Introduction it. The first question that comes to


The essence of forming a corporation is to provide goods
and services to the consumers and build a reputation of its own to increase its
presence in the industry and society. The bigger the presence more is the need
to handle the affairs of the company in a sophisticated way. When the
corporation is of a smaller size, it does not normally need substantial
maintenance. However, with increase in the size, there increases the need to
maintain a balance between the management and beneficiaries. There grows a
separation of ownership from control.

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The beneficiaries and the management are the two limbs of
the corporation. The shareholders are referred as the beneficiaries who are the
owners of the company. The management includes the board of directors appointed
by the shareholders to deal with the company’s day-to-day business.

The first part
of this essay will look at the shareholders’ position in a corporation, the second part would discuss the arguments on
whether the boards are incentivised to look after their own needs because of
their position in the corporation and third
part will discuss possible measures on the boards’ mismanagement, if any
and conclusion.

Why don’t the
shareholders manage the business?

Now, as spoken above about the two limbs, their position
comes with sets of duties and powers. The directors have the duty to internally
manage the company while the shareholders choose the corporation’s managers and
enjoy the benefits from it. The first question that comes to mind is why would
the shareholders themselves not manage the company rather than choosing someone
else to do it? To answer this, firstly consideration has to be made to the
interests of the shareholders in relation to the company. The shareholders care
about profit maximization of the company in order to increase their share
values mostly. However, there can be numerous shareholders with the same motive
but different ways to achieve it. This could lead to chaos amongst them, as
there would not be a specific right way for the object to be fulfilled.

Secondly, not every shareholder wants the hassle of
running a business on a daily basis. So, they would either be too reluctant to
care or not do the job at all, especially if they are minority shareholders.
Again, this leads us to the first point of having different approaches for a
common objective. Hence, they choose the directors to manage the company for

looking after their own interests and its consequences?

Adam Smith in The
Wealth of Nations1,
writing about joint stock companies, stated:

directors of such companies, however, being the managers rather of other
people’s money than of their own, it cannot well be expected that they should
watch over it with the same anxious vigilance with which the partners in a
private copartnery frequently watch over their own. Like the stewards of a rich
man, they are apt to consider attention to small matters as not for their master’s
honour, and very easily give themselves a dispensation from having it.
Negligence and profusion, therefore, must always prevail, more or less, in the
management of the affairs of such a company. It is upon this account that joint
stock companies for foreign trade have seldom been able to maintain the
competition against private adventurers.2

He considered the separation to be problematic in that
managers of such companies would lack the incentives to operate the corporation
in the same manner as the owners. They would thus operate the business in an
inefficient manner.

Jensen and Meckling3 characterized
the separation of ownership and control as an agency problem4.
They said that if both the principal and the agent (boards) are “utility maximizers”5,
then there is a good chance that the agent might not always act in the
principal’s best interests. This means that even if certain agent costs were
levied to restrain them from acting in a certain manner, they would still want
to maximize their utility to the optimum level for their own needs if they want
to. Moreover, the case Equitable Life
Assurance Society v Bowley6
shows the delay and costs of holding directors to account in addition to the
agency costs7.

With the immense power given to the boards, there is a
high chance for them to want to use those in their favour, to look after their
own. However, there is an increasing need for the directors to look out for the
shareholders’ interests, otherwise, it could lead to disastrous results as
proven time and again, like the examples discussed below.

Although the duties of the directors are clearly set out
in the Companies Act 20068, there
have been many corporate scandals and failures in the world. The board were
given so much power in these cases that when the power bubble burst, it took
down the entire corporation into shambles. One spectacular example would be the
financial crisis in 2008 where the boards of the particular banks completely
disregarded the shareholders’ interests. This led to a dramatic drop in the
share prices of the banks and other companies on the London Stock Exchange,
which in turn almost led to the collapse of the UK financial sector.

would be the Enron scandal. The
collapse was because the board became very powerful and self-involved,
completely disregarding the shareholders’ interests. Their fraud was out in the
open and the image of the perfect company came shattering down in no time when
an internal whistle-blower Sherron Watkins turned them in and people started
adding two and two together.9

That year was followed by another scandal of WorldCom
where the officers inflated asset values to show the projected profits. Another
big blow where the board members tried to think only about themselves is the
investment bank Lehman Brothers scandal. This scandal intensified the 2008
crisis in the US.

The examples above would be one of the main reasons as to
why the boards might be reluctant to direct the power for their own needs.

for upholding shareholders’ interests:

Alternatively, it can also be argued that the directors do
not always think about themselves. To be fair, it can be said that the scandals
are rare because ultimately the directors would want to uphold the essence of
the company as mentioned in the first paragraph. They would want to look after
it also because it is ethical10.
If there is a constant need to cheat on people and fill in the pockets, which
are bringing the corporation down every time, then what is the point of setting
up the company in the first place?

The company and the board fall under the agency
relationship under statute. It is their duty to protect the principal’s interest.
To build up a society, there needs to be a flow of goods, services and money.
If there is only self-indulgence, and it grows big enough to land them in jail
or crash the corporation, then a society would never be able to grow. Certain
banks have paid heavy fines for inappropriate conduct and paid out billions as
compensation for unethical usages.11

The agency relationship affects the board and the
corporation directly. The directors are liable to the company for any breach of
This brings back the question about the relationship between shareholders and
directors. Although there is no need for the board to justify their actions to
the shareholders because they owe a duty to the company, the relationship is
indirectly linked. The shareholders are owners of the company and the directors
are agents of the same. They can be said to be the manager of the money invested
by the shareholders.

While it is true that there will always be a ‘risk element’ that the board would look
after their own needs, s 172 of Companies Act sought to overcome this by
putting an obligation on the board to think about the company and its people. A
breach towards the company would be a fiduciary breach while towards the
shareholders would also be a breach and they can co-exist in certain cases as
found in Platt v Platt13.

Furthermore, under Boardman v Phipps14,
it was held that the beneficiaries are entitled to force the board for
unauthorized profits made in breach of fiduciary duties and likely conflict of

Another possible argument would be reputation15.
To create a permanent presence in the society, the work done by the corporations
need to be consistent and transparent. To gain the faith of the investors, it
is quite desirable for the company to build a good reputation leading to its
goodwill and ultimately, its increased value. The board’s ultimate aim at the
end of the day would be to maintain the brand created and not crumble it for a
moment’s happiness.

The boards might want to think about the shareholders’
interests for legal reasons16
as well. All around the world, laws to curb the wrong behaviour are coming into
force, which nudges the boards’ actions in the desired way. It could be argued
that boards could hide behind the corporation’s name for their ill doing but the
corporate veil can be lifted as held in Adam
v Cape Industries17.

Furthermore, to answer the question as to whom the board
owes the duty to, Dodd18 went
far to argue that the boards have duties not only to the shareholders but the society
as a whole. As a counter-argument, Friedman19
stated that the duty is to the shareholders only subject to legal and ethical
He went on to argue that sometimes, the boards spend money on ‘social responsibilities’ like reducing
poverty or inflation and have nothing to do with their own interests. However,
they are still spending as an agent and that is wrong.

Does Corporate
Governance code help?

There has been an urgent introduction of various rules to
alleviate the possibility of such past events and an overwhelming need for
corporate governance. Corporate Governance looks after the balance of interests
of the company’s stakeholders and management. Accordingly, these laws aim to
prevent such costs by assigning fiduciary duties to managers and directors,
which aim to prevent avoidance and disloyalty.2122

UK has been trying to delegate more power to
the shareholders under the Corporate
Governance Code (CC)23 and the Companies Act 2006, where they are the main concern. Their rights
and duties are to question any decision made by the board or review an act if
it does not seem in line with the interests of the company and/or themselves.


However, because of the lack or limited
interest in the internal activities, they might not be more interested in the
meetings to voice there concerns as required under section 281 of the Act.
Also, the code is following a lenient approach towards board’s duties until
stringent actions are needed.


 For example, the CC states that a
single person should not be the chairman and the CEO24,
otherwise he would get too much power to contain. Although Sir Stuart Rose’s
position as both, at M, had faced outrage from the shareholders for the
same reason, the code followed the “comply
or explain”25
route. The companies might deviate from the code as long as they can
clearly explain why.26
Lord Harris, who had been the CEO and the Chairman of Carpetright said, “If we are doing well, why change it? A good
audit committee and strong non-executive is what’s most important.”27


Additionally, CC pinpoints the need to
appoint non-executive directors (NEDs). NEDs devote some of their time to
review the executive director’s activities on behalf of the shareholders as a
third party. Their role has become much more pivotal now because of the series
of events happening all around the world. They are concerned with areas like
the remuneration of directors and audit, trying to push the company in a more
favourable direction.


On the debate on NED’s role, Kiarie28
says that they bring a fresh viewpoint, identifying opportunities and threats
while increasing shareholder’s confidence, bringing in new investors or further
investment from existing ones.


However, Sweeney-Baird29
argues that the role is more conflicting. If they devote less time, they have
less time to monitor activities. If they devote more time, they are vulnerable
to lose their independence. Another argument would be that sometimes the NEDs
would become too involved with the internal activities. They would play along
with the executive directors and expect the favour to be returned. For example,
when the NEDs were responsible to determine the pay and Fred Goodwin was paid
Even worse, they would not even know what their role entails because they did
not receive any developmental training.31


Following all these, there might be
doubts about the effectiveness of the CC since it is a soft law. But, its
positive outcome can be seen in reports such as FRC report32
and Walker review33.


Is there a suitable balance
of power between the board and the shareholders?

Firstly, the shareholders are given the option to
exercise their rights through voting (one vote per voting share) under section
168 of the Act. The Court in Re Dorman
held that “it is essential to see
that the explanatory circulars sent out by the board of the company are
perfectly fair and, as far as possible, give all the information reasonably
necessary to enable the recipients to determine how to vote.”35
The disclosure requirement is an
important step towards a more open and transparent business. The effort towards
it has led to increased transparency, improved annual accounts and audit reports.

Secondly, the big shareholders are normally the ‘institutional investors’36
who hold bigger percentage, hence more control of rights. The management
consults them frequently, which gives them the opportunity to speak for the
shareholders as a whole. However, these shareholders
might at times act for personal gains and not use the votes they are given for
the general welfare of the shareholders and maintain high level of governance,
as required under the code.37

Thirdly, another incentive
to get higher returns with good corporate governance might fuel the board’s
need to think more about the company and its people. Moreover, the board
members are shareholders themselves. Like others, they would want to maximize
the value of the shares for themselves as well. This could help and protect the
other’s interests.

to control the board’s fraud or dishonesty:


Hannigan indicated, “no single mechanism can provide an answer
to this so-called agency problem between the shareholders and directors and a
variety of responses is required.” 38 The focus has to be on
both internal and external mechanisms.


Legal restrictions on the
board’s duty of loyalty not to self-deal (theft, misappropriation, excessive
managerial perks) can be held potentially important.39

Minority shareholders can
call derivative suit4041 to account for
mismanagement, diversion of assets and fraudulent behaviour.42Courts are however quite reluctant
to put stringent rules on corporate law practices because it might defeat the
aims of the company. Lord MacNaghten in Dovey
v Cory43
case stated, “I do not think it is
desirable for any tribunal to do that which Parliament has abstained from
doing- that is, to formulate precise rules for the guidance or embarrassment of
business men in the conduct of business affairs.”


Moreover, the threat of
displacement and acquisitions in case of underperforming management in large
corporations also serves as an incentive to work harder. For fraudulent
management, various regulatory authorities are bringing in rules like the
Sarbanes-Oxley legislation, which was introduced after Enron. It is to ensure
that the commitments of the directors towards the shareholders would be



A quote very beautifully sums up this essay, “There is
more to a company than distinct legal personality and the blank façade of the
instrument of incorporation. Instead, there are human beings- with their
aspirations, hopes and dreams- inside companies”.44


Although there will always
be a risk that the board might use their power to benefit themselves, the
detriment they would suffer for such actions both personally and legally seems
miserable. Various rules and regulations are making sure that the investors are
given as much power as possible to stop the boards from wrong-doing.

The invention of a
corporation is an awesome thing. Even after scandals like the ones mentioned
above, millions of people voluntarily invest their personal money, entrusting
the directors to take care of such and by far they do not seem to be
disappointed. The healthy growth of corporations (start-ups or multinationals),
as well as the growth of the society, establishes this point.

1 Adam Smith and Germain GARNIER, An Inquiry Into The Nature
And Causes Of The Wealth Of Nations … With A Life Of The Author. Also, A View
Of The Doctrine Of Smith, Compared With That Of The French Economists … From
The French Of M. Garnier. (T Nelson 1852) 311

2 ibid.

3 Michael C. Jensen and William H. Meckling, ‘Theory Of
The Firm: Managerial Behavior, Agency Costs And Ownership Structure’ (1976) 3
Journal of Financial Economics.

4 Agency relationship is defined as a contract under which
one or more persons (the principal(s)) engage another person (the agent) to
perform some service on their behalf, which involves delegating some
decision-making authority to the agent.

5 ibid 3, p. 5

6  2003
EWHC 2263 (Comm)

7 ibid 3

8 Companies Act 2006, ss 171-177.

9 Bethany McLean and Peter Elkind
published the book The Smartest Guys in
the Room in 2004 followed by the documentary based on it portrays a clear
picture for the same.

10 Colin Coulson-Thomas, ‘Corporate Ethics
And Ethical Business Practices’ (2017) Vol. III Director Today

11 ibid.

12 Companies Act 2006, s 170

13 1999
2 BCLC 745

14 1967
2 AC 46, 1966 UKHL 2, 1966 3 All ER 721

15 Thomas H. Noe, Michael J. Rebello and Thomas A. Rietz, ‘The Separation Of Firm Ownership And
Management: A Reputational Perspective’

16 E. Merrick Dodd, ‘For
Whom Are Corporate Managers Trustees?’ (1932) 45 Harvard Law Review

17 1990 Ch 433, 1991 1 All ER 929,
1990 2 WLR 657, 1990 BCLC 479, 1990 BCC 786 

18 ibid 14

19 Milton Friedman, ‘The
Social Responsibility Of Business Is To Increase Its Profits’
1970 The New York Times

20 Stephen G. Marks, ‘THE

21 Katharine V. Jackson, ‘Towards a Stakeholder-Shareholder Theory of Corporate Governance: A Comparative
Analysis’, 7 Hastings Bus L.J. 309 (2011).

22 ‘The UK Corporate Governance Code’ (, 2016)

23 ibid.

24 ibid
22, p. 8

25 ibid 22, p.4

26 Zoe Wood, ‘Marks
& Spencer’ The Guardian (2008)

27 ibid.

28 Sarah Kiarie, ‘Non-Executive
Directors In UK Listed Companies: Are They Effective?’ 2007 International
Company and Commercial Law Review

29 Margarita Sweeney-Baird, ‘THE ROLE OF THE NON-EXECUTIVE

30 The Telegraph, ‘Ten
Years On: The Key Players In The Financial Crisis – Where Are They Now?’

31 Derek Higgs, ‘Review
Of The Role And Effectiveness Of Non-Executive Directors’ (The Stationery
Office 2003)

32 Financial Reporting Council, ‘2009 REVIEW OF THE COMBINED CODE: FINAL REPORT’ (2009)

33 David Walker, ‘A
Review Of Corporate Governance In UK Banks And Other Financial Industry
Entities Final Recommendations’ (2009)

34 1934 Ch.
635 (Chancery Division)

35 ibid.

36 A financial institution, such as a bank, pension fund,
mutual fund and insurance company, that invests large amounts of money in
securities, commodities and foreign exchange markets, on its own behalf or on
the behalf of its customers.

37 ibid. 20

38 Brenda Hannigan, Company Law (4th edn, Oxford
University Press 2016) p 121

39 Brian R. Cheffins, ‘Does Law Matter? The Separation Of
Ownership And Control In The United Kingdom’ (2000)

40 A lawsuit brought by the shareholders, on behalf of the
corporation, against the officers and/or directors of the corporation for
mismanagement or other malfeasance that caused harm to the shareholders’
interest in the corporation.

41 Companies
Act 2006, s 260

42 ibid 36, p.9

43 1901 A.C. 477

44 Alastair
Hudson, Understanding Company Law (2nd edn, Routledge 2018) p.163