Internalities and the Foundations of Corporate Governance

Introduction

The traditional ‘Anglo American’ model (Hansmann and Kraakman 2001: p. 439) of corporate governance is founded on a discourse of externalities whereby the corporation is divided between active and information-rich insiders and passive or excluded outsiders, relations are established and capital is allocated in a market for contracts, and those relations are mediated through patterns of financial incentives. The administrative functions of the firm are assumed to emerge from and be dependent upon this web of market devices. Indeed, for instance, Easterbrook and Fishel (1991: p. 38) deem ‘who cares?’ to be the appropriate response to inquiries into any specific corporate purpose or structure. Such things are a matter of the market allocation of contracts and so, providing the specific firm’s purpose is clear to investors, no corporate governance problems arise. Corporate governance is, in this context, understood as the challenge to align incentive structures for insiders with the stipulations of contracts entered into by outsiders.

More critical perspectives on the corporation focus on different kinds of externality: the effects of corporate power on those who come into the corporation’s orbit or those who stand in its way would be one such externality. The presence of extraction industries in the Niger Delta or in the Democratic Republic of the Congo (on the Niger Delta, see for instance Amnesty International, 2009; Idemundia, 2007; Wettstein, 2012; on Glencore in the Congo (and elsewhere), see Silverstein, 2012) is held to reflect a pattern of conduct by corporate persons concerned with profit before environmental impact (or worse). On other occasions, discussions of corporate abuses of power focus on relations with employees, especially in the context of global supply chains (on Nike for instance, see McBarnet, 2007: p. 40ff; Vogel, 2005: p. 77ff; on Apple and Foxconn, see Duhigg and Barboza, 2012; Frost and Burnett, 2007; Moore, 2012; Vascellaro, 2012; Warman, 2012; for a related issue, although focused on the USA, see also McClelland, 2012). Here corporate power and ‘globalisation’ are held to produce forms of exploitation that would be unacceptable in the countries where – most often – products are consumed.

We argue in this paper that, by limiting their vision to ‘externalities’, both perspectives only give a partial view of the corporation and corporate governance. Both accept – although with radically differing degrees of approval – the corporation as a ‘black box’. Governance is posed either as a mundane function of the interplay of markets and incentives (this, we believe, is Easterbrook’s and Fischel’s point above), or as a means to legitimate the company imagined as hidden behind market discourses (for one example of this perspective, see Fineman, 2008: p. 5). We are interested in discussing the company and corporate governance as a series of internalities. That is, first, we do not accept the market-driven analysis of the corporate purpose. In particular, we reject the idea that corporate governance in a broader sense ought to be analysed as narrowly subordinate to market rationalities. We think of corporate governance as something far more interesting – and urgent – than that. We also reject, second, the notion that we should abandon our study of the company at the market’s doors, so to speak. Problems of corporate governance can and should be addressed through corporate governance mechanisms, broadly defined. Corporate governance contains more possibilities in approaching problems of corporate power than critics on the left sometimes allow for.

In this paper we seek to explain the company and corporate governance as a series of responses to the weaknesses exposed first by industrial production and subsequently by the corporate form itself. We discuss corporate governance as the administration and delegation of responsibilities in the light of various exposures that emerged first in early industrial organisation and subsequently through the corporate form. We see the company as a political entity subject to the vagaries of laws, codes and markets, rather than a fixed and stable entity. We regard the company as an institution that in large part is those laws, codes and markets. The firm is an unstable, contested space that is subject to discourses and arguments, both constructed by and towards ideas of law, administration, regulation and economics, which develops a series of gestures towards those ideas and which is rooted in ‘myths’ about fairness, equity and desert. Where someone invokes the ‘black box of the market’, we see an appeal to a certain conception of the corporation as a fixed edifice and the shutting down of a conversation about economic life. We propose that corporate governance itself – as distinct from state or market-based regulation of corporate conduct – can play a role in shaping the corporation’s place in social life and the global economy. Corporate governance holds in tension the relationship between investors, broadly conceived, managers and the corporate board, and it is from that tension that a change in corporate culture will emerge. Imagining possible state roles in maintaining that tension may be more constructive than simply imagining the state’s approach to corporate governance as being one of restricting or policing corporate activities. Our analysis primarily focuses on the structures of corporate governance as they have emerged in the UK, although if this specificity is ignored, the points made transplant to the systems of corporate governance found both in the USA and in other common law countries.

The corporation as we describe it above is a series of vacillating, culturally specific and imperfect iterations of an institutional device, each iteration attempting to tackle some of the vulnerabilities thrown up by production in modern capitalist societies. The corporation is unstable precisely because each generation of corporate capitalism produces new power alliances, and with them new vulnerabilities that the corporation attempts to check in pursuit of social goals. That these goals are narrower and far less perfect than a progressive theorist might wish ought not to obscure the fact that there is some potential in the corporate form. If the rhetoric of the ‘black box of the market’ does not dissuade us from attending to it, we can view the corporation as containing the possibility of reform towards a broader standpoint. For the moment, the institutional checks contained in the current iteration of corporate governance (and hence of the company), rooted in wide dispersal of ownership, although ‘disappointing’ (Erturk et al., 2004) in many ways, is preferable to concentrations of ownership, either by financier-shareholders bent on liquidating firms (Froud and Williams, 2007; cf. Salter, 2008: pp. 251–260) or – as we shall see below – by dominant owner-managers bent on retaining/diverting corporate power and resources to themselves. In a sense, as we discuss at the end of the paper, the company is a vehicle for holding potential abuses in balance, or even manufacturing some kinds of imbalances directed towards avoiding the emergence of tyrannical power bases in industrial capitalism.

The main part of this paper involves an account of the ebbs and flows of the company as an institution; how it responds to new interrogations as they emerge as threats to corporate reputation, individuals’ careers and shareholder capital investments. Before that account, we deepen our discussion of the company as an institution, highlighting the corporate economy as a whole – markets, laws, conventions – as the basis for our understanding of the company as a governance device. All this is conditioned on the institutional distribution of power that comes from the roles of (dispersed) investor voice and the power of shareholder exit in corporate governance (Hirschman, 1970), from the conventions instituted in the UK’s Corporate Governance Code and from the ‘regulatory conversations’ (Black, 2002) that take place in that environment. Our discussion shows, following Belcher (2003), that an analysis of the company is more rewarding and illuminating than the ‘black box’ rhetoric allows. We finish with the presentation of two cautionary examples, focusing on what happens when some of the components of corporate governance that embody the current set of vulnerabilities are set aside. One example focuses on the perils of the owner-manager, who evades the balances produced by the latest iteration of corporate governance through the concentration of power in a single pair of hands. The other example demonstrates that profit generation is insufficient to trump the values of what is considered to be ‘good’ governance. While corporate governance and the corporation – as currently conceived – might not produce a redistributive imperative, they do produce constraints on the capturing of commercial and societal power and suggest possibilities for building more democratic and sustainable forms of production.

A Comment on Laws and Rules

As Suchman and Edelman point out, organisations have been the target of ‘many – perhaps most – of the great legal innovations of the 20th Century’ (Suchman and Edelman, 1996: p. 906). The contemporary administrative organisation, combining a capacity for common action with considerable information-gathering power, is a function not only of legal and other formal rules but also of underlying norms and administrative cultures. Formal structures of governance are produced and rationalised by ‘deeply ingrained’, ‘widespread understandings of social reality’ (Meyer and Rowan, 1977: p. 343), which themselves promote the reconfiguration of organisational forms as ‘institutionalised rules’ (Meyer and Rowan, 1977: p. 347).

We cannot simply understand organisations like corporations as creatures of, say, market forces shaped by rules of the game. Rather, the formulations of rules, of organisations and of market forces are all part of a conceptual whole. The modern organisation emerges matched with, and legitimated by, its relation to these ‘myths’. It is founded not simply on internally enforced rules, but is an elaboration of ideas that depict the rules as being the best means for attaining notionally desirable ends: the organisation’s fitness, in other words, is determined by the social, and in particular the normative, environment in which it is placed.

In this context law ought not to be seen as a simple articulation of rules of the institutional game. Law, rather, is uncertain and ambiguous and is itself constitutive of reality rather than merely a mechanism for regulating reality (Suchman and Edelman, 1996). For Suchman and Edelman, for instance, law is actually a welter of conflicting principles, imperfect analogies and ambiguous generalities. Thus, lawyers, judges, enforcers and target populations negotiate the meaning of law in each application, seeking workable consensus rather than logical certainty (Suchman and Edelman, 1996: p. 932).

As such, law ‘may be best conceptualized not as an objective external constraint but rather as a source of uncertainty in organizational life’ (Suchman and Edelman, 1996: p. 932). While law ‘establishes a taken-for-granted categorical structure for social relations – and provides a set of accepted rituals for manipulating that structure’ (Suchman and Edelman, 1996: p. 937), the character of those structures and rituals is contested and subject to ‘regulatory conversations’ (Black, 2002) between policy-makers, stakeholders and the subjects of law. Organisational cultures ‘speak to’ law, but law is itself part of a conversation about how the structures from which those organisational cultures emerge are formed, legitimated and sustained.

Our discussion of the corporation and of corporate governance is shaped by this thinking. We think of the corporation not simply as a product of market forces and not simply as something mandated by law. Rather, a series of forces, including those produced by product and equity markets, those produced by conventions surrounding perceptions of law and those produced by prevailing mercantile and social conventions, contribute to the corporation as a feat of imagination. The corporation as it acts in the world is a product of how all these forces combine. It is in large part an institution that rests on the kinds of myths that Meyer and Rowan mention. Corporate governance, furthermore, and the precepts of shareholder value, agency costs and investor privilege are not simply forces that are brought to bear on the company. They are (an important) part of the cultural and normative environment and narrative through which the company’s existence is defined and explained.

Company law and codes, rules and conventions of corporate governance are not, by this measure, external forces brought to bear on markets. They are the markets properly enacted and understood; the institutions that act in economic exchange from day to day. The rights conventionally conferred by share ownership, for instance, tend to extend far beyond those specified in (UK) company law. The share as a purely legal device is little more than a security that may yield future revenue in dividends (at the discretion of managers) and to which some residual control powers have been attached (on the distinction between the share as imagined in law and conventional views of share ownership, see Worthington, 2001a, b; see also, Ireland, 1999; Ireland et al., 1987). Nor ought we to see shares as being solely a product of market forces (as suggested for instance by Easterbrook and Fischel, 1991) where the promises attached to shares are designed to entice potential investors to contract with company proposers. The share is characterised by both legal and quasi-‘contractual’ factors, no doubt, but it is also the product of a wider set of underlying cultural conventions about the role of capital and of financial markets in the corporate economy and the economy more generally, the different positions of different kinds of shareholding persons and institutions and the varying political and normative voices of all stakeholders, including various shareholders.

Nowhere is the cultural role of the share clearer than in relation to retirement savings. The decline of occupational pension schemes, in terms of both availability and conversion to defined contribution plans from defined benefit plans, and the dire warnings of many governments, including the UK, about the unlikelihood of state provided retirement funds to cover the costs associated with the prospect of increased longevity, has pushed huge numbers of individuals into share ownership as indirect investors. They have become reluctant participants – through life assurance products and pension plans – in the corporate economy, their interests contained in impersonal funds managed by unknown fund managers (Langley, 2004).

So, while ‘the company, acting through its directors, has an almost unconstrained discretion to deliver additional, non-contractual or non-compulsory benefits to any stakeholder’ (Worthington, 2001b: p. 312; see also, Pettet, 1997), the conventions and myths of corporate capitalism confer a special status on shareholders. Corporate governance also consists of both the formal mechanisms and the informal regulatory conversations that take place in answer to that special status. The regulatory force of corporate governance is as much ‘relational’ as it is in any sense ‘legal’ (on corporate governance as a relational device, see Pendleton, 2005; see also Pendleton and Gospel, 2005).

The UK’s Corporate Governance Code, as we shall see, actually enshrines the uncertain, conventional and disputed character of corporate governance in the running of certain kinds of firm, primarily those characterised by the ‘separation of ownership and control’, to coin the phrase of Berle and Means (1932). Rather than being the writ of law, and rather than reflecting an opaque set of market forces, corporate governance, like the company itself, formalises a moral and conceptual environment within which a series of vulnerabilities are thrown up by industrial and post-industrial capitalism.

The institutionalising of a moral and conceptual environment is brought to bear on corporate officers and boards. The formalisation of codes and rules and of processes of commendation and condemnation instils in corporate officers the drive to pursue the interests of a vaguely defined and uncertain shareholder body and to subordinate the interests of other kinds of stakeholder. Corporate governance and the company imagined through the UK’s Corporate Governance Code inculcates ‘a kind of “ethical virtuosity”’, through which corporate officers might discern ‘what is required for the type of person they are in the type of situation in which they find themselves’ (Pinkard, 1999: p. 227). As such, corporate governance is educative. Its formal processes draw their legitimacy from a moral vocabulary that explains to organisational officers how behaviour ought to be shaped, how action ought to be guided and how ends cohere with more general precepts about human flourishing or the good life. Primary among the facets of corporate governance as an institution, we see the emergence of accountability as a disciplinary tool as relying on the manufacture of ‘approved’ vulnerabilities. Such vulnerabilities have become so ingrained in the modern institutional form that it is difficult to conceive of economic or administrative life without the incorporation of some vulnerabilities as disciplinary devices, aligning individual behaviour with institutional goals.

The Corporation and its Markets

The company as an institution is not a stable thing. It is a set of interrelated responses to different problems posed by industrial capitalism. The formal development of company law and of corporate governance codes was brought to bear on existing relationships and on markets that were themselves deeply entwined with social, state and financial power. As such, the company as commonly understood now – as a purely economic vehicle separated out from all but market forces – is a wholly inadequate description of how people and societies negotiate their way through economic life. Our task is not to see corporate power as a simple problem, but to investigate the manner in which the company, as a dynamic institution, has sought to solve certain problems and vulnerabilities, how successful it has been in doing so and where it has failed.

It is worth recalling that, while Parliament’s rather stuttering extension of access to the limited liability corporate form, in a series of Acts across the second half of the nineteenth century, is regarded as one of the major outcroppings of the industrial revolution, the corporate form itself emerged not from Britain’s industrial strength, but from the organisational weaknesses and social perils that industrial expansion exposed. It was not a visionary innovation that freed hitherto tethered markets, but an incremental set of responses to problems as they were exposed (Searle, 1993).

Primary among those weaknesses and perils were the problems brought about by the separation of capital ownership from managerial control in large industrial and trading organisations. As such, the company is a response to many of the problems thrown up by the particular course that capitalism took in the UK. As Johnson notes, the market of Victorian England was a deliberate, and thus far from natural, construction of ideas, conventions, beliefs, customs, laws and enforcement mechanisms. As with any construction, the building blocks were assembled not randomly, but in accordance with the design of key actors, and thus reflected both their interests and their political power (Johnson, 2010: p. 24).

The extension of credit or equity involved less active participation in corporate conduct. Simultaneously, the implications of business failure were increasingly profound for corporate owner/managers. Moreover, where creditors were concerned, legal action in pursuit of debts against large unincorporated companies was virtually impossible given that all partners had to be jointly named in any action brought. In other words, the changing character of trade and industry produced a range of new vulnerabilities and exposures (Alborn, 1998: p. 127ff). These, combined with frustration in Parliament at the sheer number of petitions for private bills of incorporation, seem to have been the primary drivers for the extension of corporate personhood and limited liability to the economy at large (see Johnson, 2010: p. 116ff).

Another aspect of the extension of the company was of course the opportunity for new kinds of fraud and misfeasance that accompanied the increasing complexity of economic life. As complexity increased, the capacity of (large) investors to monitor their investments was diminished. An emerging cadre of professional managers could increasingly exploit informational advantages to their own ends, exposing investors to new kinds of risk. Unsurprisingly therefore the rise of the company has been met everywhere with attempts at clarifying the requirements for transparency and legibility in corporate life, from the Joint Stock Companies Registration and Regulation Act 1844 (Johnson, 2010: pp. 120–121; on accounting and large investors, see Maltby, 1998 with a rejoinder from Jones, 1999) to the various reports encapsulated in the Corporate Governance Code as we see it today.

The story of the company, therefore, is in part a story about the struggle to control information, not just in terms of disclosure but also in terms of formulating and formalising an ‘account’ of organisational life. Any modern organisation, whether public or private, is in the business of rendering its actions legible not only to itself, but also at times to others (on modernity and legibility, see Scott, 1998; see also Miller and O’Leary, 1987). Just as the character of that information is shaped and formed by its intended use, so institutions are shaped and formed by the need to render them accessible for information flows – for accounts, reports and from that for the distribution of penalties and rewards. More than that, however, the production of information can – and did in the case of the company – have a profound effect on the formation of social structures beyond the subject of surveillance. This was the force behind one perhaps unexpected aspect of corporate governance: the coupling of corporate fortunes with fluctuations on a largely autonomous secondary market for shares.

While the various components of the company emerged as a means for administering capitalism as it had developed, financial markets developed not only as venues for raising investment in business, but as free-standing venues for trade in shares based less directly on expected returns on investment to companies themselves and more on possible future values of the share in the context of mandatory disclosures about corporate performance (Ireland, 1996; see also Ireland et al., 1987; Ireland, 1999).

Ironically, this shift was perhaps further encouraged by the rise of the management cadre as independent actors in corporate life. The company was originally intended to act as a kind of polity, where managers acted on behalf of a sovereign or quasi-sovereign college of shareholders embodied in the general meeting (on this, see Pearson, 2002). This dialogical model was quickly eroded both in the courts – most notably through the Court of Appeal’s judgment in Automatic Self-Cleansing Filter Syndicate Co Ltd v Cunninghame (1906) ¹ and through everyday corporate life. As such, the board’s power to manage came to exist largely independently of shareholder influence. A residual shareholder power to remove directors, at least in companies with a large and diffuse shareholding body, remains, ² but given how difficult it is to build coalitions towards shareholder action, and more lately given the character of the market for shares itself, this is a weak and rarely pursued check on managerial power.

So, conceived of as a stand-alone exercise in disciplinary government, shareholder power is weak. Conceived as part of a broader set of myths and conventions about the corporation, and balanced out with other forces, however, shareholder power attracts its own symbolic capital. As the examples at the end of this paper demonstrate, restraints on corporate and managerial power emerge from conventions that form around how the corporation is imagined, not from mechanistic market forms. These conventions, formalised in corporate governance, produce the internal tensions that restrain managerial power.

The company, as a result, emerges as a key entity not only in markets for products and services, but also in the market for shares. While liquid equity markets prove to be of some benefit in terms of the capital-raising capacities of firms, they have been increasingly driven by a trade in shares as free-standing investable securities. The share, in other words, has become the subject of speculation, based on the flow of information from companies, with a view more towards its trading value and not the residual political powers attached to ownership, or even perhaps the call on corporate surpluses (at the managers’ discretion) through dividends. This shift in the trade in shares becomes crucial for our understanding of the company as a market, political and governance institution in recent years. Given the perils of managerial control, it may not be surprising that investors have come to rely on a secondary trade in shares in addition to (and sometimes instead of) the extraction of dividends as a means of generating revenue. Strategic entries and exits from shareholdings have, over time, become far more lucrative and less labour-intensive forms of investment than the exercise of ownership voice within firms. Nonetheless, the dominance of the trader-shareholder, very often an institutional manager of capital on behalf of others, coupled with the broader increase in the power of finance in the UK, has led to a rebalancing of power within the corporation. ³ Perhaps the only respite from this trend occurred, in a sense, from the late 1970s until the end of the 1980s, during the leveraged buyout boom. This phase in the history of corporate governance was driven by a collaboration of investors and creditors using debt to purchase equity in ‘underperforming’ companies, thus concentrating ownership, replacing boards and then either selling those companies’ shares back into markets or stripping the companies of their assets. Profits were reaped either on the improvement in performance or on the company’s remains (Jensen, 1989).

While the leveraged buyout boom was relatively short-lived, it had a profound effect on the role of the market for shares in corporate governance, on how the balance of power was played out in the corporation and on corporate governance scholarship in the academy. The primary consequence of the boom was a shift in the power relations both within equity markets and within the company, and in the linkages between the two. Equity markets, first, were integrated more closely with financial markets in general. As we said above, the trade in shares was increasingly characterised by the trader-shareholder rather than the owner-shareholder in a free-standing market that some have called a ‘kind of ponzi scheme’ (Erturk et al., 2008). That is, share ownership was increasingly motivated by speculation as to the future trading value of the share more than it was by dividend income or by particular attachments to specific firms. As such, whereas in 1990 share turnover by value on the London Stock Exchange was 40%, by 2007 it was 154%, with the vast majority of trades located in the FTSE100 (Pendleton and Gospel, 2005: p. 73; World Federation of Exchanges, 2007).

The playing out of the balance of power – or perhaps imbalance of power – in the corporation, and between corporations and equity markets, lies in the reformulation of the corporation through the conventions of agency theory. At first blush, the key aspect of contemporary corporate governance, as articulated by Easterbrook and Fischel (1991) above, is the orientation of managerial agents towards shareholder principals. The long-standing privileging of investor power is now articulated through a frame defined by the trader-shareholder. The convention relies on various market dynamics to maintain discipline. Given that shareholders have very few means for intervening directly with managers, discipline is imagined as being articulated indirectly through markets. So, for instance, the market for corporate control provides that, should managers underperform, investors will exit their shareholding; a lower price for shares will make the company susceptible to leveraged buyout, which would involve the demise of the board, and so – knowing this – the board will work hard to maintain share values by encouraging corporate performance (Manne, 1965). The appearance, therefore, is that finance is king.

So, shareholders’ exposure to managerial power was alleviated by the emergence of strong requirements for disclosure and by the use of information gleaned, not for direct governance, but in order to feed trade in the market for shares. The company as an institution came to be regarded as less of a device oriented towards production than as a repository for capital that would be tasked with maximising capitalist funds, be it through production or through liquidation (most often with the turn to shareholder value, company strategies have pursued both production and liquidation). At the very least, this protected shareholder interests to some degree as institutional shareholder power took off (for a discussion of the development of disclosure regulation in the UK, see Cheffins, 2003, pp18-22).

That said, the new status quo produced its own vulnerabilities. The company has come to be characterised by a ‘hidden’ alliance between certain categories of trader-shareholder and managers that emerged when their interests were aligned through the development of equity-based incentive structures for executives (on the background to the alliance between financiers and managers, see Boyer, 2005: p. 18ff; for a parallel account, see Erturk et al., 2004). So long as the company’s resources and corporate information were directed towards enhancing share values, senior managers were left free to reward themselves with increasing levels of remuneration.

While this alliance may or may not privilege various kinds of investor (depending on the investor’s trading strategies, on good fortune for the company and on executives’ skills), it privileges trade itself. The privileging of trade, the rise of stock market fluctuations as an indicator of economic well-being and the centrality of finance in life has also, as it has turned out, helped to legitimate the spectacular upward turn in management fortunes, delivering an unprecedented increase in remuneration packages and delinking remuneration not only from wage levels but also from corporate performance on the whole.

So, while the increased prominence of financial markets has certainly benefitted financiers and managers, it is less clear that it is has had a beneficial effect on the corporate economy as a whole. The increasing financialisation and complexity of the corporate economy has made the company less transparent to investors, undermined the stability of employment contracts and destabilised economic life. The coupling of the interests of managers of companies with those of managers of capital produced a new set of tools through which companies could be exploited towards the goals of capital managers. The company, in answering an earlier set of vulnerabilities, has created another set of vulnerabilities through the alliance of financial markets with managerial power.

Corporate Governance and the Return of the Owner-Shareholder

The current iteration of corporate governance through the Corporate Governance Code is an attempt to deal with the failings discussed above. Rather than relying on trade to produce discipline, the Code relies on the development of relationships and conflicts within the board (Roberts et al., 2003) and between the board and certain kinds of shareholders, and these relationships and conflicts are expected to check managerial power within the company. As such, the institutionalisation of corporate governance as imagined in the Code contains the potential to answer some of the new vulnerabilities thrown up by the financialised company, not quite through the promotion of renewed shareholder activism but through the institutionalisation of norms that are rooted in the division of powers between management and investors.

Corporate governance initiatives in the UK were driven in the first place by the instabilities produced by tyrannical executives, most notably Robert Maxwell (for a brief account of the Maxwell scandal, see Wearing, 2005, chap. 3; see also Boyd, 1996; Clarke, 1993). The Cadbury Committee’s report in the wake of the collapse of the Maxwell empire, and the subsequent reports that have been incorporated in the Corporate Governance Code (Financial Reporting Council, 2010), have focused on the production of formal procedures designed both to disrupt executive power and to increase transparency so as to bring market power to bear on corporate officers.

We ought to note, however, that while the conception of market power articulated in the Corporate Governance Code seeks to discipline management through shareholder action, it seeks to do so through a focus on the owner-shareholder rather than the trader-shareholder. That is, the Corporate Governance Code relies on ‘voice’ before trade as a disciplinary mechanism. It seeks to reshape the board as an institution with in-built checks on executive power, especially by putting non-executive directors in a position to scrutinise the audit relationship and executive remuneration, and by instilling in the board (again, especially non-executive directors) a focus on the importance of relationships with the larger shareholders (code provision E1.1). The board, in other words, is refocused as the embodiment of shareholder interests and of shareholder voice.

This occurs in the context of an understanding of the company as being a relational as well as a market institution (see Pendleton, 2005). Corporate governance has emerged as a mutual, relational, enterprise, through which conflict between different powers are formalised and developed. The dynamics surrounding the Corporate Governance Code, as described above, are not dissimilar to those which Suchman and Edelman ascribe to law. While the Code is an attempt to co-opt both the disciplinary voice of owner-shareholders and the possibility of disciplinary exits on the parts of trader-shareholders in focusing companies on corporate governance, its power also emerges from the manner in which it helps produce organisational culture. First, it constitutes contest in formal structures, reconfiguring the board as a site of conflict over corporate strategy and indirectly guiding corporate officers in developing and defining gestures that might be required to maintain corporate legitimacy, both in the view of investors and in the view of society in general. Second, the Code builds ambiguity into its own structures by establishing spaces for questions to be addressed but not providing for solutions, provoking internal and external regulatory conversations over how precisely good governance ought to be defined. It is, as such, a key aspect of the relational formation of corporate society.

Most of all, however, the production of gestures of compliance produces substantial changes in the formal make-up of organisations, and following from that, it leaves the space for constraints on managerial power, whether through market actions, less formal shareholder meetings (on which see Roberts et al., 2006) or – and this is crucial – substantial internal adjustment to the priorities produced by corporate governance. These adjustments do not occur directly through legal or financial coercion, but rather indirectly through the acceptance of the cultural and normative substance of the Code.

The Code’s contribution, by this measure, is both organisational – it outlines formal requirements of the board – and professional – its sheer existence communicates to boards what is important about their roles. Rather than simply bringing opaque market pressure to bear on the company from the outside, the production of corporate governance also constitutes itself from the inside. The corporation’s conception of its purpose is not situated solely in markets, nor indeed in state support for markets, but in the fully social environment in which the corporation and its rituals are formalised, articulated and acted upon. Companies do not exist in markets, and nor do they function behind a ‘black box’. The evidence of the Corporate Governance Code is that companies can be seen as institutions that are in part self-made, and that can be brought to answer not only to markets, but also to other social actors and to themselves.

The Power of Rules Against the Rule of the Powerful

The power of the Corporate Governance Code, by these lights, comes not solely from market pressures as understood by economists, nor from the coercive power of laws. Rather, its institutional ideals provide boards with a mandate to challenge and restrain executives through the reformation of the company as an agonistic forum. In fact, through the ‘comply or explain’ principle, the Code institutionalises the contested and uncertain character of legal regimes. The corporation, understood as including its attention to formal codes of governance, seeks to retrieve power from executives in a way that a solitary focus on markets has not achieved.

It does so, rather, by reinforcing a series of balances in the corporation (understood as an institutional whole), between executives, boards and the shareholder. Interestingly for our purposes here, corporate governance works through the active production of vulnerabilities. That is, managers especially are left exposed to the coercive power of law, to reputational damage and even to the end of their careers, through their exposure to investor power. That is not to say that they are often exposed to active investor power. Rather, the structures of corporate governance are designed to render executive action legible, in the first place to boards and then to financial markets and regulators.

So, this production of accountability in corporate governance is, we argue, a method for rendering managers vulnerable as a counterweight to the economic vulnerability of investors. At one level this shows how exposure to loss of reputation, or to loss of income, or indeed to incarceration, is held to maintain managerial discipline. At another level the institutionalisation of corporate governance, through its production of a narrative of balances between managerial and investor interests, and buttressed by ‘regulatory conversations’ (Black, 2002) both within boards and between managers and certain investors, can, if articulated and formed properly, lead to some degree of mutual recognition of vulnerabilities, articulated through the commitment to both the form and the workings of corporate governance.

Given this, while executives might insulate themselves to a degree – through for instance adopting short-run and high compensation-based ‘supermodel’ approaches to their jobs (Hill, 1998) – they are exposed to forces that seek to shift their standpoints away from self-interest and towards the interests of others. For our purposes here, what is interesting is that the current iteration of the corporation includes a sense that the kinds of exposure set out above may not necessarily be a bad thing, especially when it is put to the service of balancing out powers within organisations. The unstable character of the company is in a sense a product of attempts to manage vulnerabilities, not evade them. This may contain lessons for the future, especially as the scope of state regulation is narrowed.

As things stand, the globalisation of the economy – or more to the point, the rise of the globalised corporation – has reduced state power for regulatory action in the corporate arena. Individual states cannot hold multinational firms within their geographical boundaries and so subject them to their particular laws unless those corporations wish to remain there. What emerges is a competition between states to capture corporate charters for taxation revenue purposes and corporate operations for employment opportunities. Capital is highly mobile and able to move between states, either so that it is subject to a ‘friendlier regime’ or so that it avoids threatened enforcement action by a particular state. The two corporations in our case study below are examples of this. The parent company of one of them, News Corporation, changed its domicile from Australia to the US state of Delaware in order to take advantage of a more management- and less shareholder-orientated corporate law, and ENRC continues to threaten to relocate from London to Switzerland to take advantage of a lower corporation tax regime, while its corporate operations have no physical connection with either location. The capacity for the state to act as a restraining force from outside the corporation is diminished by the ability of corporations to indulge in ‘creative compliance’ (McBarnet and Whelan, 1991; see also McBarnet, 2010) with state-based regulation.

That said, we do not argue that states ought only to focus on developing ‘enabling’ regimes to support ‘private ordering’ through corporate contracts (Bottomley, 2007: p. 19ff). We argue instead that states have two important roles. They may act in order to create and support the kinds of regulatory conversations that take place within firms that are characterised by a delicate balance between actors within the corporation. States might do this not only through their driving of corporate governance codes but also through being an active participant in those regulatory conversations in more and less public forums, using their powers to focus minds on important questions and issues. Secondly, they might refrain from following mercantile impulses and alliances with ‘domestic’ global companies in order to pursue action in regions and areas of policy that are less visible to domestic citizens. That is, state actors ought to avoid exploiting the corporate form in pursuit of unpalatable political agendas (one category of which is described in De Londras, 2011). Internationally, states ought to refrain from collaborating with firms in pursuit of resources and advantages that harm those least able to resist corporate power. The key to our position is that it is not helpful to think of the state’s role as being one of regulatory coercion. Nor is its role simply to support ‘markets’. It is, however, the role of the state to maintain the corporation as a locus where different parties meet and where they are exposed to counterveiling threats and incentives, and to ensure that norms and cultures that emerge as a consequence restrain and discipline from the inside, so to speak. Or rather, that the corporation should be reimagined as not having an inside that is closed to social discourse or insulated from it.

Two Unbalanced Firms

We use two recent examples, both drawn in order to illustrate how corporate governance is a vehicle for holding in a tension a series of relationships that prevent the exercise of tyrannical power. One of our examples concerns the issues of corporate governance that are raised by the phone hacking scandal that enveloped News International Limited, the UK incorporated subsidiary newspaper publishing business of News Corporation, in the summer of 2011. The seemingly worldwide interest that the scandal generated can be contrasted with our second example, which concerns the corporate governance issues raised by the dismissal of two non-executive directors from the board of Eurasian PLC (ENRC), a mining company listed on the FTSE 100, by its shareholders. Interest in this was confined to the business section of the quality print media and to sector specialist publications. However, it is much more significant than this for two reasons. First, the natural resources sector (mining sector and oil sector combined) is now 15% of the FTSE’s weighting and increasing. Secondly, as a member of the FTSE 100, shares in ENRC are held by thousands of indirect investors who have stakes in index tracking funds through their occupational and private pension plans, ISA or life assurance investments. The sheer size of ENRC would make it an automatic holding for many other investment funds. Eurasian PLC has a corporate history (shared by other recently FTSE 100-listed mining corporations such as Kazakhmys) as a business interest of both oligarchs in the former Russian Republic of Kazakhstan and now the Kazakh Government. In common with other members of the mining sector, ENRC’s only connection with the UK (aside from its stock exchange listing and its incorporation required under those listing rules) was with the requirements of the UK Corporate Governance Code. As with, for instance, Glencore (see Silverstein, 2012) and in contrast to News International Limited, ENRC’s corporate operations are carried out in faraway places rich in natural resources such as chromite and aluminia.

News Corporation as an entity has been forced into our everyday consciousness by what seems to be a routinised failure of ethics on the part of its reporting staff, with a wider question being formulated as to how much knowledge the corporation’s senior management had of these ethical lapses. However, issues of power and accountability within the governance of News Corporation have been issues for much longer than this. The corporate governance arrangements within News Corporation have been graded at the lowest possible grade – F – for the last six years by rating agencies such as The Corporate Library, with a securities class action rated as a ‘very high risk’ (see Governancemetrics International, available at www.thecorporatelibrary.com). News Corporation’s shares are considered to ‘trade at a discount’ because of the negative view taken of its corporate governance. News Corporation has a rather unusual dual class share structure for a publically listed company. Its shares are divided into two classes: Class A and Class B. Class A shares have no voting rights but are numerically vastly superior, representing around 70% of the capital value of News Corporation. All the voting rights held by shareholders attach to Class B shares. Rupert Murdoch, the founder of News Corporation, owns 40% of the Class B shares and in value terms this is about 12% of News Corporation.

Strategically, the importance of voting rights attaching to a personal holding of this size is huge because it means that Murdoch controls both sides of the corporate governance interaction:

as Chief Executive he is the professional manager on whom shareholders rely to run the company;

The thrust of the suit is that, for over a decade, subsidiary companies of News Corporation have engaged in activities that have caused News Corporation financial and reputational damage and that the board has failed to deal with a pervasive culture of ‘wrongdoing’. The opening statement of the Summary of the Action begins, ‘recent self-interested transactions and revelations about News Corporation’s operations giving rise to this action are the proverbial straws that break the camel’s back’. The precise complaints are of excessive personal remuneration, the use of News Corporation resources for personal and political objectives, the appointment of directors lacking independence and the entering into of transactions at over value to benefit family members without any intention of increasing shareholder value (specifically the acquisition of film and television production company Shine Group Ltd, wholly owned by Elizabeth Murdoch). Indeed clause 8 of the summary of the action asserts that Murdoch ‘has treated News Corporation like a family candy jar, which he raids whenever his appetite strikes’.

Derivative actions are rarely successful in the courtroom (Armour et al., 2009), not least in Delaware (Petrin, 2011). However, success might be measured in terms of the governance changes and other measures that are taken by News Corporation to reassure its investors of the security of their investment. News Corporation announced in August 2011 that it would embark upon a $5bn share repurchase scheme to bolster its falling share price, which dropped 14% in the first week of July 2011. The dividend return is the only right held by class A shares, as there are no voting rights attached to them. News Corporation has begun conversations with some of the institutions that hold Class B shares and has made some minor changes to its board of directors. It remains to be seen whether these small concessions, in the light of sustained pressure to reform as evidenced by the votes of 35 and 34%, respectively, against the reappointment of two Murdoch sons as directors of News Corporation, will restore the relationships in the governance matrix to the required tensions. One of these directors, James Murdoch, is also the Chairman of a FTSE 100-listed company, BSkyB. It is a distinct possibility that contagion will attach to his FTSE role and will result in the raising of scrutiny of governance in that company. At the time of writing, scrutiny of James Murdoch continues to mount. The key lesson from the debacle in News Corporation is that this particular company lacks the mechanisms through which tensions between stakeholders can be imagined, formalised and contained. It lacks these mechanisms quite simply because power in the company flows through the seat of an owner-manager-chair.

ENRC was a company floated on the London Stock Exchange in December 2007. A London floatation gave it access to a broader capital market and a higher price for its shares than would have been available on other exchanges, and for the UK Listing Authority and the London Stock Exchange there was the advantage that its presence increased the international flavour of the London exchange. The prospectus for the IPO declared that ‘the founders will exercise significant influence over the Group after the global offer … including the election of directors’. That this was a promise that was going to be fulfilled was clear when ENRC was allowed to float and enter the FTSE 100 with less than the required quota of 25% (it had 18%) of shares available for acquisition by outside investors and the majority of the remainder of the shares closely held by three oligarchs with 14.6% each and Kazakhmys, another mining company, with 26%. None of these block holders were on the board of directors of ENRC post its floatation. Kazakhmys, as a fellow FTSE 100 listee, was thought to have potential conflicts of interest and each of the three oligarchs was under the cloud of a longstanding criminal investigation in Belgium for money laundering, which was thought to make them unsuitable for the board of a listed company.

ENRC had 14 directors (large by FTSE standards) on its board, seven of whom were independent. This quotient of independence makes the objections to its governance quite distinct from those surrounding News Corporation. The principal objection here was that the board did not reflect the company’s power structure. The board reflected, following floatation, a certain protection for the interests of minority shareholders but not a constraint on the power of majority shareholders. Majority shareholder power did not run through the board, but rather was manifested in the executive suite. Running the company in the interests of all shareholders through debate and dialogue at board level when many of the company’s executive officers remained in post from the period prior to flotation was going to be very challenging. Turbulent corporate governance was evident in 2009, when the chairman of the board, appointed post flotation, resigned, to be replaced by the then CEO. Movement from CEO to chairman is warned against under the UK Corporate Governance (code provision A.3.1) in a classic illustration of its ‘comply or explain’ approach unless major shareholders are understood to support the move following consultation. The wishes of major shareholders were thought to be behind both the resignation and the subsequent appointment and so their approval was something of a foregone conclusion.

This turbulence continued in February 2011, with the resignation of the CEO, rumours in March 2011 that the majority shareholders had negotiated a £1bn loan from the China Development Bank for expansion and acquisition activities into new commodities in high-risk locations that the board had no knowledge of, and suggestions in April 2012 of frequent and heated board meetings with conflicts between directors and managers, culminating in June 2011 with the news that the senior independent non-executive director and another non-executive director had been voted off the board at the ENRC annual general meeting by shareholders. Voting not to re-elect directors is a perfectly legitimate thing for shareholders to do. However, it is not something that has occurred in a listed company for 27 years. It suggests that there is serious conflict between the holders of power within the company that has not been able to be resolved in a less stark manner. The narrative of governance as a series of conversations around the control of power through checks and balances has broken down. The sound bite attributed to one of the ousted directors about ENRC being ‘more Soviet than City’ emphasises this.

In an effort to restore tensions to the appropriate balance, ENRC announced a review of corporate governance that would look at board structure. Like News Corporation, the changes that have been offered as a result of this review are small and incremental. A new senior independent director with experience of the mining sector has been appointed. However, the same individual is the also the chairman of a company that is controlled by a previous takeover suitor of ENRC, Glencore. This would seem to add to, rather take away from, the issues of control and conflict within the strategic direction of ENRC. ENRC has announced its intention to buy the remaining 75% of shares that it does not own in Shubarkol, a Kazakhstan-based coal mining company. However, given that these shares are owned by the three oligarchs who are the majority shareholders in ENRC, this looks like a suspiciously connected transaction rather than a strategic consolidation.

Market analysts assert that shares in ENRC trade at a 26% discount to their mining sector peers, despite their profitability. Simply selling their holdings in ENRC is not an option for the many funds that track the FTSE 100 and the losers from this discount are indirect investors in these funds. Only if the governance dynamic at ENRC is changed will the discount cease. This could be achieved by ENRC removing itself from the FTSE 100 with the attendant disadvantages that brings, or perhaps less drastically, by representatives of the three oligarchs joining the board so that control, management and direction have some prospect of adopting the tensions within their relationship that equate to better governance.

The issues raised by these examples are subtly different. In ENRC the majority shareholders, who have indicated that they wish to exercise a governance role in relation to ENRC, should be on the board of the corporation and so within the matrix of debate, dialogue and ultimately accountability that defines the well-balanced company and is formalised through the Corporate Governance Code. High levels of profit are insufficient to ‘buy off’ the values of governance held by existing and potential minority shareholders, as ENRC’s share price continued to reflect a large discount because of concerns over its governance. In News Corporation the issue is that the internal debate, dialogue and accountability function embodied by the Code is stymied by the lack of independent voice on the board (contrary to a central feature of the UK code, the NASDAQ (where News Corporation holds its listing) listing requirements and Delaware corporate law (Rodrigues, 2008)), which results in the capture of the board. This capture leaves News Corporation susceptible to the exercise of unchecked power by its founder, who is also the dominant shareholder, board chairman and chief executive. Some of the consequences of this are still being played out as still more revelations emerge about the interception of private communications and the organised surveillance of private individuals that appear to have been routine activities at News Corporation’s UK subsidiary, News International Limited. Other consequences, such as the loss of employment for workers at the News of the World, have already occurred.

Conclusion

Our aim in this paper is to highlight the role, far beyond the ‘black box’ perspective on corporate power, of corporate ‘internalities’ in the construction and projection of corporate power. We see these internalities as both threats and as opportunities. They are threats in that, absent the counterveiling balances inherent in corporate governance, tyrannical executives – for instance – can act without constraint in attending to their own interests. At the same time, corporate governance provides an opportunity for the creation of serious attention within the corporation for ameliorating the more damaging aspects of corporate power. We do not say this naively. Rather, we seek to highlight the fact that the corporate form has a more open-ended character than is often assumed: it coheres through the regulatory conversations that surround it. How these conversations are conducted is one important component in how corporate power works.

We show how the corporation, founded on conventions and myths that have been formalised in codes and practices of corporate governance, and through which the company itself is defined, are actually dialogical in character, are contested and are subject to constant revision. The well-balanced company, at its best, maintains some of the collegiate character required in order for dialogue to take place and for managerial power to be restrained.

Corporate governance, although very far from perfect, has evolved through various attempts to minimise weaknesses produced by complex industry and then by the corporate form itself. Now, we claim, it holds some of the possibilities required from which greater corporate responsibility, both to insiders and outsiders, might be promoted. As the examples of News Corporation and ENRC suggest, the perils of corporate power often emerge from internal power, and are not simply brought to bear on society at large. Corporate governance, well done, balances interests within the company and holds the potential to at least limit manifestations of corporate power in society as a whole. Given this, the role of the state ought to be to find ways to maintain and extend the dialogue that is at the heart of corporate governance. Doing so will not solve all the problems of contemporary capitalism but it will solve some of the problems caused by the extension of corporate power into society.