I. Introduction
The concept of stakeholder theory has been a part and parcel of corporate governance since the early 80’s. The scholarship in this area is evergrowing and is one of the key issues of debate and deliberations in most jurisdictions around the world. The idea of incorporating stakeholders into the management fold first emanated from the landmark work of Freeman, published in 1984.[1] He focused his notions of the stakeholder theory upon the creation of value for all and not just one stakeholder. The theory thus acts as a counterbalance to the traditional notion of shareholder theory which emphasises that the purpose of a business is the maximisation of value to shareholders. Stakeholder theory in contrast, has been described as the collection of metaphors, ideas and expressions that help a company achieve value for all intersections of stakeholder interests.[2] In this sense this theory is broader in its approach and does not consider stakeholder interests as a means to achieving the end of shareholder value creation only, but propounds for these interests being the very ends a company must concern itself with.
The classic tug of war between these two theories also raises some important questions which are specific to the role and duties the directors of the company have in this regard. For instance, should the focus of directors be all stakeholders or just shareholders, with whom the ownership of the company lies? The question is under great focus and scrutiny now more than ever, specifically by legislatures and institutional investors across the world. In India for example, consideration of stakeholder interest is now crystallised as a statutory duty upon the directors under Section 166(2) of the Companies Act, 2013. While the full extent and consequence of the duty itself or the claims for breach of such a duty is unknown due to legislative ambiguity and lack of judicial precedent, it is interesting to note that the idea of stakeholder and shareholder theories being binary opposites is slowly but surely evolving into a more conciliatory approach. In jurisdictions like the US and the UK, the staunch shareholder-centric approach is slowly giving way to the realisation of interests of other stakeholders as well. This position is in stark contrast with a country like Norway where the stakeholder interest will take supremacy over shareholder interest if it must. These positions are in turn different to the model followed in Canada or even South Africa where the focus seems to be more upon striking the balance of interests between all stakeholders by providing for enforcement rights. The position in Canada, as we will further examine, is thus different than most, for no other jurisdiction offers enforcement rights to its stakeholders, including India.
This paper thus aims to trace these very changes and trends in the perception of corporations, legislators and investors in deciding which theory and which practice is better suited for the increase of value to businesses. The paper compares instances that focus on a director duty model like the US and UK, to the accommodation of stakeholder interest based on a remedy-based model in Canada to stakeholders enjoying a hegemonic status as in Scandinavian countries. The paper then concludes with the views of the author having specific regard to the Indian context, in how and what might be the best way forward in advancing and reconciling stakeholder and shareholder interests in an economy such as ours, where the shareholding is closely held and not widely disbursed.
II. Jurisdictional Analysis
(a) Director Duty Model
(i) The United States
The idea of the supremacy of the shareholder is one that developed in the US.[3] The traditional notion of the shareholders being owners of the company and hence that the directors act as guardians of the shareholder’s property developed in the 19th century[4]. This was further crystallised by the landmark decision of Dodge v. Ford Motor Co.[5] wherein the court held, “A business corporation is organised and carried on primarily for the profit of the stockholders and the powers of the directors are to be employed for that end.”[6] What is however interesting to note is the fact that despite the ratio of Dodge v. Ford Motor Co.[7], academics often argue that Dodge does not abandon the idea of corporate philanthropy altogether, but propounds it to be something that is incidental to the main business of the corporation.[8] Other judicial decisions and statutes in the United States also seem to uphold this thesis. For instance, in cases such as A.P. Smith Mfg. Co. v. Barlow[9] or Davison v. Gillies[10] the Court upheld the company action that invested in and protected the stakeholder interest. There is also further evidence to suggest that even in the 19th century, certain statutory provisions made shareholders liable for payment of wages to the employees or the payment pending to creditors in cases of default.[11] Yet the idea was to ensure that such efforts that served interests beyond the shareholders, were to only remain incidental to the business in question and were never at the expense of shareholder interest. In this context one may say that shareholder supremacy was indeed the norm and might still be.
Even with recent debates and advancement of ideas of the changing norms of corporate governance and while it is well acknowledged that many jurisdictions in the US have specifically and statutorily recognised the idea of stakeholder interests, the fact that implementation of the same lacks uniformity or that they do not form part of a mandatory requirement seem to spell more harm than good. The pressure of having a duty to perform when it comes to the interests of the stakeholders is seriously lacking. For instance, out of the 31 States in the US that do recognise the idea of a stakeholder system, only two — New Mexico and Arizona, place a compulsory duty upon the directors to take into consideration the interests of the stakeholders in all cases.[12] In other cases the duty is voluntary and comes without the pressure of an obligation. What is even more problematic is the case of Connecticut, where a reverse process of moving from a limited mandatory duty upon directors to a fully optional regime, for larger corporations was introduced.[13] Even the State of Delaware, known to house the largest number of public corporations has failed to incorporate the stakeholder regime in its statutes.[14] What is however interesting to note is the fact that there seems to be judicial protection to these interests in Delaware.[15] Moreover, in Tennessee while the obligation to consider and enable stakeholder interest is missing, a director may not face adverse action in case he has indeed considered such interest.[16]
The application of the stakeholder theory in the US thus seems episodic in nature and in most cases it is confined only to instances of takeover or liquidation. Even in those cases where the interest is acknowledged, the stakeholders lack the means to enforce their rights for there is a serious lack of entitlement to bring claims for breach of duty by the directors against the stakeholders.
(ii) The United Kingdom
Common law countries have traditionally understood and upheld the shareholder primacy theory. Even the Companies Act of the UK tends to describe a company as a collective of its shareholders.[17] In such a scenario, one may argue that the incidental standard of corporate philanthropy as existed in US also resonates in the UK where there is a strong emphasis on the principle agent relationship of the shareholders and the directors. This claim is also supported by the findings in the 1883 case of Hutton v. West Cork Rly. Co.[18] wherein it was held that if only the expenditure on charity was for the benefit of the company, would the same be allowed.[19] Thus the emphasis was on curbing the resources at the disposal of directors when it came to the protection of shareholders. This position was further reiterated in Parke v. Daily News Ltd.[20] in 1961.
It was only after two decades of the Parke decision that efforts to incorporate the interests of stakeholders and specifically those relating to employees of the company were introduced to the corporate body of law.[21] These were amendments to expand director duties to incorporate the stakeholder system by placing upon them the duty to, only consider, the general interests of the employees.[22] What is important however to note is the fact that this amendment had the effect of equating secured creditor claims with dues to the employees, thus reducing their vulnerability, but at the expense of another stakeholder in the process.
To further strengthen and acknowledge the legitimacy of stakeholder interests and considerations, the UK in 2006, amended its Companies Act to introduce the “enlightened shareholder value” (hereinafter “EVS”) model of governance. The approach is a cross between the shareholder approach and the stakeholder approach and as per the requirement of Section 172 of the UK Companies Act, 2006 requires that the directors treat the interests of the stakeholders as the means to the end of shareholder value enhancement.[23] Evidently, the stakeholder interest is subordinated to shareholder interest and in case of a conflict the latter shall prevail. The said amendment is applicable to all companies on an ongoing basis and bears on it a mandatory character as well.
A critical reading of the EVS amendment seems to suggest that the fact that other stakeholders have not been granted the same status as shareholders means that the amendment is not all that different from what existed prior to 2006. Perhaps the amendment was only an effort to codify what already existed and does not seem to alter the position of stakeholders considerably. Even with the conscious effort on part of the legislature to codify the theory of stakeholder interest, the same lacks enforceability much like in the United States and seems like a toothless provision. This claim is further strengthened by the fact that Section 172 of the Act is hierarchical in nature, placing shareholders interest above all other interests and reaffirming the notion that the EVS model might just be a lip service provision, only prima facie trying to keep up with the changing demands and interests of institutional investors.
(a) Remedy Model
This part of the paper will focus on the application of stakeholder theory primarily in Canada. Canada was one of the first common wealth systems to recognise the stakeholder principle of governance which received judicial backing in Teck Corpn. Ltd. v. Millar[24] in 1972. Much like the United States, Canadian law recognised the principle and allowed for cases of corporate philanthropy as early as 1965 by the enactment of the Canada Corporations Act.[25] The provisions of the said Act allowed corporations to make contributions for general or public object or to the welfare of current and/or former employees. Thus comparatively, the appreciation and acceptance of stakeholder interest above and beyond the shareholder interests was well in place in Canada and the same does not seem to have been borne out of a struggle or out of any judicial precedent as has been the case in a few jurisdictions.
Canadian legislation takes this approach a step further as well. It is important thus in this context to bring forth the unique and equitable provisions of the Canada Business Corporations Act (hereinafter the “CBCA”). The Dickerson Committee, that drafted the CBCA, did not consider shareholder supremacy a valid consideration. In doing so, they thus disbanded the idea of shareholders holding a proprietary right over the other stakeholders or the fact that the duty of a director was to primarily represent and protect their rights.[26] For the Committee, the shareholder was at a position that was just a little more than that of a mere security holder.[27] This had the effect of placing shareholders at a rough parity with other stakeholders like employees, creditors, etc. and takes away any special position that might have been granted to them in other jurisdictions.
It is in this context that the CBCA extends the remedy of derivative action suit and relief against oppression to stakeholders as well.[28] Section 238 of the CBCA equates the rights of shareholders and creditors and allows even directors or officers, including former employees and government officers, acting in public interest, the remedy actions aforementioned.[29] The Court is even empowered to determine who might be proper party in such cases, which further broadens the scope of the section. It is pertinent to note that traditionally and in fact even in most other jurisdictions across the world, this right is restricted only to shareholders. It is only in Canada as also in South Africa that this right of enforceability has gone beyond the traditional notions and to the stakeholders directly. How effective these remedy provisions have been is however still an open-ended question.
(b) Representational Model
The focus of this part of the paper would be on Scandinavian countries with strong stakeholder governance models and Germany that embodies a co-determination model. The model in Germany allows non-shareholder a representation on the Board of Directors thus allowing them a participative right.[30] It is needless to say that such representation must be substantial enough to allow a valid representation of stakeholder interest on board.
In Scandinavian countries, the position is at a stark contrast compared to the US or the UK for the stakeholder interests enjoy a hegemonic status since the 1970’s and shareholder interests, in fact, might be considered subordinate to them. The industry practice and companies further provide enough evidence in support of the said contention. While there are numerous examples of company practices demonstrating stakeholder supremacy in this context, for the purposes of this paper we would focus on the engagement practices of Norsk Hydro, a Norwegian extract company. The company is often acknowledged for its stakeholder engagement practices as is reflected in terms of its corporate policies that focus on collaborative efforts that ensure benefits to not just the shareholders but even more so to the stakeholders.[31] The focus thus is not the creation of value for the company through the stakeholders but the creation of value for both the company and the stakeholders at parity. The company also follows the trend of not just engaging with the stakeholders directly but accommodating and addressing these stakeholder concerns into best business practices.[32] Almost similar practices are followed by the Danish pharma giant Novo Nordisk.
It is, however, pertinent to note that in engaging in and implementing these stakeholder friendly-practices the idea of corporate ownership plays a major role. In Norsk Hydro, the 34% stake is held by the State itself which makes it easier for the voice of stakeholders to be heard in these corporations.[33] Similarly, in the case of Novo Nordisk, the majority stake is held by a corporate foundation. The ownership resting either the State or a corporate foundation is a common phenomenon in the Scandinavian region.[34] One may in such a scenario argue that the ease of incorporating and addressing stakeholder concerns over shareholder concerns and interests is in fact owed to the kind of corporate ownership pattern the corporation follows — thus where the ownership is stakeholder centric, the supremacy of the stakeholder interest would indeed be easy to establish.
III. Conclusion
The aim of this paper has been to put forth and portray the varied trends and approaches that there are to the emerging field of stakeholder engagement. The paper has covered the extreme examples of US and UK to Scandinavian Europe to finer and seemingly more balanced approaches followed by Canada. If the implementation of these approaches were to be adjudged in light of Section 166(2) of the Companies Act, 2013 the following similarities and observations would follow.
Much like the United States and the UK, the right of enforceability of the stakeholder interest claims is missing in the Indian context as well. The extent of the duty of the director and the nature of the duty of the director to the stakeholder is also vague and ambiguous. Further, much like the UK’s EVS model, Section 166(2) seems to only superficially do what it was intended to do. Despite being a mandatory duty upon the director the scope of enforcement of this duty vis-à-vis the shareholder interest and specifically when the majority shareholders in the Indian context represent the Board of Directors, seems to be amiss. Even the idea of having a representational board where in, like Germany, employees could form part of the board would be a futile exercise in the Indian context given that majority shareholding is family held in our country and that the board is often synonymous with the majority as well. Even the Scandinavian model would perhaps not be best suited in terms of Section 166(2) for corporate ownership patterns in India are not foundational. Perhaps the probability of the Canadian model functioning in the Indian context is the highest. How the Indian courts would ultimately rationalise the scope, nature and practical application of Section 166(2) is, for now, an open-ended question and it is only hoped that the shortcomings envisioned would be addressed sooner than later either through legislative intervention or through judicial interpretation, but either way for the benefit of the stakeholder.
† Final year student at JGLS, Sonipat.
[1] Strategic Management: A Stakeholder Approach (Freeman, 1984); see also, The Scandinavian Cooperative Advantage: Theory and Practice of Stakeholder Engagement in Scandinavia, Robert Strand, R. Edward Freeman, CBS Center for Corporate Social Responsibility.
[2] Ibid.
[3] P.M. Vasudev, The Stakeholder Principle, Corporate Governance, and Theory: Evidence from the Field and the Path Onward, Hofstra Law Review, Vol. 41 Issue 2 Art. 6 (2012).
[4] Santa Clara Revisited: The Development of Corporate Theory, 88 W. VA. L. Rev. 173, 200 (1985).
[5] 170 NW 668 (Mich 1919).
[6] Ibid.
[7] 170 NW 668 (Mich 1919).
[8] Ibid.
[9] 98 A 2d 581 (NJ 1953).
[10] (1879) 16 Ch D 347.
[11] James Willard Hurst, The Legitimacy of the Business Corporation in the Law of the United States, 1780-1970, at 15 (1970).
[12] 98 A 2d 581 (NJ 1953).
[13] Ibid.
[14] Jeffrey W. Bullock, Delaware Division of Corporations, 2011 Annual Report, available at <https://corpfiles.delaware.gov/2011CorpAR.pdf>.
[15] Unocal Corpn. v. Mesa Petroleum Co., 493 A 2d 946 at 958 (Del 1985).
[16] Tennese Code 48-103-204- Corporation not liable for resisting merger, exchange, etc.
[17] Adolf A. Berle and Gardiner C. Means, The Modern Corporation and Private Property 294 (Harcourt, Brace & World Inc. 1968) (1932).
[19] Ibid.
[20] (1961) 1 WLR 493 : (1961) 1All ER 695.
[21] Companies Act, 1948, 11 & 12 Geo. 6, Ch. 38.
[22] Alfred F. Conard, “Corporate Constituencies in Western Europe”, 21 Stetson L. Rev. 73, 80-81 (1991).
[23] The Stakeholder Approach Towards Directors’ Duties under Indian Company Law: A Comparative Analysis, Mihir Naniwadekar and Umakanth Varottil, NUS Working Paper 2016/006, NUS Centre For Law & Business Working Paper 16/03.
[24] (1972) 33 DLR (3d) 288, 314-17 (Can. B.C. Sup. Ct.).
[25] RSC 1970, c. C-32.
[26] P.M. Vasudev, The Stakeholder Principle, Corporate Governance, and Theory: Evidence from the Field and the Path Onward, Hofstra Law Review, Vol. 41 Issue 2 Art. 6 (2012).
[27] Ibid.
[28] Canada Business Corporations Act, RSC 1985, c. C-44, §§ 238-241.
[29] Ibid.
[30] Companies Act, 1948, 11 & 12 Geo. 6, Ch. 38.
[31] Strategic Management: A Stakeholder Approach (Freeman, 1984); see also, The Scandinavian Cooperative Advantage: Theory and Practice of Stakeholder Engagement in Scandinavia, Robert Strand, R. Edward Freeman, CBS Center for Corporate Social Responsibility.
[32] Ibid.
[33] Thomsen, S. and Hansmann, H., 2009, Managerial Distance and Virtual Ownership: The Governance of Industrial Foundations, Working paper, available at <http://webs2002.uab.es/dep-economia-empresa/recerca/DocsSem/S_Thomsen_22_4_10.pdf>.
[34] Ibid.
