ethical.
The shareholder’s primacy is now key factor in corporate governance. However, it does not mean that the stakeholders’ interest should not be protected. It Only suggests that the most effective legal safeguards for interest protection of the stakeholders, or at the very least, all constituencies other than creditors, are not covered by corporate law. For example, labour laws are applicable to protect the interest of the workers. As far as, the creditors are concerned, they are well covered by the insolvency or rescue provisions (e.g. Insolvency & Bankruptcy Code, 2016).
Protecting the interest of the minority shareholders’ is also a basic tenet of the shareholders primacy. Inefficient management and investment decisions frequently result from controlling shareholders receiving an excessive portion of corporate benefits. This means that when controlling shareholders put their own interests ahead of the corporation’s overall success, it can have a negative effect on the company’s performance and make it more difficult for it to make wise investments.
It is useful to summarise the key findings of the abovementioned paper by Kraakman –
Leading jurisdictions’ business, political, and legal elites are coming to the normative conclusion that corporate managers must act in the best interests of their shareholders. This consensus is based on the conviction that the traditional shareholder-oriented model of corporate governance encourages better economic outcomes.
The adoption of the shareholder-oriented model of corporate governance has been facilitated by the failure of competing models, such as state- or labor-oriented models. Businesses that are structured and run in accordance with the standard model have a competitive advantage over their rivals thanks to things like easier access to capital and more powerful incentives for effective decision-making.
Corporate law can converge as a result of international competition for corporate charters. However, until there has been significant convergence, the adoption of the choice of law rules required for this competition may not take place. Prior to allowing explicit cross-border competition for charters, the most crucial steps toward convergence are anticipated to be taken.
The interests of controlling shareholders and the requirement for legislative action, for example, may present barriers to rapid institutional convergence, but the expanding ideological agreement on the standard model is likely to encourage reforms and the adoption of comparable laws and procedures everywhere. In the reasonably near future, it is anticipated that the pressure for moving toward the standard model will become insurmountably strong.
The paper’s overall thesis contends that a shareholder-oriented model of corporate governance is becoming more prevalent, propelled by pressures from the market, economic performance, and normative consensus. Incorporated law and corporate governance procedures are predicted to significantly converge as a result of this convergence.
(Hansmann & Kraakman, THE END OF HISTORY FOR CORPORATE LAW).
It will be useful here to see the summary of another paper, Brian R. Cheffins, The History of Corporate Governance (ECGI), Law Working Paper N°.184/2012January 2012 –
Introduction –
It is notable that Corporate governance became a subject of global debate in the 1970s.
The abovementioned paper focuses on the period between the mid-1970s and the end of the 1990s.
Corporate Governance History –
Corporate governance has a long history, dating back to the formation of major chartered companies in the 16th and 17th centuries.
A comprehensive history of corporate governance would be challenging due to its vastness.
This paper focuses on how debates about managerial accountability, board structure, and shareholder rights became channeled through the term ‘corporate governance’.
Corporate Governance Comes on the Agenda
During the post-WWII economic boom in the US, corporate governance was not a high priority.
Boards were expected to be supportive of management, and shareholders were often indifferent.
But in the mid-1970s, the Securities and Exchange Commission (SEC) began treating managerial accountability as part of its regulatory remit.
The SEC brought proceedings against outside directors of Penn Central for misrepresenting the company’s financial condition.
The discovery of widespread illicit payments by US corporations to foreign officials further drew the SEC into the corporate governance realm.
S.E.C. Hearings on Corporate Governance
The S.E.C. held six weeks of hearings in 1977 on shareholder participation in the corporate electoral process and corporate governance.
Key reforms resulting from the hearings focused on disclosure requirements for publicly traded firms.
Voluntary Reform by Corporations
S.E.C. chairman Harold Williams advocated for voluntary reform by corporations rather than imposing regulatory measures.
Harold Williams believed in an ideal board structure with only one managerial appointee and the establishment of various committees.
Legislation Efforts and Debates
Senator Howard Metzenbaum appointed an advisory committee on corporate governance, but they failed to reach a compromise on suitable legislation.
Metzenbaum introduced the Protection of Shareholders’ Rights Act of 1980 which prescribed minimum federal standards and required an independent director majority on boards.
Early Theorization of Corporate Governance
The book ‘Taming the Giant Corporation’ by Ralph Nader, Mark Green, and Joel Seligman introduced the term ‘corporate governance’ and advocated for reform through federal laws. The book argued that the legal model of corporate governance allowed for managerial autocracy and advocated for returning the board to its historical role.
Recommendations for Board Structure
Various groups recommended substantial outside director representation on boards and the exclusion of executive directors from certain committees. The Business Roundtable stated that boards should be composed of a majority of non-management directors and establish audit, compensation, and nomination committees.
The American Law Institute’s Efforts
The American Law Institute committed to undertaking a project on corporate governance in 1978. In 1980, a conference was organized with support from the business community, but a political earthquake would soon change their stance. In 1980, there was a belief that the battle over governance was fundamental. The election of Ronald Reagan and a political shift to the right ended the 1970s movement for corporate governance reform.