Corporate Governance (with Aubrey Silberston)


The issue has existed for as long as there have been social institutions; yet two decades ago, the term ‘corporate governance’ had not been coined.


Professor John Kay

Professor Aubrey Silberston


The issue has existed for as long as there have been social institutions; yet two decades ago, the term ‘corporate governance’ had not been coined. The matters involved were of concern only as an esoteric branch of commercial law. Today, the subject is a central political and economic issue around the world. With the collapse of socialism and centralised planning, attention is focused on different styles of capitalism (Albert, 1991; Blinder, 1995; Hampden-Turner and Trompenaars, 1994). Corporate governance both exemplifies and influences these styles.

The Nature of the Corporation

The 1985 Companies Act introduced into British law a distinction between a limited company and a PLC. The distinction has little practical significance (a PLC must have a share capital of £50,000 and may, but need not, offer its shares to the public). Many people think, mistakenly, that the distinction between a PLC and other firms corresponds to that between quoted and unquoted companies.

The reason for the distinction is that it already existed in several other European countries. The French regime is perhaps the one to express the objective most clearly. Most large French companies have the status of Societé Anonyme, and any with more than fifty shareholders must. The governance structure of a Societé Anonyme is the subject of detailed statutory prescription. The artisan who trades under a corporate vehicle mainly in order to limit his personal exposure to the risks of his trade will normally operate through a SARL (Societé à Responsabilité Limité). A SARL is subject to minimal regulation, mostly concerned with registration. Germany maintains a similar distinction between the Aktiengesellschaft (AG) and the Gesellschaft mit beschränkter Haftung (GmbH). As in France, the structure and organisation of the AG, and also of the large GmbH, is the subject of detailed statutory prescription.

British law, by contrast, makes no real distinction between ICI and BT on the one hand and the incorporated local plumber or garage on the other. Indeed, British statute law is virtually silent on how corporations are to be organised. Since the corporation is regarded as a creation of private contract, obligations on companies are mainly there to prevent abuse of the privilege of limited liability, and concern formal matters such as registration and audit. Corporate governance is a matter for the company itself to determine and to describe in its articles of association. The legal system therefore provides, and is intended to provide, no more than a mechanism for the negotiation and enforcement of these contracts. The American position is broadly similar.

These differences are not matters of accident. Nor are they just questions of law, though they are partly a product of the difference between the private law tradition of England, based around the enforcement of contract, and the administrative law general in continental Europe, where behaviour is regulated by public codes. They reflect basic differences in the ways large corporations are perceived in the countries concerned. In continental Europe, and in Japan, the corporation is an institution with personality, character, and aspirations of its own. Its objectives encompass the interests of a wide range of stakeholder groups – investors, employees, suppliers, customers and managers – but cannot be equated with any of them. The corporation is therefore naturally perceived as a social institution, with public responsibilities, and a proper public interest in defining the ways in which it is run and governed. In the Anglo-American environment, the corporation is a private rather than a public body, defined by a set of relationships between principal and agent. Shareholder-owners, too busy and too numerous to undertake the responsibility themselves, hire salaried executives to manage their affairs.

Much of the concern with corporate governance arises from the tension between the Anglo-American model and the practical reality of how large corporations operate everywhere. The organic model of corporate behaviour – which gives to the corporation life independent from its shareholders or stakeholders – describes the actual behaviour of large companies and their managers far better than does the principal-agent perspective, and that this is as true in Britain and the United States as it is in Japan.

Yet the near unanimous view of those who criticise the present structure of corporate governance is that reality should be made to conform to the model. The principal-agent structure should be made more effective, through closer shareholder involvement and supervision. All experience suggests that this is not very likely to happen, and would not improve the functioning of corporations if it did. The alternative approach – of adapting the model to reality rather than reality to the model – deserves equal consideration. After all, no one disputes that the German and Japanese models produce many successful companies.

Companies in Britain and the United States

The term governance invites comparison with political structures. Most experience of governance systems is derived from comparative politics. There are obvious resemblances between the system of corporate governance we have and entrenched authoritarian political systems, such as those which prevailed in Eastern Europe before the fall of the Berlin wall.

The governing elite is self-perpetuating, in the sense that it appoints its own members by reference to its own criteria. The process of succession is normally internal and orderly, but from time to time there are peaceful palace revolutions and occasionally externally induced coups d’etat. The hostile bid for the corporation parallels the military take-over of a government. There is a nominal process of accountability through election of directors, but in practice it is defunct. There are no genuine alternative candidates and incumbents are re-elected with overwhelming majorities. The formal ritual of the corporation’s annual general meeting parallels the meaningless elections which routinely returned Mr Brezhnev and Herr Honecker to power. The flow of information about the affairs of the organisation is managed by incumbents and, except in times of acute crisis, is uniformly favourable and optimistic in tone.

Authoritarian political structures sometimes work well. They offer opportunities to make rapid change and to impose firm leadership which more accountable systems lack. In the hands of honest leaders of determination and vision, they give opportunities for stability and long-term planning which democratic regimes often find difficult to achieve. One might cite the practical governance of Lee Kwan Yew’s Singapore, although it is difficult to think of many other examples.

There is an important reason why this authoritarianism is less disastrous for companies than it has generally proved in politics. Many firms operate in competitive markets. So deficiencies in performance are more evident in corporations than in political systems, and internal and external pressures for reform and improvement build up more rapidly. Competition ultimately works for governments as well, and it was, above all, the failure of Eastern European regimes in economic competition that brought about their downfall, although the process took many years. But not all firms operate in competitive markets, and for these, such as privatised utilities, governance issues are still more acute.

For all but the most remarkable of men and women, authoritarian structures are insidiously corrupting. Leaders hang on to power too long, and many prefer to undermine those who might seek to replace them than to develop potential successors. Cults of personality develop, and are supported by sycophantic lieutenants. These are often associated with inappropriate accretion of privileges, and excessive fascination with the trappings of office. Slogans replace analysis, rallies replace debate. There is an alternation between periods of too little change and phases of instability in which there is too much. These features are today as commonplace in business as they were in politics. Authoritarian governance structures have a deservedly bad reputation.

And there is another way in which Anglo-American corporate governance curiously mirrors the Eastern Europe of the past. Both structures claimed legitimacy by reference to what was, in reality, empty rhetoric. Socialist bureaucrats purported to exercise power on behalf of the workers. They argued that their devotion to the interests of the workers was such that it did not matter that the workers were not involved in the process of government in any observable way; indeed, that to so involve them would inhibit the capacity of their leaders to promote their interests. The managers of many large British and American companies similarly defend their positions by claiming to act in the interests of the shareholders. Yet, if shareholder intervention (much of which is in fact ill-informed, frivolous or motivated by factors other than the interests of the company), seriously interferes with managerial prerogatives, it frequently encounters fierce resistance.

Who “Owns” the Company?

It is often said that a company is owned by its shareholders. It is, however, not very clear what people mean when they say this. At the very least, when we say “BT is owned by its shareholders”, we are using the word “own” in a slightly different sense to the one we employ when we say “I own my umbrella”. What do we mean by ownership? What could we mean by the ownership of a company?

Most legal theorists point to the classic exposition of the nature of ownership developed forty years ago by AM Honoré (1961). Honoré noted that what we mean by ownership and property has varied across times and cultures. But, he concluded, “there is indeed a substantial similarity in the position of one who “owns” an umbrella in England, France, Russia, China. In all these countries, the owner of an umbrella may use it, stop others using it, lend it, sell it, or leave it by will. Nowhere may he use it to poke his neighbour in the ribs or knock over his vase”. Honoré went on to explain that there was no simple definition of ownership: rather there are a series of characteristics of ownership, and if sufficient of these characteristics are identified, it is sensible to describe the resulting relationship as ownership. Honoré lists eleven such characteristics.

There is the right of possession: I may hold my umbrella in my hand, place it in my briefcase or an umbrella stand. There is the right of use – I am free to put it up whenever it is raining – or, for that matter, when it is not. There is a right to manage – I can tell the cloakroom attendant where to put it and if I lend it to you I can insist that you shake off the water before folding it up again, however irksome you may find that requirement.

I have a right to the income from it – if I rent out my umbrella to golf fanatics on wet days, I can keep the revenue. And I have a right to the capital value – if I sell it, I pocket the proceeds. I enjoy a right to security from expropriation – if you steal my umbrella, I can call on the police to pursue you, and if the government nationalises it without compensation, I can appeal to the European Commission on Human Rights. I have the power to transmit my umbrella by sale, gift or bequest to someone else. Then there is no limit of time on these rights. I am, as it were, the freeholder rather than the lessee of my umbrella. I have, Honoré argues, a duty to refrain from harmful use of my umbrella – hence the restriction on my right to poke you in the ribs.

Then there is another particular legal characteristic which distinguishes from yours my property – it can be used to obtain satisfaction of judgement against me. If I fail to pay my debts, my umbrella may be seized by bailiffs. And there is a right of residual control. While I may lend you my umbrella, and you may enjoy all these other attributes of ownership for the period of the loan, when the term of the loan comes to an end all these rights in the umbrella revert to me.

These are the thing we mean by ownership of an umbrella. If we apply these tests, do BT shareholders own BT? Begin by noting the difference between the statement “BT shareholders own their shares in BT” and the statement “BT shareholders own BT”. There is not much doubt that the first of these is true. They enjoy the rights of possession of their shares – even under CREST, you can still insist on holding a physical share certificate if you want one. And no-one will dispute your right to the income from the shares, or to the capital value of your shares, or argue with you if you want to sell them or give them away. You may not use your shares harmfully – it is difficult to think of how you might – and your creditors may take them over when you fail to meet your obligations.

But none of this means that the owners of BT shares own BT – after all, investors own BT bonds, landlords own BT premises, and lessors own BT equipment, but no-one would suggest that BT itself is owned by these investors, landlords or lessors. The claim that BT is owned by its shareholders implies that there is something special about their contract with the company which means that they are owners, not just of that contract, but of the company itself.

Now whatever it is that is special about the company’s relationship with its shareholders, it does not seem to meet Honoré’s tests of ownership. Does a BT shareholder have a right of possession? Not at all: if he goes to a telephone exchange, or the BT head office, he will be turned away at the door. Does she have a right of use? Only the same rights to use its services – no more, no less – as any other BT customer. And the right to manage – somewhat tenuously.

What of rights to the income from the sale of BT’s services? Up to a point. The actual right is to the dividend declared by BT but, in principle, the shareholders collectively could vote to pay themselves the whole of the income. There again, the employees collectively could demand a larger share of the income, and are more likely to do so. And what of the capital value of BT? This shareholders are entitled to this only in the event of the liquidation of BT, an improbable event and one in which shareholders rarely in fact get anything back.

Shareholders do not have rights against the expropriation of BT assets: this was precisely the issue in leading case of Short vs Treasury Commissioners (1948, AC534 HL), and the shareholders lost. Shareholders cannot sell, gift or bequest BT assets (as distinct from their BT shares): they have no duty to prevent BT conducting itself in a harmful or abusive manner: and BT assets cannot be used to satisfy their debts.

Of Honoré’s eleven tests of ownership, only two (and these rather minor) are unequivocally satisfied by the relationship between BT and its shareholders: three are partly met: six are not fulfilled at all. We could make a better case, in fact, for saying that BT is owned by its directors. There is not much doubt that they have rights of possession and management, and the ability to decide on the disposal of its assets: theirs is the duty not to do harm: and with them lies both the right and the duty to take action if BT’s assets are expropriated. What they do not have is personal rights to income and capital, (although the development of options and incentive plans in certain other firms suggests that there are some directors who think they do).


Right Me over my umbrella BT shareholder of BT BT shareholder over BT shares BT directors over BT

Possession Yes No Yes Yes

Use Yes No Yes No

Management Yes Some Yes Yes

Income Yes Some Yes No

Capital Yes Some Yes No

Security Yes No Yes Some

Transmission Yes No Yes Yes

No limit of term Yes Yes Yes No

Duty not to do harm Yes No Yes Yes

Judgement liability Yes No Yes No

Residual control Yes Yes Yes Yes

There is, in fact, an even deeper problem here. What is the object whose ownership we are discussing? Take a company like Marks & Spencer. We can see the stores, and the goods on the shelves. I could buy both of them and yet not have bought Marks & Spencer. The brand name and the reputation are essential parts of the company. I could buy these too. Imagine that Woolworths bought them, and hung signs outside its stores saying Marks & Spencer. It might do it a bit of good for a few days, but it would not last. You would come out of the shop saying that this was not really Marks & Spencer, and whatever the structure of legal relationships you would be right.

What really is Marks & Spencer is a set of systems and routines and a structure of organisation. These systems and routines enable what are, in the main, individually rather unexceptional people to perform, in aggregate, in very exceptional ways. The essence of the company is a structure of internal relationships among the staff, and a collection of external relationships with suppliers. It is not just that these things are the essence of Marks & Spencer. It is these things, rather than the stores or the name, which make Marks & Spencer the extremely profitable company it is.

But if this is true, it is difficult to see how the concept of ownership – analogous to ownership of an umbrella – could be relevant. What could we mean by the ownership of a set of routines, or a structure of relationships? You can benefit from the returns they generate, but that is not at all the same as owning them. If anyone did own these things, it is more likely to be the employees than the shareholders. But they do not really own them either. We are talking about things to which the concept of ownership simply does not apply, like friendship, or conservatism, or tennis. That seems at first sight disconcerting, but only because we are used to thinking in different terms. There are plenty of functioning entities that do not appear to be owned by anybody (not just friendship, conservatism or tennis), like London, the River Thames or Oxford University.

The obvious conclusion, then, is that no-one owns, or could own, BT or Marks & Spencer. Many individuals and groups have rights and obligations around these companies – customers, shareholders, lenders, employees, directors – but none of these claims can plausibly be described as ownership. And so long as we all understand the nature of these claims, that raises no particular problems. It should hardly need to be said that the differences between my umbrella and the modern corporation are so wide ranging that the legal and conceptual apparatus we use to deal with one is not very likely to be applicable to the other, and that the moral outrage I feel when you violate my rights over my umbrella is not relevant to my feelings about corporate governance. But the pursuit of this mistaken analogy between companies and tangible property has wide ranging effects.

The Alternative Model

The divorce of ownership and control, the source of so much tension in Anglo-American corporate governance, is less marked, or at least different in form, in other jurisdictions. Of the 200 largest German companies, over 90 per cent have a shareholder (most commonly a bank or another company) with at least 25 per cent of the equity (Franks and Mayer, 1990). Even in Britain (or the USA), concentration of ownership in large companies is not altogether absent (Nyman and Silberston, 1978), but it is true that, by and large, shareholder control of corporations is now largely a myth in the Anglo-American world. It is tempting to conclude, on the other hand, that shareholder control of corporations is still a reality in Germany. That is a misleading over-simplification.

There is an extended German literature on the role of the corporation in society which is not easy reading for anyone brought up in an Anglo-American tradition. In sharp contrast to the shareholder agency model, this tradition originated a century ago with Gierke’s concept of the ‘Verbands-persönlichkeit’, the corporate personality. For Gierke, as for some other German writers of his day, there was a mystical collectivism about this – the corporation sought to achieve a ‘physio-spiritual unity’. While for obvious reasons this thinking is now unfashionable, that perspective continues to underpin the German view of the corporation. “The social substratum to be personified is not simply a (static) social structure. Instead, it is an internal dynamics system, with selections of its own, and with a capacity for self-organisation and self-reproduction.” (Teubner, 1988.)

The role of concentrated shareholding in German companies needs to be seen in this light. Many of these shareholdings are controlled or influenced by banks or other major companies, and they certainly do not imply that large-scale German enterprises are closer to the model of owner-manager than British or American corporations. Rather these shareholdings are themselves evidence of the German conception of the company as a social institution; a community in itself and an organisation in turn embedded in a community. This perception is reinforced by other widely noted institutions of the German market economy, such as the supervisory board, co-determination, and the co-operative relationships of the Mittelstand (the constellations of small enterprises which are such an important element in the success of German manufacturing business). It would be wrong to think that by reproducing these institutions we could automatically reproduce their effects. The institutions are the product of a different view of the corporation and its role in society.

The concept of the large company as social organisation, rather than the product of private contract, emerges equally clearly in Japan. Japan does not have the difference in formal legal structure between major firms and owner-managed concerns which characterises much of Europe, but the demarcation in operational structure and economic function between large and small companies in Japan is a factor noted by many commentators. The notion that the Japanese company is described by an agency relationship between shareholders and managers would be incomprehensible to most Japanese businessmen. “We shall eliminate any untoward profit-seeking, shall constantly emphasise activities of real substance, and shall not seek expansion of size for the sake of size”, was the prospectus on which Sony began operations. It is difficult to imagine an Anglo-American company proffering a similar statement of intention. In Japan, “Corporate growth is appreciated and sought after primarily for its contribution to utilising the enriching human resources and in creating promotion opportunities…..workers identify their interests with those of the company which, as a consequence, is regarded as a sort of community.” (Odagiri, 1991, p. 106.)

In other European countries, the same distinction between private and public company emerges in similar if not identical form. In France, many large corporations are part of a social and economic structure in which the boundaries between state and corporate bureaucracy are barely discernible to the non-Frenchman. Indeed, these formal boundaries have frequently shifted over the last fifteen years of nationalisation and denationalisation, with small effects on the operations concerned. In Italy, as in Spain or Greece, the large company is often not only a social institution but a political one. But most of what we have said about Anglo-American companies would apply equally to corporations in Australia, Canada, New Zealand or, indeed, South Africa. While there are elements of caricature in the sharp distinction we have drawn between the corporate governance systems of the English-speaking world and those of the rest of the world, the differences are wide ranging.

Corporate Personality and Corporate Behaviour

It is easy to regard the issue of whether a corporation does or does not have a personality distinct from those of the agents who contract with it as a question best left to legal theory and a certain kind of abstruse continental European philosophy. Actually, it is central to an understanding of the competitive advantage of firms.

The Anglo-American agency model of the corporation posits the maximisation of shareholder value as its goal. Managers in continental Europe and Japan are inclined to view the development of the company as an end in itself. This model charges its managers with sustaining the interests of all stakeholder groups without giving priority to any particular one. Corporations with these different objectives and styles of operation are likely to behave differently, in relation to issues such as:

· willingness to undertake industry-specific, as distinct from firm-specific training;

· the provision of security and continuity of employment for their workers;

· the degree to which the firm should exploit its market power;

· readiness to undertake investment or development activities if, because of imperfect information, such investment or development is not expected to be fully reflected in share prices.

What then is the purpose of the corporate manager? Is it to build a good business, judged against many and imperfectly specified criteria, or is it to maximise shareholder value?

A persuasive account of the first approach is given by Solomons (1993). Rejecting any maximisation framework, he argues that business is, and ought to be, a practice or a profession, and cites a medical analogy. We expect that a doctor’s aspiration is to be a good doctor, not to maximise his income, and assume that a good doctor will at least weigh the interests of his patients against his own, if not put them ahead. The curious commercial implication of this is that a doctor whose primary motivation was to increase his income would not be perceived as a good doctor and would be unlikely to succeed even in maximising his income. Doctors who do not aim to maximise revenues may expect to earn more than those who do.

A superficial interpretation of this observation is to conclude that there is, in fact, no conflict between the commercial interests of the doctor and the interests of the patients, and indeed statements of this kind (“good business is profitable business”) are frequently made. But, as a generalisation, this is obviously false. Doctors know very well that commercial concerns and patient care do not necessarily coincide, and this is a matter of concern to every conscientious doctor.

The underlying paradox is this. Robert Maxwell or Ivan Boesky, on qualifying as doctors, might correctly conclude that their income maximising strategy was to give their patients honest advice, even if this sometimes deprived them of revenues. The problem they would face is that there is no operational mechanism by which they can commit themselves to follow this course. The medical profession does try to provide such mechanisms – doctors may subscribe to the Hippocratic Oath and/or are supervised by the General Medical Council. But these come into play only in the most egregious cases. In the end, the uncertainties surrounding medical care, and the fact that the adjudicator can never have exactly the same information as the practitioner had on the day, mean that it is impossible to enforce disinterested behaviour by appeal to an external agency.

It follows that the good doctor, and the successful doctor, is the one who puts the interests of his patients first because that is his genuine concern rather than the one who puts his patients first because he believes that such behaviour is a good commercial strategy. And it is easy to see why: in dealing with the latter doctor, we can never be confident that this is not an occasion when he has decided that putting patients first is no longer the best commercial strategy. The man who believes that honesty is the best policy is not an honest man, and it is the honest man, not the man who believes that honesty is the best policy, whom we trust.

The commercial analogy follows directly. When we trade with a respected company, we expect fair dealing and value for money. To the extent that we think about it at all, our expectations are not based on beliefs about the policies that the Boards of these companies have adopted on behalf of their shareholders. We attach little, if any, weight to the commitments to customers or trading charters which many much less well regarded companies display in their stores. We have these expectations of the firm because that is the kind of company it is. It is a style of behaviour, not a policy adopted to maximise profits. And because of that, it would be difficult to implement a policy to change it. If the board of such a firm was to decide that now was an opportune moment to cash in on the company’s long-established reputation, it is very doubtful whether it could actually bring this outcome about. Key employees would leave; the probable result, in practice, is that the organisation would reject the new management style and those who sought to introduce it, and revert to its traditional modes of behaviour.

The issue follows directly from the Grossman and Hart thesis. Commercial life necessitates many incomplete and implicit contracts, and we make such contracts with firms as employees, as customers, and as suppliers. Ownership confers the right to determine the unresolved terms of these contracts. If the governance structure of the firm allows, or indeed requires, all such incomplete terms to be resolved in favour of the shareholders, we will be reluctant to make such contracts, or indeed to do business with the firm at all. It follows that shareholder-owned agency firms will be at a competitive disadvantage in areas where such implicit contracts are important. It is not an accident that the international competitive successes of Japanese and German companies are focused on precisely those areas of business which have these characteristics – such as the development of trust relationships with suppliers that secure reliable component quality, just-in-time inventory management, and flexible response to changing market conditions; trust relationships based on close consultation with, and consideration of, all relevant stakeholders. The achievement of British and American companies, in contrast, are more often based on factors – such as reputation, innovation, and brands, which flourish in their different corporate environments (Kay, 1993, 1994).

The Trusteeship Model of Corporate Governance

Thus there is an alternative to the shareholder-agency model of the corporation. It recognises the existence of corporate personality, and its economic and commercial importance. It accepts that the large public corporation is a social institution, not the creation of private contract. But if senior management are not the agents of the shareholders, what are they?

There is a well-established structure in English law to govern the behaviour of individuals or groups who control and manage assets they do not beneficially own; it is the concept of trusteeship. Grossman and Hart have described the central role of what they call the owner as being the determination of the residual terms of incomplete contracts. What they define is exactly the historic function of the trustee. The settlor of property, unable to anticipate all the contingencies which might arise after his death, would appoint an honest man to determine what should be done in these circumstances. The concept is generalised to cover the governance of other institutions, such as Oxford University or the National Gallery.

The notion that boards of directors are the trustees of the tangible and intangible assets of the corporation, rather than the agents of the shareholders, is one which the executives of most German and Japanese companies, and of many British firms, would immediately recognise. The duty of the trustee is to preserve and enhance the value of the assets under his control, and to balance fairly the various claims to the returns which these assets generate. The trusteeship model therefore differs from the agency model in two fundamental ways.

The responsibility of the trustees is to sustain the corporation’s assets. This differs from the value of the corporation’s shares. The difference comes not only because the stock market may value these assets incorrectly. It also arises because the assets of the corporation, for these purposes, include the skills of its employees, the expectations of customers and suppliers, and the company’s reputation in the community. The objective of managers as trustees therefore relate to the broader purposes of the corporation, and not simply to the financial interests of shareholders. Some British companies have seen it as entirely appropriate, in pursuit of shareholder value, to dispose entirely of an existing collection of businesses and buy a new one. This course would seem inconceivable to a Japanese manager. A new vice-chancellor of Oxford University, or trustee of the National Gallery, who suggested that the University should become an international language school or that the Trafalgar Square site would make an excellent shop and restaurant complex, would be seen as having fundamentally misunderstood the nature of his responsibilities.

The concept of corporate personality acknowledges, as the principal agent model cannot, the path dependent nature of the behaviour of companies. Businesses are defined by a nexus of long established trust relationships; the principal agent model sees only a group of people who find it expedient every morning to renew their contracts with each other. Many of the ludicrous business books on the management of change see the Markovian nature of business evolution as a problem; yet for most successful companies, their history is a principal asset rather than a liability.

Thus the trusteeship model demands, as the agency model does not, the evolutionary development of the corporation around its core skills and activities because it is these skills and activities rather than a set of financial claims, which are the essence of the company. This does not preclude diversification or divestment, but it restricts operations to areas that relate in an obvious way to the firm’s distinctive capabilities. Deal making, even if profitable, becomes again a function of financial markets rather than corporate management. Chandler (1990), in contrast to our views, places emphasis on the virtues of diversification. But we suspect that diversification is often sought by managers of companies in order to insure (however misguidedly) against risks to themselves rather than to insure against risks to shareholders.

The second fundamental difference between the agency model and the trusteeship model is that while the agency model expects the manager to attach priority to the current shareholder interest, the trustee has to balance the conflicting interests of current stakeholders and additionally to weigh the interests of present and future stakeholders. Thus future customers and employees, and the future interests of current suppliers, also come into account. These two distinct differences have the joint effect of materially shifting the balance of considerations in management towards long-term development of the capabilities of the business.

We believe that many non-executive directors already see their role in these terms. The trusteeship role is a more natural and appealing one than the position – which the agency model points towards – of shareholder spy in the boardroom, a function which would not be easy to perform and which most non-executive directors do not in fact perform, or aim to perform. (Davis and Kay, 1990.)

Performance in the Anglo-American Environment

The choice between structures of corporate governance ultimately depends not on legal theory but on economic performance. In this section and the following, we consider the relationship between corporate governance and behaviour in two areas: strategies for the development of the business, and activities that straddle the boundaries between public and private sectors.

It is widely argued that the difference between Anglo-American and German-Japanese capital markets makes it more difficult for companies in the former to undertake long-term investments. Much of this argument is superficial or wrong. Fund managers may be monitored on their quarterly or annual performance; but that does not imply that companies will therefore operate on a quarterly or an annual basis. Indeed, that is to misunderstand the fundamental role of a stock market, which is to enable the time horizons of investors to be divorced from the time horizons of the firms in which they invest.

Perhaps more importantly, there are many examples of companies which have found it easy to access the British capital market for long-term investment. Pharmaceutical research and development often involves a ten year time scale, but the industry is an unequivocal British success story, and funds have been readily available for both established quoted companies and start-up investments. The discovery of North Sea oil led to the development, in Britain, of project financing techniques which were widely imitated elsewhere.

What makes these industries different is that they have consistently delivered good returns to investors. If British capital markets denied funds to its car industry and were reluctant to support new civil aviation projects, it was mostly for good reason. Many myths about short termism have been effectively debunked by Marsh (1990). There are certainly grounds for criticising the relationship between finance and industry in the UK. But the problem is less that the services of the capital market are insufficiently available to UK companies; rather it is that they are available too readily. If the Anglo-American company does not have a corporate personality, it is instead essentially a creation of the capital market.

The intellectual underpinning of this model is provided by the market for corporate control. Corporate governance is a market process rather than a political one; alternative teams of managers bid for the right to deploy corporate assets. Provided there is sufficient competition in the market for corporate control, transactions costs are low and assets will be delivered to the highest value users.

Problems arise because transactions costs are not low, and there are large asymmetries of information between insiders – incumbent corporate managers – and outsiders. Indeed, if these things were not true, it is not easy to see why firms would exist at all. To buy a company involves paying not only substantial fees to advisers, but a considerable control premium over the underlying value of the company.

Incumbent management will, or should, know more about the value of a company than outsiders. There are two relevant groups of outsiders: the company’s existing stockholders, and prospective bidders. The problem for management is how, in the face of this information gap, they can make credible signals about the company’s prospects to shareholders. There is substantial evidence that the market is not as irrational as many managers would argue, because most information feeds rapidly into prices (see Marsh (1994) for a survey), but there is no escaping the fundamental disparity of information. Insider trading rules, designed to protect small investors by ensuring equality of information, have actually had the effect of reducing its amount.

Bidders face the problem of a ‘winner’s curse’; it is companies which over-estimate the value of the assets they hope to acquire, not firms which under-estimate them, which are likely to enter the auction. And there are many managers who have a natural inclination to over-estimate the value which they will add to the operation of other companies. If transactions costs were low, then the correction of such mistakes would be rapid and inexpensive; but they are not.

So the costs of the market for corporate control, and the problems created by imperfect information, interact. Some bids function as the theory describes – replacing under-performing management by abler teams – and companies such as Hanson and BTR have built successful businesses by operating in this way. But others are the result of managerial self-aggrandisement, or temporary market under- or over-valuations, and in other cases the costs of dislodging incumbents prove to be too great. Taken as a whole, the evidence that this process adds any substantial value is slight.

That is important because in the Anglo-American environment, in contrast to that of Japan or Germany, merger and acquisition activity is central to business activity. Indeed, conversation with senior executives, or a perusal of the financial press, would suggest that corporate strategy consists of little else. The senior executive appears as a meta fund manager, juggling a portfolio of businesses as an investor juggles a portfolio of shares. These preoccupations persist despite analysis which suggests that the contribution of corporate ownership to performance is almost negligible, and that competitive advantages are to be found in operating businesses, rather than in buying and selling them. (Rumelt, 1991; Campbell and Goold, 1991.)

Criteria for a Model of Corporate Governance

It is often too easy to conclude that the grass is greener on the other side of the channel, or the world, and the German-Japanese model is by no means free of weaknesses. “Making bosses accountable to many stakeholders might make them accountable to none, as there would be no clear yardstick for judging their performance.” (Bishop, 1994.) This problem is familiar from Britain’s experience with nationalised industries, where the multiplicity of goals led to confusion between the concerns of government and those of the industry. It also enabled managers to conceal their lack of success in achieving any of these goals; or simply allowed them to pursue objectives such as expansion or technical excellence with little concern to balance these things against efficiency or value.

We see similar problems in private corporations operating under the stakeholder model. Philips is a good example of a company whose technical excellence was not matched by manufacturing efficiency or marketing effectiveness. What critics of the Anglo-American system commend as the ability to take a long-term view can easily become an opportunity to disregard external comment or criticism, however well-founded. There are instances of similar underperformance in German companies, and the French PDG is often more autocractic than a British or American CEO.

The sharpness and clarity of the objective of shareholder value maximisation, and the greater prospects of monitoring performance against it, are reasons why that model is increasingly popular even outside its Anglo-American base. Part of the problem is that if there is atrophy in the Anglo-American system – a formal structure which has become empty – there can also be atrophy in the alternative. The German supervisory board may often be no more than an agreeable lunch club. The close relationships between the senior management of many large French companies and the agencies of the French government have sometimes been a source of strength, but it is not a structure which encourages self criticism.

Any governance structure – political or corporate, democratic or authoritarian, American or Japanese – has a natural tendency to embrace those who share the basic values of those who currently operate it, and to reject those who do not. Moreover, such behaviour is easy to defend; is it not better to confine involvement to those who understand the business? So Proned – the UK recruitment agency for non-executive directors – naturally confines its register to those who are already directors of other companies.

Yet there is something in these arguments. A board of directors clearly works better if it is cohesive, and can avoid reiterated argument about fundamental values on every specific proposal before it. Building societies have sometimes been arrogant and patronising in their reaction to attempts to nominate directors by groups of members – in contrast to the normal building society and PLC practice of nomination by the existing directors. But it is difficult to believe that their operations would have been improved by the election to their boards of people who were often no more than vocal cranks. Attempts to bring reality into line with an impractical ideal of member democracy are not truly constructive directions of reform. Other experiments in the appointment of directors specifically charged to represent particular interests – whether shareholder spies in the boardroom or formal representatives of employees – have rarely proved a success. If unwelcome or unqualified members are appointed to a board, the likely practical consequence is that substantive decision-making will take place elsewhere.

The widely accepted consensus among those who have written about corporate governance in the last decade (see, for example, Cadbury, 1992; Monks and Minnow, 1991; The Economist, 1994; Charkham, 1994) is that the key requirement is to give content to the existing structure of notional accountability to shareholders. We are sceptical about this prescription. We doubt whether shareholders have either incentive or capacity to provide such monitoring. We doubt whether shareholder priority is an appropriate rule for the large corporation in any event. And we are not persuaded that the main lines of the proposed remedy – an enhanced role for non-executive directors, more extensive involvement of shareholders in major decisions, and the provision of fuller information about corporate affairs – represents a suitable monitoring mechanism. It is precisely the form of relationship which government, as controlling shareholder, traditionally enjoyed with nationalised industries, and its effect was to undermine management responsibility for corporate performance without providing stimulus to the effectiveness of corporations.

Moreover, there are dangers in an attempt to breathe artificial life into a model of accountability that has little practical reality. In the stultified authoritarian regimes of Eastern Europe, the rhetoric of popular democracy was used to provide spurious legitimacy for self-interested behaviour. The creation of supposedly independent remuneration committees by large companies in Britain and the United States has had precisely the same effect. The independence is generally a sham, and the institution has proved to be a mechanism not for restraining excess but for justifying it.

Thus we can identify the delicate balancing of criteria which has to be achieved by corporate governance. It should give recognition and content to the trusteeship model which acknowledges corporate personality. It should allow managers to pursue multiple objectives, yet hold them responsible for their performance. It should encourage cohesion within an executive team, but be sufficiently open to outside influence to discourage introversion and ensure that success is rewarded and failure penalised. That basic objective of “managerial freedom with accountability” is well set out in the Cadbury Report (1992).

It is important to recognise that the quest for perfection in systems of corporate governance is a hopeless one. We have emphasised the comparison between political systems and corporate governance. It has been wisely, and memorably, said that democracy is the worst form of government ever invented, except for every other form of government invented.


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