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Secondly, in most countries the tendency in recent years has been to increase the statutory requirements for corporate disclosure and the regulation of corporate affairs. Further, the tendency to resort to civil litigation has been increasing. The threat of court action has become a significant element in the corporate governance process in some countries. This has been particularly the case in the United States, where class actions (that is the ability to join all members of a class, such as shareholders, in a single action) and contingent fees (that is the process of a lawyer offering to take a case on the basis of tees contingent on the success of the case and the size of any damages awarded – a practice, incidentally, that is prohibited in many other countries) have encouraged such litigation. But other countries, such as the United Kingdom, Australia and Canada, have also seen significant increases in actions being brought against companies, their auditors, their boards and individual directors by shareholders and others alleging, Inter alia, negligence and directors' failure to exercise their proper duties of care and trust.
Thirdly, despite the significant differences in the legal position of directors between jurisdictions, there are a few very general points that are broadly applicable to directors everywhere.
E. Responsibilities to the Shareholders
In most cases directors are formally appointed by the shareholder members of the company. As we saw in Chapter 1, ownership is the underlying basis of power to nominate and elect directors, even though in practice nominations for new board members may come from the incumbent board, which might also fill casual vacancies. Nevertheless the shareholders, meeting together in a properly convened meeting, typically hold the confirming power. Exceptions to the general rule of shareholders appointing directors include some state-owned corporations where the government exercises that power under the relevant statute, and where the articles of association of a company provide otherwise.
Consequently, a director's basic responsibility is to the shareholder members. As we will explore subsequently, boards need to provide strategic direction for the business, setting relevant policies, and to supervise the activities of top management. Further, the board is required to be accountable to the members, including the requirement to present regular reports and accounts, duly audited in most cases, in the statutory form. In some jurisdictions these accounts are filed and are available for public inspection.
F. Directors' Obligation to Honesty and Integrity
In almost all jurisdictions a company director is expected to act with honesty, integrity and candour towards the company – in particular its members. This fiduciary duty is to the company as a whole. In practice this can be difficult if, for example, a dominant parent company exercises power over a subsidiary in which there are minority outside shareholders. Decisions must be taken in good faith for the common good. British-based common law allows directors to determine the best interests of the whole, subject to the right of appeal to the courts; directors of American companies owe specific fiduciary duties to any minority shareholders.
The primary duty, in other words, is to act honestly in good faith, giving all shareholders equal, sufficient and accurate information on all issues that could affect their interests. Directors may not treat a company as though it exists for their personal benefit.
A director, consequently, must not make a secret profit out of dealings with the company. His duty is to disclose any such interests to the board and to abide by their decision as to what is in the company's best interests. Insider trading, that is dealing in the shares of a quoted company, on the basis of privileged, price sensitive information is considered improper in all jurisdictions and is a criminal offence in most (though not all).
A further duty imposed on directors, either by statute or case law, is the duty to exercise reasonable care, diligence and skill in their work on the board. The interpretation of what constitutes such reasonable skill and care varies between countries. A general proposition is that the standard of professionalism now expected of directors, around the world, is significantly higher than a few years ago. Courts will act if fraudulent or negligent behaviour is alleged, or where there seem to be abuses of power by directors: it is not the role of the courts to second guess commercial judgments made by directors, even though by hindsight they have been misguided.
G. Theories of Corporate Governance
The original corporate concept enshrined a philosophical assumption about the nature of man, one that has been reflected in subsequent developments of company law – a view that man is essentially trustworthy, able to act in good faith in the interest of others with integrity and honesty. This is implicit in the fiduciary relationship required of directors. Certainly checks and balances are involved, but only to catch the occasional rogue.
This perspective has been termed stewardship theory (Donaldson and Davis 1988) and is consistent with some behavioural theories; for example with theory Y of Macgregor, whose principal propositions include:
1) that management is responsible for organizing the productive elements – men, machines, materials and money – in the interests of economic ends;
2) that people are not by nature passive or resistant to organizational needs;
3) that the motivation, the potential for development, the readiness to direct behaviour towards organizational goals are all present in people.
However, one of the earliest studies in the field of corporate governance, by Berle and Means in 1932t provided a challenge to the conventional assumptions of stewardship theory. They pointed out that] ownership in large public companies had become separated from management. No shareholder owned significant proportion of the equity capital. The top managers themselves held only very small stakes, if J any. Consequently the shareholders were no longer able to monitor the affairs of the business in which they had invested – they had surrendered their control to management. Moreover, the interests of owners and management was likely to diverge – the former seeking increased corporate worth reflected in share price and dividend stream, the latter in job security, reward packages, and other personal benefits.
Berle and Means contended that managers did not have the same interest and motivation as the owners to make full and efficient use of the corporate assets. Consequently the owners had to introduce other means to ensure an alignment of owners and managers interests. Jensen and Meckling (1976) extended the argument by assessing the agency cost of this alignment. They define the shareholder relationship as one of agency: a contract under which one or more persons (the principals) engage another person (the agent) to perform some service on their behalf which involves delegating some decision making authority to the agent. If both parties to the relationship are utility maximizers there is good reason to believe the agent will not always act in the best interests of the principal.