Con Keating, seasoned observer and friend of the High Pay Centre, responds to Chris Philp MP’s paper
This blog is a response to the High Pay Centre publication “Restoring Responsible Ownership” produced by Chris Philp MP. There is a companion High Pay Centre blog “Responsible Capitalism”
The principal issue with this paper is that, even though clearly well-intentioned, it is founded on a fallacious premise, that shareholders own the company.
A Company is a juridical person. This means that it owns itself in intrinsically the same manner as a natural person. It also means that this person has responsibilities with respect to civil society in similar fashion. The most important point here though is that it renders the concept of an ownerless corporation evidently fallacious.
Note that this is quite separate from any limitation of liability to third parties in tort, though that is an extremely valuable further concession granted on incorporation. There are some unique responsibilities falling upon the founders of a company which arise from these characteristics, but as they are not central to this, I shall omit their discussion here.
The juridical person is reified and substantiated by the board, in the direction process. The board delegates certain limited powers to its management. This has explicit form in the European term Fonde de Pouvoir.
This is all well recognised by action on the part of all stakeholders. They negotiate with, and contract with the company through these authorised agents. This is true of all stakeholders including shareholders. Indeed, it is not uncommon for some contracts to require explicit company approval, by act of the Board. These contracts give rise to certain limited property rights for the stakeholder.
The acquisition, for example in a secondary market, of an instrument conveying some element of these rights involves tacit acceptance of the previously negotiated terms and the validity of the process which created them. Property rights are defined and enforced by the state .
Shareholders have very limited rights in the sense that there may be and usually are prior claims on the assets and cash flows. The shareholder is very much the residual claimant in liquidation and has rights to dividends awarded at the discretion of the board. Note that property rights are exclusive – the same right cannot be pledged, assigned or awarded among more than one class of stakeholder. Mere information does not share this property. Indeed, of the many rights of a person, there are many which may be retained by that person. This gives rise to the possibility that a company may have value in the sense of being wealthy in its own right – retained earnings are an example. Contrary to the popular belief, these are only the property of shareholders in a liquidation; prior to that, their disposition, if any, is at the discretion of the Board of Directors. Herein lies the argument for companies paying income taxes in their own right, rather than being the pass through arrangement usual for partnerships.
It is also worth noting that all stakeholders have responsibilities, though contingent liabilities may be a better description, arising from their possession of these limited property rights. Notwithstanding limited liability, it would be possible to take derivative action against a shareholder if that shareholder had actively encouraged the Board to engage in illegal activity; this would be joint enterprise, though it may be that this would need to be repugnant in nature to ensure that it is justiciable. Of course, what is and isn’t repugnant is a matter social norms and conventions.
It was extremely disappointing that the only stakeholders considered were employees. There are many others, and as Chairman of the European Bond Commission of EFFAS, the lack of recognition of debt holders was a glaring absence. I would make three points here;1) it would be far simpler to introduce limitations on executive pay through covenants as these would require absolutely no changes in corporate law, 2) debt markets are a far larger source of capital and financing for companies than equity, 3) the origin of the external audit lay in the desire of these creditors to verify compliance with covenants and warranties.
I also noted the visceral neo-liberal antagonism to employee collectivism when, inconsistently, Chris Philp was suggesting precisely such collectivism among shareholders. The proposal amounts to the award of a particular property right to shareholders, which is currently unallocated. This is problematic in the sense that it is inequitable among stakeholders. We should also recall that stakeholder interests are not well-aligned; in fact, they are often in conflict. The history of the early private equity markets was one of the explicit exploitation of debt holders. The shareholders would sell (at an inflated price) and cease to be stakeholders and the private equity shop would then introduce much senior debt, reducing the value of the pre-existing creditors’ claims; the shareholders and the acquiring company were colluding to extract value from other stakeholders. Publicity and appropriate covenants now greatly restrict the viability of this strategy.
The main point though is that there are incentives for management and shareholders to collude and extract value for their own benefit at the expense of other stakeholders, such as partial liquidation through share repurchases. These proposals would reinforce that position.
My reaction as a creditor would be clear; if I did not simply decline to lend at all, I would in my covenant requirements restrict payments to shareholders by way of dividends or share repurchases and I would introduce a claw-back clause applying to all executive compensation in excess of some basic salary – say £250,000.
In a nutshell, shareholder primacy is nonsensical. Of the three proposals:
Mandatory Publication of Pay Ratios – will be interesting but this is most unlikely to have any effect upon the pathological and those who mimic in the relative game of positional goods acquisition.
Binding Annual Votes on Pay – I think this is open to abuse on a grand scale, with secretly agreed collusion between shareholder and management figuring large.
Mandatory Shareholders Committee – this will reduce to a box ticking exercise; yet another committee. I am not exactly impressed by the Investors Forum, least of all its secrecy.
It will be interesting to see the manner in which these issues are framed in the coming consultation paper.