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Shareholders v Stakeholders: Companies Protecting the Environment?

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About The Author

Nikita Collardova (Guest Contributor)

Nikita is a Law & Business finalist at the Univesity of Warwick with an interest in commercial and criminal law. She has undertaken internships in several countries and uses the experience gained in her roles as Head of External Relations and Sponsorship at the Warwick Finance Society. Outside the law, she has an interest in the environment, and discovering languages, places and literature.

© Cameron Strandberg

Progress is impossible without change, and those who cannot change their minds cannot change anything.

George Bernard Shaw

By definition, a company is a group of people authorised by law to act as a legal personality, having its own powers, duties, and liabilities. It is a separate legal entity run by directors, who act as fiduciaries to the company. Any action of the fiduciary should be to the advantage of the beneficiaries, in this case shareholders. There is therefore a two-way obligation: shareholders must have faith in the directors to make decisions with the best possible result, and directors owe a duty to always act in the best interests of shareholders.

By taking on the role of beneficiaries, shareholders place themselves into an important role: they are the hidden force that needs satisfaction with any work done by the company. They therefore play a substantial role in the general direction the company will follow, though it is up to the directors to decide the final course.

As such, shareholders may be of primary influence when directors are guiding company decisions. Gail Henderson explains that ‘shareholder primacy’ occurs where the:

directors’ sole duty is to maximize shareholder wealth, leaving it up to governments to address the negative social impacts of corporate activity.

However, increasing shareholder welfare does not result in an increase in overall welfare. In particular, it often comes at the cost of failing to reduce environmental footprints of the companies. In light of the UN Intergovernmental Panel on Climate Change’s recent warning that we have just 12 years to act to ensure global warming is kept to a maximum of 1.5°C – failure to do so would reportedly result in catastrophic consequences – world leaders (and governments) are failing to meet the targets they set at Climate Change Conferences.

Many even argue that shareholders are not the only party involved in the company. Would it be possible for the directors to take employees, customers, suppliers, and local communities (hereafter referred to as ‘stakeholders’) into account when making decisions? This latter point brings into focus the struggle that takes place behind director decisions: should more focus be given to shareholders or stakeholders?

The Companies Act 2006

Section 172 of the Companies Act 2006 (CA 2006) imposes a duty on directors to ‘promote the success of the company for the benefit of its members as a whole’, with ‘members’ meaning shareholders. It lists factors which the directors may take into account when undertaking this duty. In particular, the factor under Section 172(1)(d) – the impact of the company’s operations on the community and the environment – opens a window to promoting the interest of stakeholders, referred to as 'enlightened shareholder value' (ESV).

Interpretation of this fiduciary duty has the greatest impact on the operating standards of directors as, through ESV, directors must consider the interests of shareholders without ignoring the interests of stakeholders. These interests are likely to conflict: as shareholders own rights to profits, they are more likely to be interested in the directors making decisions that maximise profits instead of those that benefit other aspects of society. If the directors failed to do so, the shareholders would likely take action to protect their own interests, either by selling their shares or petitioning to remove the director, or threatening to do either.

Nonetheless, because all operations undertaken by companies create externalities which impact stakeholders, it makes sense that the wishes and needs of these stakeholders should be taken into account. As a result, ESV creates a certain moral and ethical aspect which directors must incorporate into company projects.

Securing public registration for a company adds additional weight to stakeholders’ voices. If public companies fail to control or combat the negative impacts that they have on the planet – whether that be their carbon footprint or their effect on wages – legislative, disciplinary or societal action may be taken against that company in order to ensure there is a change in the decision-making positions of those companies.

This is not necessarily a negative thing, both for society and for the company itself. After all, it can be argued that a learned stakeholder may be able to give a more informed opinion than the average shareholder about how the company should act. A stakeholder is, of course, more likely to view matters in a more holistic way, rather than taking interest only in the maximization of profits. Approaching issues with this mindset places less restrictions on how the company might act. For example, the taking of environmental precautions, which would increase a company’s costs and potentially make it less profitable, might be blocked from a purely shareholder-focused point of view; on the other hand, the viewpoints of a stakeholder, who appreciates the costs resulting from environmental damage and the fact that taking such precautions might have long-term profit benefits, may now be accepted.

Various subsections of Section 172 of the CA 2006 encourage directors to look at the long-term effects of the company’s operations on a variety of stakeholder groups. Indeed, the post-war generation – often referred to as ‘baby boomers’ – has enjoyed such benefits partly due to a lack of understanding and anticipation of any subsequent long-term effects. The world at present was shaped by past generations and given the previous lack of environmental legislation, it is crucial to redefine what companies should aim for. It is now accepted that humanity no longer lives on a planet with abundant resources and must begin to look for sustainable solutions.

Need for additional legislation?

Since the 1960s, there has been an environmental legislative spree in the USA, limiting the amount of pollution companies can produce in any area. Despite this, the USA remains one of the biggest polluters on Earth. This signifies that environmental legislation alone will not change the way companies act. Corporate law therefore needs to evolve.

At first sight, it appears that English law started to do so in the CA 2006 through the Section 172 checklist. However, it must not be overlooked that the factors in Section 172 are combined with the phrase ‘must have regard’. As a result, it is voluntary whether directors take such factors into account when making decisions. The present law, therefore, does not go far enough. Indeed, Gindin and Panitch write that:

[I]f we are serious about incorporating environmental needs into the economy, this means changing everything about how we produce and consume and how we travel and live.

External regulation through environmental law?

To truly have effect, we must enforce such obligations through law. Doing so may necessitate ‘external regulations’: those which indirectly limit the decisions made internally in a company. Environmental law is such a kind of regulation and has achieved a certain improvement.

However, environmental law is limited only to specific areas regarding the environment. Thus, unless one of the directors is an expert on those limitations, there is information asymmetry between the aim of the regulation and subject of those regulations. If, for example, the directors ignore or are unaware of the impact of their operations, they cannot accommodate those operations to the requirements of the regulations, rendering the regulations unhelpful.

Additionally, any form of regulation requires a controlling system that will ensure regulations are maintained, increasing the time for operations to begin. Therefore, where directors decide through their own discretionary power to change the way the company operates, managers would receive direct orders that could not be delayed – directly in contrast to the expectations of external regulations – which instead go through a lengthy process.

Most importantly, the difference between imposing external regulations and amending the current role of directors is that the economic market in which companies operate is dynamic and those that adapt quickly have the best chance of surviving. On the other hand, the legal system was created to be predictable through policies and precedence. External regulations are in this sense limited and support the view that incentives to improve the positions of corporations towards the environment should be made via corporate regulations, whereas traditional regulatory approaches require legislation to be shaped so that corporations take into account environmental factors more seriously than they have been up until now.

Both also require a tremendous amount of information to be effective. Filling the gaps in environmental protection left by traditional regulatory approaches requires regulation that focuses more on changing decision-making procedures within corporations, ensuring environmental factors are taken into account when decisions are being made.

Subtle pressure through corporate law?

As such, Gail Henderson notes that the reason for imposing this duty under corporate law statute, rather than under environmental legislation, is to make the duty part of the legal framework governing how directors make decisions.

Section 172(1) of the CA 2006 provides it is up to directors to make the correct decision. It is also for them to follow the legislation. Corporate legislation therefore can support those moral decisions by subtly imposing them on the directors. If there was a change in legislation – say, a more decisive word used for Section 172 regarding the environment and stakeholders – there would be an increased standard in the industry. In addition, competition could develop in the market to become the most competitive on the grounds of being the best at protecting the environment.

This latter point would feed into the requirement under Section 172(1)(e)  of the CA 2006 to consider ‘maintaining a reputation for high standards of business conduct’. However, consideration should be given to exactly who determines what the standards are and what makes them ‘high’. This question gives rise to market competitiveness; whomever seems to be the most competitive has the best chance to survive. Indeed, damage to reputation is a factor to a company’s profit. If an event occurs that may damage the reputation of the company, the impact on the profits may be greater than expected. Consumers sensitive to brand image are highly likely to switch to another company as they will not want to be connected to the company, thus decreasing the revenue. Likewise, if a case is brought to a court, a cost – for either penalty, proceedings, or both – may be imposed on the company. Ensuring reputations are not damaged by a scandal, for example Nike’s child labour or the connection between Dow Chemicals and the Bhopal disaster, therefore decreases potential profits.

However, the legislation simply imposes the low limit of maintaining business standards. This gives the directors an opportunity to rise above those standards and improve their reputation. Consequently, they would become more competitive and, for other companies to catch up, they would have to raise their standards too. It would therefore seem that no legal intervention is needed.

Nevertheless, taking a step into the unknown is risky and decreased profit in the short run is likely to discourage directors from such steps. Indeed, Shane Guster argues that:

When people think first and foremost of their own self-interest, they are much less likely to modify their own behaviour or support government intervention designed to achieve environmental objectives.

The amendment of existing corporate legislation is therefore crucial to rebuild the hidden mechanics of companies so that they fit into the world the society currently lives in. As such, if policy makers fail to connect environmental values with those companies, there will be no reason for directors to change course of their operations from profit-maximizing behaviour to one of morality. As Margaret Thatcher stated:

Economics are the method; the object is to change the heart and soul.

Derivate Claims

Incentive to not err is provided, to some extent, by derivative claims under Section 260 of the CA 2006. Under this section, a company shareholder may bring an action against the director on behalf of the company. This ability of shareholders reinforces the fiduciary duty of the directors.

However, it can also be used as a shield rather than a sword. Section 260(3) defines specifically under which circumstances an action can be brought, as further discussed by Abouraya v Sigmund [2015] and Langley Ward Ltd v Trevor [2011]. Moreover, by incorporating environmental factors into the decision, it is unlikely an action will be brought under Section 260 of the CA 2006 unless the company suffers one of the causes specified under Section 260(3) of the CA 2006, namely, an ‘actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director’.

Conclusion

Legislation has provided basic guidelines for directors, yet that is all they are: guidelines. Directors are not bound to take them into account if they find that the company would be better off if, for example, environmentally conscious steps are not made. However, the legislation must go one step further and ensure that the environment is taken into account. By exploiting the innovative capacity that leads to greater competitiveness, companies could achieve a decrease in the environmental impacts as long as the directors are pushing for such innovation.

To make such changes more attractive, one must take into account the perception of any legislation. Henderson notes that since:

almost any human activity has some effect on the natural environment, controlling corporations’ environmental impacts cannot be achieved through “thou shalt not” criminal law-style prohibitions.

Amending the phrase ‘have regard’ in Section 172 of the CA 2006 to a more decisive one, wherein directors are required to – as opposed to strictly refraining from acting in certain ways – must also seriously take stakeholders into account, would undoubtedly have several benefits. It would fill in the gaps left by external regulations and create a better perception than by imposing a negative duty. In addition, directors would take into account the impact of the company before it is too late while ensuring a successful performance of the company. It is submitted that there is therefore no reason to not incorporate obligations to minimize environmental impact as a core into the fiduciary duty.

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Tagged: Company Law, Environmental Law, Regulators

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