Set out below is my article published by The European Financial Review on How shareholders, corporations and directors can become ethical, August 26, 2019, pp. 28-32, <https://www.europeanfinancialreview.com/how-shareholders-corporations-and-directors-can-become-ethical/>. It has posted today to provide a reference for a "Rear Window" article published on the back page in the Australian Financial Review today, 30 September on: "Governance Institute of Australia parrots Computershare". Refer to: https://www.afr.com/rear-window/governance-institute-of-australia-parrots-computershare-20200929-p5608a
How shareholders, corporations and directors can become ethical
A difficulty for individuals wanting to become an ethical director is that most corporations are organised as centrally controlled hierarchies that provide power for managers to exploit stakeholders. Ethical directors become reliant on the same managers to report problems that they may have created and/or do not know about.
Another systemic challenge is that publicly traded corporations hide insider traders. This is because corporations do not require shareholders to routinely disclosure their Ultimate Owners and Controllers (UOCs). Some jurisdictions may require this disclosure for companies offering to take over another. Ethical directors would require corporations to amend their constitutions to remove both above problems.
Neither or the two problem are removed by so called “For Benefit” or “B” corporations. They may not disclosure their UOCs and they likewise replicate the same centralised toxic power relationships found in political dictatorships.
Ethical directors would require their corporations to do no harm. The largest investor in the world, Blackrock Inc. with $US6.4 trillion under management wants to do more. Larry Fink, the CEO of Blackrock wrote to all the CEOs of their investee companies in 2018 wanting them to: “benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate.” [i] To achieve this outcome Fink wants “A new model for corporate governance”.
A new model is required because the existing model is based on the centralised power of toxic hierarchies accountable only to shareholders, not stakeholders or society. However, shareholder primacy is still accepted by so-called “good” governance principles and practices.
A new model is required to provide shareholders and their ethical directors formal feedback from stakeholders, independently of management if stakeholders are exposed to harms, risks, mismanagement, misconduct or malfeasance. In this way ethical directors obtain a requisite variety of information, independent of management, to evaluate management and the strengths, weaknesses, opportunities and threats to the business.
Ethical directors can escape the hegemony of management information that can shut out or frustrate due diligence inquiries by conscientious directors. Like political dictatorships command and control hierarchies shut out and punish dissidents and whistleblowers. Finks specifically wants directors “ to become less likely to succumb to group think”.
More importantly, the new model makes it possible for ethical directors to directly harness the information, knowledge and wisdom of their stakeholders to promote mutual interests and trust. It allows ethical directors to meet the call of Fink: “to bring other critical stakeholders to the table.” Critically, it allows ethical directors to cross check management reports for gaps, biases, errors and/or fake news.
Formal processes of stakeholder feedback provide ethical directors with information to answer the questions raised by Fink:
Companies must ask themselves: What role do we play in the community? How are we managing our impact on the environment? Are we working to create a diverse workforce? Are we adapting to technological change? Are we providing the retraining and opportunities that our employees and our business will need to adjust to an increasingly automated world? Are we using behavioural finance and other tools to prepare workers for retirement, so that they invest in a way that will help them achieve their goals?
To encourage and protect the ability stakeholders to report independently, provisions need to be introduced into corporate constitutions and/or by-laws to recognise stakeholders and give them a formal voice. These provisions would allow any common interest stakeholder constituency to appoint its own advisory board and/or stakeholder advocates. An approach that is likely to be more cost effective and efficacious than employing internal ombudspersons, customer complaints officers or mediators. Stakeholder elected boards creates a creditable basis to establish trust.
The interest of stakeholders to become continuously involved in corporations has been demonstrated by the existence today of Citizen Utility Boards (CUBs) organised by Ralph Nader over thirty years ago[ii]. Stakeholder boards could establish Key Performance Indicators (KPIs) for interested shareholders like Blackrock to become informed if corporations were providing stakeholder benefits. Governments could use stakeholder KPIs to evaluate their regulators established to protect stakeholders.
No business can exist without employees, customers, suppliers, host communities and ecology of sub-contractors, distributers, agents and representatives. Management typically engages operationally with stakeholders to obtain access to innovations and/or other operating advantages like Just-in-time supply lines, Total Quality Management of goods and services. Integrating stakeholders into the governance architecture of business provides a formal framework to protect and enrich the value of stakeholder added contributions.
Including stakeholders in the governance architecture of firms introduces a rich source of bottom up networks providing feedback on business strengths, weaknesses, opportunities and threats. Network governance allows complexity to be simplified reliably from the bottom up. This is not possibly in top down hierarchies that rely on mangers simplifying complexity incompletely through each level of the chain of command. A process that is subject to error, biases and/or overlooking existential risks, threats and opportunities. This explains why nature has designed our brains to adopt network governance without any chief executive neuron and so no command and control hierarchy.
This new model for corporate governance is actually a very old model found in nature. It provides profound mutual benefits. By benefiting all stakeholders corporations become a “common good”. Such socially desirable businesses could find it easier to attract and retain socially conscious employees. Common good businesses would establish a broad political constituency for promoting corporate capitalism rather than alternatives.
Common good corporations would enrich democracy and mitigate social and political alienation that supports extreme forms of dysfunctional activism. Critically, it allows corporations to promote global common goods to further the United Nations Development Goals to sustain humanity on the planet.
To promote trust with all stakeholders, ethical directors would need to remove the systemic conflicts of interests that arise from directors possessing both the power to manage the business with the power to govern the corporation. As a result directors obtain absolute power to identify and manage their own conflicts of interests. According to Professor Bob Tricker, who pioneered the study of corporate governance, this creates the ability of directors to mark their: “own examination papers” [iii].
The separation of director powers does not require any change in the law, only a change in the corporate constitution to create a Board of Governors elected by shareholders separately. Your author has twice used this approach to raise millions of dollars to fund two businesses he co-founded, one that later became publicly traded[iv]. Senator Andrew Murray recommended to the Australian Parliament that all listed companies establish governance boards[v]. Unlike the European two-tiered system shareholders would appoint both boards.
Besides removing systemic conflicts of interest, a Governance board reduces the workload of ethical directors. This arises because the Board of governors replaces the need for directors to evaluate themselves, manage their own conflicts of interest or form committees to determine director nomination, remuneration, audit or manage any other conflicts that may arise like the conduct of AGM’s at which shareholders hold them to account. The reduction in workload allows ethical directors to be more focussed on business operations.
Ethical directors would also want to remove insider trading and/or manipulation of corporate securities. This problem could be substantially removed by corporate constitutions introducing sunlight share trading.
Sunlight trading can be achieved by corporate constitutions requiring all shareholders to disclose details of their UOCs on the web page of the corporation. It would disclosure shareholder relationships to any director, adviser, officer, employee or other stakeholder of record. Disclosure would also be required of any contingent contracts or arrangements like liens, options, vote-lending or derivatives relationships. New investors seeking to purchase shares would likewise be required to make a similar disclosure. Such disclosures are also required because the nature of buyers or sellers can be price sensitive information.
As all transactions and relationship are open to public inspection, any member of the public would have the ability to identify any time later any inadequate disclosures. This could lead to invalidating transactions to establish a self-regulating regime for insider trading or manipulation.
Another advantage of sunlight trading is that it provides a basis for corporations to trade their own shares without the expense of using a third party exchange agent and the complications introduced by assuring settlements. The spread of employee share ownership plans in the US has resulted in more US companies trading their own shares than there are publicly traded companies in the US.
The Australian Securities Exchange (ASX) trades its own shares but it does so covertly so traders cannot know the nature of their counter party. This is serious regulatory oversight. Knowing with whom you are dealing with is one of the most basic requirements for ethical business.
Ethical directors would want to protect both public investors in their shares and their shareholders from opportunistic brokers, dealers and advisers covertly becoming counter parties or operating through what is described as “dark pools”. Bloomberg reports that more shares of New York Stock exchange companies are traded through dark pools than are traded on the Exchange[vi].
The needs of ethical directors illustrate the irrelevance of so called “good’ governance principles or practices. Its time replace them with outcomes that can make corporations a common good and capitalism compatible with sustaining humanity on the planet.
[i] Fink, L. 2018. A sense of purpose. Blackrock. Annual Letter to CEO’s, New York, <https://www.blackrock.com/corporate/investor-relations/2018-larry-fink-ceo-letter>.
[ii] Givens, B. 1991. Citizens’ Utility Boards: Because utilities bear watching. Centre for Public Interest Law, University of San Diego, School of Law, CA. <http://www.cpil.org/download/CUB_Report.pdf>.
[iii] Tricker, R.I. 2011. New Frontiers for Corporate Governance. Hong Kong Institute of Chartered Secretaries, January, p. 2, <http://www.bobtricker.co.uk/assets/bob-tricker---new-frontiers-for-corporate-governance.pdf>.
[iv] Barwon Cotton Ltd. and JAC Tractor Ltd. described in Turnbull, S. 2002. Corporate Watchdogs: Past, present and future? At: <https://ssrn.com/abstract=608244>.
[v] Murray, A. 1998. Minority Report: Report on the Company Law Review Bill 1997, March. Australian Parliament, https://www.aph.gov.au/Parliamentary_Business/Committees/Joint/Corporations_and_Financial_Services/Completed_inquiries/1996-99/companylaw/report/d01