Most accounts of corporate governance trace it back to the 1992 Cadbury Report on The Financial Aspects of Corporate Governance, which aimed to hold managers accountable to shareholders by the appointment of more non-executive (or independent) directors (NEDs), and more engagement by institutional investors. The currently dominant, but highly flawed, shareholder primacy theory of corporate governance focuses on managerial accountability for creating shareholder value. The corporate governance and stewardship codes that the Cadbury Report inspired fit very well with this, and have proliferated around the world as countries seek to attract capital with familiar governance frameworks.
In my recent article in Business History, ‘The Bank of England the “Prehistory” of Corporate Governance’, I show that the main recommendations of Cadbury actually date back to discussions in the Bank of England in early 1971, and were developed over the following years in response to a very specific political economic crisis and context. I show that it was simply taken as given, or viewed as obvious, that managements had to be made accountable to shareholders as ‘owners’. The ‘proprietorial gap’ had to be reduced and the power of management limited. Shareholders and their influence were not to be marginalised. But far from being demanded by shareholders and capital markets, and so justifiable in the sense that they were ‘market-mimicking’ or transaction cost-reducing, these policies were designed by the Bank and then heavily promoted to the institutional investors that it thought would benefit from them.
The early 1970s and the origins of corporate governance
In 1970, one of the UK’s largest companies, Rolls Royce, had encountered financial difficulties after contracting to supply newly developed jet engines to a US company. A change of government meant that state-led restructuring was not possible, and so another solution needed to be found. While Rolls Royce itself was bailed out (and the engine turned out to be very successful over the following decades), the Bank decided that changes were needed to what later came to be called ‘corporate governance’. The Bank highlighted that the ‘rise of management and the decline of the proprietor left the large public company in a position of autonomy’. Rejecting nationalisation and the then dominant ideology that managerial control would allow the balancing of competing interests in the company, the Bank decided to develop a new approach that would operate within the existing legal form of the company.
Guinea Pigs no More: Non-Executive Directors as Part of the Solution
The Bank decided that ‘it would be desirable for something to be done to strengthen the position of the part-time director within the board of directors.’ This was something of a surprise, since part-time directors had been widely derided as ‘guinea pigs’ earlier in the twentieth century. Rebranding them as non-executives, the Bank promoted its agenda through its formal and informal contacts with financial institutions and management associations. Later in the decade, it was unable to find evidence that companies with more NEDs obtained better results, and was told that all major companies that had collapsed since 1970 had had plenty of NEDs. Nevertheless, the Bank doubled down on its policy, concluding that this simply ‘points up the need for quality rather than quantity’. It then worked very hard to get those the Bank considered ‘the great and the good’ onto corporate boards. When Adrian Cadbury, who had joined the Bank as a NED in 1970, and been involved in its policy discussions for the next 20 years, was appointed to make recommendations on how corporate governance could be improved following a succession of corporate failures and frauds, it is perhaps not surprising that his report largely codified the Bank’s longstanding policies in this area.
Encouraging shareholder influence: The origins of the Stewardship Code
Second, the Bank sought to mobilise ‘the influence… of a company’s principal owners’. The Bank pushed very hard in the face of indifference on the part of institutional investors, who preferred to sell their shares or wait for a takeover to come along rather than engage. These efforts basically came to nothing during the 1970s and 1980s, and, despite endorsement in the Cadbury Report (para 6.5), the 1990s. Shareholders starting wielding more influence in the 2000s, but this did not work out well, as they pressured banks to take more risk, and were one of the drivers of the 2008 Global Financial Crisis. When David Walker was tasked with making recommendations to improve corporate governance after the crisis, he proposed the introduction of a Stewardship Code. This seemed a perplexing response to a crisis caused in part by shareholder engagement. However, it becomes a little less surprising when we know that Walker had been one of the main architects and supporters of the Bank’s policy from 1977 onwards. He did not hesitate to dust off the old policy he had supported for so long behind the scenes in the Bank.
A very sticky policy
As corporate governance has gradually drifted towards a tentative embrace of sustainability, the claimed benefits of preserving these old norms has subtly shifted. For example, the UK’s Stewardship Code 2020 now claims that shareholder stewardship will result in ‘long-term value’ and ‘sustainable benefits for the economy, the environment and society’. This is the precise opposite of the effects of shareholder engagement before 2008. Likewise, provision 5 of the UK’s 2024 Corporate Governance Code envisages a designated NED as one way for companies to engage with their workforce. The norms remain the same, only the justifications have changed.
Time for fundamental change?
Promoting the uptake of NEDs and institutional investor engagement have been the standard policy response to corporate governance crises for over 50 years. Yet, despite repeated failures, there was never any meaningful debate within the Bank, or indeed more widely among policymakers who have followed the Bank’s lead, about whether appointment of NEDs and shareholder engagement are the best way to steer companies towards long-term sustainable success. This is probably because these policies created a governance landscape in which shareholder primacy could thrive to the benefit of executives and powerful institutional investors and at the expense of pretty much everyone else.
To be sure, there are signs of more far-reaching change: the EU’s double materiality-based Corporate Sustainability Reporting Directive and recently agreed Corporate Sustainability Due Diligence Directive represent – at last – some fresh thinking. However, the time has surely come to abandon the Bank of England’s 1971 blueprint for corporate governance and fundamentally reappraise how rights and responsibilities are allocated in corporate governance.