Economic impact of radical reform of 'shareholder value' in company law

Paul Sweeney: A couple of weeks ago, David Jacobson raised the issue of the conflicts which the auditing profession can have, and how its role can be conflicted when it acts on other business matters for the same firms which it audits.

With the economic crisis, important microeconomic issues can be neglected. Reform of these issues a decade ago could have contributed to a much reduced economic crisis today. For example, it is widely recognised that the lack of control by the boards of major financial companies of their own top executives, led to the crisis (in this regard, today's piece in the Financial Times, on the manner in which mutual funds have contributed to excessive executive pay in the States by voting in favour of compensation plans, is of interest). Yet this vital issue of corporate governance is little discussed in Ireland.

A key debate now has to be to question the fundamental basis of company law in Ireland (and in the UK and US). The Anglo-Saxon model is based on shareholder value, almost exclusively. To focus exclusively on shareholder value leads to managements’ interests dominating, especially where shareholders are diffused. It also leads to short-termism. But all is not lost. Things are changing, and radically. However, in Ireland, we have hardly noticed.

On 12 March, the “Father of Shareholder Value”, Jack Welch, admitted that the whole basis of company law, based on shareholder value was wrong. He had espoused this narrow view everywhere in his syndicated columns, and as the domineering CEO of the huge conglomerate GE.

Welch did not just recant. He said that the shareholder value was “a dumb idea”. He had promoted “shareholder value” since he made an influential speech in 1981. Now, he says “shareholder value is the dumbest idea in the world”. Today, he admits that it is a result and not a strategy. He now admits that employees, customers and products matter!

It is essential that there is a debate on this important micro-economic area by economists, academics and business-people. It seems obvious after the economic debacle that the broader “stakeholder interests” should now be rooted in Irish company law, and the sooner the better. This would also help ameliorate Ireland’s tarnished enterprise reputation.

Even with the existing narrow standards of Irish company governance, much of which is based on voluntary codes of practice, it is still poorly executed by companies. A recent Grant Thornton Governance review on the extent of compliance with the Combined Code by Irish Companies found approximately 50% of Stock Exchange companies non-compliant. It concluded that the voluntary approach to the Code has failed, and that the only acceptable solution is to incorporate governance principles into legislation. The report pointed out that too many Irish companies are lacking in their standards of practice and adherence to the Combined Code or core principles of transparency and independence.

The government must ensure that it enacts legislation to enforce existing corporate governance measures, otherwise it will be difficult to restore international confidence in Ireland as a suitable place to invest and to do business. But just as importantly, the balance of power is too narrowly vested in top executives under the shareholder value dominated Irish company law. This must be radically reformed.

Ireland has a Company Law Review Group but, to my knowledge, it is not even debating this vital issue. The government should ask the Group to conduct a review of the area, and to recommend fundamental changes in the basis of company law. The corporate governance laws must be broadened out to give certain rights in law to all other stakeholders in companies, from suppliers, customers and employees to the community, the environment etc. However, noting the conservative composition of the CLRG, this won’t happen unless the Group itself is changed to reflect society’s interest, and not largely those of what is perceived to be business interests.

The best way to demolish Cosy Irish Capitalism, as the too oft-quoted “Financial Times” editorial called our economic governance system, is to shift power from shareholders only (usually including the top executives) to all stakeholders. Let’s try and have a debate.