Discuss about the Fiduciary duty of the Director that they owe to the Company.
According to the prevailing ideology of ‘shareholder primacy’ most of the Boards of Directors believe that they are prevented from considering the stakeholders other than the shareholders while determining the material issues and reporting or strategy. Research shows that the prevailing legal foundations for the Board of Directors require the directors to take the stakeholders into consideration (Bromiley et al. 2015). In this report, we discuss about the fiduciary duty of the directors and to whom the directors owe their duties; the significance of materiality in corporate governance shall be reviewed and the audience-focused materiality determination approach shall also be reviewed.
It is a universally existing ideology that the fiduciary duties of the directors require them to give more priority to the interest of the shareholders as compared to the stakeholders. However, research shows that this is an ideology and not law (Eccles and Youmans 2016). Shareholder value is the consequence of the use of the capitals by the company and it is not an objective of the company. The providers of the financial capital and the shareholders are one addressees of the corporation. As the company assembles manufactured, financial, human, social relationship, natural capital and intellectual, each capital has one or more stakeholders who have an interest in this type of capital.
The ideology of shareholders primacy is rejected in most of the countries as they consider that the directors do not owe their fiduciary duties only to the shareholders. Being a separate legal entity, a corporation has mainly two essential objectives: to thrive and survive. While the shareholders delegate their stakes to the Board of Directors in a corporation, the shareholders are comprises just one of the addressees among others that the board may consider while making decisions on behalf of the Corporation (Wheelen and Hunger 2017). In every jurisdiction worldwide, the Board of Directors owes primary duty to the Corporation itself owing to its separate legal entity. In no jurisdiction, the duty of the directors to the shareholders is not higher than the duty that the Board of Directors owes to the corporation itself. The stakeholders may include other financial stakeholders including the NGOs, suppliers, customers who represent various concerns of the society. Therefore, irrespective of the size of the corporation, the Directors must take into consideration the preferences of the several audiences while making choices with respect to the significance of such audiences.
The Boards of a corporation often spends most of its time developing strategies or crisis management plans and reviewing risks. In other words, the Boards are engaged in building mechanisms to safeguard the corporation or strengthen the ability of the corporation to respond any threatening events. Besides this role, the Directors owe fiduciary duties towards the organization as well which requires them to act in the best interests of the corporation and its members including the shareholders (Eccles and Youmans 2016).
A director is under statutory obligation to perform its fiduciary duties under the Corporation Act 2001 (Cth). The director is required to act honestly and in good faith and, they are required to give more priority to the interests of the company against their individual interests. The directors owe its duties toward the corporation and the directors must give priority to the company first irrespective of the fact that several situations might arise where the interests of the third parties must be taken into account but above all the Board must ensure that their primary duty is towards the corporate person itself (Larcker and Tayan 2015). The corporate privilege of separate legal entity that is granted by the society, a corporation disembarks at its own legal identity which is distinct from its shareholders, managers, employees and other stakeholders, which makes it capable to survive several generations.
However, the fact that the company makes decision only considering the choices of the shareholders is only an ideology and not law. A company must focus on significant audiences while determining issues that are material to the ability of the corporation to sustain itself for a stipulated period of time.
Since the ideology ‘shareholder primacy’ has been perceived universally as a statutory requirement, the directors have not considered the full array of potential audiences who are the significant to the corporation.
The relevance of materiality in corporate governance is time frame and audience dependent and is ultimately based on the decision of the Board of Directors. The determination of materiality is an integral part of the fiduciary duty of the Directors and is the basis for establishing the legality of the role of the corporation in the society (ArAs 2016). After taking into consideration the possible combinations of issues and stakeholders and other financial and non-financial attributes such as environmental, social and governance issues, it would make the fiduciary task of the directors impossible as the corporations have limited resources and restricted competencies to organize these capitals. In the face of these limited resources, the directors must make choices with respect to determine which audiences are significant as these would be dividing all the stakeholders of the firm. These significant audiences shall determine the issues that are material to the ability of the corporation to sustain itself for the self-defined period of time.
It is often observed, that the directors of a company concentrate on issues that are material for short-term financial performance. The directors are suggested to focus on significant audiences which imply a wide range of issues over a longer time frame shall be taken into consideration in determining the materiality. The involvement of ‘audiences’ raises the question ‘who does the board address when it determines which issues are material and which are not.’ Although the shareholders are significant audience but there are other audiences who exerts pressure on the firm with respect to their determining the material issues (Moriarty 2014). While determining the issues that are material, the corporation must for its own good, take into account the stakeholder’s perspectives beyond the shareholders and the providers of the financial capital.
In order to determine the relative importance of different providers of financial capital and of other audiences is ultimately a responsibility of the Board of the corporation. The Board is suggested to issue a forward-looking ‘Statement of Significant Audiences and Materiality (The Statement)’ annually. This statement shall inform the providers of financial capital, management and all the other stakeholders of the audiences which the Board considers vital to the survival of the corporation.
The Statement is a one page document that the board of directors of a corporation issues every year. The Statement identifies significant audiences and time frames and includes the description of the responsibility of the corporation in the society. The statement denotes the responsibility of the Board that it owes to the corporation for the purpose of determining the materiality. It is the right and responsibility of the Board to make judgments that would be based on honest and open conversation between the corporations and all its stakeholders (Johnson, Schnatterly and Hill 2013).
The significance of the Statement clearly communicates the view of the Board of directors of the company with respect to the priorities of the company by identifying the limited number of which the company considers as significant audiences and which are not considered as audiences. This would enable the bondholders, shareholders and the other several audiences of the company can make their own decisions with respect to resource allocation in terms of how they are engaged with the corporation.
The role of the corporation in the society is described by the Board in the Statement and whose interests are being served by the company and in what time frame. According to the growing demand for the corporate accountability on non-financial performance, the Board of directors has a valid reason to issue an annual Statement (Christensen et al. 2015). This particular requirement has been fulfilled by the Dutch Insurance company Aegon’s management Board which is considered as the one of the first Board of directors to complete Statement. The company has identified its non-financial and financial issues and investigates how they affect various stakeholders. With the help of the Statement, the Board of Director of the company has defined the role it plays in the society which enabled all its stakeholders to determine their respective resource commitments to the company.
A further research is going on with several prominent organizations to establish a legal case that Boards of Directors have fiduciary obligation to the corporation and not to the shareholders alone. Such organizations include the UN Global Compact, Sustainable Development Task Force and with support from and in coordination with the Principles for Responsible Investment and UNEP Finance Initiative.
The stakeholder theory is related to the business ethics and organizational management that concentrates on values and morals in managing an organization. This theory requires the directors of the management to consider the interests of every stakeholder in the governance process of the company. This implies that the directors must strive to resolve conflicts between the interests of the stakeholder and must concentrate on the interests of any third party that is dependent on the corporation to a certain extent. The internal stakeholders include employees and directors; external stakeholders include auditors, customers, suppliers etc.
The entity theory refers to the assumption that every economic activity conducted by the business is separate from the activities of the owners. This theory is based on the idea that the activities of the company shall be accounted independently from the activities of the owners. Hence, the owners are not responsible personally for any loans and liabilities of the company.
The proprietary theory states unlike the entity theory, there is no significant distinction between the owners and its entity, that is, the entity does not exist separately from the owners. The main focus is to provide information that is useful to the owners; hence the financial statements are prepared from their perspective.
The enterprise theory perceives the corporation as a social institution that functions for the advantage of the creditors, stakeholders, employees, government and general public. The enterprise is considered as a decision-making center for the people who are participants irrespective of the extent to which they are related to the organization.
Conclusion
As discussed above, that the duty of the Board is to give more priority to the interest of the corporation than to the interest of the shareholders. While the Board may decide to consider shareholders as one of the significant audience, it is not mandatory to do so. The Board is required to decide which audiences are fundamental for the ability of the corporation with a view to create value over the medium, short and long-term. Once the board has identified its significant audiences it is said to have provided a base of the materiality determination process for corporate reporting.
In some jurisdiction, remarkably the United States, there is a prevalence of the concept of ‘primacy duality’ which implies that the duty of the directors to the company is co-equal to the director’s duty towards the shareholders. There is no such jurisdiction where the duty of a director towards the shareholders is higher than the duty it owes to the corporation which is a separate legal entity itself. In Australia, the duties of a director is stipulated under Section 181(1) of the Corporations Act 2001 (Cth) where the director is required to act in good faith and in the best interests of the corporation which implies that in case of conflict between individual interests and the interests of the company, the interests of the company shall prevail.
The corporation is also under an obligation to act in the interest of the society as well. Since the society has granted the corporations with privileges thus, enabling the corporation to operate in their sole interest, therefore, the corporations have a moral duty to think about the good of the society and not only of profits. This highlights the duty of the corporation which is not to just perform its business activities but to report back to the society about the material actions beyond the profit-related actions.
Reference List
Bromiley, P., McShane, M., Nair, A. and Rustambekov, E., 2015. Enterprise risk management: Review, critique, and research directions. Long range planning, 48(4), pp.265-276.
Eccles, R.G. and Youmans, T., 2016. The Climate Custodians.
Wheelen, T.L. and Hunger, J.D., 2017. Strategic management and business policy. pearson.
Eccles, R.G. and Youmans, T., 2016. Materiality in Corporate Governance: The Statement of Significant Audiences and Materiality. Journal of Applied Corporate Finance, 28(2), pp.39-46.
Hill, C.A. and McDonnell, B.H., 2013. Reconsidering board oversight duties after the financial crisis. U. Ill. L. Rev., p.859.
Larcker, D. and Tayan, B., 2015. Corporate governance matters: A closer look at organizational choices and their consequences. Pearson Education.
Tricker, R.B. and Tricker, R.I., 2015. Corporate governance: Principles, policies, and practices. Oxford University Press, USA.
Christensen, J., Kent, P., Routledge, J. and Stewart, J., 2015. Do corporate governance recommendations improve the performance and accountability of small listed companies?. Accounting & Finance, 55(1), pp.133-164.
ArAs, G., 2016. A handbook of corporate governance and social responsibility. CRC Press.
Epstein, M.J. and Buhovac, A.R., 2014. Making sustainability work: Best practices in managing and measuring corporate social, environmental, and economic impacts. Berrett-Koehler Publishers.
Moriarty, J., 2014. The connection between stakeholder theory and stakeholder democracy: An excavation and defense. Business & Society, 53(6), pp.820-852.
Johnson, S.G., Schnatterly, K. and Hill, A.D., 2013. Board composition beyond independence: Social capital, human capital, and demographics. Journal of Management, 39(1), pp.232-262.
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