Reflecting on the lessons we can learn from the financial crisis, Ian Adderley and Stephen Hockman argue that there is an urgent need to look at specific reforms to the legal framework within which business activity takes place. Only through doing so will it be possible to prevent the harmful consequences of unrestrained business activity, whilst at the same time preserving the capacity of business to improve society through the creation of goods, services and jobs.
The financial crisis exposed some basic weaknesses in our capitalist system. But it was not until the Conference speech by the leader of the Labour party in 2011 that there was an explicit recognition of the need for a more responsible form of capitalism. We need to explore how capitalism could be more responsible and what means are available to achieve this.
The difficulty in achieving a more responsible capitalism lies partly in the inherent nature of the capitalist system itself. The main purpose of establishing a limited company with its own separate corporate identity is to limit the liability of the individuals involved, whether as shareholders, directors or otherwise. The system rests on the assumption that even if those involved in the ownership and management of companies act for their own selfish ends, nonetheless the net result will be for the benefit of the community as a whole. Recent events have yet again called this assumption into question.
There are problems with limited liability but the way forward cannot be to return to the pre-industrial era, when those involved in business remained personally responsible throughout. The way forward must be to develop mechanisms which will prevent the harmful consequences of unrestrained business activity, whilst at the same time allowing such activity to continue to benefit the community through the production and distribution of goods, services, jobs etc.
It seems logical to start by discussing mechanisms relating to the way in which companies are structured. The work of the Ownership Commission seems of greatest interest and relevance here. The Commission’s recommendations included the need for more plurality of forms of ownership, involving “new mechanisms and tax concessions to support the build up of equity capital in the medium sized family business sector”. They consider that shareholders and directors should have the definition of their fiduciary obligations widened to include better stewardship, and for this to be enforced by closer links between the ultimate owners of the company and its managers. They say that institutional investors should be required to comply with the Stewardship Code. But a call for a duty of stewardship means little until this concept is defined and enforced.
Looking now at shareholders, there can be little doubt that their powers need to be increased, so as to enable shareholders to control more effectively the composition and remuneration of the board of directors. However, by itself, a measure conferring greater control on shareholders is likely to be insufficient, since shareholders, particularly those who have invested in more substantial and profitable companies, are themselves likely to be motivated primarily by the profitability of their own investment. Consideration should therefore be given to imposing a minimum period between the acquisition and disposal of shares, though research is needed to evaluate what the effect of such a measure is likely to be. Alternatively, as proposed by Lord Myners, there should be a two-tier share register, with long term investors monopolising voting rights.
Turning to the responsibilities of directors, in this area some progress was made by Labour in the Companies Act 2006, but there must be scope for greater progress here. It may be that the most promising approach for the foreseeable future will be to work on the development of codes of conduct like the Corporate Governance Code. The Labour leader has suggested that those in business, particularly in banking, ought to be bound by similar codes of conduct to those who work in teaching, medicine and the law. As he pointed out: “those professions have clear rules, codes of conduct which lay down what is expected. We need the same for banking, anyone who breaks the rules should be struck off”.
On executive pay, the decision-making has historically been in the hands of the directors themselves. It now seems to be widely accepted that there should be greater involvement by the company’s owners/shareholders and by its employees. The time has surely come for society to take a more active role in relation to systems of payment. At the centre of these arguments is the point that performance based remuneration should not generally be based on the paper value of transactions without any attempt to correlate that paper value with the true underlying value of the transaction to the company concerned.
The issues involved in creating a responsible capitalism have been discussed only briefly in this short article, but what is increasingly clear is that a “Standing Commission on Responsible Capitalism”, which could carry forward such proposals, and build on the work of the various temporary inquiries referred to above, is what we now urgently need. As Keynes observed, a system which works for the collective benefit also tends to maximise individual profit, but (as we have all observed much more recently) a system which fails to work for the collective benefit risks destroying individual profitability, and thereby destroying the system itself.
This article is based on a report published by the Policy Network.
Note: This article gives the views of the author, and not the position of the British Politics and Policy blog, nor of the London School of Economics. Please read our comments policy before posting.
Ian Adderley is editor of the Society of Labour Lawyers’s publication ‘Justice for All’ and a member of its Executive Committee.
Stephen Hockman is a regulatory lawyer, Head of Chambers at 6 Pump Court, and Chair of the Society of Labour Lawyers.