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The ethical dimension of corporate governance

by Simon Longstaff

Introduction

The key issues in corporate governance involve, at a fundamental level, questions about relationships – within the company and beyond.

The board is ultimately responsible for all that the company does. Given that it is only through the actions of a corporation that we might come to know it, the board is also ultimately responsible for what each corporation is.

Finally, we should recognise that corporations are entirely artificial entities. It is easy to forget this fact; that corporations are inventions of the human mind – existing under the guise of the fictional, legal 'person'. The only 'reality' is that comprised of the people who work within or interact with the corporation and by the social and physical environments that provide the context for its operations.

This may be to state the obvious. However it helps to emphasise the point that corporate governance is ultimately about relationships. A list of the key relationships to be considered includes (in alphabetical order):

• Competitors
• Creditors
• Customers
• Employees
• Government
• Shareholders
• Society (as a whole)
• Suppliers
• The environment

Enter the 'stakeholder'

It is increasingly common to argue that each of these parties has a 'stake' in how the corporation behaves. That is, that the corporation has an obligation to take account of how its actions affect each group. This is not to say that all 'stakeholders' have to be treated identically. Nor is it suggested that all stakeholders should have a direct say in the way corporations are governed.

Despite these limitations, the emergence of 'stakeholder theory' represents a departure from an older view in which company directors were thought to have few obligations beyond those owed to shareholders and the law.

Indeed, some directors have held that they have an obligation to do anything lawful that might advance the interests of shareholders – irrespective of the consequences for other groups. Such a perspective might be attractive because of its relative simplicity. Boards of directors adopting this position would certainly have a relatively simple test to apply when considering how best to proceed.

Those who would prefer a somewhat simpler life will have been frustrated by two related trends. First, the rise of stakeholder theory means that there are an increasing number of people who have an expectation that their interests will be taken into account by directors. Second, developments in the law have extended the range of obligations owed by directors. For example, Australian directors now have an expanded range of legal obligations owed to employees, customers and even the natural environment. This expansion in the range and number of legal obligations has reinforced a climate of increased expectations amongst stakeholders.

Added to all of this is the extension of personal liability to directors. Hence the perception (and reality) of increased complexity.

The relevance of ethics

The attached notes and papers explore a number of different dimensions relating to ethics and corporate governance:

• How do our attitudes about human nature shape the framework for corporate governance?
• What is the purpose of the board and how do we go about evaluating its performance?
• What are the basic obligations of directors when it comes to creating an ethical culture?

It is important to note that the whole focus of ethical thinking is to establish a series of practical responses to the issues that people face.

As such, ethical thinking is an indispensable tool for those who encounter a constant stream of new challenges in a rapidly changing world. 'Old' solutions lose their currency at such times and new thinking is then required. However, as recent research makes clear (see attached papers) corporate performance ultimately depends on the consistent application of a founding set of values and principles.

Finally, it should be noted that ethics is also, at heart, ultimately concerned about relationships. For example, to whom do I owe a duty of care: myself, my immediate family, my community, all humanity, all creation?

Traditionally, boards have been comprised of people with a broad range of experience and, to a fair degree, common sense. This used to be adequate preparation for the challenges faced by directors. In addition to the vast majority of directors were recruited at a time when there was broad consensus about the founding values and principles of our society. There were also a number of reasonably authoritative institutions able to offer guidance: the church, the professions, government and so on.

The contemporary environment, in which directors work, is very different. So a much greater extent than before, directors are on their own when trying to determine how best to proceed. If, as seems likely, boards of directors continue to operate in a world of rapid and profound change, then it is difficult to see how they are going to be able to manage the task of corporate governance without significantly improving their level of skill in ethical reasoning.

Conformance and performance

It is not uncommon to hear mention of the fact that the increased level of regulation and surveillance, coupled with an extension of the liability of directors, has caused a corresponding decline in attention to corporate performance.

Instead, boards have become overcome by the need to ensure that they comply with their legal obligations. This focus on legal requirements has not necessarily led to any increase in the level of attention, paid by boards, to the ethical dimension of their activities. Indeed, it could be argued that an over-emphasis on law (in which the correct course of action has been prescribed by others) has been at the expense of ethical reflection.

To the extent that the law prescribes or proscribes, so individuals and organisations have less reason to form their own opinions and take personal responsibility for the decisions they make. That is, there is a subtle (and not so subtle) substitution of 'accountability' (to regulators etc) for responsibility.

As the attached papers make clear, there is considerable evidence to suggest that there is, at least, a coincidence of interest between those who would increase company performance and those who would highlight the need for a consistent and 'behaviourally evident' commitment to ethical business practice (which is nigh on impossible to achieve without active board support)!

This may seem to suggest that there is something to be said for the view that "good ethics is good business". However, this is a na've view that, paradoxically, is bound to fail. The benefits of ethical behaviour only flow to those who choose to act in this way because of a sincere (and not merely tactical) commitment.

The role of the company secretary

While it would be highly desirable for company directors to develop better practical reasoning skills and an ability to identify and apply the core values and principles on which they would base the actions of the companies that they lead, it is more likely that they will (for the foreseeable future) either 'make do' or rely on the advice of others. Whatever their approach the issues will not go away. As the attached papers make clear, there is an important role for the company secretary to play in assisting directors.

Key issues:

1. Is the current preference for a majority of non-executive directors justifiable, or just the latest fashion?
2. Are there any prudent limits to the amount of delegation that the board might pass to management?
3. What should be done when a company director is judged by management to be incompetent?
4. What should be done when directors fail to discharge either their legal or ethical obligations? For example, what if a director (or board) fails to act appropriately in response to an identified conflict of interest?
5. Can the duties of directors be 'prioritised'?
6. If 'stakeholders' have at least some claim to make upon the company, then how might these claims be ranked in terms of importance?
7. Should companies act according the letter of the law, the spirit of the law or both?
8. What are the social responsibilities of business?
9. What steps might be taken by governments in order to support positive developments in the field of corporate governance?
10. To whom does a company secretary owe a primary duty – to the board or to fellow members of senior management? What should the company secretary resolve a conflict?
11. Is it possible for a company secretary to discharge the responsibilities of a member of a profession while being the employee of a company?

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