Flexibility and Proportionality in Corporate Governance

OECD

• Publisher: OECD
• Year: 2018
• eBook ISBN: 9789264309616
• Topic: Social Sciences
• Subtopic: Sociology
• Index: Social Sciences

Chapter 1. Introduction

This section offers an introduction to the topic of the thematic review, describing the background against which the work was conducted. It covers the concepts of flexibility and proportionality; their use in the G20/OECD Principles of Corporate Governance; and describes the rationale for a flexible and proportional approach to corporate governance by offering historical and contemporary examples. It also highlights its applicability to some of the opportunities and challenges that come with current capital market developments.

The purpose of the Corporate Governance Committee's (the Committee) thematic peer reviews is to facilitate effective implementation of the G20/OECD Principles of Corporate Governance (the G20/OECD Principles) and to help policy makers, regulators and market participants to respond to developments that may influence the relevance and effectiveness of their existing corporate governance framework.1 For this purpose, the Committee decided to conduct a thematic analysis on how flexibility and proportionality can be used when implementing the G20/OECD Principles.

This report presents the results of the review which identifies criteria and mechanisms that may motivate and allow flexibility and proportionality in the implementation of rules and regulations relating to selected regulatory areas covered by the G20/OECD Principles. It is structured as follows: This first chapter introduces the overall approach. The next two chapters describe the methodology and present the main results. Then six separate chapters address the results in more detail for the areas of regulation that are reviewed.2 Each of these six sections also contains a case study to illustrate the reasoning behind proportionality and flexibility provisions and their application in one of the participating jurisdictions. The annex presents the full questionnaire used for the reviews.

Flexibility and proportionality in corporate governance

Flexibility and proportionality, as general concepts, form an inherent part of the legal framework of most jurisdictions. In the context of corporate governance, it is manifested in the many options for contractual freedom that company law allows for when establishing a company’s governance structure and purpose, as well as in the differential application of elements of legal and regulatory framework to companies depending upon their specific character.

The opposite end of the spectrum from flexibility and proportionality would be a “one-size-fits-all” approach, in which the corporate governance framework (or elements thereof) would be mandated to all companies equally, without taking into account relevant differences among them. Typical flexibility and proportionality considerations reflected in corporate governance frameworks include characteristics such as the size of a company, ownership and control structures, geographical presence, sector of activity, a company's stage of development and/or whether a company's securities are publicly traded.

The main point of departure for applying flexibility and proportionality in practice is to enable the corporate governance framework to accommodate differences in company practices that while achieving desired regulatory outcomes, allow or facilitate companies’ individual development and the most efficient overall deployment of their resources. Likewise, flexibility and proportionality prevent the unnecessary adoption of requirements that may impose burdens and restrictions on companies without effectively promoting the overall outcomes.

As a result, flexibility and proportionality rules have been applied in relation to a variety of matters within corporate governance frameworks. Disclosure rules for example are frequently differentiated according to various criteria. Other factors that are commonly subject to a flexibility and proportionality approach are the composition of the board, the establishment of board committees, remuneration practices, shareholder and stakeholder (including employee) rights. Well known national examples of applying flexibility and proportionality in the area of corporate governance include the US JOBS Act3 and the European Union's Accounting and Transparency Directives.4 But examples abound.

Within the Italian framework, for example, flexibility and proportionality are provided for SMEs in the Consob regulation and in the listing rules.5 In Chile, independent directors are only mandated if a company has market capitalisation and a free float above a certain minimum.6 Similarly, in Sweden, worker representation on the board is mandatory only in companies of a certain size.7 In the UK, the flexibility and proportionality approach is used in the 2016 Green Paper on Corporate Governance Reform8 as it seeks to discuss whether the UK's largest privately-held companies –where they are of similar size and economic significance to public companies– should be expected to meet higher minimum standards of corporate governance and reporting than other privately-held firms.9

More recently, the European Commission has launched a consultation for "Building a proportionate regulatory environment to support SME listing"10 that aims to assess the impact of regulation on SMEs incentives to listing so as to "further alleviate the administrative burden on listed SMEs and revive the local ecosystems surrounding SME-dedicated markets, while keeping investor protection and market integrity unharmed" (European Commission, 2017).

The public policy rationale for flexibility and proportionality

In a market economy, the production of goods and services can be organised in a great number of different legal forms. Co-operatives, partnerships, limited liability corporations, joint stock companies, either privately-held or listed, are just a few examples. The reason why our legal systems make all of these different forms available is that the character of economic activities varies, as do the personal preferences of the individuals that are engaged in these activities.

For example, a law firm whose business model requires little fixed capital may be best served by choosing the limited liability partnership form, while a capital-intensive mining venture with an uncertain outcome may opt for the joint stock corporate form. The variety of legal forms also facilitates the pursuit of different objectives that founders and participants may have. Some organisations are established to generate profits, while others are run for social purposes, charity, or the advocacy of special causes.

The G20/OECD Principles do not refer to any specific legal form, since they focus mainly on companies which are "publicly traded" and that, in principle, can include different legal forms. The dominant legal form of publicly traded companies is the joint stock company, but there are examples of publicly traded companies adopting other legal forms, like the limited liability companies in the US or the cooperatives in Italy.

Irrespective of their legal form, publicly traded companies are not a homogenous group. They differ greatly with respect to size, ownership structure, stage of development and the industries in which they operate. This is why the G20/OECD Principles state that policy makers have a responsibility to make sure that the corporate governance framework for listed companies is flexible enough to meet the needs of firms that operate under widely different circumstances.

Just like good corporate governance, the notion of flexibility and proportionality is not an end in itself. And it is by no means a way to weaken the effectiveness of the corporate governance framework. On the contrary, flexibility and proportionality is a necessary prerequisite for creating an effective legal environment that can support the ultimate policy objectives of the G20/OECD Principles, namely to support economic efficiency, sustainable growth and financial stability.

When addressing the issue of flexibility and proportionality, it is essential to think about regulation in economic as well as legal terms. It requires an understanding of the incentives of market participants and how ongoing structural developments in the financial and corporate sectors may influence, or even alter, these incentives. After all, in order to achieve their objectives, laws, regulations and practices must be designed with respect to the economic reality in which they will be implemented.

As a first step, it may therefore be useful to briefly recapitulate the evolution of the corporate form. Why was it established and how has it evolved over time in response to economic events. By doing that, we will find that legislators have never been alien to the concepts of flexibility and proportionality when circumstances change. This is true for differences between corporate forms as well as the ability of publicly traded companies to deviate from the default rules that are provided in the typical company law contract.

Flexibility and proportionality in company regulation

As regards joint stock companies, one of the first flexibility and proportionality reforms took place in Germany almost 150 years ago. The very first German joint stock companies act (Aktiengesetz) was introduced in 1870. It applied to all joint stock companies (Aktiengesellschaft) and was considered very liberal. Due to abusive use of the liberal regime, the act was replaced in 1884 by a new, more formalistic and restrictive piece of legislation, including mandatory rules on, inter alia, the organizational structure of the company.

Complaints were soon heard against this mandatory approach from small and medium sized businesses. They requested a new form of limited liability company adapted to the, typically, more closed structure of ownership in small firms. Eight years later, in 1892, Germany therefore introduced a separate form of company with limited liability, the Gesellschaft mit beschränkter Haftung (GmbH) aimed at smaller businesses, typically with a smaller number of owners.

During the decades to come, equivalents of the GmbH concept spread all over Europe. In France the joint stock company, Societé Anonyme (SA), was complemented with the Société à Responsabilité Limitée (SARL) in 1925, and in Italy the S.p.a. was complemented with the S.r.l. in 1942. In the UK two categories of the limited liability company, private and public companies, were introduced in 1907. Today, in almost every country in the world there are two major forms of companies with limited liability for the owners or two categories thereof: AG – GmbH, SA – SARL, S.p.a. – S.r.l., Plc – private company, etc.

But flexibility and proportionality in company law reforms did not stop after these developments. In many jurisdictions additional steps have been taken by the legislator. In France, for example, a new company form "in between" the SA and the SARL was introduced in 1994, called Société par Actions Simplifiée (SAS).11 It was introduced to combat certain rigidities in the law governing the SA and the SARL, which could not always ...

Table of contents

• Title page
• Legal and rights
• Foreword
• Executive summary
• Main findings
• Chapter 1. Introduction
• Chapter 2. Scope and methodology of the thematic reviews
• Chapter 3. Overview of survey results
• Chapter 4. Board composition, board committees and board member qualifications
• Chapter 5. Say on pay and the detail of disclosure of remuneration
• Chapter 6. Related party transactions
• Chapter 7. Disclosure of periodic financial information and ad-hoc information
• Chapter 8. Disclosure of major shareholdings
• Chapter 9. Takeovers
• Annex A. Survey instrument
• About the OECD