The proposal was to add to section 131 of the Companies Act:
To avoid doubt, a director of a company may, when determining the best interests of the company, take into account recognised environmental, social and governance factors: such as
The suggested clause then listed several possible areas that may be taken into account:
- recognising the principles of the Treaty of Waitangi (Te Tiriti o Waitangi)
- reducing adverse environmental impacts
- upholding high standards of ethical behaviour
- following fair and equitable employment practices
- recognising the interests of the wider community.
The Economic Development Select Committee suggested that, if the Act were to proceed, the clause be changed to:
To avoid doubt, in considering the best interests of a company or holding company for the purposes of this section, a director may consider matters other than the maximisation of profit
The current Act notes makes clear the obligation of directors to act in the best interests of the company but makes no mention of profit maximisation.
If the amendment to the Act does proceed, the next step would be a second reading and then debate by the ‘Committee of the Whole House’ when the suggested change would be considered.
Is our debate on business in the contemporary world so unsophisticated that the best we can do is write into law only the possibility that things other than profit maximisation might exist? We are a very sad country if that is the case. Peter Drucker’s original observation about profit being a test of business validity rather than its core purpose has been adroitly paraphrased:
Profit is to a corporation as oxygen is to a human being: necessary for existence, not the reason for it.
Prudent financial management already involves many things other than the simple maximisation of profit: training, R&D, upgrading of plant and so on. Sadly, we see ample examples of neglect of these essential items for short-term gain.
Law firms noted that the amendment’s drafting was poor and, as it stood, left the possibility of opening directors up to litigation. Poor drafting can be addressed, but the possibility of litigation surely flows from the very existence of the law. As Steven Moe points out in his opinion piece [1] for the Auckland District Law Society, the equivalent statute in the United Kingdom uses ‘must’ not ‘may’ and the sky hasn’t fallen in the 17 years that has been in force.
To be fair, most commentators were not opposing a focus on these broader matters but suggested that this approach was likely to achieve little. We tend to agree.
The Institute of Directors’ submission on the proposed change, while canvassing a range of views, reads as a masterwork in fence sitting. However, it does include some useful perspectives. Their own Director Sentiment Survey indicates that directors are increasingly taking a long-term view, with 41% actively considering the organisation’s social licence to operate. Their submission offers three options to consider.
First, to rely on other instruments of guidance, legislation, governance codes, disclosure regulation etc. For instance, the forthcoming changes to the NZX corporate governance code [2] look to climate disclosure matters. Second, to make a company’s approach to ‘best interests’ more transparent through a mandatory statement table at the annual meeting. Finally, as the Companies Act is now 30 years old and the world has fundamentally changed, it probably warrants a considered and thorough review. That would seem sensible.
We acknowledge the necessity for legislation in all contexts, but the law sets a minimum standard. There is too frequently evidence of approaches where actions are justified because ‘it is not against the law’—but often against the spirit of it. Or we are likely to get away with it and, if not, the potential penalty is modest compared to the upside, especially if we have deep pockets for legal fees.
Undoubtedly it is difficult to legislate for ethical behaviour. As the burgeoning AI industry is finding, determining ethical frameworks is not simple. Who decides? And what about varied cultural frameworks? One only needs to look to the increasingly partisan culture wars in America to see how difficult achieving a common view on ethics is.
Our argument is that, while it is necessary to have legislation and regulation set the boundary fences for behaviour, it is more helpful for each board to be clear about its values framework. We can usefully go back to governance commentator Bob Garratt who saw fit to title his 1996 book The Fish Rots from the Head. [3]
There is a strong case that the board needs to set, own, live by and oversee organisational culture. It follows that directors (and staff) are recruited into an environment where the boundaries of [acceptable?] behaviours are known. Values in adult humans do evolve over time depending on context and experience [4] but the fundamentals are set early in life. It follows, therefore, that words on the wall behind the reception desk are not going to fundamentally influence behaviour. Rather, those with an inconsistent value set need not hop on board—or should get off the at the earliest opportunity—if it proves to be the wrong bus.
The role of the board in this regard is increasingly being written into governance codes. One of the best articulations is found through the work of Professor Mervyn King [5] in the South African King (IV) code: [6]
The governing body should exercise ongoing oversight of the management of ethics and, in particular, oversee that it results in the following:
a) Application of the organisation’s ethical standards to the processes for the recruitment, evaluation of performance and reward of employees, as well as the sourcing of suppliers
b) Having sanctions and remedies in place for when the organisation’s ethical standards are breached
c) The use of protected disclosure or whistle-blowing mechanisms to detect breaches of ethical standards and dealing with such disclosures appropriately.
d) The monitoring of adherence to the organisation’s ethical standards by employees and other stakeholders through, among others, periodic independent assessments.
The board’s ethical framework has two elements: those set at the entity level and those individual directors bring to the table.
At the entity level, the idea of social licence is useful. The right to operate within any given community should be granted by those affected by the organisation’s activities. Of course, similar ideas have previously been offered. In 1956 the German economist Wilhelm Röpke [7] wrote in his book The Humane Economy:
...those who compete in the market require the social and moral bonds of community to prevent competition from [degenerating] most grievously into a state of affairs where man is denied the conditions (social and material) proper to his nature and dignity as a human being.
Even the darling of libertarian causes, economist Friedrich Hayek, [8] accepted there were some things that could not be left to the market—control of pollution being one.
One hopes that the world has moved past Milton Friedman’s doctrine of shareholder primacy first published in 1970 [9] but that may be over-optimistic. This and other related mantras such as ‘the rising tide lifts all the boats’ continue to be heard in many quarters, including New Zealand’s political discourse. These ideas have not served society well.
In fact, there is a reasonable argument that Friedman’s writing was used somewhat selectively. The same essay also contained the following statements:
…to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom
And…
...engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.
It is clear that Friedman was not advocating a boundless capitalism unfettered by law or moral norms.
The Stigler Center’s publication ProMarket published an opinion piece marking 50 years on from the Friedman article, entitled, The Purpose of Business is to Solve Problems of Society, Not to Cause Them. [10] This did suggest several legal approaches to force American corporations away from the focus on shareholder primacy. It is a great title and an excellent sentiment to place at the centre of ethical behaviour.
Among the submissions on the proposed Companies Act amendment, Richard Lauder’s [11] stood out as a well-argued and thoughtful paper [12] in which he suggests including a ‘do no harm’ requirement in a code of practice for directors:
Directors of all companies shall routinely assess all potential and actual sources of direct harm to staff, other persons, to the environment and biosphere, to pristine natural places and waterways and to the communities in which they operate, and that all practicable steps to firstly eliminate that harm, and where elimination is not possible, to minimise that harm. This obligation on directors also applies to the management of, and relationship with, the company’s supply chain and contractors.
This is consistent with the ProMarket article and very aligned with the concept of social licence. Profit should not be derived from harm.
Values are the foundation element of any governance-level policy framework. From these statements flow subsequent and subordinate policies down through the layers into operational matters. In the absence of anything prescriptive, we fall back on values. They are the first discussion to be had and warrant time and effort to get clear and correct.
Our point is that each board needs to discuss and set its own framework. There are ample ethical references on hand if needed. The United Nations Guiding Principles on Business and Human Rights [13] is a good starting place.
At the individual level, self-awareness is a fundamental prerequisite for good leadership. Leadership courses focus there first, understanding that without self-awareness you cannot effectively lead others.
We suggest that this extends to individual directors and an awareness of what is in the ‘ethical backpack’ they carry to the table.
Again, the law sets some boundary fences, including conflicts of interest, meeting obligations, care, diligence, exercise of power for proper purpose etc. Board charters and codes of ethics also usefully set things out: focus on the long term; be prepared; respect for peers; speak with one voice; abide by legal and moral obligations etc.
These are all helpful as long as they are actually ‘in play’ and not languishing in a drawer somewhere. Beyond this, there are some core beliefs that an individual director should carry with them. The first is Greenleaf’s idea of servant leadership. [14] The director is first there to serve and create benefit for others, not themselves. This removes ego and status from the role.
Second is an open mind, not one with dogmatic positions, but open to the idea that new information may require a revaluation of any position. Nicely summed up in psychologist Daniel Kahneman’s quip, [15] ‘No one enjoys being wrong, but I do enjoy having been wrong, because it means I am now less wrong than I was before’.
Third, the board is a team [a group with collective responsibility], and it is the aggregate of skills and opinions [and how these are integrated] that makes it effective. Remembering the trite phrase that there is no ‘I’ in team would serve some directors well.
And finally, the performance expectations that I am happy to place on others equally apply to me. A director tries to be the best they can, is open to regular peer review and will maintain a regime of learning that ensures they remain an informed and relevant contributor.
We agree that the Companies Act (1993), a 30-year-old piece of legislation, warrants a thorough review—the world has moved on. But it will only ever outline boundary fences. Each board must set its own framework of beliefs and each director needs to bring a considered and self-aware approach to the role.
References
- Moe, S. In defence of the proposed changes to the Companies Act ADLS newsletter October 2022
- https://www.nzx.com/regulation/nzx-policy/consultations
- Garratt, B. The Fish Rots from the Head. Harper Collins Business 1996
- Psychology Today September 2015
- Mervyn King
- King IV Report on Corporate Governance for South Africa 2016. Institute of Directors in Southern Africa, 2016. p. 45
- Wilhelm Röpke
- Friedrich Hayek
- Friedman, M. The Social Responsibility of Business Is to Increase Its Profits. New York Times Magazine 1970
- https://www.promarket.org/2020/10/09/purpose-business-solve-problems-society-not-cause-them-friedman/
- Richard Lauder
- Richard's submission
- Guiding Principles on Business and Human Rights
- Greenleaf, Robert K. Servant Leadership: A Journey into the Nature of Legitimate Power and Greatness Paulist Press 1977
- Kahneman in conversation with Adam Grant, cited in Macmillan Learning blog. February 2021
