CORPORATE GOVERNANCE AND INDEPENDENT DIRECTORS

• Published date: 01 December 2003
• Author: TAN CHENG HAN
• Date: 01 December 2003

A Introduction

1 The company is today the most widely used business vehicle, far outstripping associations of persons in partnership. In the developed countries of the common law world, for example, only the professions and sundry small businesses generally use the partnership vehicle. Where the professions are concerned, this is largely due to the perception that professional persons should be held to a higher standard and be subject to the prospect of unlimited liability. However, the requirement for professionals to engage in their profession only through the partnership vehicle, and with the prospect of unlimited liability for all partners, is being rapidly eroded. One of the main advantages of incorporation is that investors in the enterprise are not personally liable, in the absence of any direct assumption of responsibility on their part, for the debts and other liabilities of the company.1 It is becoming increasingly accepted that professional practices are also essentially business enterprises that ought to be allowed the benefit of limited liability afforded by the corporate vehicle. In addition, as the number of professional negligence suits has increased, the professions have also lobbied vigorously for such protection. It is often argued by the professions that the potential liability each professional person bears is out of all proportion to the fees charged for their professional services, thereby shifting risk unfairly to them. It is also often said that as professional indemnity schemes are common, indeed sometimes compulsory, the professions are the ones ultimately insuring losses caused to third parties even where there are other parties (usually uninsured) involved. Today, as a result of these views, many jurisdictions allow associations of professionals to carry on business

through a corporate vehicle.2 Some also allow limited liability partnerships,3 which are common in Europe4 but never really took off in the common law world.

2 Although a company in the eyes of the law is a different creature from a partnership, where small or closely held companies are concerned, the operation and management of such companies may be little different from a partnership. Indeed, many small or closely held companies may have previously been partnerships that later adopted the corporate form. Such companies are often referred to as “quasi-partnerships”5 although the term is of course misleading.6 In such companies, there may be virtually no difference between ownership and management. Many of the shareholders of such companies will be involved in the management of these companies. Even where they are not directly involved, the often-informal nature of such associations will usually mean that their views will be taken into consideration, or that they will be consulted on important matters.

3 In the case of large companies whose shares are listed on a stock exchange, the fact of the listing will usually mean that the shareholder spread is diverse. In publicly listed companies, there is usually some dichotomy between ownership and management. In a famous work, attention was called to the prevalence in the United States of widely held companies where ownership is dispersed among small shareholders, with control vested in managers who have small or non-existent equity interests. In such companies there is a clear separation of ownership and

control.7 However, such a clear dichotomy does not exist in all companies. In some companies, where a particular shareholder or group of shareholders own a significant percentage of the company’s shares, such percentage may be sufficient, even when not a majority interest, to give these shareholders effective control over the company due to the diffused nature of the company’s shareholders. Such shareholders who hold a significant interest will often be part of the management. As a general rule, though, most shareholders in public listed companies will have a relatively small number of shares in the company and not be involved in management. Even where shareholders or groups of shareholders have a relatively large percentage of the company’s shares, they may in some cases prefer not to be directly involved in management but to entrust that to the care of professional managers. Thus, the distinctive feature of publicly listed companies is that a diverse group of shareholders will entrust the management of the company to agents, some of whom themselves may be large shareholders.8

B An excursion into history

4 From a historical standpoint,9 it will be seen that even without anything resembling a public listing today, wherever business enterprises

were of a large and complex nature, the need for risk takers (shareholders today) to delegate management to agents became necessary. The modern company can be traced back to medieval times where it was used by ecclesiastical bodies and boroughs. In the commercial sphere, it was also used by guilds of merchants and craftsmen. The principal function of these bodies was to regulate the affairs of its members. Corporate status was obtained by royal charter.10 This secured for the borough territorial self-government from feudal lords. For the guilds, it secured a monopoly over a trade that could be practised only by members of the guild. Members carried on the trade on their own account or with others subject to the rules and regulations of the guild. The guild itself as an entity was not engaged in the trade and was principally an administrative and self-regulating organisation for that particular trade.

5 The next stage of the development of the ‘company’ saw it evolve from one principally interested in internal administration to one engaged in external trade. In the sixteenth and seventeenth centuries, the crown’s desire to expand foreign trade led to charters being granted to entities that pursued commercial gain in overseas territories. Initially, these entities were not much different from the guild associations. Membership of the company allowed each member, subject to the rules of the company, to pursue the overseas trade in question either on the member’s own account, or in joint account with other members. The royal charter was intended to grant the company, and therefore its members, a monopoly over a particular aspect of foreign trade. It was also a means by which the crown enlisted private resources to the king’s business. Incorporators would venture their own funds for the state’s ends, in effect paying for the privilege.11 The company therefore had a strong political dimension. As Holdsworth puts it: “It was from the point of view of trade organization and the foreign policy of the state, rather than from the point of the interests of the persons composing the company — from the point of view of public rather than commercial law — that the corporate form was valued.”12

6 However, over time the mode of engaging in business changed. This was hardly surprising. Overseas ventures required more in the way of capital and expertise. The risks were greater and each endeavour took a much longer time. Merchants could not expect their wares to arrive in the marketplace within a relatively short time. Ships could be away at sea for months and be subject to all the attendant risks then present of sea travel. It became impractical for all but the wealthiest merchants to continue to trade on their own account. Gradually, more and more began to trade on joint account and with a joint stock in trade.13 Eventually, this became the only means of trading through the company.14

7 We see in this gradual development many of the features of the modern publicly listed company. The medieval entity had evolved into a body that traded for the benefit of its members rather than one that merely regulated the affairs of its members in the pursuit of a foreign commercial enterprise. The company had a permanent joint stock that resembled the capital subscribed for in modern companies. As private trading became forbidden, the company itself was the vehicle for the pursuit of the monopolistic commercial enterprise. Most importantly, this in turn saw the rise of professional management, a relatively select group of persons who in effect managed the company. Yet it should be borne in mind that in many respects these ‘companies’ were very different from modern companies. One particularly important difference was that many of these joint stock companies were not incorporated companies with a separate personality but unincorporated partnerships. Legal ingenuity enabled many of these unincorporated associations to have many of the advantages of incorporation by the use of trusts. The company would be formed under a ‘deed of settlement’ under which the subscribers would agree to be associated in an enterprise with a prescribed joint stock divided into a specified number of shares. The trust deed would specify many of the terms on which the members would associate, including the delegation of management to a committee of directors, the vesting of the company’s property with a separate body of trustees, and how the provisions of the deed could be varied.15 When additional capital was needed, it was raised by levies on the existing members. The important advantage of limited liability conferred only by incorporation does not appear to have been fully appreciated.16 However, what is important to note was that by the end of the seventeenth century, the idea of

combining capital with entrepreneurship was appreciated. So too was the need to entrust management to professional agents.

8 In the first two decades of the eighteenth century, there was a speculative fervour that led to a bursting of the bubble in 1720. One of the most speculative enterprises, the South Sea Company, saw its stock price collapse precipitously. Many other companies failed completely and this led to public confidence in joint stock companies being destroyed to the...