Peter Dey is the chairman of Paradigm Capital.
In her recent essay on shareholder primacy (The Globe and Mail, Sept. 16), Sarah Kaplan asks a timely question: “Where does Canada stand?” It warrants some thought.
Prof. Kaplan, who teaches at the University of Toronto’s Rotman School of Management, accurately points out the perspective of the 1994 report on corporate governance, Where Were the Directors? That report affirmed the legal and business thinking at the time – that directors “have only one constituency and that is the corporation and its shareholders generally.”
That thinking evolved when the Supreme Court of Canada heard a 2008 case involving the proposed buyout of BCE Inc. In its landmark ruling, the court held that the directors of a corporation have a fiduciary duty to act in the best interests of the corporation, laying to rest the belief that their duty was to the shareholders and, by inference, to create shareholder value – the shareholder primacy principle.
Back in 1994, most boards believed that in order to create shareholder value, the board should consider the interests of all stakeholders. By shutting down a plant to cut costs and improve profits, the board understood that it would be damaging its relationships with the labour force and the community in which it operated. But the ultimate measure of its ability to manage all of the corporation’s constituencies would be the shareholder value it created. If a board was making money for investors, it must be managing its stakeholders effectively.
Today, directors owe a duty to the corporation – not solely to the shareholders nor any other stakeholder. In order to discharge that duty, they must consider the effects of their decisions on the corporation, and this requires an understanding of the effects of those decisions on stakeholders: customers, suppliers, the community, the environment, employees and, yes, shareholders. In summary, the corporation should act as any good citizen in a community would act.
The process of reaching a decision combines quantitative and qualitative analysis. It requires the board to balance the competing interests of stakeholders and look at the impact of its decision over the long term. The principal quantitative measure is the impact on shareholder value, but this must be balanced with an assessment of the impact on other stakeholders.
The impact on other stakeholders may not be easily determined mathematically. Determining the impact on stakeholders other than shareholders requires all members of the board to draw on their experience. This is where board diversity plays an important role.
An evolving issue in the context of stakeholder primacy is accountability. How does a stakeholder know that their interests have been fairly and equitably considered by the board? This is not an easy challenge to meet because the board’s analysis will be an exercise in balancing the interests of all stakeholders. And the well-advised board will have used a process that reflects diligence and good faith and allows the board to rely on the business judgment rule, which says that if the board’s process is sound, the court will not interfere with the board’s business judgment.
Canada has gone further than most jurisdictions in providing stakeholders with a remedy to hold the board to account: the oppression remedy. A “complainant” has an action if they feel they have been treated unfairly or prejudicially. The law and the governance practice continue to evolve with changing circumstances and changing markets.
The Business Roundtable’s recent statement that increasing shareholder wealth is no longer the sole purpose of corporations should stimulate reflection in the Canadian business community. Given the re-ordering of the importance of a corporation’s stakeholders in judging what is in the best interests of the corporation, courts, when given the opportunity, will more carefully scrutinize the applicability of the business judgment rule.
In addition, when our courts are reviewing the manner in which a board of directors reached a particular decision, they will look beyond the creation of shareholder value. Did the board look at the impact of its decision on the corporation’s business over the long term? Did the board identify the stakeholders of the corporation and did it understand the contribution of each stakeholder to the business of the corporation? What factors did the board consider in balancing the interests of the various stakeholders? What information did the board have in front of it to reach its decision?
Many Canadian boards are already responding to these tests of their processes. It is time for all Canadian boards to raise their game in advance of this heightened scrutiny – for the benefit of the corporation and the general community.