The most significant trend in corporate governance during recent years has been the increasing importance of the need to consider wider stakeholder interests in corporate decisions.
The latest edition of the UK Corporate Governance Code is clear in highlighting the importance of sustainability and corporate culture in succeeding in the long-term. Companies “need to build and maintain successful relationship with a wide range of stakeholders”, according to the code.
This is possible where a company’s culture promotes integrity and openness, values diversity, and is responsive to the views of different stakeholders, including shareholders.
The sustainability revolution in corporate governance in the UK is expected to continue. The increasing societal attention to environmental challenges—including climate change—and social challenges means that the next version of the corporate governance code, which is expected in the not-too-distant future, will put more emphasis on sustainability.
Indeed, in a recent position paper outlining next steps in the transition to a new regulator, the Financial Reporting Council announced plans to change the corporate governance code by, among other moves, reinforcing the emphasis on sustainability and ESG reporting.
The shift away from the de facto shareholder-oriented model of corporate governance towards a model where companies are encouraged to be more attentive to the interests of a wider group of stakeholders has important implications for the core criteria based on which companies are regulated.
One of the standards of regulation that needs rethinking is the typology of companies between public and private. Traditionally, regulators invoked investor protection to justify extensive regulatory requirements for public companies.
The extension of demanding rules and best practice standards on information disclosure, audit, the composition and functioning of corporate boards, and executive remuneration to private companies, which do not issue shares to the public, would create unnecessary costs for business without much added value.
This regulatory approach worked well in a world where the main purpose of high corporate governance standards was to protect shareholders from managers by strengthening the accountability, transparency, and oversight of managerial decision-making.
But a public and private typology of companies is a bad match for the newly evolving model of corporate governance. The growing use of corporate governance for promoting more sustainable corporate behaviour for the benefit of both shareholders and non-shareholder stakeholders means that the beneficiaries of tighter corporate governance regulatory regimes in modern times are not only investors in public markets but other stakeholders as well.
If companies, regardless of their public or private status, create large negative externalities for stakeholders, there are good reasons for covering them by corporate governance rules and recommendations.
Past its sell-by date
The simple public vs private dichotomy of companies is outdated for the rising sustainability-focused corporate governance regime. This division encourages private companies to stay private and public companies to spin off and sell their business divisions with the largest footprint on stakeholders to private owners, thereby distorting business organisation and financing decisions.
To be clear, this typology has a similar distortive effect where the purpose of corporate governance rules and recommendations is investor protection. But the negative consequences of the decision to stay or go private on investors are limited simply because private companies do not offer their shares to the public.
By contrast, the impact of corporate activities on non-shareholder stakeholders, such as the environment or employees, is not linked to the company’s public or private status.
This questions the adequacy of maintaining different corporate governance regimes for public and private companies in the modern times. The rise of corporate governance for all calls for a new system of classification of companies.
The application of new pro-stakeholder disclosure rules and the next corporate governance code only to public companies does not make sense; they should apply broadly beyond public companies. But the diversity of stakeholder interests means that there is no one easy and straightforward benchmark based on which regulators can define which companies to include within the regulatory regime.
We need combinations of various criteria – investor base, company size based on sales and/or the number of employees, carbon emissions, the relative weight of a company in a local market and community – that will define whether a company is subject to stricter corporate governance rules and best practice recommendations.
The old public vs private typology or any other simple measure that is relevant for a limited stakeholder base misses the target of the rationale of regulation.