EC corporate governance report draws criticism

The European Commission report on directors’ duties and sustainable corporate governance, published earlier this year, is drawing heavy criticism from law experts.

Writing on the Oxford Business Law blog, the European Company Law Experts Group said the study is “not a document on which to base sustainable proposals for legislative action”.

The study, compiled by EY on behalf of the European Commission, examines short-termism in corporate governance.

It found that listed companies within the EU still tend to focus on short-term benefits of shareholders rather than on the long-term interests of companies.

The Commission also highlighted that sustainability needs to be further embedded into the corporate governance framework.

However, the European Company Law Experts group said the study appeared biased and did not support assertions that managers and investors took a short-termist approach and that corporate law was responsible for it.

It highlighted a number of methodological shortcomings, including the failure to define key concepts such as ‘short-termism’ and ‘short term financial return’, adding that it also fails to examine in depth the relationship between short-termism and sustainability issues.

The study is based on a review of listed companies in 16 European countries, including the UK. However, the group said a significant proportion of these companies were from the UK, which it found unacceptable. It also pointed out that the web survey was too small, producing only 62 responses and that there were no profiles of the companies making up the database in terms of nationality, size, or business sector.

Another major point of contention for the group is that with short-termism, the study focuses on the evolution of the ratio between company payouts - dividends and buybacks - and net income.

It said the chosen denominator had failed to include capital inflows through equity issuances and investments in the business, with the assumption that distributed funds ‘disappear’.

The group said: “This is not the case in a market totally dominated by long-term institutional owners. Funds paid out are essentially redeployed in new investments in the business community.”

The study concludes that it is the characteristics of company law that give rise to excessive payouts, especially the imprecise definition of the directors’ core duty of loyalty.

The group said: “This argument ignores the point that such imprecision promotes managerial consideration of stakeholder interests.

“In any event, there is no legal system we know of which says managers must promote short-term profitability. Moreover, the risks associated with a politicised stakeholder-oriented definition of the corporate purpose are very superficially analysed.”