Article
Change, business leaders are fond of exhorting their
employees, is a constant. Within business organisations, owners and CEO’s are
fond of continuously changing the structure of the organisation, its reporting
responsibilities, its compensation practices and its business strategy. However,
when it comes to their own existence, all three participants in the world of
corporate governance (shareholders, directors and senior management) have
withstood any change. They ensure that the relationships between each of them
and the basic structure of those relationships have remained unchanged since the
first corporation came into existence. During this period of fossilisation, they
have been ably supported by business academicians in remaining in that state.
The first modern corporation established 500 years ago was
the East India Company. No Companies Act existed in those days and any corporate
entity could come into existence only by obtaining a Charter from the King.
Charles II issued a Charter imbuing life into the East India Company. This
company became the first juridicial person, ever. The Charter contained those
provisions that today one finds in a memorandum and articles of association and
in the Companies Act. It required that the shareholders of the company annually
hold a general meeting. The general meeting would elect the Board of Governors
(Directors) and also the head of that Board (Chairman and CEO). The Governor and
the Board of Governors were responsible for overseeing the management of the
company’s business. Each shareholder had a voting right proportionate to his
share-holding. Detailed bylaws would be prepared and those would have to be
approved in a general meeting. In the century that followed the setting up of
the East Indian Company similar Charters were proclaimed for companies that
traded with Russia, the Levant and Canada (Hudson Bay Co.). The last named still
exists and is the oldest extant corporation in the world. The Dutch also set up
corporations. As the readers will observe, the fundamental principles of
Corporate Governance laid down 500 years ago remain unchanged today. These are
that shareholders ‘own’ a company, managements manage the business on their
behalf and directors provide management oversight as agents of the
share-holders.
The basis for this form of democracy in corporations goes
back to far earlier times. After all, democracy is a word associated more with
the governance of nations than with the governance of companies. The oldest
known form of democracy was the Greek city states. However, that form of
democracy died with the decline of those city states and for over a thousand
years after that the world had no form of democracy. Democracy returned (to
Britain) in the 11th century A.D. The Anglo-Saxons and the Normans had grand
councils that advised the ruler. However, this was not of lasting nature and it
was only after the signing of the Magna Carta by King John that kings in the
U.K. were deprived of divine and absolute rights over their subjects. The Magna
Carta resulted in the establishment of the first Parliament in 1265. In the next
500 years this evolved but in essence Parliament represented the landed class.
While there were seats reserved for the clergy, essentially, the members of
Parliament were those who gave taxes and soldiers to the King. These happened to
be landlords because in those years land revenue was the only source of taxation
and land owners had powers over their serfs; they used these powers to send
serfs to the king’s army when he had to fight his wars.
The grant of the right to participate in democracy depended
upon whether an individual contributed to the State. Those who made no
contribution had no say in Parliament. Vast sections of the population were
deprived, whereas the landed classes became very powerful. The 18th century saw
a change in this thinking. French thinkers such as Voltaire influenced the
public thinking that eventually led to a revolution and the end of monarchy in
France. However, the Parliament that was established after the French Revolution
still did not provide for universal adult franchise. The true founders of a
democracy based on adult franchise were the founding fathers of the United
States of America. They propounded, for the first time, the concept that every
human being who is affected by the behaviour of a State should have a say in the
election of its Parliament. There was considerable debate upon how it would be
possible to provide for voting by millions of Americans spread right across the
country, many of whom had no concept of democratic participation. However, the
founding fathers persevered. Eventually, this belief spread across the world and
all countries today equate democracy with universal adult franchise. It would be
preposterous to even suggest that a person’s right to vote should depend upon
whether he paid taxes to the State or contributed to it in some other fashion.
Every person who is affected by the conduct of the Government is considered to
have the right to vote in the elections for its Legislature.
When the scheme of corporate governance for the East India
Company was conceived of, public thinking was limited by the democratic model
then prevailing in the British Parliament. Only three participants were
identified — management, directors and shareholders. In those times, there was
no scarcity of land or of labour; of the three economic factors, only capital
was in short supply. Consequently, the providers of capital, the shareholders,
were granted the right to elect the Board of Directors and approve their
corporation’s regulations. The contributions made by other factors of production
were wholly ignored. At that time, wealth was tangible. It consisted of
classical assets such as land, precious stones and metals. All tangible assets
were tradable for money and their ownership could change hands freely.
Consequently, he who had money would acquire wealth. Without money, the
acquisition of wealth was not possible. Indeed, capital was the only factor of
production that had mobility. Today, wealth lies not in tangible assets but in
intangibles such as ideas, technology, new ways of doing business, intellectual
property and other such intangibles. These are created not through vast outlays
of money, but through having outstanding individuals in an enabling environment.
In many companies now, tangible assets are amongst the smallest items in their
value.
Since the setting up of the East India Company through the Industrial Revolution and until the mid-20th century, business was mainly concerned with the rudimentary conversion of natural resources to meet basic human needs. Today, business comprises of the sophisticated networking of large numbers of stakeholders.
However, the world of governance is yet to comprehend these changes. The guru of American-style governance, Milton Friedman, has pro-pounded the capitalist view that management and directors should never be motivated by any consideration other than profit maximisation. Relationships with vendors, customers and employee are only transactional, governed by contracts. Those with the government and the public are legal, governed by the laws. Friedman believed that conscience should not motivate companies – only maximising shareholder value within the confines of laws should.
It is such thinking that has resulted in the nasty outcomes less than ten years ago in major U.S. companies (the Enron years) followed shortly after by the collapse of Wall Street. These events have shaken confidence in a model driven by Friedmanian greed. Worse, global companies have changed public behaviour – greed has engendered hedonism. And hedonism (combined with unchecked population growth in India) is the cause of climate change.
Not only has the old form of governance resulted in losses of trillions of dollars, it has created a threat to the very existence of the natural world. It is time this changed.
If the concept underlying democracy in a public sphere can also be applied to corporate democracy, it will require that anybody who is affected by the conduct of a corporation should have a say in electing its governors. In other words, all stakeholders in business should influence its governance, not only its shareholders and management. This would require a fundamental shift in thinking. The nature of reporting by directors and management (stewards), the holding of meetings, the provisions of memoranda and articles of association, the nature of resolutions requiring stakeholder approval and many other governance issues would need to be changed. So too, would be the change in the nature of the audit of stewardship reporting. Indeed, finance would be only one of the disciplines required of auditors. The first rudiments of such change are already visible in the Global Reporting Initiative. GRI reports bring out information classified by different stakeholders, but they are still attuned towards segmenting the information stakeholder-wise for use by shareholders. If stakeholders are to have a say in governance, such reporting would not be different.
It is unlikely that such a tectonic change will occur in the near future. It needs to overcome powerful vested interests including the entire world of the capital markets. But, until that happens, many of the major aberrations of corporate behaviour are unlikely to be controlled.
