When the South Sea Company collapsed in 1720, Parliament responded by seizing the entire wealth of its directors, then publicly debating how much they should be allowed back to live on. The most crooked of the lot was granted nothing at all; his partner in crime was handed a mere £1,000 from a fortune of over £183,000.
Nowadays, directors presiding over high-profile insolvencies—of which Carillion is just the latest example—have less to fear.
Ten years after the global financial crisis, the one-way bet for senior executives that skewed risk-taking in banks lives on across the economy. In limited liability companies, it is directors’ liability to loss that is most limited of all. While shareholders stand to lose their investments and creditors their dues, directors are seldom required to dig into their pockets—however deep they have become from the company’s coffers in the run-up to the collapse.
Large companies’ stakeholders encompass, beyond shareholders and creditors, their employees and many others. The 2007-8 crisis demonstrated how, in some cases, this stakeholder community extends to the entirety of the participants in the financial system.
More recent corporate collapses (or narrowly-avoided ones) have threatened far-reaching social damage, whether by burdening the Pension Protection Fund, creating devastating pockets of unemployment, or interrupting the provision of public services. The largest companies today are, if not too big to fail, big enough to inflict deep pain well outside the confines of their investors if they do.
That this pain so rarely extends as far as the directors’ personal fortunes, even when they are apparently at serious fault, matters for at least two reasons.
First, it erodes trust in business. If stratospheric remuneration is supposedly justified by the value executives add, it provokes justifiable anger when companies collapse. Shareholders, creditors and employees may experience disastrous loss, yet financial liability for the director is spared. It is not surprising that public opinion is outraged when, in these circumstances, executives walk away with their fortunes more-or-less intact.
Second, it leaves directors with insufficient incentive to check the risks that their actions pose of future harm, especially beyond investors. The UK’s current system of corporate governance revolves around duties owed by directors to their shareholders (to whom shares are often little more than short-term betting slips), with precious little protection for anybody else.
A fudge enacted in 2006 means that directors must, in theory, have regard to the interests of wider stakeholder—such as employees and the community at large—but only in the course of promoting the interests of the shareholders. Anyway, it is only the company that is owed the duties and only the company that can enforce them.
To fundamentally rewrite this aspect of company law so as to erode the primacy of shareholders might be regarded as a drastic step, for which markets are unready.
Nonetheless, there are other tools, in large measure already available, which could help to rebalance the incentives on directors within the existing framework. It is time for government to wield these tools more purposefully.
For more than three decades, it has been possible to disqualify directors (meaning they are banned from acting as directors for a set time) where a company has gone into liquidation and they are found guilty of unfit conduct.
Whether the regime has had much deterrent effect up to now is open to question, but new powers have lent it greater teeth. The Secretary of State is now able to seek orders for directors to pay compensation where their unfit conduct has caused loss to creditors. If fully used, these powers pave the way for a better balance of risk and reward for those at the helm of the UK’s largest companies.
Furthermore, if expanded, the powers could send a wake-up call to directors who are presently failing to have adequate regard to the interests of wider stakeholders. The fatal weakness in the existing provision is the absence of any practical means of enforcing a wider duty than that owed to shareholders. It should be open to the government to seek compensation from directors of an insolvent company if their unfit conduct has caused loss, wherever in society the loss may fall.
One valuable consequence would be to focus attention on how to strike the right balance between the (often competing) interests of shareholders and these wider stakeholders—in the Carillion case, for example, paying sufficient attention to the risk that, if the company’s punt on contracts fails, taxpayers will have to pick up the tab for the delivery of public services on which millions rely. Well-publicised judgments requiring directors to make recompense would focus minds in the boardroom well before situations of insolvency arise and help to avoid them.
Business failures are an inevitable feature of a capitalist economy, but those caused by boardroom greed are not, as Parliament was swift to recognise back in 1720. The danger, without a rebalancing of the incentives on directors, is that, in the twenty-first century, society increasingly proves its victim.
