The ownership myth and its complications

The myth that “shareholders own the company” and the one that is thought to follow from it, namely “directors have a duty to maximise financial returns for shareholders” are two key obstacles that prevent many companies from getting to the solution to our countries’ and our world’s sustainability crisis.

It is in large part companies whose business models are based on stimulating wants and over-consumption, at the expense of contributing to well-being, which are destroying the natural environment and exploiting human resources. These companies have brought our country and the world to the dangerous place we are in today.

The needs of many in today’s society are far from being met. Young people have realised that the business-as-usual approach is sawing off the proverbial branch which supports us. Our children and grandchildren will have to find new, innovative ways to meet their needs, because we have used up more than our fair share of resources and we are leaving the world in a very precarious state.

Are we locked into this path? We require companies to be part of the solutions that we desperately need.

Shareholders do not own companies

Courts, legal scholars and business commentators agree on one thing: shareholders do not own companies.

Nevertheless, the myth is so strongly embedded in common vocabulary that many governance codes, guidance documents for “good practice,” and even corporate-governance courses still use the ownership concept and thereby continue to lead companies down the wrong path.

John Kay, writing in the Corporate Governance column of the Financial Times, provides three key references: first, the UK Court of Appeal declared in 1948 that “shareholders are not, in the eyes of the law, part owners of the company.” Second, in 2003, the House of Lords reaffirmed that ruling in unequivocal terms. And third, scholarly legal work by Tony Honoré identified 11 tests of ownership. The relationship between shareholders and the company satisfies only two conditions, three in part, and six conditions are not met at all.

So, is there an alternative name to "owners"? ISO 37000, the first global standard on governance of organisations, provides the generic alternative to all those stakeholders, like shareholders, who have a legal obligation or defined right to make decisions in relation to the governing body and to whom the governing body is to account: member stakeholders.

Shareholders are member stakeholders. "Members" is also the term used in most companies’ acts.

I am not a lawyer, and this column does not constitute legal advice, but I will certainly follow the advice of lawyers and legal scholars such as Beate Sjåfjell or Prof Mervyn King, who point out that shareholders who act as though they own the company have found themselves in jail.

So if it is so clear that shareholders are not owners of companies, that leads to two more questions: who actually owns the company?

The second, more consequential question: do directors have a duty to maximise returns to shareholders, and how does this prevent them from contributing to sustainability?

John Kay’s answer to the ownership question is insightfully short: “No one does, any more than anyone owns the river Thames, the National Gallery, the streets of London, or the air we breathe.”

Duty of directors, act in best interest of the company

The company acts of Barbados, Jamaica, St Lucia and Trinidad and Tobago all use the same expression when it comes to the duty of care of directors: “act honestly and in good faith with a view to the best interest of the company.”

Company acts continue to be the same the world over, with a variety of specifications for what to consider when “determining what are the best interests of the company.” Some say directors “must;” others give more leeway and say “may” have regard to the interest of its shareholders (others say members).

All also specify the interest of employees in this clause.

The Company Act of Jamaica further specifies that directors “may have regard to the community in which they operate” (174.4), while St Lucia specifies that “the interests of its shareholders shall in all cases prevail” (97.2).

In other jurisdictions, like the UK, the duty to promote the success of the company specified in the Companies Act (paragraph 172.1) is more elaborate:

A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to:

a) the likely consequences of any decision in the long term,

b) the interests of the company's employees,

c) the need to foster the company's business relationships with suppliers, customers and others,

d) the impact of the company's operations on the community and the environment,

e) the desirability of the company maintaining a reputation for high standards of business conduct, and

f) the need to act fairly as between members of the company.

Sustainability, the smart way to succeed

In order to bust the myth of the supposed need to maximise financial returns to shareholders, note three important things: first, company acts are all clear that the duty imposed on directors of a company is owed to the company alone. Secondly, shareholders are always just one of the constituents to take into account, it is never exclusive: success for the company comes first and any shareholder returns from that. Third, even though contributing to sustainability is the smart, and only, way to succeed over time, the law currently does not require directors to do so.

Even though company laws in some parts of the world are significantly more elaborate about what directors should consider when determining the best interest of the company, there is an important international legislative movement under way to reform company laws in a more fundamental way: demand that the governing body of every company and organisation explicitly and bindingly defines not only its areas of activity, but the purpose of the organisation.

What ultimate benefits does the organisation seek to achieve sustainably for stakeholders?

So instead of creating a long list of considerations, which could still collapse into “shareholder primacy,” once companies specify their purpose, the duty and accountability of directors would be lot clearer and stronger and our chance for a sustainable future much improved.

Dr Axel Kravatzky is managing partner of Syntegra-ESG Ltd vice-chair of ISO/TC309 Governance of organizations, the co-convenor and editor of ISO 37000 Governance of organizations – Guidance. He is currently the project leader for ISO 37006 Indicators of effective governance.

Disclaimer: the views presented are those of the author and do not necessarily represent those of any of the organizations he is associated with.

Comments and feedback that further the regional dialogue are welcome at axel.kravatzky@syntegra-esg.com