in countries with dispersed ownership of shares, individual shareholders will often have little...

Monthira Pimsarn, International Corporate and Governance Law

Coventry University School of Law, UK

May 9, 2013

Coventry University School of Law

“In countries with dispersed ownership of shares, individual shareholders will often have little incentive to monitor management because their small stakes in the company give them very little power to do so. On the other hand, this is counter balanced by the presence of highly developed and liquid equity markets that enable the minority shareholder to exit from the company and, furthermore, the presence of large numbers of small shareholders also makes the company vulnerable to takeover offers, the possibility of which has the effect of disciplining management.”

2013

Introduction

In regard to the increasing size of modern corporations, it has become commonly

accepted that shareholders are too dispersed to exercise any effective degree of

control over the company’s management. Therefore, It could however be stated that

this negative observation was countered by the existence of alternative controls,

which serve to control and regulate the company management. Whether this can be

said of both shareholder and non-shareholder-related controls, then this paper will

examine the ‘dispersed shareholder’ argument in a bid to determine its accuracy in

practice. By observing important mechanisms such as the Combined Code on

Corporate Governance and the Companies Act 2006 ( hereafter CA 2006 ) as well

as shareholder mechanisms of corporate control which it will be argued that

corporate governance is moving towards more effective and stringent controls.

Monthira Pimsarn


Coventry, United Kingdom



May 9, 2013


Shareholder Rights and Control over the Corporate Structure

Any model of corporate governance is commonly rooted in the principal-agent

theory.1 As in Berle and Means point out the problems caused by the separation of

control and ownership of the company which are ultimately caused by broadly

distributed and hence dispersed shareholding.2 They state that whether a company

has a high number of shareholders, and it prevents any single shareholder from

holding a sufficiently large share to exercise any influential degree of control over the

conduct of the management.3 Most modern corporations feature such a separation

of ownership and management, which has the potential to render management

largely unaccountable to the shareholders.4 Consequently, the need to implement

an “inclusive approach” according to directors are required to consider the broader

relationships of the company was proposed by the Department of Trade and

Industry.5 Owing to this approach necessitates that directors maintain awareness of

the broad variety of interests involved when making decisions, which thereby

extends management relationships to all members of the company. However, it has

been pointed out that therefore, the separation of management and ownership of the

company increases the level of democracy in the company6 and directs

management attention away from the gaining of profit.7

Indeed, the size of corporations has increased over the past decades and the need

to more clearly apply principles of corporate governance has emerged. This is

particularly so in the UK because there do not appear to be any mechanisms that

regulate or control the management of the company.8 In practice, a resolution may

be the only mechanism available to counter management because it stipulates a

1 Wearing, R T Cases in Corporate Governance (Sage 2005) at page 8; Dine, J The Governance of Corporate Groups (CUP

2000) at page 25. 2 Berle, A A & Means, G C The Modern Corporation and Private Property (2nd ed. Transaction 1991) at page 55. 3 Kim, K Nofsinger, J R & Mohr, D J Corporate Governance (3rd ed. Prentice Hall 2009) at chapter 4; Smerdon, R A

Practical Guide to Corporate Governance (4th ed. Sweet&Maxwell 2010) at page 92. 4 Lowry, J & Reisberg, A Pettet’s Company Law: Company and Capital Markets Law (3rd ed. Pearson 2009) at page 59;

Talbot, L Critical Company Law (Routledge Cavendish 2008) at page 119. 5 DTI, ‘Modern Company Law for a Competitive Economy: The Strategic Framework’ (DTI 1998) at paras. 3.5, 3.7. 6 Bell, D The End of Ideology (Collier 1962) at page 12; Roe, M J Strong Managers, Weak Owners (Princeton University

Press 1994) at page 20-25. 7 Talbot, L, supra n4, at page 108; Kaysen, C ‘The Social Significance of the Modern Corporation’ [1957] 47(2) AER 311, at

page 316. 8 Dine, J supra n1, at page 142.



May 9, 2013


specified number of shareholders vote in agreement with a proposed decision or

action. However, whether a company has few shareholders, therefore, this

mechanism is rendered ineffective. It similarly does not ensure whether all

shareholder wishes will be accounted for or not because such resolutions only

enforce the wishes of the majority.

Additionally, the independence of non-executive directors has been criticised as

insufficient since 2003. Therefore, the law has attempted to respond to this problem

in an attempt to ease the negative aspects of a sole or powerful managing director.

This issue in general “reflected more widespread defects in the corporate

governance systems of large British companies.”9 The Higgs Report proposes that

non-executive directors should be given a more prominent role in the constitution of

the company along with the majority of board members should be a non-executive in

order for the agency effect to be reduced.10 For instance, cases of director fraud

such as Enron highlight the need for greater independency in the context of non-

executive directors,11 as well as the need for a non-executive directors to be

“experienced enough to ask searching questions” so that board decisions are

properly made.12 While the task of non-executive directors is to observe the daily

running through the company; although they may not possess the knowledge and

expertise of executive directors, which therefore, their role is considered to be

important in preventing director fraud. It is ultimately the task of non-executive

directors to “sound warning bells if anything suspicious comes to their notice”.13

In practice, whether the powers of non-executive directors may not be as

independent as they appear to be in theory.14 Again this is due to the fact, therefore,

they are largely controlled by executive directors in terms of their appointment. This

renders the degree of observation that non-executive directors may have rather

9 Davies, P L ‘Board Structure in the UK and Germany: Convergence or Continuing Divergence?’ (2000) 2(4) International

and Comparative Corporate Law Journal, at page 435 - 456. 10 Higgs, D ‘Review of the Role and Effectiveness of Non-Executive Directors’ (Department of Trade and Industry 2003) at

paras. 27-30. 11 Armour, J & McCahery, J A After Enron: Improving Corporate Law and Modernising Securities regulations in Europe

and the US (Hart 2006) at page 122. 12 Mallin, C A Corporate Governance (3rd ed. OUP 2010) at page 3. 13 Dine, J & Koutsias, M Company Law (6th ed. Palgrave Macmillan 2007) at page 185. 14 Davies, J R Hillier, D & McColgan, P ‘Ownership Structure, Managerial Behaviour and Corporate Value’ (2005) 11(4)

J Corp Financ,pp. 645 – 660, at page 651.



May 9, 2013


restricted. Even more that is therefore, non-executive directors do not generally

have the authority to influence important decisions which mean they cannot

ultimately prevent executive decisions, from being acted upon. According to the

2010 Code on Corporate Governance, however, non-executive directors have the

power to determine the remuneration of executive directors, as well as their

appointment and removal.15 It is commonly recognised that the effectiveness of the

powers of non-executive directors is, in fact, undermined and controlled by executive

directors; the amount of authority possessed by the former ultimately depends upon

how many there are on the board. Likewise, it is therefore proposed that the lack of

a sole definition of the term ‘independence’ in relation to non-executive directors

renders their role uncertain, as well as the fact that executive directors often have

access to more detailed information than non-executive directors.16

The rights of shareholders are a vital and a core element of corporate governance;

the law has indeed attempted to maintain their importance as part of the company

constitution. The requirement that the company be structured so that shareholders

may enjoy greater powers, and benefits is deemed to be an extremely important

endeavour of corporate governance. 17 As Parkinson states that “the law respects

the right of shareholders to determine the objectives of their association...and that by

virtue of their capital contributions, they should be regarded as the owners of the

company”.18 Yet it could on the other hand be argued that increasing the importance

of shareholders too greatly could enable them to hide beneath the corporate veil and

hence avoid “outsider monitoring.”19 Even more the shareholders are a vital part of

any company because they are its investors; they are therefore defined as

possessing considerable power when removing and electing board directors.20 On

the other hand, the directors are commonly defined as the most powerful members

of the company despite considerable restrictions on their powers.

15 Code on Good Corporate Governance 2010, A.4; Dine, J supra n1, at page 112. 16 Brennan, N & McDermott, M ‘Alternative Perspectives on Independence of Directors’ (2004) 12(3) Corp Gov, at page

326. 17 Grantham, R B ‘The Doctrinal Basis of the Rights of Company Shareholders’ [1998] 57 CLJ 3, at page 555. 18 Parkinson, J E Corporate Power and Responsibility: Issues in the Theory of Company Law (Clarendon 2002) at page 75-

76. 19 Morck, R Wolfenzon, D & Yeung, B ‘Corporate Governance, Economic Entrenchment and Growth’, 2004, available at

<http://www.nber.org/papers/w10692>( last accessed: 16/4/2013), at page 45. 20 Monks, R A G & Minow, N Corporate Governance (5th ed. John Wiley & Sons 2011) at page 33-35.



May 9, 2013


Aside from the ability to appoint and remove directors, shareholders also have the

potential power to influence the policies and laws of the company, such as changing

the actions of directors so that they coincide with the articles of association and the

laws of the company. In other words, this is not to state that shareholders have

great power over the company, although their voting power renders them rather

important in the context of the company’s daily functions.21 So that might say that

the most potent power vested in shareholders is their ability to vote directors out of

the company so then this is an important mechanism which ensures that directors

act in their best interests. However, this power is diluted by the fact that the removal

of directors is generally expensive and requires a long time to complete. The

importance of shareholder rights remains a prominent issue for corporate

governance,22 although it is evident that considerable trust is put in directors who

retain a potent level of power over the company.23 The UK evidently attempts to

balance the “importance of ensuring that firms are managed efficiently” with the

importance of shareholder ownership.24 Yet shareholder rights are overall

considered to be weak because they have no direct participation in the daily

functions of the company and possess no property rights in the company’s assets.

And It is generally taxed to determine the rights that shareholders actually have and

what they should have, and this is extremely negative for corporate governance in

this respect.25

Corporate Governance and Directors’ Statutory Duties

It can be seen that the increasing importance of corporate governance over the past

decade has provoked the implementation of various regulations and legislative

provisions in the attempt to instruct and guide company members. The concept of

corporate governance applies to and concerns practically every function, unit and

21 Dine, J & Koutsias, M, supra n13, at page 3-4. 22 Hopt, K J ‘Modern Company Law Problems: A European Perspective’ Keynote Speech, Hamburg, 2000, available at

<http://www.oecd.org/dataoecd/21/28/1857275.pdf> (last accessed 12/4/2013), at page 3. 23 Hopt, K J & Keyens, O C ‘Board Models in Europe: Recent Developments of Internal Corporate Governance Structures in

Germany, the UK, France, and Italy’ [2004] 2 Law Working Paper 18, at paras. 2.2, 2.2.1. 24 Njoya, W ‘Employee Ownership and Efficiency: An Evolutionary Perspective’ (2004) 12 ILJ 33, at page 14. 25 Dan-Cohen, M Rights, Persons, and Organizations: A Legal Theory for Bureaucratic Society (University of California

Press 1986) at page 21-22.



May 9, 2013


action of companies, and consequently, the broad and expansive nature of corporate

governance has resulted in major problems. Likely, the most impressive step

towards better regulation of corporate governance can be found in the Companies

Act 2006. Again CA 2006 represents a major reform of company law in that, and it

aimed to accomplish “better regulation” coupled with sufficient “flexibility” so that it

could apply to the vast nature of company law.26 A major issue under the act was

that of directors’ duties, and also it has become clearer thought. Therefore, the law

was disparate and unnecessarily confusing in this area. The need to be ensured

and elevate director's awareness in terms of how they are expected to perform is a

core element of corporate governance.27 In right of this observation, the CA 2006

attempted to codify and streamlines directors’ duties so that they could be

understood more clearly whilst offering greater protection against abuse and fraud.28

Evidently, a central aim of the CA 2006 was to implement a “simple, efficient and

cost effective framework for carrying out business activity” which in turn would

improve levels of corporate governance within the companies.29

The relationship between corporate governance and directors’ duties has been met

with both applaud and scepticism; the latter group suggested that it would not be

possible to contain the vast area of directors’ duties in a single legislative provision.30

Such scepticism was largely provoked by the discrepancy between the restrictive

nature of codification and the broad nature of directors’ duties and companies within

which they were to function.31 The relationship between corporate governance and

directors’ duties similarly necessitates a compromise to be made between sufficiently

rigorous regulation and the need for flexibility.32 These two principles are ultimately

contradictory because the conditions needed for adequate flexibility (ambiguity)

contradict the conditions needed for effective regulations (precision).33

26 House of Lords 2006. ‘Hansard HL Debate’, volume 677-678, Ser 5, 11 January 2006, at col 182. 27 House of Lords 2005. ‘Company Law Reform Bill – The White Paper’, HL Bill 34, at ch 3. 28 House of Lords, supra n26, at col 243. 29 Company Law Review Steering Group ‘Modern Company Law for a Competitive Economy: Developing the Framework –

Final Report’ (DTI 2001) at app. A. 30 Dignam, A & Lowry, J Company Law (7th ed. OUP 2012) at page 311. 31 Smerdon, R, supra n3, at page 127. 32 Lowry, J & Reisberg, A Pettet’s Company Law: Company Law and Corporate Finance (4th ed. Pearson 2012) at page

160-161. 33 Alcock, A Birds, J & Gale, S Companies Act 2006: The New Law (Jordans 2007) at page 15-28.



May 9, 2013


In addition, The Combined Code on Corporate Governance (hereafter ‘The Code’) is

a primary source for determining the directors’ duties;34 which it is continually

updated and contains the core elements of corporate governance in the form of

guidelines. The Code primarily renders the board of directors responsible for the

application and implementation of “effective controls, which enable risk to be

assessed and managed.”35 Moreover, The Code reinforces the importance of

attaining transparency in company functions, encouraging “sufficient disclosure” in

order for the performance of companies to be checked and inspected.36 It can be se

seen that the Code and the CA 2006 functions in a clearly complementary manner in

that the former expands upon the content of the latter.37

In the context of the board of directors, the Code provides that the board must make

decisions in the best interests of the company, and in an objective fashion.38 This

element clearly expands upon section 172 of the CA 2006, which contains the duty

to promote the success of the company for the benefit of its members as a whole.39

In the meantime, the Code also distinguishes between executive and non-executive

directors, allowing the latter to determine the remuneration of the former based upon

assessments of their performance. It is so evident that the central purpose of

corporate governance regulation is generally to ensure a “proper balance of power

between the factions within the company structure.”40 Company directors do enjoy

an almost unfettered power over the company, and so they are naturally subject to

the full rigour of corporate governance requirements.41

Section 171 of the CA 2006 contains the duty to act in accordance with the

company’s constitution and to exercise powers for the purpose for which they were

given. This section parallels the same common law principle; therefore, the term

‘constitution’ is expansively defined to include the articles of association, resolutions

34 Lowry, J & Reisberg, A, supra n32, at page 221. 35 The Combined Code: Principles of Good Governance and Code of Best Practice (2001) A.1 (p. 3). 36 Law Commission, ‘Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties’ [1998]

Law Com No 153, at para. 1.33; Solomon, J Corporate Governance and Accountability (3rd ed. John Wiley 2010) at page

51. 37 Hannigan, B Company Law (2nd ed. OUP 2009) at page vi. 38 Code of Best Practice, A.1 (p. 3). 39 This was a fiduciary duty which was restructured by way of section 170(3-4) of the Act. 40 Dine, J & Koutsias, M, supra n13, at page 141; Hannigan, B, supra n37, at page 115. 41 Dignam, A & Lowry, J, supra n30, at page 311.



May 9, 2013


and decisions. This duty particularly accentuates the need for directors to achieve

and preserve a continual awareness about the activities and functions of the

company. The act as in the context of this particular duty does not provide the

standards that director decisions must satisfy, however; it has been pointed out that

these standards have necessarily been omitted so that they may be “worked out, in

particular, cases.”42 From this approach clearly demonstrates the recognised need

to maintain a degree of flexibility so that the duty may apply different standards

depending on the type of director and the type of company. Section 171 which duty

is evidently rooted in the notion that directors should not be free to use their powers

to retain arbitrary power over the company or pursue personal benefit. Indeed,

problems have arisen in terms of the Act’s evident inability to list each and every use

of a power that can be defined as improper.43 As a result, the test applied is partly

subjective and partly objective so that the court can be able to examine whether a

decision or act was intended to pursue a purpose which falls outside of the director’s

powers. The core purpose of a decision or act is generally examined, which allows

the provision to apply to any act and any stated purpose. If an improper purpose (for

example to defeat a takeover bid)44 is revealed to influence an act or decision, then it

is likely to be deemed a breach of the director’s duty.45 From Section 171 can be

deemed to promote good corporate governance because it imposes the duty to

make proper decisions for the company upon directors and thereby prohibits them

from making subjective bona fide or personal decisions, which may actually not be in

the nest interests of the company.

Further in Section 172 of the CA 2006 also contains the duty to promote the success

of the company for the benefit of its members as a whole. This again parallels and

replaces the prior common law duty to act bona fide in the interests of the company;

there are hence no major differences between the two duties.46 The new duty

however extends the interests of the company so that they are not restricted in the

interests of the shareholders only.47 This duty is double-sided as it includes both the

42 Alcock, A et al, supra, n33, at page 144. 43 Lowry, J & Reisberg, A, supra n32, at page 192. 44 Lowry, J & Reisberg, A, supra n4, at page 64. 45 Davies, P Principles of Modern Company Law (8th ed. Sweet&Maxwell 2009) at page 502. 46 Gore-Brown, F Boyle, A & Sykes, R (eds) Gore-Brown on Companies (44th ed. Jordans 2004) at chapter 15. 47 Lowry, J & Reisberg, A, supra n4, at page 57.



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interests of the company and those of its members.48 A list of considerations

accompanies this duty, which states the factors that directors must consider when

making decisions. The list includes factors such as the interests of the company’s

employees and the potential long-term consequences of a decision.49 This list is,

however, not rigid, nor is it exhaustive; it does not define the weight to be attached to

each individual consideration and hence its approach and content can be accurately

defined as flexible. The duty to act in good faith is therefore presumed to exist as an

overarching consideration. The House of Lords, however, has made it clear that the

duty was not intended to impose the duty “to do more than good faith, and the duty

of skill and care would require” upon directors.50 From this approach has caused

some problems because the considerations contained within the list have functioned

rather differently in practice to how they were initially envisioned in theory. No

guidance is provided in terms of whether each and every consideration must be

made relevant to a decision, yet this is simply in recognition of the fact that some

considerations may not be important or relevant to certain decisions.

The duty contained in section 172 contains recognition of the fact that directors often

have major interests in the company, and that this threatens to form an overlap

between the types of interests that a director may consider. Consequently, the

directors may not make decisions, which promote any individual interests, although it

is commonly accepted that directors may promote their own interests as

shareholders if the decision is for the benefit of the shareholders as a whole. The

test set by section 172 has attracted criticism of the basis that it “allows for greater

judicial intervention in corporate decision-making than what might otherwise be the

case.”51 However, the subjective foundation of the test in practice restricts judicial

intervention because the amount of discretion that directors are given is substantial

in recognition of the fact that they have been trusted to make suitable decisions

under this particular duty.52

48 Company Law Review Steering Group ‘Modern Company Law for a Competitive Economy: Developing the Framework’

(URN 00/656) (DTI 2000) at para 3.51. 49 ss. 172(1)(a) and (b). 50 House of Lords, supra n26, at col 846; Boyle, A J & Birds, J Boyle and Birds’ Company Law (7th ed. Jordans 2009) at

page 12-17. 51 Sealy, L & Worthington, S Cases and Materials in Company Law (8th ed. OUP 2008) at page 284. 52 House of Lords, supra n26, at col 592, per Margaret Hodge.



May 9, 2013


Section 174 of the CA 2006 contains the duty of care and skill;53 which builds upon

the same common law principle, although it makes the subjective knowledge and

experience of the director relevant provided “it improves upon the objective standard

of the reasonable director.”54 Overall, the objective standard expected of directors is

more important, although the test actually contains both subjective and objective

elements.55 Section 174 imposes perhaps one of the most rigorous of directors’

duties, and it can therefore be defined as the most important for corporate

governance. Considerable controversy has surrounded this duty in its codified form;

critics question whether codification was actually necessary56 because the judiciary’s

approach has not been altered by the Act.57 Codification of this duty can be said to

respond to the need to tighten the previous leniency of the common law duty of care

and skill. Section 174 can therefore be said to update previous principles formulated

at common law.58 Section 174 is more rigorous, in the attempt to more effectively

implement the principles of corporate governance, as the previous approach of the

common law was unable to accord to the differing levels of director’s knowledge and

experience.59 Previously, the test favoured directors with greater knowledge and

skill and was harsh to directors with less experience.60 The law has, however, been

rendered inconsistent as a result of the conglomerated approach of common law

principles and section 174. This has caused some to conclude that the Act is not

entirely able to facilitate good corporate governance.61 Parkinson, however, points

out that the Act at least emphasises the need to increase the standards expected of

directors in the quest to improve standards of corporate governance,62 while

“historically, the standard of diligence set by the courts has been comically low.”63

The fact that the law now distinguishes between different degrees of director

53 Boyle, A J & Birds, J, supra n50, at page 20. 54 Davies, P L, supra n45, at page 490. 55 Palmer, F B Company Law: A Practical Handbook (4th ed. Bibliobazaar 2009) at page 125-129. 56 Riley, C A ‘The Company Director’s Duty of Care and Skill: The Case for an Onerous but Subjective Standard’ [1999] 62

MLR 5, at page 670-675. 57 Lexi Holdings (in administration) v Luqman [2009] EWCA Civ 117 58 Davies, P L, supra n45, at page 491. 59 Ferran, E ‘Company Law Reform in the UK’ [2001] 5 Singapore Journal of International and Comparative Law 516,

pp.520-522. 60 Pettet, B Company Law ( 2nd ed. Pearson 2005) at page 162; Boyle, A J & Birds, J, supra n50, at page 28. 61 Palmer, F B, supra n55, at page 167. 62 Hannigan, B, supra n37, at page 34-35. 63 Parkinson, J E, supra n18, at page 98.



May 9, 2013


experience means that corporate governance may become a clearer and more

accessible target.64

Corporate Governance and Directors’ Fiduciary Duties

The concept of directors’ fiduciary duties is rooted within a relationship of loyalty and

trust between the members of the company and the directors. The CA 2006

replaces and codified directors’ fiduciary duties in order for them to be understood

more easily.65 The CA 2006 stipulates that directors’ duties are to be based upon

‘certain common law rules and equitable principles… [to be]… interpreted and

applied in the same way’.66 Hence, despite the Act, common law fiduciary directors’

duties maintain their relevance. Due to the extensive powers of directors, they are

commonly deemed to necessarily be “subject to the full rigour of the fiduciary duties

developed by equity”;67 therefore, the provisions of the Act that deal with these

principles are extremely important.68

Equitable principles function to subject directors to the fiduciary duty of loyalty and

trust with respect to the company and its members.69 Yet the duties in this respect

are mostly owed to the company and not its members, creditors or other directors.70

This means that the rigour of fiduciary duties depends ultimately on shareholder

action; they are in practice rather difficult to enforce. According to section 170 “only

the company can bring actions for breaches of duties”;71 therefore, actions largely

depend upon whether a fiduciary relationship can be said to exist.72 Section 171(a)

requires that directors act ‘in accordance with the company’s constitution’ and

exercise powers ‘for the purpose for which they are conferred’.73 Clarity here is not

64 Walmsley, K Butterworths Company Law Handbook (23rd ed. Butterworths 2009) at page 182-187; Parkinson, J E, supra

n18, at page 103. 65 House of Lords, supra n26, at col 243. 66 CA 2006, section 170 (3). 67 Dignam, A & Lowry, J, supra n30, at page 311. 68 Aberdeen Railway Co v Blaikie Bros (1854) 1 Macq. 461, 17D (HL), per Cranworth LC. 69 Bristol and West Building Society v Mothew [1998] Ch 1, per Millett LJ at 18. 70 Percival v Wright [1902] 2 Ch 421; Multinational Gas and Petrochemical Co v Multinational Gas and Petrochemical

Services Ltd [1983] Ch 258, 288; Western Finance Co Ltd v Tasker Enterprises Ltd (1979) 106 DLR (3d) 81 71 Sealy, L & Worthington, S, supra n51, at page 283. 72 Ultraframe (UK) Ltd v Fielding [2005] EWHC 1638(Ch) 73 Ss 171 (a) and (b).



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entirely evident as it does not state how far directors must depart from their duties in

order to be said to have breached them.

However, a major problem concerning the fiduciary duties of directors is exactly

whom they can be said to owe them to. It is commonly accepted that such duties

are owed to the company, yet this assumption is not exactly straightforward or clear.

Dignam and Lowry state that “the courts have cleverly fudged the answer,”74

although they generally define the company as the “corporators as a general body.”75

Recent instances of director fraud such as Enron demonstrate that the Act is not

able to completely prevent or detect director fraud.76 Section 171 also limits the

power and authority of directors, despite the fact that they may have actually acted in

the bona fide belief that their actions would promote the best interests to the

company.77 This can be considered a ‘necessary evil’, because it in practice

prevents directors from concealing decisions made in their own best interests under

the claim that they acted in good faith.78

It has been proposed that directors should no longer be subjected to fiduciary duties

because their positions are based upon “prudent, risk-adverse people whose priority

is to preserve the capital value of trust assets.”79 In this respect, it could be argued

that the directors’ fiduciary duties prevent them from pursuing the best interests of

the shareholders. In the modern business world which, therefore, the need to fulfil

fiduciary duty conflicts with the need to take risks in order to raise capital.

74 Dignam, A & Lowry, J, supra n30, at page 314. 75 Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286, per Evershed MR. 76 Enron Europe Ltd (in administration) v Revenue and Customs Comrs [2008] SWTI 390; Wearing, RT Cases in Corporate

Governance (Sage 2005) at page 69. 77 Dignam, A & Lowry, J, supra n30, at page 318. 78 Piercy v S Mills & Co Ltd [1920] 1 Ch 77 79 French, D Mayson, S & Ryan, C Company Law (27th ed. OUP 2010) at page 470.

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Conclusion: Shareholder Control Mechanisms

While it is clear that shareholders play a prominent role in the implementation of

corporate governance, regulations such as the Code and the CA 2006 attach

importance to other considerations. This means that shareholders may exert some

degree of control over directors in general, but their dispersed nature severely limits

such control. This does not mean that shareholders are not equipped with powerful

mechanisms to counter the potentially unfettered control over the directors. A useful

mechanism which allows shareholders to pursue and implement corporate

governance is the takeover bid.80 Manne indeed comments that “only the takeover

scheme provides some assurance of competitive efficiency among corporate

managers and thereby affords strong protection to the interest of vast numbers of

small, non-controlling shareholders.”81 Takeover bids give shareholders the power

to reinforce and alter their contract with the company’s management in that it allows

another party to take control of the company and change the contract if it has

become unsuitable or insufficient. Due to the fact that takeover bids usually occur

when the company’s value reduces, directors will be unlikely to take decisions that

serve their own interests. The takeover bid can thus be said to provide for the

revision of directors’ requirements and duties. They of course do not wish for this to

occur, so they will hence be less likely to take decisions that serve their own best

interests.82

As it has been recognised that takeover bids occur when the value of the company’s

shares falls; this means that the takeover company will offer to purchase the

shareholders’ shares. If successful, takeover bids result in the restructuring of the

company, which results in directors being given more duties and subject to different

standards of government.83 Due to the fact that takeover bids generally occur when

the company’s governance is ineffective, directors will seek to ensure that their

management of the company is effective in order to avoid them. There are,

however, disadvantaged in respect of this mechanism in that directors are able to

80 Lowry, J & Reisberg, A, supra n32, at page 531. 81 Manne, H G ‘Mergers and the Market for Corporate Control’ (1965) 73 (2) Journal of Political Economy , at page 115. 82 Scharfstein, D ‘The Disciplinary Role of Takeovers’ (1988) 55 (2)Review of Economic Studies, at page 186. 83 Dine, J & Koutsias, M, supra n13, at page 302.



May 9, 2013


defend themselves against takeover bids by taking certain defensive measures. For

example, the ‘poison pill’ defense allows directors to render a takeover bid less

desirable through the utilisation of flip over plans, preferred stock plans or back end

plans.

Therefore, the supervisory board is also a potent mechanism for shareholders

because it consists of the board of managers elected by the shareholders and allows

the latter to promote their interests through corporate governance.84 The supervisory

board has the power to regulate, appoint and dismiss both the CEO (Chief Executive

Officer) and the executive directors of the company. The board in general gives

directors authority to make decisions via the CEO. In this respect, the board can be

defined as an important corporate governance tool for shareholders. Moreover, it

advises directors, votes on important financial decisions and ensures that the

finances and activities of the company are presented honestly to the shareholders.

The board of directors following the Cadbury Committee Report was reformed when

it emerged that the company structure was disadvantaged by the domination of the

CEO or sole managing director.85 The Cadbury Committee proposed that the board

be restructured in order to eliminate the likelihood that a single powerful individual

would govern the company.86 The Combined Code, therefore, states that the board

must control and lead the company, requiring that it consist of at least a one-third

share of non-executive, independent directors. The advantages of a non-dominant

manager are clear; most prominently, it ensures that executive directors do not

possess an unfettered power. The board similarly ensures that shareholders are not

deceived or misinformed in relation to the financial situation and plans of action for

the company.87 The board also maintains the efficiency of decision-making and

reduces agency costs, as well as taking care to ensure that directors invest

shareholder funds carefully.88 The board can ultimately be defined as

representatives of shareholder interests, as it seeks to coincide with the decisions

and actions of executive directors with the interests of shareholders.

84 Smerdon, R, supra n3, at page 98. 85 The Cadbury Committee. The Financial Aspects of Corporate Governance (Gee 1992) at para. 4.2. 86 Lowry, J & Reisberg, A, supra n32, at page 64; Lowry, J & Reisberg, A, supra n4, at page 62-64. 87 Tricker, B Corporate Governance: Principles, Policies, and Practices (OUP 2009) at page 61-63. 88 Talbot, L, supra n4, at page 126.



May 9, 2013


Even so, this is not to state that disadvantages do not exist within this structure; the

perceived need to disperse power suffers because the CEO (as the Chairman)

maintains an extremely powerful position.89 It can therefore be observed that the

CEO makes the company ultimately depends on his chosen policies, which may

cause shareholder interests to be overridden. The CEO also may group with non-

executive, independent directors for the purpose of avoiding a takeover bid.90

However, It can therefore be observed that there are a number of mechanisms

available to shareholders in the bid to achieve control of the company’s

management. Coupled with regulations such as the CA 2006 and the Combined

Code, the ability of shareholders to ensure corporate governance is potent.

89 Hannigan, B, supra n37, at page 122. 90 Nordberg, D Corporate Governance: Principles and Issues (Sage 2011) at page 157-159.



May 9, 2013


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https://www.icgn.org/files/icgn_main/pdfs/best_practice/inst_share_responsibilities/2007_principles_on_institutional_shareholder_responsibilities.pdf

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