CORPORATE GOVERNANCE : First Loyalties – Getting priorities straight

In the flurry of debate surrounding the nature of good governance, notable element has been cast aside. Whatever happened to the notion of trust? To date, the idea that trust may be common element in governance relations has largely been left to chance.
Yet it is difficult to identify any business transaction or exchange between parties where some degree of trust is not required by either one party or the other, or both. Any purchase or exchange of goods and services is predicated on trust.
The very reason that we have organisations rather than individual contractors is because transaction costs are often significantly lower than the cost of contracts. The role of trust is, therefore, explicit in the creation of organisations.
In the few instances when either party is subsequently revealed to be untrustworthy all hell breaks loose. Both the media and increasingly the internet have important roles in quickly disseminating news of the behaviour of untrustworthy parties.
Sadly the ‘good governance’ debate has largely focused on eliminating these exceptions rather than attending to the often poor performance of organisations. However, the potential role of trust in the ‘good governance’ debate is only relevant if roles and responsibilities are well understood.
Through the course of working with directors in research, consulting, education and training we invariably ask who they serve. But broad array of answers is provided to what ought to be trivial, almost banal question. We invariably can classify each of these responses into one of three groups.
The first large group of respondents considers that directors are there to serve, or to act in the best interests of, the shareholder. These respondents are typically emphatic in their response and often greet the question with the contempt it deserves.
There is no doubt in their minds that their role and res-ponsibility is to act in the best interest of the providers of equity capital. Whether that provider is the state or private investor does not appear to moderate this view.
A second, and equally large, group of respondents, considers that the role of the director is to serve broader group of bene-ficiaries including shareholders, employees, management, buyers and suppliers, society, and sometimes the physical environment.
Despite the proximity of shareholders – recipients of business outcomes (capital) – with other stakeholders – more typically the recipients and beneficiaries of business processes – we classify these latter views into that of serving stakeholders.
By comparison to the first set of respondents, this group often waivers in providing its response, treating the question with circumspection.
We wonder if being asked by academics – albeit ones with strong practitioner interest in business – may engender suspicion.
So often is the answer provided with doubt that we could be forgiven for thinking this audience considers the question Marxist promotional stunt.
The third and final group, and one that is relatively small (between five percent and seven percent of respondents) states bluntly that directors are there to serve the company – or other legal entity to which they have been entrusted.
This often forgotten legal entity provides the only means through which all other demands may be met, those of both shareholders and stakeholders alike.
The Companies Act 1993 provides assistance with the discussion in that Part 8 (s126 to s162) states that ‘a director of company, when exercising powers or performing duties, must act in good faith and in what the director believes to be the best interests of the company’.
There is no ambiguity with this statement. So why, then, do the majority of directors we work with report that their role is to supposedly serve someone else?
At the centre of the governance discussion ought to be the company (and we are using the term liberally here to include other forms of legal entity to whom directors or trustees may be assigned). The company should then be the major focus of the attention of governance.
To be sure, directors have requirements to shareholders and other identifiable groups and/or individuals. But at the centre of their role and responsibilities remains the company. Service to any group, whether or not that is at the expense of the company, augurs poorly in terms of both understanding and likely company performance.
At times the company will assume the fragility of butterfly or be as vulnerable to external shocks as day-old chick. At other times the company will be as robust and solid as breeding bull defiant in the face of competition. Or it may have the capacity to adopt the guile and cunning of our wily mountain kea.
The role of governance is not to serve the needs of either shareholders or stakeholders. It is to serve the needs of the company.
For it is only when the company is served that the demands of other groups may somehow be met. To serve any of these groups in deference to the company is to court disaster.
New Zealand’s business landscape holds legacies to the excessive demands by shareholders (in one form or other) who were served before the very needs of the company were met.
In last month’s column we made the observation that the research community has now considered directors themselves source of the agency problem.
Perhaps they are right. We hope not. However, if directors report that they are there to serve, or to act in the best interests of various groups including shareholders, then researchers may well have something useful to report.
Sadly though, that finding would be at the expense of trust – the trust we place in directors to act in the best interests of the company to which they are assigned.

James Lockhart is director of Massey University’s Graduate School of Business.

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