The Inner Circle

The e-Advocate Quarterly Magazine Mark 4:33-34

The inner Circle

“Helping Individuals, Organizations & Communities Achieve Their Full Potential” Vol. V, Issue XVIII – Q-2 April| May| June 2019

The Advocacy Foundation, Inc. Helping Individuals, Organizations & Communities Achieve Their Full Potential

The Inner Circle “Turning Your Nonprofit Into a Powerhouse”

“Helping Individuals, Organizations & Communities Achieve Their Full Potential 1735 M arket Street, Suite 3750 | 100 Edgewood Avenue, Suite 1690 Philadelphia, PA 19102 Atlanta, GA 30303

John C Johnson III, Esq. Founder & CEO ______

(855) ADVOC8.0 (855) 238-6280 § (215) 486-2120 www.TheAdvocacyFoundation.org

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Biblical Authority ______ Mark 4:33The Message (MSG) 33-34

With many stories like these, he presented his message to them, fitting the stories to their experience and maturity. He was never without a story when he spoke. When he was alone with his disciples, he went over everything, sorting out the tangles, untying the knots.

John 15:15The Message (MSG) 11-15

“I’ve told you these things for a purpose: that my joy might be your joy, and your joy wholly mature. This is my command: Love one another the way I loved you. This is the very best way to love. Put your life on the line for your friends. You are my friends when you do the things I command you. I’m no longer calling you servants because servants don’t understand what their master is thinking and planning.

No, I’ve named you friends because I’ve let you in on everything I’ve heard from the Father.

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Table of Contents ______

Biblical Authority I.

Introduction How to Assemble a Board of Advisors Building a Better Board Whom Do You Want How to Get Them Aboard How to Run the M eetings

Advisors or Directors?

Resources Advisory Alternatives II.

Nonprofit Law Blog Advisory board v. Board of Directors – A Distinction with a Difference Common Missteps Other Considerations

Attachment A: The Board of Directors: Composition, Structure, Duties and Powers Attachment B: Teaching For The Outer And Inner Circles

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The Inner Circle How to Assemble a Board of Advisers

BY Inc. staff An advisory board is a rare species in the small-business ecology, yet assembling such a board may be one of the most important steps a CEO can take to assure an enterprise's success. Besides offering credibility and contacts, advisers working together provide guidance sharpened by boardroom debate, something individual mentors can't match, says Corey Hansen, a financial adviser specializing in small businesses at Smith Barney in Bellevue, Washington. For family businesses, boards are invaluable, particularly when it comes to the delicate matter of succession. "A board has the willingness to bring the subject up, in a supportive and patient way," says John L. Ward, a professor at Northwestern University's Kellogg School of M anagement and author of Creating Effective Boards for Private Enterprises. "Then once it's on the table, it creates a forum of safety for the conversation."

Unlike a board of directors, which has formal legal authority over a company and a fiduciary duty to its shareholders, an advisory board won't make decisions for you and has no obligation to the owners or liability for the company's actions. That said, "if you're not willing to execute the advice of the board, then you'd better not put one together," warns Tony Eisenhut, managing director of KensaGroup, which forms companies to commercialize technologies developed by universities.

"Because the greatest disrespect to a board, having given you a commitment of their time, is taking their time and doing nothing

with it. Not only will you lose credibility with that board but with future board members as well."

Building a Better Board 1. Whom Do You Want?

Though we often think of sound business advice as universal, a good board is tailored to the opportunities and obstacles in the path of your specific company. Ward suggests starting the process by defining your company's key success factors -- the characteristics that most determine whether the business will thrive and the strategic challenges the company will face. What you come up with will determine the makeup of your board. "What you're looking for," Ward says, "are people who have already experienced what you're about to experience. If you're a service business, two of your three outside advisers should be from service businesses. If you're trying to grow from 50 to 200 employees, then you want two of three outside directors who have had that experience."

The Right Level of Experience "The advisory board should be at the level you want to go to, rather than the level you're at," says Hansen. M embers, he adds, should have experience building a business, not merely running one. Don't make the mistake of recruiting a highly visible executive from a big company. "You want somebody who's beyond -- but just beyond -- where you want to be," says Eisenhut. "Billion-dollar experience might be great for attracting VCs, but if you're going for $10 million in sales, you want some $10 million to $20 million experience." You're looking for people who know how to execute with the Page 7 of 23

resources you have available. Strive for "inthe-saddle, facing-the-same-music CEOs," says Ward. Very recently retired executives are second-best, in his view. A note of realism: Hansen says a small company, especially one just starting up, will probably struggle to find ideal advisers. Though you may not know personally someone who is a perfect fit, such people are probably closer than you realize. Your local networks -business organizations, Small Business Development Centers, and professional advisers can provide the introduction.

The Right Number A board should be made up of three to five outsiders. Two people "are always trying to find mutual agreement," says Ward. With three, an adviser "can afford to take chances." And "a group of more than five tends to

dramatically reduce productivity," says Hansen. "With every person you add, it becomes a geometric increase in interaction; you want to keep things simple."

Whom to Avoid M ost counselors recommend against asking professional advisers, such as lawyers, accountants, and bankers, to join your board, unless their fields dominate your strategy -- as an intellectual property lawyer's would in the case of a tech company. Even in those instances, though, don't impanel the pros you've hired (though there may be a place for them in a more limited board; see "Advisory Alternatives"). Instead, find advisers "who have full-time jobs and who are intrigued by what you're doing," suggests M eriby Sweet, director of the M aine Small Business & Technology

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Development Center. "You want somebody who's not making a living from your business." And a board generally shouldn't include friends, family, or anyone with an emotional interest in the business.

'I value your time as much as my own," says Ward. "And it should hurt enough that you make sure to get as much out of the investment as you can."

3. How to Run the Meetings

2. How to Get Them Aboard Solicit candidates with a two-page prospectus describing the business. Explain why you want a board and what you're looking for. Then detail how it will operate, including compensation. Describe your initial discussion with prospective members as exploratory, because even as you solicit them you should be evaluating them. "M ake sure that they're sharp and experienced but also willing to share," says Eisenhut. And that they'll mesh with the personalities in the room, including yours. It can be uncomfortable to kick someone off a board, so as a fail-safe, institute short terms of service. "I typically ask for one year at a time," says Hansen. "Those I want to keep, I ask to renew; those I don't , their terms expire."

The Pay The matter of compensation is tricky. Some experts say it's entirely unnecessary, and nearly all warn against advisers who take the position for the money. "You can attract anybody for pay," says Hansen. "But you're not necessarily going to get the kind of advice you want.

You want people who are attracted to the type of business that you're building." On the other hand, some form of compensation - even token -- tends to sharpen an adviser's sense of responsibility and commitment.

Hansen suggests a modest payment once an adviser serves for a sustained period -- three years, say. Ward's formula is to calculate your base hourly or daily salary (excluding bonuses) and pay your board members for their time at that rate. (Assume prep time is equal to meeting time.) "You're telling them,

Your board should meet two to four times a year. (Ward prefers three times, because it gets you out of the quarterly cycle, with its emphasis on earnings -- the board, he says, should be looking forward, not back.) Try mightily to maintain the board's strategic focus: If you can't meet at the company offices without interruption, borrow a meeting room from another company or a hotel or restaurant. M eetings should seldom last more than three hours.

S tructuring the Conversation At each meeting, focus the board's attention on a few core strategic matters. Don't follow the stultifying pattern, set by large corporations, of reading the minutes, reviewing the previous quarter, etc. Eisenhut suggests devoting an hour to each of two major topics and half an hour to each of two follow-up or future topics. Ward recommends that the CEO ask himself or herself in advance, What's the biggest unanswered question facing our company today? That topic starts the meeting. In any case, put the agenda in writing, and state clearly what you expect the board to contribute to each item. Help your advisers prepare by sending a week in advance the information they need to digest.

Keep it short, thoughtful, and processed -don't send raw data. Between meetings, keep them updated on any developments.

It can be difficult for an entrepreneur to face a board frankly over difficult issues. But the advisers, having been there themselves, will recognize this and guide the CEO, says Ward. He suggests asking one to co-

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facilitate the meetings, at least to start.

"After the first meeting, it gets easier."

Advisers or Directors?

The Case for Directors: If you can spare the time and the expense of the reporting requirements that accompany a statutory board of directors, then you might consider establishing a directorate, says Northwestern's Ward. "When it's a legal commitment, the directors feel a deeper, broader sense of responsibility to the company, to all the stakeholders, and the well-being of the company and the institution -- to the continuity of the enterprise," he says. "Especially when there's an emergency."

The Case for Advisers: Still, Ward concedes that you'll get 80 percent to 90 percent of the benefit of a directorate from informal advisers, and most of the longtime small-business counselors Inc. interviewed recommended against chartering a board of directors. Even a company with a corporate structure that requires a formal board of directors might still want an advisory board, says Hansen. "On a board of advisers, I can give my best advice and not be constrained by the possibility that it's going to come back and bite me. It does change people's perspectives."

Resources At www.inc.com/keyword/buildaboard, you will find many articles on the creation, care, and feeding of boards. "Friendly Persuasion" suggests strategies for swaying reluctant board candidates. "Four Tips for Working With Board Search Firms" lists boardroom consultants. "Weeding Out Weak Board M embers" offers tips for evaluating boards and their members and dismissing them gently when it's time for a change. Several

of the articles are drawn from Boardroom Insider (boardroominsider.com), an online newsletter.

Advisory Alternatives If you are unable to devote the time and resources necessary to a full-fledged board of advisers, there are alternatives: • A board of professional advisers: If nothing else, convene your paid, professional advisers (including, perhaps, your banker and a consultant if you have one) a couple of times a year just to bring them up to date on the business. Some entrepreneurs may find this threatening (and expensive, if the advisers are billing). But, Ward is quick to add, "these are smart people who see lots of businesses and are going to raise questions."

M oreover, preparing for the presentation forces you to do your homework. Because you are already a client, the arrangement can also ease disclosure fears. •

The ad hoc board: Instead of constituting a board with regular meeting times, approach potential mentors individually, meeting with each for coffee occasionally or corresponding by e-mail. Or recruit a board for a short-term project. Either approach can serve as a tryout of sorts for a more rigorous approach later on.

• The task-specific board: Some experts, including Eisenhut, believe advisory boards are best constituted for a specific purpose and a limited time. In this view, when convening a board for a strategic objective,

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"you need to have 60 percent to 80 percent of the framework in place," he says. "Then you go back to the board and have them put the final touches on." Each member of the board should have a particular area of expertise: finance, operations, purchasing and supply chain logistics, and a variable--regulatory, say, or real estate knowledge.

http://www.inc.com/magazine/20080701/how-toassemble-a-board-of-advisers.html

Youth Advisory Council

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Nonprofit Law Blog –

Advisory Board v. Board of Directors – A Distinction with a Difference

by Emily Chan on April 20, 2011

A nonprofit corporation is required to have a board of directors. States can vary among respective requirements of a board of directors but the general idea is the same: there must be a board of directors that serves as the ultimate governing body of the corporation. In addition to being legally responsible for the overall management of the corporation, a director is legally required to perform his or her responsibilities subject to the fiduciary duties of care, loyalty, and obedience to the nonprofit corporation. (See, e.g., California Corporations Code Section 5231 which states duties must be performed “in a manner that the director believes to be in the best interest of the corporation and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.”).

Sometimes, a board of directors will elect to set up an “advisory board.” To an outsider, this advisory board may look very similar to the board of directors in some respects – for example, some advisory boards attend all board meetings, participate in discussions on important matters of the board of directors, and are composed of important stakeholders such as past directors and valuable donors.

Although this group of individuals may be referred to as an advisory board, this “board” is not synonymous with the type of “board” that constitutes the board of directors. It is actually a committee created by the board of directors for advisory (or honorific) purposes but given a title that includes the word “board.” Accordingly, an advisory board is not the legal governing

body of the organization and does not carry the same legal responsibilities and fiduciary duties as the board of directors.

Additionally, in most cases, an advisory board tends to be a non-board committee, which means that it cannot act with the authority of the board of directors and may not be relied upon to the same extent as a board committee.

While an advisory board can provide valuable assistance to an organization and its board of directors, a problem occurs when the line between the two groups becomes blurred in practice. Understanding the difference between an advisory board and board of directors is important for ensuring proper oversight of the organization and for directors in satisfying their fiduciary duties.

Below we’ve outlined common missteps and potentially important considerations for an organization using or contemplating the use of an advisory board.

Common Missteps Voting A director on the board of directors has the right to vote as a member of the governing body. (See California Corporations Code Section 5047). A member of an advisory board does not have such right. While members of an advisory group may be entitled to vote on decisions within the advisory board, an advisory board does not have legal authority to govern the organization, and, like other committees, any tasks or powers of the advisory board are delegated by the board of directors and ultimately subject to the direction and control of the board of directors.

Additionally, valid actions of the board of directors at a meeting require a quorum and sufficient vote of the directors. If an

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organization is confused about who counts for quorum and voting purposes, it could cause a series of past board actions to unravel or be cast into suspicion. Should someone challenge the validity of a board action, an organization may need to reach back many months, if not years, to determine whether important matters such as amendments to Bylaws or Articles and elections of the current directors were valid.

Except where otherwise expressly provided, ‘directors’ means natural persons, designated in the articles or bylaws or elected by the incorporators, and their successors and natural persons designated, elected or appointed by any other name or title to act as members of the governing body of the corporation. A person who does not have authority to act as a member of the governing body of the corporation, including through voting rights as a member of the

Non-established Structure The confusion between the advisory board and board of directors can arise from situations such as commonly referring to both groups as “the board,” or when the advisory board starts to act like the board of directors due to a lack of clarification or understanding about roles (or vice versa).

This confusion is sometimes compounded by the fact that the organization lacks any documented explanation about the role of the “advisory board” whether through a board resolution or its bylaws. There are many reasons that both individuals on an advisory board and those on the board of directors should want written clarification about the advisory board’s role.

First, such clarification is important for those on the advisory board in reducing personal liability risks and not undermining a defense that they were not part of the board of directors in a lawsuit. For example, California Corporations Code Section 5047 states, in part:

governing body, is not a director as that term is used in this division regardless of title.

(Emphasis added).

Because title alone is not determinative of who is on a board of directors and might instead be determined in part on the actions of such individual, unclear bylaws can be an invitation for debate about whether individuals claiming to serve only advisory roles are actually members of the board of the directors and can be held liable as directors.

Incorrect assumptions about who is a director can also expose the board of directors to liability risks. For example, the confidentiality attached to sensitive matters

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discussed among the directors can be destroyed if that information is shared with non-board members such as individuals on an advisory board. Additionally, depending on the circumstances, a failure by the directors to clarify whether such individual is in fact a director can call into question whether the directors have met their fiduciary duties.

Second, beyond liability concerns, an advisory board will be most useful to the organization and its board of directors if it understands what purpose it is intended to serve and how it is supposed to help.

Written clarification through a board resolution or otherwise is also useful for the board of directors in holding an advisory board accountable and recruiting individuals who are at least aware of the commitment they will be making prior to joining the advisory board.

Third, it easier for both parties to avoid inadvertent confusion when there is something tangible to refer to rather than relying on word of mouth or informal practices. Ideally, if the organization has an advisory board or is likely to have one, it should be written into the bylaws – not because this language is required to authorize such an advisory board to exist but because it provides clarification to everyone about what’s going on. Furthermore, whatever the organization decides to call this advisory committee, everyone in the organization should stick with that language as much as possible not only in documentation such as meeting minutes but also in everyday verbal communications to avoid future confusion.

Other considerations In her article, “What is an Advisory Board and Should We Have One?,” Jan Masaoka

highlights four common reasons for creating an advisory board: fund raising, programmatic input, prestige, and fiscal sponsorship. There can be a wide array of reasons beyond these four and accordingly, looking at the purpose for the advisory board can raise a variation of additional considerations. For example, if the organization is seeking fund raising prestige, it may not want or expect much interaction with the advisory board with respect to meetings of the board of directors or participating in non-fund raising discussions. Alternatively, if it is foreseeable that members of an advisory board will someday become part of the governing board, there is likely a greater importance in having procedures in place to groom potential candidates for a director position during their service in only an advisory capacity. Depending on the purpose of the advisory board, other considerations may include: Executive Sessions Determining whether or when to allow advisory board members, if any, to be involved in executive sessions is a precautionary step to address prior to an executive session given that these sessions are often used to discuss sensitive matters outside of the presence of the staff and other non-director individuals. It may be helpful for directors to discuss questions such as: • • •

Should an advisory board be allowed to sit in on executive sessions?

When might this be appropriate?

When would this not be appropriate?

Does allowing such participation help the advisory board to better help the board of directors or does it cause more potential problems than benefits?

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Engagement

Testing the Waters/Training Ground

Although advisory board members are legally different from members on the board of directors, one similarity they share is likely being perceived as walking billboards of the organizations to the public.

Advisory boards are viewed as ambassadors of the organization and their involvement may be widely known, for example, through publication on the organization’s website or letterhead, or through their individual communications with others about their role on the organization’s advisory board. Especially for advisory boards that are intended to garner attention and prestige, an organization may want to consider message training or other activities to keep the advisory board engaged, knowledgeable, and good advocates of the organization.

Consider strategies for addressing issues such as:

Advisory boards are often subject to less rules and procedures commonly attached to a board of directors such as terms, term limits, nominations and election procedures, and removal processes. This can be expected when there is a purposeful intention to create a less formal structure and less demanding commitment, such as an advisory board intended for outgoing directors or individuals who are seeking less time commitment to the organization or for an organization that has no plans for the individuals beyond the advisory board.

However, in some situations, involvement in an advisory board may be the precursor to someday joining the board of directors. For example, organizations may want the advisory board to serve as (1) an opportunity for individuals to test the waters of their fit with the organization, availability, and other commitment factors; and (2) a training ground for finding and grooming potential directors. The board of directors should consider what types of additional procedures may be appropriate through questions such as:

•

•

•

Are the members of the advisory board aware of the organization’s mission, activities, and values?

Do they have the tools to effectively communicate this information to outsiders?

Do they have opportunities for staying engaged in and passionate about the organization?

• •

How might the advisory board evolve in the future?

Is or should the advisory board serve as a mechanism for developing future directors of the organization?

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•

If so, is the advisory board set up in a way that will help the organization find the best candidates and facilitate such a transition?

http://www.nonprofitlawblog.com/advisory-board-vboard-of-directors-a-distinction-with-a-di fference/

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Attachment A The Board of Directors: Composition, Structure, Duties and Powers

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The Board of Directors: Composition, Structure, Duties and Powers by Paul L Davies Cassel Professor of Commercial Law London School of Economics and Political Science

Company Law Reform in OECD Countries A Comparative Outlook of Current Trends Stockholm, Sweden 7-8 December 2000

I.

Introduction

Core company law is concerned with addressing three main sets of principal/agent problems. These arise out of the relationships between, first, the management and the shareholders as a class; second, between majority shareholders and minority shareholders; and, third, between the controllers of the company (whether managers or majority shareholders) and non-shareholder stakeholders.1 This paper advances the following three propositions. First, the rules relating to board composition, structure, duties and powers (‘board rules’) are capable of being utilised to address any one or more of these sets of agency problems. Second, however, there is a trade-off between breadth and depth, that is, if board rules address more than one set of the agency problems, their effectiveness in relation to any one set is reduced. Third, the focus of the recent corporate governance movement has been on enhancing the board’s effectiveness in addressing the first agency problem (management and shareholders as a class) and in consequence the burden of addressing the other two agency problems (and especially the third, that between controllers and non-shareholder stakeholders) has been thrown onto other parts of company law or onto bodies of law other than company law.

II.

Core Company Law and Principal/Agent Problems

Core company law addresses three sets of principal/agent problems which are inherent in the structure of large companies: those arising between management and the shareholders as a class; between majority shareholders and minority shareholders; and between the controllers of the company (whether managers or majority shareholders) and non-shareholder stakeholders. Within a particular company the first two sets of problem are mutually exclusive (at least at any one point in time) and which predominates depends upon the structure of shareholdings. Where shareholdings are dispersed, the principal/agent problem which emerges is that between shareholders as a class and the management of the company. No matter what the formal governance rights of the shareholders may be, their collective action problems may make it in practice impossible or very difficult for the shareholders to exercise effective control over the management of the company. In consequence, management may give priority to non-shareholder interests, including the interests of the managers themselves. The question for company law, therefore, is what contribution it can make to reducing the costs of diversified ownership and the principal/agent problem generated by such diversification.

Copyright © OECD 2001 All rights reserved 2

On the other hand, where a single or small number of shareholders hold a substantial block of shares in the company (say, in excess of 25% of the voting rights), securing managerial accountability to the shareholders (or at least to the controlling shareholders) through the traditional governance mechanisms of company law will not usually be difficult. What, however, emerges in such a situation is the principal/agent problem between the controlling shareholders and the noncontrolling (or ‘minority’2) shareholders. What contribution can company law make to protecting minority shareholders from diversion by block holders to themselves of a disproportionate share of the company’s economic surplus?

What is true of a single company tends also to be true of company law systems, according to the typical pattern of shareholdings in large companies in the jurisdiction. Where the typical pattern is one of dispersed shareholding (as in the UK), legislative and policy attention tends to focus, as the provisions of the Combined Code3 demonstrate, on the first agency problem. Where, on the other hand, large block-holders typify the pattern of shareholdings in large companies, policy-makers are likely to take the view that the second set of agency problems presents more pressing demands on their resources.4

Whatever the orientation of a legal system as between the first two principal/agent problems, it will have to go on and address the third set of principal/agent issues. These arise out of the relationships between the controllers of the company (whether managers or shareholders) and non-shareholder stakeholders.5 All company law systems address one type of such stakeholder relations, namely those between the company and its creditors. This is because company/creditor relations are 1

I am grateful for discussion of these issues in recent years with my colleagues from the International Faculty for Company and Capital Markets Law: Henry Hansmann, Reinier Kraakman, Klaus Hopt, Gérard Hertig, Hideki Kanda and Ed Rock.

2 In fact, the ‘non-controlling’ shareholders may collectively hold more voting shares than the ‘controlling’ shareholders. However, if the non-controlling shares are widely dispersed, effective control of the company will lie in the hands of the block-holder, even if that block consists of less than 50% of the voting shares. In this paper the terms ‘non-controlling’ and ‘minority’ shareholders are used interchangeably, with some preference for the latter term because it is shorter!

3 The Combined Code may be found at the end of Financial Services Authority, The Listing Rules (London, 2000). It is discussed further below in section VI. 4 See Brian C Cheffins, ‘Current Trends in Corporate Governance: Going from London to Milan via Toronto’ (2000) 10 Duke Journal of Comparative and International Law 5. Of course, minority shareholder protection may demand legislative attention even in jurisdictions where shareholdings in large companies are dispersed, if one broadens the focus from large companies to the population of companies as a whole. Within a particular jurisdiction, even if shareholdings in large companies are dispersed, that is unlikely to true of small companies. In such a case, the first two principal/agent problems end up sorting themselves by size of company. This is true of the UK where legislative protection for minority shareholders is discussed almost entirely in relation to small companies.

5 For the purpose of this paper ‘stakeholders’ may be taken to be any group of people who have a potentially long-term relation with the company, the terms of whose contracts cannot be specified in full ex ante and the quality of whose relationship with the company is vital to the company’s business success.

Copyright © OECD 2001 All rights reserved 3

crucially affected by one universal feature of core company laws across jurisdictions, namely, the principle of limited liability for the company’s shareholders, at least as the default rule. In addition to providing for limited liability, company laws seek to control the incentives to opportunistic behaviour on the part of company controllers which limited liability generates.6

Many company law systems do not deal with stakeholder relations beyond those with creditors.

Where systems do go further, the driving force is a policy of using company law to regulate company/employee relations. This policy is particularly strongly embedded in the company laws of Germany and the Netherlands, but is found less strongly in about half the countries which are members of the European Economic Area. Beyond creditors and employees company laws do not seem to pay significant attention to any other category of stakeholder relation.

The above is an attempt to analyse the role of company law as a whole in the regulation of principal/agent relations. This paper, however, is not concerned with such a large topic. It deals only with the role of ‘board rules’ in addressing the three principal/agent problems identified above.

Therefore, this paper will not consider in any detail company law techniques for addressing principal/agent problems which do not involve the board, for example, a rule requiring distributions by companies to be made pro rata to the proportion of the equity held by each shareholder. Sections III to V analyse the range of options in principle available to policy-makers for the use of board rules to address the three principal/agent problems; section VI says something about current trends in policy making; and section VII concludes.

III.

Board rules and the principal/agent relationship between managers and the shareholders as a class.

(a) The division of functions between shareholders and the board One could say that the principal/agent problems between the managers and the shareholders as a class are most effectively met by shifting decision-making out of the hands of the agent (the managers) and into the hands of the principal (the shareholders). However, although this would solve these principal/agent problems at a stroke, the costs of such a strategy in a large company are normally far too high for the shareholders to bear. This strategy would deprive the shareholders of 6

Because company law’s interest in creditor relations is driven by the principle of limited liability, company law does not usually provide a complete code of rules for company/creditor relations, but only for those aspect of the relationship upon which limited liability impinges. Other aspects of the relationship are governed by rules pertaining to Copyright © OECD 2001 All rights reserved 4

all the benefits to be gained from allocating decision-making to a small number of expert and committed managers. If in large companies centralised management is a sine qua non for effective conduct of the company’s business, this first class of principal/agent problem cannot be so easily eliminated. For this reason, all company laws are very cautious about allocating decision-making to the shareholders’ meeting on a mandatory basis. Company laws commonly take this step only in one of three situations: changes to the company’s constitution; decisions which are as close to investment decisions as they are to management decisions (for example, the decision whether to merge the company with another one); and decisions on matters where the directors are conflicted.7 The current controversies revolve around the scope of the second category: should any board decision which has sufficiently large impact upon the company’s business be treated as analogous to an investment decision and so require shareholder approval.8 Even in these cases, shareholders in some cases acquire a decision-making role only if the management has proposed the decision in question. In such cases the shareholders have a veto right over certain classes of decision but no power to take the initiative. Such an arrangement is more protective of centralised management than rules giving shareholders the power of initiative.

Thus, for good functional reasons the boards of large companies operate in all systems under a broad mandate of powers: the division of functions between shareholders’ meeting and the board is one where the board takes the lion’s share. This result may be required by company law (as in Germany and the US) or it may result from practice, as in the UK, where the shareholders, even in large companies, could keep nearly all decision-making for themselves, but in fact choose the opposite policy. Only one further thing needs to be said about the division of functions between shareholders and the board. A particularly effective technique for ensuring accountability of the board to the shareholders as a class is to facilitate an exit right for dissatisfied shareholders via a hostile take-over bid. The hostile bid depends crucially on the ability of the bidder to make an offer to the target shareholders over the heads of the incumbent management of the target. A central issue for take-over regulation, therefore, is whether it seeks to side-line management in the bid procedure (ie allocates decision-making solely to the shareholders) or whether it aims to preserve a role for centralised management even where the target board is potentially in a position of severe conflict of creditor/debtors in general (ie whether the debtor is a company or not). See, for example, the personal property rules on reservation of title or the insolvency rules on putting assets out of the reach of creditors.

7 In this latter case, the costs of shareholder decision-making may still be regarded as so high that alternative techniques are used, such as decision-making by non-conflicted directors or by an outside body such as a court.

8 See the Holzmüller decision of 1982 in Germany (83 BGHZ 122). This decision suggests the addition to the list of instances where shareholder approval is required that of ‘fundamental business decisions’. This idea can be found, though expressed in very different language, in the UK Listing Rules’ requirement for shareholder approval of ‘Class One’ transactions: above n 3, para 10.37. An alternative technique is to give the shareholders an exit right in such a situation (see, for example, art 5.6.6 of the règlement général of the Conseil des Marchés Financiers in France) but, of course, this technique takes us beyond board rules, as defined for the purposes of this paper.

Copyright © OECD 2001 All rights reserved 5

interest as between their personal interests and those of the target shareholders. As is well known, the British City Code on Take-overs and Mergers adopts the first approach,9 as indeed do the recently adopted stock exchange laws dealing with takeovers which have been adopted in continental Europe. By contrast, US state laws tend to preserve an important role for the management of the target through their freedom to adopt, and to refuse to redeem, poison pills.10 Even in Europe, however, the matter remains one of controversy in the drafting of the proposed EU Directive on takeovers.11 Thus, although centralised decision-making is in general in the shareholders’ interest, the effectiveness of the market in corporate control rests upon the takeover bid decision being kept wholly in the hands of the shareholders.

Leaving aside the issue of take-over bids, a substantial allocation of decision-making power to the board, either by law or in practice, seems uncontroversial. In consequence, therefore, the first set of principal/agent problems need to be addressed by board rules. There are three main techniques available within company law. These are: giving shareholders appointment and/or removal rights in respect of the directors; subjecting directors to legal duties which require them to exercise their discretion in the interests of the shareholders as a class; and structuring the incentives of the members of the board so as to induce them to promote the interests of the shareholders as a class.

We shall now say a little about these techniques. However, there is one preliminary point which is worth making. Although the first principal/agent problem has been described above in terms of management/shareholder relationships, the company law strategies described in the previous paragraph all focus on the board, not ‘management’. This illustrates the ambiguous position of the board in large companies. In nineteenth century literature the board is often conceptualised as the body which supervises the management on behalf of the shareholders. If, however, the accountability of the board to the shareholders is weak, the board will be ‘captured’ by management and become an expression of the unaccountability of the management rather than an instrument for the control of management by shareholders. Legal strategies, however, focus on the board and its members, either because they seek to restore the board to its nineteenth century ideal or because they take the members of the board to constitute the apex of the managerial structure of the company and proceed on the basis that legal regulation of the board amounts to regulating the top 9

At least once a bid is in the offing. Pre-bid, the Code does not apply and general company law is more favourable to the adoption of takeover defences by boards, provided such defences can plausibly be argued to promote a commercial interest of the company.

10 See M Kahan ‘Jurisprudential and Transactional Developments in Takeovers’ in Hopt et al (eds) Comparative Corporate Governance (Clarendon Press, Oxford, 1998) 683.

11 Contrast the final version of the proposed Directive adopted by the Commission (OJ C 378/10, 13.23.97) art 8(b); the common position adopted by the Council (OJ C 23/1, 24.1.2001) art 9; and the recommendations of the Committee on Legal Affairs and the Internal Market of the European Parliament (A5-0368/2000, final) art 9.

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management of the company. Either way, whilst business schools talk about the senior management of companies, the law schools talk about the role of the board of directors and of individual directors.

(b) Appointment and removal of board members The most obvious way to make the board accountable to the shareholders as a class is to make it easy for the shareholders to remove directors of whom they disapprove. Thus, removal rights for shareholders, exercisable by ordinary majority, which can be exercised at any time and for any reason to remove all or any of the directors would appear to be a powerful tool to make the board accountable. At least, this should be so where the removal rights are coupled with easily exercisable powers for shareholders to convene meetings to consider the removal of directors and where there is a good disclosure regime in place so that the shareholders can accurately evaluate the board’s performance. By contrast, rules which secure the board against removal except at certain intervals (for example, only at the annual general meeting or at the expiry of a term of office) or which do not give the shareholders direct powers of removal (as in two-tier board systems where the managing board is not removable by the shareholders but only by the supervisory board) or which deny shareholders removal rights altogether (as in the Dutch ‘structure’ regime, where the board is a self-appointing body) all operate so as to dilute the power of shareholders to remove directors.

However, even where the shareholders formally have strong appointment or removal rights over the board, these rights may in practice prove difficult for the shareholders to operate effectively in jurisdictions with dispersed shareholding structures, because of their collective action or other problems. These problems may exist even at relatively low levels of dispersal of shareholdings.

Thus, in the UK there has occurred over the past 40 years a relative re-concentration of shareholdings in listed companies into the hands of pension funds and insurance companies (and their fund-managers), so that institutional shareholdings in the 3 – 5% range are common.

Nevertheless, for reasons related to competition among the institutions and conflicts of interest between the fund management and other arms of financial conglomerates and insurance companies,12 co-operation among institutional shareholders to exercise their removal rights (which in the UK are strong) has often proved difficult. As ever, the ‘law in the books’ is one thing, its operation in practice may be quite another, and assessment of its impact needs to take account of the incentive-structure which applies to those who are apparently intended to make use of the rights which company law confers. Further, the law may itself may put obstacles in the way of collective 12

See Company Law Review, Completing the Structure, Consultation Document 8 (DTI, London, Novermber 2000) paras 4.49 – 4.62.

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shareholder actions, for example, if it contains rules which make communication among shareholders difficult.13

(c) Setting the incentives of members of the board The practical difficulties surrounding the exercise of removal rights explains in large part the interest in jurisdictions such as the UK in reform of the rules concerning the composition and functioning of the board. After the Cadbury Code of 1992 and now the Combined Code there is considerable pressure on listed companies14 to increase the number and role of non-executive directors (NEDs) and especially of independent NEDs on the boards. In particular, their role in the areas of audit, executive remuneration and board appointment is to be increased. In the US similar pressures have led to a position where the majority of members of the boards of large companies are NEDs.

The theory behind the NED-movement seems to be based on the supposed value of introducing onto the board a group of directors whose incentive structure is different from that of the executive directors and who, therefore, will be better positioned to discharge the traditional function of the board of monitoring the management on behalf of the shareholders. Thus, whereas shareholder removal rights are consistent with a structure in which the shareholders monitor the board and the board leads the company, the injection of a strong element of independent non-executive directors onto the board supposes that the board will perform a monitoring role as against the company’s management as well as a role of setting the company’s strategy. In this schema a continuous element of monitoring of management is provided by the non-executive directors which supplements the necessarily episodic monitoring which is provided by the shareholders collectively.

However, why should NEDs be thought to be effective monitors? There seem to be two arguments.

The negative argument is that NEDs are not subject to the potentially high-powered conflicts of interest to which executive directors are subject. The scope which executive directors have to advance their own interests at the expense of the shareholders is not replicated in the case of nonexecutive directors. By itself, however, this argument might lead one to expect supine NEDs rather than ones who actively protect the shareholders’ interests. The positive argument is that NEDs are subject to incentives, albeit low-powered ones, to do a good job on behalf of the shareholders, 13

For example, how easy is it for a shareholder to find out who the other shareholders in the company are and to communicate with them? This may depend in part upon whether shares are issued in registered form, but even if they are, a shareholder may not have free access to the register of shareholders.

14 For a discussion of the scope of application of the Combined Code see section VI below.

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because in that way they will enhance their reputations and promote their careers. It has to be said that the jury is still out on how far, or in what circumstances, NEDs are capable of operating as effective corporate monitors. It is not clear that the reputational incentives are strong enough to induce NEDs to overcome strong opposition to board monitoring from dominant CEOs, at least without some degree of accountability of the NEDs to the shareholders.15 Equally, in some areas the NEDs may share, albeit at one remove, the same conflicts of interest to which executive directors are subject. For example, if NEDs are typically executives of other companies and/or are responsible to executives of fund management companies, they may share the same ‘high compensation’ culture as the executive directors and thus perform poorly as monitors of executives’ remuneration packages.

A strategy alternative or additional to the mandatory introduction onto the board of NEDs with different incentive structures to those of the executive directors is re-structuring the incentives of the latter.16 The aim now is to align the personal incentives of the management with those of the shareholders, normally by making a substantial element in the financial rewards granted to senior management dependent upon proof of achievement of shareholder-oriented goals. Instead of trying to constrain, through either shareholder or NED monitoring, the tendency of management to pursue personal goals, this strategy makes use of the personal goals of the management to advance the shareholders’ interests. As far as I am aware, no legal system requires this strategy to be adopted,17 but systems do vary in the extent to which they facilitate such alignment of executive and shareholder interests through share-option schemes or other forms of long-term incentive plans.

Particularly important here are company law rules relating to non-standard share issues and share re-purchases and, of course, tax rules about the profits made on such schemes.

The risk involved in the adoption of incentive schemes for aligning management’s interests with those of the shareholders is that the process of setting the scheme will be captured by the executive directors. The resulting incentive schemes will thus be more an expression of the executives’ conflict of interest than a way of overcoming that conflict. Attempts to address this problem have focussed on three main elements: full disclosure of the detail of individual directors’ remuneration

15

For an instructive example see the recent debate in the UK about the failure of the non-executive directors of Tomkins plc to act with sufficient vigour to control waste of corporate assets by a strong CEO: Financial Times, October 31, 2000.

16 Anglo-American law has long facilitated this technique. Recently, Prof Ferrarini has remarked that, now, ‘these mechanisms have been subject to sweeping changes in Continental Europe’: ‘Shareholder Value and the Modernisation of European Corporate Law’, paper delivered at a conference on Company Law and Capital Market Law held at the University of Siena, March 2000, p 20.

17 Except, in some jurisdictions, in the weak form of requiring directors to have a minimum shareholding in the company.

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packages; reducing the role of executives in setting their remuneration packages (remuneration committees to consist wholly of NEDs; shareholder approval of remuneration policies or packages); and requiring demanding performance criteria for the awarding of the incentives. However, the area of executive remuneration continues to be problematic. Governments are unwilling to set substantive pay levels or even to control rates of increase in remuneration in the private sector of market economies. On the other hand, there is good evidence of market failure in the setting of executive remuneration. Neither of the strategies discussed above (shareholder monitoring and monitoring by non-executive directors) seems to have been wholly successful in addressing such market failures. Consequently, even in countries in which ‘corporate governance’ reform has been taken a long way, the setting of executive remuneration remains an area of controversy.18

(d) Legal liability Despite the fact that imposing liability upon directors who act incompetently or disloyally would seem to be an obvious legal strategy to deal with the principal/agent problem between management and shareholders as a class, this approach has been left until last, because it plays a relatively small role in constraining the activities of boards of directors. We are principally concerned here with a court reviewing managerial conduct ex post by reference to some fairly broad standard. All systems in principle have provisions which could be invoked to impose liability on directors who act incompetently. In practice, however, such provisions are invoked only in egregious cases: qualifications such as the business judgement rule, a subjective formulation of the duty of care or the requirement that directors need only avoid ‘gross’ negligence mean that such liability is not a routine way of monitoring the performance of boards. In principle, this seems correct. Litigation is an expensive and uncertain way of monitoring boards and judges are not necessarily expert in discharging the monitoring role. Nevertheless, competency standards do perform a necessary background role, by setting minimum standards, and the modern tendency has been to increase their rigour.

Turning to duties of loyalty, an obvious background rule to have in order to protect the interests of the shareholders as a class is one which requires the board to exercise its necessary discretion in the interests of the shareholders. In many legal systems, there is some doubt about the scope of this background rule, because the duty is said to be to further the interests of the ‘company’ and it is not clearly specified whose interests are the company’s interests. Even where, as in the reforms 18

See Pensions and Investment Research Consultants, Corporate Governance 2000 (London, 2000), laying the blame in part on the freedom the Combined Code gives companies not to implement its recommendations fully, provided reasons are given for non-implementation (see section VI below); Department of Trade and Industry, Directors’ Remuneration: A Consultative Document (London, July 1999).

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proposed by the Company Law Review in the UK,19 it is made clear that the company’s interests are the interests of the shareholders as a class, the practical impact of this background rule is rather limited because of its subjective formulation, at least where there is a plausible commercial explanation for the directors’ decision. For the same reason that it is undesirable to have the courts monitor the competence of directors, it is also undesirable to have them assess whether another decision than the one the directors actually took would have advanced the shareholders’ interests more effectively. Both the competence and the basic loyalty rules are designed to catch only egregious cases.

Where the directors’ lack of loyalty takes the more obvious form of self-dealing, courts are probably better at identifying the proscribed conduct, and legal systems tend to have stronger rules on self-dealing than other forms of lack of loyalty to the shareholders as a class. The issue which concerns all systems, whether common law or civil law, is how widely to distribute the power to initiate legal action against self-dealing on the part of the directors. Directors, even those not involved in the alleged illegality, may not have a strong incentive to begin legal action; whilst shareholders as a body in large companies may experience collective action problems in relation to the litigation decision just as they do in relation to any other class of decision they are allocated.

Pushing the power to initiate litigation further down within the shareholder body, to either minority groups of shareholders or even to individual shareholders, creates the risk that litigation will not be brought in the interests of the shareholders as a class, but in order to promote the particularist interests of small groups of shareholders. Both the UK and Germany are currently wrestling with law reform in this area.20

IV.

Board rules and principal/agent problems between majority and minority shareholders

The importance of good legal protection for minority shareholders is now well recognised as an important policy issue if it is thought desirable to encourage outside investment in companies and the development of stock markets.21 Such protection is clearly a major task for core company law, but how far is it a task for board rules? The answer is that in principle the legal strategies identified above to deal with the management/shareholders as a class relationship can also be deployed to address the majority/minority shareholder relationship, but that in practice less use is made of board

19

See section VII below.

For the UK see Law Commission, Shareholders’ Remedies (Cm 3769, London, 1997); for Germany see Baums, Gutachten F zum 63. Deutschen Juristentag.

21 Bernard S Black "The Core Institutions that Support Strong Securities Markets" (2000) 55 Business Lawyer 1565.

20

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rules to address the latter conflict than the former. We shall return to why this might be after we have analysed in the majority/minority context the legal strategies identified in the previous section.

(a) Allocation of functions to the board The allocation of decision-making to the board, and thus away from the shareholders in general meeting, has the potential to protect minority shareholders against majority shareholders. This potential certainly exists in jurisdictions where the shareholders do not have strong removal rights as against the directors, and may even be true in jurisdictions where shareholders have strong removal rights in law but find it difficult to exercise them in practice. The point is that a board which is not directly responsive to the shareholders has less incentive to promote policies which advance the interests of the majority against the minority of the shareholders. In other words, whilst centralised management may be in the interests of both shareholders as a class and of minority shareholders, their interests may diverge over legal rules which facilitate the removal of directors by the shareholders (ie the majority). However, there is a clear trade off here, because boards which are not made responsive to the shareholders may pursue policies which are in the interests of neither majority nor minority shareholders. Protection of the minority as against the minority may thus be bought at the cost of relegating shareholders’ interests within the company across the board.

Even where decision-making has been allocated to the shareholders in general meeting, the influence of the board (and, thus, possibly the interests of the minority shareholders) may be preserved to some degree by giving the shareholders only a veto right over the decision in question.

In this situation, unless the board proposes a certain decision, the shareholders are unable to consider it; on the other hand, without the shareholders’ consent the decision may not be adopted by the company. By contrast, in full shareholder decision-making the shareholders may both propose and approve the decision. Of course, minority interests can be directly protected, at least to some extent, by setting supermajorities for the passing of certain types of resolution or allowing minority shareholders to obtain a court review of the majority’s reasons for adopting a particular resolution, but such techniques lie outside the scope of this paper since they do not involve to board rules.

(b) Appointment and removal rights As we have seen, centralised management under a board relatively unresponsive to the shareholders creates only the potential of protection for minority shareholders. It does not guarantee that the board will protect the minority from either the majority’s or management’s self-interested decisions.

A more effective technique of minority protection may be to secure representation of minority interests on the board. This may enable them to influence the board’s decisions in their favour and, Copyright © OECD 2001 All rights reserved 12

at least, will put them in a position where they are better informed about the board’s activities.

Minority shareholders may be able to bargain for board representation, but mandatory rules on the matter are rare. The most obvious technique to promote minority representation on the board is cumulative voting, but that has never been a popular mandatory requirement except in the United States and even there it is now a requirement only in a small minority of states.22 The reason for this may be that where there is no strong conflict between majority and minority shareholders, cumulative voting is unnecessary; where such conflict does exist, cumulative voting simply shifts that conflict to the board and reduces the effectiveness of centralised management.

A lesser form of protection for minority shareholders which does not have the same potential to transfer conflict to the board room is to limit the voting rights of large shareholders through voting caps. Here, however, there is a clear conflict between the solutions to the two main principal/agent conflicts considered so far. A voting cap may hinder an overbearing majority from inflicting its will on the minority; it may also protect inefficient or self-seeking management against removal. In particular, a voting cap is likely to have the effect of making the removal of management by a successful take-over bidder much more difficult. It will chill take-overs and help to entrench management against such bidders, thus rendering less effective one of the primary tools for security management responsiveness to shareholders as a class.

(c) Legal Liability For the reasons given in the previous section, it is doubtful whether judges are better arbiters of majority/minority conflicts than they are of management/shareholders as a class conflicts. However, in this area too legal rules perform an important background function, setting minimum standards, and so there is a case for using liability rules to provide a basic level of protection for minorities.

There seem to be two basic approaches. One is to extend the competence and loyalty duties currently owed by directors. They may be extended in terms of the beneficiaries of the duties, so that they are owed not only to ‘the company’ (shareholders as a class) but also to individual shareholders. They may also be extended in terms of who is subject to the duties, ie beyond the directors of the company. Since the controllers may exercise their powers as shareholders as well as directors, it would be necessary, on this approach, to impose such duties on controlling shareholders as against non-controlling ones, at least in some cases. This latter extension may be particularly useful within groups of companies when it can be used to impose liability in appropriate cases on the parent company vis-à-vis the outside shareholders of a subsidiary company. However, within 22

See Jeffrey N Gordon, ‘Institutions as Relational Investors: A New Look at Cumulative Voting’ (1994) 94 Columbia Law Review 124, especially at pp 142-160. Note, however, the recent use of cumulative voting as a ‘self-enforcing’ Copyright © OECD 2001 All rights reserved 13

individual companies there seem to be strong arguments against replicating in favour of individual shareholders the duties owed by directors to shareholders as a class. The main argument against is that it amounts to a subversion of the collective nature of the company.23

An alternative approach is to fashion distinct legal duties owed to minority shareholders. These duties, too, should be placed on the ‘controllers’ of the company, so that it does not matter whether the majority express their influence via decisions of the board or of the shareholders’ meeting. The main problem in fashioning such duties is to determine the standard(s) by which the conduct of the controllers is to be judged. Giving the courts a free reign to determine the balance of advantage between controllers and non-controllers is likely to be welcomed by neither business people nor the judges. A minimalist form of intervention, which has been adopted by the courts in the UK, is to use such ‘unfair prejudice’ laws to enforce informal agreements and arrangements upon which minority shareholders came into the company, whether or not these understandings were embodied in the company’s formal constitution. Such an approach confines the courts to enforcing the shareholders’ own bargain, albeit an informal one.24

(d) Conclusion It is clear from the above that board rules can make a contribution to the principal/agent problem as between majority and minority shareholders, but that contribution is a modest one. There are two reasons for this. First, this task is better allocated to other parts of core company law. For example, minorities may be protected by the rules relating to voting at shareholder meetings (to be discussed at another session of the conference) or by the rule found in most jurisdictions that distributions by companies to shareholders must be pro rata to the equity holdings of those shareholders. Second, as we have noted, adjusting board rules as to address the majority/minority conflict may well make the board rules less effective at dealing with the first agency problem (management and shareholders as a class). There may thus be a trade-off between rules addressing the two sets of problems and legislators may have chosen to give greater prominence to first agency conflict. Alternatively, there may be thought to be a comparative advantage in using board rules to address the first agency conflict whilst using other parts of company law to address majority/minority conflicts. The board is institutionally the body which mediates between shareholders and management and it thus provides a natural focus for legal rules addressing the first agency conflict. Majority/minority conflict is not necessarily focussed on the board and thus is open to regulation by non-board rules. mechanism for the protection of minorities in the new Russian corporate law.

23 This issue is different from the issue discussed in section III(d), which was whether the individual shareholder should have the right to enforce on behalf of the company breaches of duties owed by directors to the company.

24 See P.L.Davies, Gower’s Principles of Modern Company Law (Sweet & Maxwell, 6th ed, London, 1997) pp 742-745.

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V.

Board rules and controller/stakeholder agency problems

The third use to which board rules may be put is for the protection of non-shareholder stakeholder interests. As already indicated, the only stakeholder interests which are in fact significantly protected in this way are those of the creditors and the employees. However, whilst creditor protection is an important function of all company laws, the use of board rules to protect creditors is not well developed in any system, at least whilst the company is a going concern. This seems to be because, at a general level and short of insolvency, the creditors’ interests are well protected by the duty upon the board to advance the interests of the ‘company’ (however that may be interpreted); whilst specific types of company opportunism as against creditors can be controlled by rules other than board rules. Thus, the risk of controllers shifting assets out of the corporate ‘box’ to the detriment of creditors can be met by rules on capital maintenance or restricting the financial circumstances in which distributions may be made to shareholders, which rules apply whether the decision which would contravene them is one proposed to be taken by the directors or the shareholders.

By contrast, employee protection through company law is not a feature which all jurisdictions display, but where company law is used in this way, it does tend heavily to involve board rules. In fact, control of the company/employee agency problem through company law is almost synonymous with employee representation on the board, ie the use of board rules to implement the policy. As with the use of board rules to control majority/minority shareholders agency problems, however, there is often a trade off between use of board rules to control the management/shareholders-as-a-class agency problem and that arising between companies and nonshareholder stakeholders.

(a) Appointment and removal rights Creditors can bargain for board representation, but company laws seem not to require such representation. This is true, at any rate, up until insolvency intervenes, when the right to appoint the controllers of the company usually passes to the creditors or some sub-group of them or to a court acting in the interests of the creditors, and the board is displaced. However, it is controversial how early in the insolvency process the board should be displaced by representatives of the creditors.

Debtor-friendly jurisdictions will allow the unsuccessful board to remain in place much further into

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the insolvency process than creditor-friendly jurisdictions.25 Postponing creditor access to control of the company may be a policy adopted to ‘encourage entrepreneurs’ (ie the incumbent management and/or the shareholders) and/or to protect stakeholder interests other than the creditors. For example, a ‘work out’ may be thought to benefit employees, customers and suppliers as well as the incumbent management of the company. It is a matter of judgement whether work outs are helped or hindered by postponing creditor control of the company.

As already indicated, use of company law to regulate the company/employee agency problem invariably involves board rules if jurisdictions use company law in this way at all. Appointment rights for employees to one third or less of the board are quite widespread in Europe. In Germany large companies (more than 2000 employees) are subject to quasi-parity representation on the board (ie the employees appoint half the members of the supervisory board, though the shareholders through the chair of the board usually retain the balance of power). The appointment rights may be vested in the employees as a whole or in representative trade unions or some mixture of the two.

Evidence from Germany, where the matter has been extensively researched,26 suggests that employee representation at board level acts both to reduce the principal/agent problem as between company and employees and to reduce the effectiveness of the board in regulating the management/shareholders-as-a-class agency problem. For example, shareholders acquiesce in the supervisory board being kept at a distance from the management board, because of the employee representation in the latter but not the former. Thus, apparently dysfunctional features of the supervisory board when view from the management/shareholder perspective (large size, infrequent meetings, caucusing of the employee and shareholder representatives in advance of board meetings) may prove functional when viewed from the company/employee perspective.

Finally, it should be noted that employee representation at board level is inconsistent with indifference on the part of the law towards the distribution of functions as between shareholders’ meeting and the board. If employee representation at board level is to function effectively, the law cannot leave the division of functions between these two bodies (or as between board and management) under the control of the shareholders. Instead, it will be necessary to specify it through mandatory rules of company law.

(b) Setting incentives

25

Philip R Wood, Principles of International Insolvency Law (Sweet & Maxwell, London, 1995) especially pp 204206.

26 Hopt ‘The German Two-Tier Board: Experience, Theories, Reforms’ in Hopt et al (eds), above n 10 at p 225.

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Structuring the incentives of board members so as to encourage them to advance the interests of non-shareholder stakeholders is a difficult task and seems to be undertaken only within the Dutch ‘structure’ regime which applies to medium and large-sized domestic companies. Here the board is a self-appointing body, but both the shareholders and works council have a limited right to challenge before a court appointees in whom they are not confident. In this unique arrangement, the management achieves a high degree of independence from both shareholders and employees, but is subject to some low-powered incentives to promote the interests of both these groups in order to retain their confidence. (c) Liability rules In countries which do not have employee representatives at board level, it is often proposed that a first step towards the protection of stakeholder interests is to relax the legal duties owed by directors to promote the interests of the shareholders as a class. Perhaps the best known example of this approach is the ‘constituency’ statutes in the United States which permit, but do not require, directors to take into account the interests of all stakeholders in the company when taking decisions, especially decisions in the face of take-over bids but sometimes more generally.27 It is doubtful, however, whether such provisions deliver any substantial degree of protection to stakeholder interests, as opposed to the interests of incumbent management, except to the extent that stakeholder interests coincide with those of management.28 It is unlikely that this assessment needs to be changed in the case of rules which require directors to have regard to a range of stakeholder interests. Unless the range of persons empowered to enforce the duty is extended to include members of the stakeholder groups and unless the courts adopt a bold and interventionist stance when reviewing management’s choice among the conflicting stakeholder interests, it is unlikely that a duty to promote a range of stakeholder interests will produce a bigger positive impact in practice on stakeholders than a discretion to promote their interests. In both cases, entrenchment of incumbent management is likely to be the largest effect of such rules.

On the other hand, amendment of the liability rules so as to replace the shareholders with a single other stakeholder group as the object of the directors’ discretion may have an impact, to the extent that liability rules are effective at all. All systems now recognise that, as the company nears insolvency, the residual claimants on the company become the creditors rather than the shareholders. This perception may be reflected in the liability rules applying to directors, as the

27

For examples of such provisions see C. O’Kelly and R. Thompson, Corporations and Other Business Associations: Selected Statutes, Rules and Forms 1998 (Aspen Law & Business, New York, 1998) pp 345-348.

28 For an analysis see Lucian Arye Bebchuk and Allen Ferrell, ‘Federalism and Corporate Law: The Race to Protect Managers from Takeover’ (1999) 99 Columbia Law Review 1168.

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company nears insolvency, so that the directors’ primary duty becomes that of advancing the interests of the creditors. Alternatively, creditor protection may be made available by creating duties within insolvency law which nevertheless reach back into the pre-insolvency period and control the directors’ actions in the interests of the creditors before any formal act of insolvency.29

VI.

Current trends

(a) The rise and fall of company/employee agency issues There have been two main waves of reform of board rules in Europe in the post-war period. The first wave concentrated on the third set of principal/agent problems identified above and in particular on company/employee relationships. The best known expression of this reform movement was the extension in Germany of employee representation rights at supervisory board level from one third of the seats30 to one half in the case of companies employing more than 2000 workers,31 although this was done in such a way as normally to retain the right of the shareholders to prevail in case of deadlock.32 The extension of co-determination rights in Germany in the 1970s was much more significant than the adoption of the one-third scheme in the early 1950s. This was not simply because the 1976 law gave the employees a greater proportion of board seats. The one-third scheme of 1952 (and the special provisions of 1951 for the iron, steel and coal industries) could be seen as part of a post-war social settlement which was particular to Germany, just as the introduction of life-long employment in Japan at approximately the same time could be viewed in this light.33 However, the extension of employee representation rights in Germany in the 1970s was part of a much wider European movement in this direction. A number of countries introduced board level employee representation in this period (though not a more than the one-third level), among them Austria, Denmark, Luxembourg, Netherlands, Norway and Sweden.34 The matter was even debated seriously in the UK, where the traditions of both company and labour law might have been thought to be hostile to such a development. A Government committee came up with a recommendation in favour of a British version of quasi-parity representation of employees at board level.35 If the 29

See, for example, the ‘wrongful trading’ provisions of the UK Insolvency Act 1986, s 214.

As laid down in the Betriebsverfassungsgestz of 1952.

31 Mitbestimmungsgesetz of 1976. For the purposes of brevity the special provisions operating in the iron, coal and steel industries are left on one side.

32 The casting vote is given to the chair of the supervisory board who is normally a shareholder representative. This aspect of the scheme was important for the constitutionality of the new law in the eyes of the Bundesverfassungsgericht: judgement of March 1, 1979, 50 BverfGE/90.

33 See Ronald Gilson and Mark Roe, ‘Lifetime Employment: Labor Peace and the Evolution of Japanese Corporate Governance (1999) 99 Columbia Law Review 34 Eric Batstone and P L Davies, Industrial Democracy: European Experience (London: Her Majesty’s Stationery Office, 1976) p 51.

35 Report of the Committee of Inquiry on Industrial Democracy (Cmnd 7231, London: HMSO, 1978) Copyright © OECD 2001 All rights reserved 18 30

proposal had had greater support from the union movement and had aimed at a more modest starting point (say, one-third representation). it might well have been adopted.

The focus of board rules on company/employee agency relations did not survive the 1970s, presumably because, with the restructuring of industry, the onset of recession and the consequent decline in union membership and trade union power in most (though not all)36 European countries, this set of problems became less pressing for policy-makers. The concerns of current labour law (flexibility, human capital development, work/life balance, partnership) tend not to direct attention particularly to board rules. The story of the move away from an exclusive focus on board rules is reflected rather nicely in the history of the various drafts of the EU proposals for a Fifth Company Law Directive and, even more so, for a European Company Statute. The drafts of these instruments from the late 1960s and early 1970s contemplated mandatory rules (based on the extant German or Dutch models) to provide some level of board representation for employees in all cases. These proposals were gradually made more flexible over the succeeding years so that board representation became just one of a number of techniques for providing employee representation in relation to the central management of the company (or group). Other techniques, which operate without reference to board rules or indeed to company law (such as works councils or collective bargaining), were given equal status.37

Nevertheless, even in this more flexible form, some form of participation was mandatory in the SE. In the common position eventually adopted by the Council in December 2000, a big dose of relativism was introduced into the project: participation, in whatever form, would be obligatory only if a significant proportion of the workforces in the companies forming the SE were already subject to mandatory participation under national law.38 The cost of this approach is, of course, that it reduces yet further the degree of commonality in the rules to which European Companies are subject, which is said to be one of the prime considerations for the creation of a federal form of incorporation.

Despite these changes of direction at Community level, individual countries which made changes in their board rules in the 1970s in order to introduce or extend employee representation seem to show no tendency to repeal these rules. Consequently, even if, as argued below, the focus of attention has move on in all European countries to the promotion of shareholder value, that policy needs to be 36

Sweden is a notable exception.

See [1982] OJ C 240/44 (draft Fifth Directive); [1989] OJ C 263/69 (draft SE).

38 The text of the common position has not yet been published officially, but the outline of the proposals has been given in Press Releases from the European Commission, available on its web-site.

Copyright Š OECD 2001 All rights reserved 19 37

implemented in countries which have opted for board level representation of employees in the context of such representation. In short, this is an example of the well-known thesis of ‘path dependency’:39 the most efficient reform of legal rules in response to change in context depends in part upon the current state of those rules, so that countries responding to the same change in context may do in different ways according to their different current sets of rules. If a Country A has committed itself to board level representation of employees as an effective way of addressing company/employee agency problems,40 it may be efficient for it to address the new demands of shareholder value via changes other than in board rules; whereas Country B, which made the opposite choice at an earlier time in relation to board rules and employee agency problems, may identify board rules as a natural focus for changes responding to shareholder value. Thus, one might contrast the extensive regulation of the board in the interests of shareholders by the Combined Code of the UK Listing Authority41 with the failure to secure in Germany acceptance of even a modest proposal to reduce the size of the Supervisory Board of AGs because of the adverse impact this was thought to have upon employees’ codetermination rights.42

It should be noted that this argument merely explains why in responding to shareholder value concerns it may be efficient for the UK to focus on board rules and for Germany not to do so or to do so to a lesser extent. It tells one nothing about which country, overall, can be said to have responded more effectively to shareholder value concerns, ie after the changes have been made.

Still less does this argument tell one which country provides the more efficient system for responding to shareholder and employee agency problems taken together. The answer to these questions would require further analysis.

(b) The rise of shareholder value43 The second main wave of reform in board rules in the post-war period has responded to the rise (or, better, resurrection) of the shareholder interest in companies. The reasons for the resurrection of the shareholder interest are tolerably clear. The capital markets now play a bigger role in financing business across the spectrum. In Europe the main competitor to capital market finance for large

39

Lucian Ayre Bebchuk and Mark J Roe, ‘A Theory of Path Dependency in Corporate Ownership and Governance’ (1999) 52 Stanford Law Review 127.

40 That board level rules do efficiently deal with company/employee agency problems has been argued by E Gerum and H Wagner, ‘Economics of Labor Co-determination in View of Corporate Governance’ in Hopt et al (eds), above n 10, at p 341.

41 Above n 3.

42 Hopt, above n 26 at p 255-256.

43 A discussion of this issue from a UK perspective can be found in my paper, ‘Shareholder Value: Company and Securities Markets Law – A British View’ available from SSRN at http://papers.ssrn.com/paper.taf?abstract_id=250324 Copyright © OECD 2001 All rights reserved 20

enterprises, namely the taxpayer, has substantially retreated from the scene. Privatisation, of course more advanced in some countries than in others, has made its mark everywhere, even in industries or services which are ‘natural monopolies’. Even the delivery of welfare state policies has been contracted out to some extent to the private sector, with the public service tending to concentrate on its core function of policy setting.

However, it is not simply a ‘taxpayers’ revolt’ or the need to meet the convergence criteria for the single currency which have produced greater recourse to capital markets. Businesses which have always been in the private sector need better access to capital markets for success, partly as a result of globalisation and the increased competition it generates and partly as a result of changes in technology. Three examples must suffice to make the points. Many countries have seen a ‘demutualisation’ of private sector companies, especially in financial services providers. Thus, in order to facilitate the raising of capital, businesses which were formed under a legal regime in which control rights were allocated to its customers (for example, policy-holders in insurance companies or depositors or borrowers in home loan associations) have reformed as standard companies with control rights allocated to shareholders who are not necessarily customers of the company. Second, a number of high profile European companies, especially from Germany, have sought listings on the US capital markets, usually the NYSE. This provides two advantages to them in their global ambitions. One is access to the world’s biggest capital market for the purpose of raising capital. The second, and equally if not more important, is access to a more liquid market which makes the company’s securities more marketable and, in turn, a better currency for financing acquisitions.44 Finally, at the start-up end of the spectrum the willingness of venture capitalists to put money into high-tech companies depends crucially upon an effective exit route being available for the venture capitalist once the company is off the ground. Although not by any means the only conceivable exit route, an available pubic market on which young companies can be floated is an important bit of infrastructure for venture capitalists.45

(c) Shareholder value and the management/shareholders-as-a-class agency problem Our concern is with the implications of these developments, not just for company law, but for board rules. They show themselves most fully in the last decade’s ‘corporate governance’ reforms, though other examples could be taken. Let us look in turn at the first and second agency problems identified at the beginning of this paper. In the US, where the corporate governance movement 44

See the discussion of the Daimler/Chrysler case by John C Coffee, ‘The Future as History: The Prospects for Global Convergence in Corporate Governance and its Implications’ (1999) 93 Northwestern Univerity Law Review 641.

45 Ronald Gilson and Bernard Black, ‘Venture Capital and the Structure of Capital Markets: Banks versus Stock Markets’ (1998) Journal of Financial Economics 47.

Copyright © OECD 2001 All rights reserved 21

began, and in the UK, where considerable attention has been given to this topic over the past decade by four high-powered committees,46 it is clear that corporate governance reform is seen as being addressed to the principal/agent relationship between the management and the shareholders. Both the American Law Institute’s Principles of Corporate Governance and the UK Listing Authority’s Combined Code focus unambiguously on this problem. The issue, as stated, is how to provide an appropriate level of monitoring of management in a universe of dispersed shareholdings, given that even the rise of institutional shareholders in both the US and the UK has not generated the strong incentives to monitor management which block-holding provides.47 The answers given in both these documents revolve around assigning a greater role for NEDs, especially independent NEDs, on the board, particularly in areas of likely acute conflict of interest between management and shareholders: audit, remuneration and board appointments. In particular, it is hoped to counteract the dominance of the company by a single powerful CEO.48

Since these codes constitute a much greater interference in the internal governance arrangements than company law has traditionally contemplated, it is perhaps not surprising that they are not made legally binding through company law. At best core company law provides indirect backing for the codes, for example, as where a board decision not to initiate litigation against alleged wrongdoing by senior management is more likely to be upheld by the courts if the decision was taken by independent NEDs. Binding force is given to the codes, in so far as it is given at all, via stock exchange rules, ie by the institutions which are specifically designed to link investors with companies. Even so, in the case of the Combined Code the UK Listing Rules require merely that the company complies with the Combined Code or explains its non-compliance. Whether any action adverse to the board follows from its non-compliance is a matter for the shareholders of the 46

Chronologically, the Cadbury (1992), Greenbury (1995), Hampel (1998) and Turnbull (1999) Committees.

See the analysis by the Company Law Review, above n 12, paras 4.49 – 4.62..

48 The salient features of the Combined Code are as follows: • The board has a dual function, both to ‘lead’ and to ‘control’ the company.

• At least one third of the board as a whole should be non-executive directors [NEDs], most of whom should be independent. Independent means ‘independent of management and free from any business or other relationship with the company which could materially interfere with the exercise of their independent judgement.’ As with the board as a whole the NEDs have a role both in setting the company’s strategy (‘leading’) and ‘controlling’ it. In the case of the non-executive directors, however, ‘controlling’ includes monitoring the performance of the company’s executive directors.

• There should be introduced committees of the board to deal with certain specific matters on which the NEDs should be the only or the majority of the members. These are the audit, remuneration and appointment committees.

• In principle, the CEO and the chair of the board should not be the same person. However, the chair of the board need not be a NED, still less an independent NED, so that, as in Germany, the chairman of the board may be a former CEO of the company. The Company Law Review was not inclined to recommend reform on this point.48 Whether the roles are combined or not, however, there should also be an identified senior independent NED on the board with whom the shareholders can liase.

• There should be a formal statement of the matters on which the board’s decision is necessary.

• The NEDs should have access to appropriate outside profession advice and to internal information from the company.

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company, not for the stock exchange or listing authorities. A surprisingly high degree of compliance with the Combined Code has been achieved through this mechanism, mainly because the Combined Code has been taken up enthusiastically by institutional investors in the UK. It is becoming clear that non-compliance with the Combined Code is not sustainable over long periods of time, given the commitment by institutional shareholders to the precepts of the Code.49 In sum, we should not underestimate the importance of the corporate governance codes on the grounds that they have not become part of traditional company law. If one takes a functional view, it is clear that the universe of board rules with which listed companies must comply has been significantly extended by the corporate governance rules.

Thus, the corporate governance codes have had a major impact on the board rules in those jurisdictions where the first agency problem (managers and shareholders) has been the traditional focus of company law. An interesting question is what impact they have had on jurisdictions (typically those of continental Europe) where the main agency problem is that between majority and minority shareholders. One form of impact might occur when companies incorporated in such jurisdictions choose to list on a foreign exchange where the codes are in force. However, the effectiveness of this step would depend upon how far foreign issuers are subject to the corporate governance provisions of the exchange in question.

This is a topic on which full-scale analysis has not been carried out, but, on a preliminary view, there seems to be a distinction between the approaches of the British Financial Services Authority, on the one hand, and the New York Stock Exchange and the Securities Exchange Commission on the other. The listing rules of the FSA seem to take the view that corporate governance is functionally a part of company law. That view is then reflected when drawing the traditional distinction between company law as a matter for the jurisdiction of incorporation or of the company’s headquarters, and capital markets law as a matter for the jurisdiction where the securities are traded. Thus, the UK listing rules require compliance with the Combined Code only on the part of companies which are both listed on the London Exchange and incorporated in the UK.50 In consequence, the UK corporate governance standards are of no concern to a company listed outside the UK.

49 50

See ‘Split in top jobs demanded’, Financial Times, November 16, 2000.

Above n 3, para 12.43A. Copyright © OECD 2001 All rights reserved 23

By contrast, although the US operates the same principle of private international law, so that foreign companies listed on the US exchanges do not become subject to US corporate law,51 nevertheless the listing agreements of the NYSE, AMEX and NASDAQ do require all issuers, even foreign ones, to accept certain corporate governance standards. In particular, the NYSE requires all issuers to have two outside directors and to establish an audit committee composed of independent directors.52 Thus, listing on a US exchange offers the opportunity for foreign companies to bond themselves to certain corporate governance standards in the way that a UK listing does not.

An alternative way in which the Anglo-American codes may have an impact in continental European countries is through their adoption and adaptation by exchanges or other bodies representative of large companies in those countries. In fact, in the wake of the Cadbury report a large number of continental European countries embarked upon similar initiatives, taking Cadbury as a starting point.53 At first sight, this is a highly surprising development. For countries where the main problem is the second agency problem (majority/minority shareholders) to take as the starting point for a corporate governance code one designed for the situation where the first agency problem (management and shareholders) is the dominant one seems irrational. Indeed, this may well explain why the continental European initiatives with corporate governance codes have generally been less rigorous, especially at the point of enforcement, than have the Anglo-American codes.

Nevertheless, the wide adoption of such codes in continental Europe must tell us something about perceived principal/agent problems in those countries. It is suggested that two things emerge on analysis. First, some techniques for addressing the first principal/agent problem may also work to some degree in relation to the second principal/agent problem. Thus, independent directors might be thought to be a way of addressing both sets of issues. ‘Independent’ directors could operate to protect minority shareholders against company controllers as much as they do shareholders as a class as against management, though the emphases in the definition of ‘independence’ would be rather different in the two contexts.54 Second, the attraction of domesticating the Anglo-American

51

If this were the case, there would be the additional tricky problem of working out which state’s rules applied.

Coffee, above n 44.

53 These codes helpfully collected together on the European Corporate Governance Network web-site: www.ecgn.ulb.be. Prof Ferrarini has remarked: ‘On the whole, market discipline is breaking new ground in Continental Europe, as an essential supplement to corporate law, and the codes of best practice play an important role with respect to directors and investors.’: above n 16 at n 51.

54 This contrast is nicely caught in the definitions of independence in the Combined Code and the first ‘Viénot’ report in France: only the latter specifically mentions independence from shareholders. Thus, the Combided Code: ‘The majority of the non-executive directors should be independent of management and free from any other business or other relationship which could materially interfere with the exercise of independent judgement’ (para A.3.2). Viénot: ‘C’est que la définition de l’administrateur “indépendent” ne l’oppose pas seulement aux directeurs généraux ou aux salariés de l’entreprise, mais également à tous ceux qui ont un intérêt particulier à leur relation avec celle-ci: actionnaires, Copyright © OECD 2001 All rights reserved 24 52

corporate governance model in continental European countries may be as a response to changes which can already be detected in share ownership patterns. In particular, increasing levels of investment by US and UK funds in continental European equities55 may be seen as heralding a move towards more dispersed ownership patterns, especially when taken in conjunction with domestic moves in the same direction.56 In any event, exchanges and others in continental Europe may wish to encourage this inward portfolio investment by providing a corporate governance environment which approximates to that to be found in the in the funds’ home states.

(d) Shareholder value and majority/minority shareholder relationships The thesis sketched above about the much enlarged role played by capital markets in company finance would lead one to expect that countries where the prevalent pattern of shareholding is one based on large blocks would take steps to enhance the levels of protection for minority shareholders. Without such enhancement investors might be unwilling to buy securities issued on the market by companies where ownership is concentrated in this way. It is possible to identify legislative trends which fit into this pattern. At EU level Directive 89/592 extends the prohibition on insider trading throughout the union and will, if the national laws are effectively enforced, deprive block-holders of one obvious way of diverting to themselves the private benefits of control. More far-reaching are legislative reforms at national level. A particularly good example of changes bolstering the position of minority shareholders are the recent ‘Draghi’ reforms in Italy. Amongst other things, these reforms gave minority shareholders representation on the supervisory board of internal auditors (collegio sindacale); improved shareholder rights to require the summoning of shareholder meetings, to secure court investigation of the company’s affairs in the case of allegations of serious misconduct, and to bring derivative actions on behalf of the company; and introduced a mandatory bid rule in takeovers. Although an (or at least this) outsider cannot judge how effective these reforms are likely to be in practice, they clearly carry the potential to strengthen the position of minority shareholders, though in the case of the mandatory bid rule equal treatment of majority and minority shareholders in a take-over bid may have been purchased at the cost of reducing the incentives for block-holders to sell out to bidders, because they can no longer secure a premium for the sale of control in the company.57 One should note too that, as indicated above, that fournisseurs clients . . .’ The first Viénot Report can be found in Hopt and Wymeersch (eds) Comparative Corporate Governance (Berlin: De Gruyter, 1997) at M-91.

55 Thus, the Committee on Corporate Governance, Recommendations on Corporate Governance in the Netherlands (Amsterdam, 1997) gave at p 9 as one of the main reasons for its initiative: ‘increasing interest from institutional investors on the international stock markets, the Netherlands included, and growing shareholder activism, further intensified by the increased ownership of Dutch shares by foreigners.’

56 For example, recent proposed German tax changes which would make the disposal of blocks of shares more attractive and recent surge of interest in corporate governance principles in that country.

57 The mandatory bid rule is a common feature of takeover regulation in Europe, though often with some differential between the highest price paid to acquire the controlling block and that contained in the public offer. The mandatory bid Copyright © OECD 2001 All rights reserved 25

these reforms do not limit themselves to board rules, even if for these purposes one takes the internal auditors as part of the board structure of large Italian companies. The Draghi reforms have recourse to provisions falling outside the scope of board rules, such as the rules relating to the summoning of shareholder meetings or those controlling the terms upon which a bidder may offer to purchase the shares of a target company.

VII.

Conclusions

The argument has been advanced in this paper that board rules can in theory be used to address any or all of the three principal/agent problems with which core company law deals. These are those between management and shareholders as a class; those between controlling and non-controlling shareholders; and those between company controllers and non-shareholder stakeholders. It has been suggested, further, that in recent years reform of board rules has been influenced mainly by the need to ameliorate the first principal/agent problem. This is because of the rise to prominence of the goal of shareholder value which is associated with the greater role played by capital markets in financing large-scale enterprise. To be sure, shareholder value would suggest more security both for shareholders as a class (where shareholdings are dispersed) and for minority shareholders (where shareholdings are concentrated in the hands of block-holders). Across company law as a whole one can detect reforms aimed to promote both types of shareholder protection. However, it has been suggested that, as far as board rules are concerned, which are the topic of this paper, they are the natural focus of reform efforts which aim to address the first agency problem, whereas reforms aimed at dealing with the agency relationship between controlling and non-controlling shareholders spread themselves more widely across company law.

With regard to stakeholder agency problems, recent reforms of board rules have not touched on this issue to any significant degree. Improvements in the levels of protection for creditors and employees, the stakeholder groups traditionally recognised by company laws, seem not to be strong policy imperatives at the present time. Indeed, in the case of creditors there is some questioning in some countries as to whether the levels of protection afforded to secured creditors are too high.

Employee representation at board level is well entrenched in some jurisdictions, but seems not to be the subject of proposals for extension.

rule will be extended to all EU countries by the proposed Directive on takeovers, if it is adopted in its present form. It is interesting that the Council’s common position (above n 11) does not require the minority to be paid the same price as the block-holder but only an ‘equitable’ price, whereas the recommendations of the relevant committee of the European Parliament (ibid) insist on the same price. These divergences probably reflect different views on the desirability of encouraging takeovers.

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However, it would be wrong, even confining one’s focus to board rules, to conclude that the only policy imperative is the straightforward promotion of shareholder value. Those who argue for the proposition that company law in general, and board rules in particular, should place the interests of the shareholders at the centre of attention do not necessarily deny the proposition that the purpose of company law is to promote the wealth of society as a whole. How does one reconcile this broad goal with the narrow focus on the shareholder interest in the design of board rules? The answer can be given58 that the interests of shareholders can be most efficiently protected by confining the board to the promotion of the shareholder interest, whilst non-shareholder interests can be most efficiently protected outside board rules and even outside company law altogether, for example, via self-help based upon private contracting (particularly important for creditors) or via mandatory rules located in other areas of law, such as labour law, consumer law or the law relating to commercial transactions. This approach makes it unnecessary to engage in the trade-offs which are inherent if board rules are used to promote the interests of those other than shareholders. Moreover, provisions outside the area of board rules may give non-shareholder interests greater protection than board rules would. Mandatory rules from labour, consumer and commercial law set the parameters within which board discretion is to be exercised and thus may give greater protection than simply requiring directors to take these stakeholders interests into account when exercising a discretion which, in the absence of the relevant labour law etc rules, would be broader. It follows from this analysis that the answer to the question of how a legal system deals with the company controller/stakeholder agency problem cannot be answered simply by analysing the rules of company law. Those rules must be assessed in the context of the contribution made to the issue by a number of other areas of law.

Finally, even if the force of the above arguments is acknowledged, it may be too categorical approach to conclude that company law, and board rules, have no contribution to make to the company/stakeholder agency problem. Company law may be well placed to support stakeholderdirected policies embodied elsewhere in the law, especially policies of stakeholder self-help.

Certain techniques which company law has developed for the purposes of shareholder protection may be capable of extension so as to promote, albeit in a secondary way, stakeholder policies.

Because these techniques are located within company law, it may be efficient, in terms of legislative effort, to use company law to promote stakeholder policies. The most obvious example of such a technique is disclosure. Because company law has developed highly sophisticated rules on disclosure in the interests of shareholders and creditors, it may be sensible to centralise within company law disclosure rules whose aim is to benefit primarily other groups. One can see this 58

Henry Hansmann and Reinier Kraakman, ‘The End of History for Corporate Law’, available from the Social Science Research Network Electronic Paper Collection.

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policy in the use by the Company Law Review in the UK of disclosure obligations within company law to support stakeholder-oriented policies.

The Company Law Review59 proposes to create in the UK a high-level statutory statement of directors duties, which previously had been embodied mainly in common law judicial decisions. In proposing its formulation the CLR has had to address the issues discussed in this paper and at first sight what it proposes is to focus board rules in the UK solely on the first agency problem. Thus, it proposes that the traditional formulation that the duties of directors are owed to ‘the company’ should be clarified so that ‘the company’ is made to mean the members (shareholders) as a whole.60 So far, this appears as a pure shareholder value approach. However, the suggested formulation goes on to require the directors, in promoting the interests of the shareholders as a whole, to take into account ‘the company’s need to foster its business relationships, including those with its employees and suppliers and the customers for its products and services; the impact of its operations on the communities affected and on the environment; and its need to maintain a reputation for high standards of business conduct.’

It is not proposed that this ‘inclusive’ duty be enforced primarily be legal action. Although such action is available in principle, it is doubtful whether it is so in practice, except in egregious cases.

This is because this part of the directors’ duties is formulated in a highly subjective manner: the director must exercise his discretion ‘in the way he believes in good faith is best calculated in the circumstances’ to promote the shareholders’ interest. The bite behind the requirement to take into account stakeholder interests when promoting the interests of the shareholders lies in an application of the disclosure principle. The CLR proposes to add to the documents which large companies must produce and make public on an annual basis an Operating and Financial Review61 which, where this is material, must include information relevant to the discharge by directors of their inclusive duty.

The proposal for the reform of company law does not go beyond mandatory disclosure: what use is made of the information disclosed is then up the those who have an interest in it, whether shareholders, employees and their representatives, customers or suppliers, and will depend on the opportunities available to them to apply pressure, whether through legal mechanisms or otherwise.

59

Company Law Review Steering Group, Developing the Framework (Department of Trade and Industry, London, March 2000) paras 3.9-3.86.

60 The director must exercise his powers so as ‘to promote the success of the company for the benefit of its members as a whole.’ (para 3.40) This does not involve prioritising short term interests of the members over their long-term interests: ibid. The company as the members was probably the view of the common law, but this was not absolutely clear, and the situation has been further complicated by the introduction in 1980 of a provisions (now Companies Act 1985, s 309) requiring the directors to take account of the interests of the employees as well as of the shareholders.

61 Ibid, paras 5.74-5.92. Such a report is not required by the companies legislation at present, though listed companies are required to produce a more narrowly focussed OFR than the CLR recommends.

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The point for company law, however, is the efficiency of a proposal which uses the well-developed disclosure rules of company, elaborated historically with shareholders and creditors in mind, to support self-help on the part of a wider range of stakeholders.

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Attachment B Teaching For The Outer And Inner Circles

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Sermon #1669

Metropolitan Tabernacle Pulpit

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TEACHING FOR THE OUTER AND INNER CIRCLES NO. 1669 DELIVERED ON LORD’S-DAY MORNING, JULY 16, 1882,

BY C. H. SPURGEON, AT THE METROPOLITAN TABERNACLE, NEWINGTON. “And with many such parables spoke He the Word unto them, as they were able to hear it. But without a parable He did not speak to them: and when they were alone, He explained all things to His disciples.”

Mark 4:33, 34.

OUR blessed Lord had two great objectives before Him in His ministry. The first was to preach the Word to the outlying masses, that out of them He might gather a people to Himself who should be His disciples. This part of His work He carried on with great diligence and perseverance, traversing the Holy Land from end to end and finding here, one, and there, another, but never ceasing to preach the Gospel to the crowds that flocked to Him. His second objective was to train those who became His disciples, that having gathered them to Himself, He might educate them in the Truth of God. He taught them concerning the Father and His love. He taught them concerning Himself, His work, His death and His Resurrection. And He taught them concerning the Divine Comforter and His indwelling and all else that would make for their progress and profit.

While our Lord was here, He gathered the men together who should carry on the work after He was gone. He did not think it enough to make converts—He wished to make disciples! He did not think it enough, even, to make beginners in discipleship, but He would have them advance in knowledge and in holiness, learning till they were able to teach others. To this day this same double work is carried on by the Divine Spirit through the ministers and servants of God. We are to preach to the multitude who make up the outer ring, for our Lord has said, “Go you into all the world and preach the Gospel to every creature.” We are bound to evangelize all, making no distinction of rank or character. To every person with whom we may come in contact, we are to proclaim the Kingdom of God. That being done, however, the minister’s work is only begun, for He is now to go on to expound the mystery, to open up the higher doctrine, to lead the discipled ones into the deep things of God that there may be fathers, instructors, and leaders in the Church. And that the Church may, in all the generations yet to come, until the Lord Himself appears, carry out the glorious purposes of God for the building up of a spiritual house and the conquest of the world.

I want, this morning, to call your special attention to the way in which the Lord spoke to the outside gathering and, then, afterwards, to the way in which He spoke to the inner circle of His own disciples. From His conduct we may learn our own. Soul-winners and soul-helpers may here see their double work set before them in pattern. We shall see how Jesus first fetched home the prodigal sons and then made music and dancing inside the house for them—how He went after the lost sheep and brought them back upon His shoulders—and how He, afterwards, folded and fed the sheep which He had saved. There must be much in all this to instruct those of us who work for Jesus.

I. First, let us study our Lord’s conduct towards THE OUTSIDE GATHERINGS. Kindly read these verses—“And with many such parables spoke He the Word unto them, as they were able to hear it. But without a parable spoke He not unto them.” First, when our Divine Lord preached to the outside multitude, He always spoke “the Word” to them. You see here what He preached—He spoke “the Word” unto them. This is a very short description, but it is intensely full of meaning. It has much more of fullness in it than I can show you just now. He always spoke “the Word”—that is to say, whatever sort of congregation gathered to Jesus, He had only one grand system of Truth to set before them. He preached “the Word,” which of old was prophesied by men of God and was written upon the roll of Inspiration.

The term, “the Word,” shuts up into a small compass the glorious Revelation of God which He has shown to us by Christ Jesus. “The Word”—here is unity—He preached not two gospels, but one. His Word was not yes and no. It was a special message—not a word, but the Word—the special speech of the Father. Jesus had received one weighty, allimportant message from God and this He delivered whenever He had opportunity. It was never His objective, when He was addressing the people, to speak to them upon subjects of merely temporal interest—He preached the eternal Word of Volume 28

www.spurgeongems.org

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Teaching for the Outer and Inner Circles

Sermon #1669

God. He did not come to instruct them in geology, or astronomy, or jurisprudence, or politics—His one business was to win their souls by proclaiming the love and mercy of the Father.

He did not even come to open up a fresh system of morals, though of necessity a system of morals grew out of His central teaching. He came to preach the Gospel and He preached nothing else! He spoke it in various ways, yet He always spoke the one thing—“the Word.” “He spoke the Word unto them”—to publicans and harlots, or to Pharisees and Sadducees. He declares to the blinded Jews, “I speak that which I have seen with My Father.” “He whom God has sent speaks the Words of God.” What a lesson this is to all of us who try to do good in the world by teaching! We have only to preach “the Word!” Some fancy that they have to preach the thought, the deep thought, the wonderful thought of modern times. I have heard that expression, “modern thought,” till I am sick of it! It is a cant phrase smelling strongly of selfconceit!

There is no command given in Scripture for us to go and preach our own thoughts! We are always commanded to preach “Christ” and to publish His Word. “The Word” is the summary of God’s thoughts, or rather of such of God’s thoughts as He chooses to reveal to men—such as He regards it important for them to know. The Lord has spoken already all that we have to speak. Our message is prescribed, our testimony is written. As to the saving Truth of God, we have no room for invention. We have no scope for discovery—our range is specified, our course is mapped out. We have to go and preach “the Word” which is laid down by the Holy Spirit in this Book and has been taught to us, personally, by the Holy Spirit sent down from Heaven. Our Lord’s mind was thoughtful, His genius profound and yet He kept to “the Word,” even as He said, “He that sent Me is true; and I speak to the world those things which I have heard of Him.” If He had pleased, He might have told us many things hidden from before the foundation of the world. He might have opened up deep mysteries and profound secrets which He knew as the Son of God, for He is the Wisdom of God. But instead of that, He concentrated His ministry upon that which God had revealed and He preached only “the Word.”

“The Word” is an utterance from the mouth of God and Jesus was God’s mouth to men—all His teaching was the Father’s Word in one way or other. He confessed, “The Words that I speak unto you, I speak not of Myself.” He said, also, “As My Father has taught Me, I speak these things.” “The Word which you hear is not Mine, but the Father’s which sent Me.” Originality of doctrine finds no sanction in the Savior’s ministry—true ministers repeat what they are told, they do not fabricate for themselves—they are not spiders to spin a web out of their own insides.

Now, beloved Brothers and Sisters, let us remember this whenever we are trying to win a soul for Christ. Souls are won by “the Word.” It is the Word of God that is “quick and powerful, sharper than any two-edged sword.” It is “the Word” which is “the living and incorruptible Seed which lives and abides forever.” Therefore we must stick to “the Word.” “Oh,” say some, “there are many that have been sitting under the old-fashioned Gospel for years and they are not converted.” What do you propose to do? Do you propose to preach another Gospel? Look, Sir, if they were not saved by the Truth of God, they will not be saved by a lie!

It seems, practically, to be conceded that during revivals you may get a little beyond the Gospel. When there is an excitement upon the people, you may say things which are not strictly accurate and you may set yourself right, afterwards, when the desirable effect has been produced. This will never do! Not so the Savior—He spoke “the Word” unto them, whoever they might be, and He never altered that Word of God! I know of no condition of the human mind which can justify me in stirring, by the breadth of a hair, from what God has revealed! The Gospel is good at all times, in lukewarm times, or in fanatical times—and, blessed is he that moors himself to it, or rather is held fast by it and has no wish to go beyond it.

To deliver “the Word” is a plain, simple and easy process, for when we have a soul to deal with, the medicine is prescribed and we have only to hand it out. The meat, drink and medicine of souls is before us. We have not to consider from our own brain a salvation that will fit this sinner or that—God has already given us the salvation, the doctrine and the Truth which will suit all sinners who will accept it. Your judgment and your careful thought will be needed to select the fitting portion of the Truth. Your heart will be needed to pray over that portion that God may bless it. Your responsibilities are still great, but happily you are delivered from the more tremendous task of manufacturing a Gospel!

I see the modern-thought workmen with their bellows full of wind and their fire of very small coal. They are puffing away at a great rate. And now they take to hammering! See how the sparks fly! They are fashioning they know not what!

Neither do their people know what they may next forge upon the anvil. As for us, we invent nothing, but testify what we 2

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have seen and tasted and handled of the good Word of God! God has promised that His Word shall not return unto Him void and, therefore, we feel sure of a happy issue. We stand upon blessed ground when we determine to speak to the outside world the revealed Word and nothing else. Within the circle of “the Word” lies life, healing, peace, joy, holiness, Heaven—what more do sinners need? Oh that they would “receive with meekness the engrafted Word which is able to save their souls.”

Notice next, that our Savior, having no difficulty about His matter, but always speaking “the Word,” spoke it simply. He never affected profundity or obscurity. Our Lord has said many things so deep that they are lower than the abyss and He has spoken Truths so high that they are higher than the highest Heaven. But still He aimed at being understood.

Some divines are like the cuttlefish, which, when it descends into the sea, often opens its ink bags, darkens the water, and hides itself from all observers. It cannot see itself amid the clouds which it purposely creates! Too many preachers are endowed with these darkening ink bags! When they have simple Truth to preach, they surround it with an atmosphere of blackness, darkening counsel and involving simplicity in mystery! They are as the west wind, which brings clouds. They must be profound if they are anything.

Now, the Lord Jesus Christ had it in His power to be more profound than any man, for He knew all things. Yet He never veiled the Truth, but set it forth before the people with clear light and overcoming evidence. His speech was always plain as the sun at noon. See how your children will read the parables of Jesus and remember them. What is the best book to put before a child when it is learning to read? Why, the New Testament, for if there are difficulties in the sense, there are none in the words! What a multitude of monosyllables we have in John’s Gospel! The Lord Jesus did not carry a gold pencil case with Him, that whenever He met with a word of 12 syllables He might write it down and say, “That goes into next Sunday’s sermon, and so the people will know what a superior Person I am.”

No, but He looked about to find homely similes and instructive emblems by which to make the Truth of God plain as a pikestaff to those who wished to understand it. Of course the brightest light is lost on blind eyes, but Jesus never withheld that light. He was all simplicity, so that the children gathered around Him, clambered to His knees and loved to listen to the gracious words that proceeded out of His mouth! The parable was the most effectual way of conveying the Truth of God and, therefore, He used it often. And though it did hide the Truth from those who were hardened, yet that was their fault, and could not be laid at the door of the parable, which, in itself, is a right royal method of instruction—a method which throws the labor upon the teacher and makes it easy to the learner. Let us learn from our Lord’s example and remember that we must do the work for those whom we would bless. We must make attention an easy matter for them by clearly setting forth the Truths of God which we teach.

Dear Brothers and Sisters, when you are teaching others, take care that you, yourself, understand that which you would communicate! Whenever a man preaches so that you cannot understand him, the secret of it is that he does not understand himself, for if he knew what he meant to say, he would, probably, be able to say it and you would know what he meant by it. But he who is not clear in teaching, in all probability does not know what he means. Therein, full often, lies his pretended wisdom—you, perhaps, look up and wonder at this superior man, when, in fact, he is an inferior man swollen with pretense! It must be so. If he were better taught, he would teach better. When a man has studied the subject so that he gets a grip of it, he is able to set it out to others. But when it passes over his head like a bird of the air, he has not seen it and cannot describe it—and neither can any others learn from his language. Our Lord and Master taught in the plainest words and if His Gospel was hid, it was hidden only to the blind in heart.

Our Lord also spoke very suitably. He adapted His language to the ignorance or knowledge of His audiences. He knew that they would not receive abstract truth and, therefore, He seldom dispensed it. He wished to instruct rather than to amaze. On the occasion which Mark, here, records, “But without a parable spoke He not unto them,” it would have been unsuitable to have spoken in any other fashion. Do you notice Mark’s expression, “With many such parables”?

“Parables” and many “of them”—priceless illustrations were abundant with Him. But Mark says, “such” parables— that is, simple ones, full of the Light of God, for the parables in this chapter are particularly plain. The Truth of God seems to lie upon the surface of them and, “with many such parables spoke He the Word unto them.”

He saw that, just then, the minds of the people were feeble by reason of ignorance—they were as sheep not having a shepherd and needed careful tending. Though He did, sometimes, deliver the Truth of God without a parable, so that they cried, “Now speak You plainly, and speak no parable”—yet for the general, when dealing with the mass of those Volume 28

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whose minds were darkened by the Rabbinical teachers of the period, and by their own indifference to the Truth—He did continually use the simplest parable that could be found. Let us try to do the same. I heard a gentleman once say that he found it very difficult to bring his mind down to the capacity of children. But the fact was that he had no mind of any consequence! He thought himself great, but this was a clear sign of littleness! He had something which he mistook for a mind, but it was an error on his part to talk of bringing it down—it needed raising up!

Those who clearly know the Truth of God will find children to be a congenial auditory. They will pick up similes as pigeons pick up seeds and their little eyes sparkle as they catch your meaning. Therefore, “many such parables” let us speak to them! If they do not always care for the moral, they are, in this, like the people to whom our Lord addressed Himself, but He put the Truth in such a form that even if they did not care for it, they cared for the picture in which He set it forth and listened earnestly to His Words—and so the Truth of God was introduced to their minds.

Dear Friends, notice, again that our Lord spoke considerately. “With many such parables spoke He the Word unto them, as they were able to hear it.” What wisdom there is here—“As they were able to hear it.” Some of us are not so considerate as we ought to be and drench those to whom we would give drink. Our Lord was not too long in His discourses—He never wearied the people by a sermon till midnight, as Paul did. It is always better to send a congregation away longing than loathing! Our Lord knew that earnest attention involves effort and tends to exhaustion. True hearing lays a strain upon the mind which cannot be overly long endured. None of us have more than a certain quantity of attention and when we have used up that certain quantity it becomes tiresome for us to hear more.

We are like narrow-necked vessels and he who tries to fill such a vessel all in a moment will spill the most of the fluid.

The filling must be done gently; the water must be poured in as the vessel is able to receive it. So did the Savior, with short parables and sententious utterances, pass on from Truth to Truth, as the people were prepared to receive His instruction. He moderated the quantity, so that they might not be oppressed with too much. He taught “as they were able to hear it”—that is to say, He did not puzzle them with deep doctrine when He wished to save them—for it is poor work to confuse a man when you want to convert him. This Master Teacher gave forth such a quantity of Truth as His hearers’ hearts could take in and the matter was so chosen as to be on the level of their comprehension.

As for His style, it was so pleasing that they who did not believe in Him, nevertheless confessed that, “Never man spoke like this Man.” They were held as with golden chains by His enchanting manner, for He spoke with an evident love to them and with an anxious desire that they should receive the Truth of God and should be saved by it. Oh, dear Friends, if you want to be useful, be careful to speak considerately! If you go into a sick chamber and the person says, rd “Would you read me the 23 Psalm?” do not bawl it out, but read in gentle tones suitable to the poor pained ears and weary brain. If you have to speak a word for Christ, let it drop like the gentle dew from Heaven and do not hurl it out like a hard driving hailstorm! You cannot bully a man to Christ—you will be wise never to attempt it.

Load the camel as he is able to carry and the mind as it is able to bear. Hearts are drawn, not driven. We are not to teach as we are able to speak, but as the people are able to hear. We must not exhaust the hearer by our attempt to exhaust the subject. Never overdo a good thing, lest it be spoiled and rendered of no effect. To conclude this matter, our Lord’s address to the outside world was such that if they did not receive the Truth, the fault lay with themselves. It is true the mass of His hearers never saw beneath the surface, for they had no heart towards the Truth of God and so the parable did tend to their blindness—yet this was not the natural effect of His parable, but the misuse of it by slothful and carnal minds. Their foolish hearts were darkened.

Jesus made the Truth of God so clear that their bleary eyes could not bear the light! The difficulty with them was that there were so few difficulties—the Truth was hard because they were proud! Had they been taught of the Father, they would have come to Jesus and delighted in the plainness of the Word—but their pride blinded them, even as He said, “How can you believe that receive honor, one of another?” They rebelled against the Light of God and this was their condemnation! They were indignant at being forced to see what they did not wish to see and so they resolved to stop in the outward letter of the parable and go no further! Let us imitate the Lord Jesus in His endeavor to win souls by speaking in such a style that if they are lost, it shall be no fault of ours.

Dear Mr. Whitefield sometimes cried out, “O Sinners, if you are lost, it is not for lack of being prayed for, nor for lack of being wept over, nor for lack of an earnest anxiety on my part to bring you to the feet of Jesus.” Make a point of being able to say the same! In your class teaching, in your private talks with individuals, so speak that you can say, “I am 4

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clear of your blood. if you do not receive ‘the Word’ it is because you willfully refuse it. I have not concealed the Word of God, neither have I embellished it so as to confuse your mind.” Oh that every worker here might say, “I have strived to commend the Truth of God to every man’s conscience in the sight of God.” Let it be so plain that he may run that reads it.

It is better to speak five words which are understood than a thousand which merely dazzle the eye of the mind. Use earnest, hearty, entreating words. You cannot chill a man into Grace. I do not believe that anybody ever rode to Christ on an iceberg—frost and winter play but little part in opening the flowers in the King’s garden. If icicles hang from our lips, we shall not melt men’s hearts. Cold hearts must be thawed by the warm, genial influence of a sunlit soul. May Heaven’s light of love rest upon us. It will if we are truly taught of the Savior. And now, you that are outsiders, see what trouble the Savior takes with you, for what He did for men of His age, He does for men of every age—He longs that you should come to Him! He puts the Truth of God so that you may see it and He preaches it persuasively and affectionately.

Alas, that men should require such trouble to be taken with them! If anyone were giving away gold and silver, he would not need to go down on his knees and entreat men to accept the precious metals. But when we have to preach “the Word,” how must we entreat, implore, beseech men to come, or else they will not come at all! Nor even when we have implored and besought will they lend a listening ear and a believing heart unless the arm of the Lord is revealed. See you to this, you outsiders—let the reflection of this make you ashamed and cause you to resolve that from now on, having ears to hear, you will hear—and when Jesus pleads, you will bow to Him! May God the Holy Spirit make it so! Thus have we set forth the manner in which our Lord spoke with the outer circle.

II. Secondly, let us see how Jesus dealt with THE INNER CIRCLE when He addressed Himself to His own disciples—“And when they were alone, He expounded all things to His disciples.” A most precious text! I wish I had the whole time for a sermon upon it. Notice, first, then, that the Lord Jesus Christ opened up to them the inner meaning of the Word of God. Never yet did a man desire to learn of Jesus whom Jesus refused to teach. When men did not want to learn, He drew back and did not force Himself on them. He kept the exposition of His own teaching for those who were prepared to receive it and who really thirsted to obtain it—“When they were alone, He expounded all things to His disciples.”

Come now, dear Friends, do we not wish to learn? Shall the Word be to us a mere husk with its kernel gone? Are we not anxious to know the inner meaning of the doctrine? Shall we be content to observe the outside structure of the Truth of God, in the parabolic form, and not to enter into its secret chambers and live and dwell in the Truth of God, itself? If you desire to have all things expounded, note well that those to whom Christ expounded all things were His own disciples! You must become a disciple of Christ if you are to know Christ’s Truth. A disciple of Christ is one who accepts Christ as his teacher and himself becomes a learner. A disciple, however, is more than that—he is one who receives Christ as his leader and Lord.

“You call Me Master and Lord, and you say well,” said Jesus. Christ the Rabbi, the Master, is also Christ the Lord—the Teacher and Leader are one. If we are to be His disciples, we must do what He bids us, as well as believe what He tells us. Unless we are willing to tread in His footsteps and follow His example, we cannot be His disciples. And until we are such, He will not expound all things to us. Do you want to understand the Scriptures? Do you long to understand the deep things of God and the high mysteries of the Word? Then, first, become Christ’s disciples! “If any man shall do His will, he shall know of the doctrine.” The teaching of Christ is spirit and life. The rabbis taught the letter, but Christ teaches the life and if we submit ourselves to Him, to receive His life and to make Him our way, He will, only then, be to us the Truth of God! But if we refuse Him; if we will not yield to Him; we shall remain in darkness with all the rest of the outer circle— hearing, we shall hear and not understand—seeing, we shall see and not perceive. Oh, my Hearer, instead of trying to untie all knots and unravel all difficulties, first of all yield yourself to Christ! If you would know, believe and obey! You must trust Christ, first, and yield yourself up wholly to Him and then shall the Divine Light of the Holy Spirit come streaming into your soul to open up to you the things hidden from the carnally wise! First, we must be, in very deed, the Lord’s disciples.

Some versions have, here, the word, “own.” Tischendorf reads it, “To His own disciples”—to those whom He acknowledged as truly belonging to Him. Our Lord will surely teach His own. “When they were alone, He expounded all Volume 28

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things to His own disciples.” If we claim to be His disciples, we must cultivate a desire to learn. No man in holy lore learns more than he is willing to be taught. Certain ones who call themselves disciples of Christ have no wish to learn, but they have a great wish to teach before they have learned anything. See the many who run away half-hatched, with the shell on their heads and yet they try to crow! They cannot teach and they will not learn. If they would wait a little while and be instructed, their time might come—but they are so anxious to fight that they will neither put on armor nor gird on a sword!

They are eager to give drink to the thirsty but they cannot spare time to fill the cup. How can they sow if they have no seed in the basket? Can a man have anything which he has not received? And if he has not learned it of the Father, how can he go with any power to tell it unto others? We must be anxious to learn. Observe how our Lord Jesus prompts His disciples to learn. When He has given them a parable, He says, “Have you understood all these things?” He comes near to them when the crowd has dispersed and He says to them privately, “Have you understood all these things? The crowd knows nothing, but they are gone. They have been pleased with My parables, but they have not entered into the soul of My teaching. Have you understood all these things?”

Now, at the end of a discourse that is full of Christ, this is exactly what Jesus says to you and to me—“Have you understood all these things?” Have you entered into the essential Truth of God and not been content to lie sleeping on the doorstep of the mere letter of it? The Savior wishes us to be inquisitive, searching into the meaning of “the Word.”

“Blessed are they that hunger and thirst” to know the meaning of His Words, for they shall be instructed, for, as I have said before, never did a heart hunger to learn and find the Lord unwilling to teach. We are to be His disciples and anxious to learn—it follows, in consequence, that we must confess that we do not know.

Many a man might have known if he had but been aware that he did not know. A sense of ignorance is the doorstep of the palace of wisdom. These men that needed to be instructed by Christ and to have all things to be expounded to them were the very pick of the saints—out of them came the Apostles and the 70 disciples—and these formed the first row of living stones laid upon the foundation to build up a spiritual house! And yet these admirable persons needed that they should be alone with Jesus to have all things expounded to them! Oh, Brothers and Sisters, let us not be so wickedly selfconceited as to fancy that we know everything!

Are there not some who think that they carry the Gospel and all the doctrines of it in their pockets as if it were a fivesided lozenge? They have condensed the infinite into a pentagon! If anyone knows more than they know, he is denounced as a heretic, hopelessly unsound! Let it not be so with us, for we dare not boast of such perfect knowledge. What do we know, my Brethren? If what we do know and what we do not know were put together there would be such a difference in the size of the volumes that they could not be bound to match! What we know is so little compared with what we do not know that we might safely take up the language of Isaac Newton, probably the greatest of human intellects, when he said that he had been like a child playing on the beach who had picked up, here and there, a beautiful shell, while all the great deep of the ocean still remained unexplored.

We are of yesterday and know nothing. Like children, we need teaching! Therefore let us be constantly coming to Christ. I do not mean you youngsters, only, but the graybeards, the most experienced and most advanced among us! Let us be sitting at His feet with Mary, listening to that heavenly voice which alone can expound all things to us! I beg you to observe carefully that these folk, whom Christ instructed in the inner sense, had to be separated from the multitude.

“When they were alone.” When they had got together as birds of a feather should. When, like sheep, they were penned in the fold—then the Great Shepherd fed them and not till then. Come you out from the world if you would learn the deep things of God! The more conformity to the world, the more shall we abide in darkness!

It is amazing what Light of God will come to a man when he learns to walk the separated path. There is a way which is narrow as a razor’s edge—along which none can walk but those whom Christ upholds—but if they are willing to walk there in strict integrity, keeping themselves from the temptations of the world and rising above the customs of society, they shall know the mind of God! “When they were alone.” When they formed themselves, as it were, into a Church and the rest of the congregation went to their own homes—when they distinctly acknowledged themselves to be Christ’s own disciples—then He expounded the Truth of God to them.

More than this, I will go beyond my text—if you and I wish to know the heart of our holy religion, we must get alone—even from the Church, with Christ. This is the pith of it—they were alone with Christ. If they had been alone 6

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and Jesus had not been there, they would have learned nothing. But they were alone with Him. Oh, Brothers and Sisters, let us practice more meditation! We are, none of us, as much alone as we ought to be in these busy days. I do not mean merely to pray and read, but to sit still and ponder and consider. More of that blessed silence, “frost of the mouth and thaw of the soul,” is what we greatly need! I find it good, in devotion, occasionally to cease praying and look up, gazing into the invisible. The heart kindles into admiration of the Person of Christ and the soul begins to speak to Him as to a friend, while all the inner man is still.

Do you know what it is to say, “I sleep, but my heart wakes”? Then it is that the Lord expounds unto us the Scripture! A good commentary is a great help, but communion with the Lord is better! If you want to understand a book, there is nothing like asking the author, “Pray, Sir, what do you mean by this?” And if you will hasten away to the Author of Scripture, how often you will understand what He meant, though the words perplex you! I believe you might go the round of all the ministers and divines now alive and say to them, “What does this mean?” and they could tell you what the letter meant—but after having done that, or without doing it—if you would ask the Lord Jesus, He would more clearly show you the sense of it.

Scripture is often like Gideon’s fleece, wet through with the heavenly dew, but you need to know how to press out the moisture and preserve it. The Lord Jesus can show you how to wring it till your bucket is filled! We get a precious text, sometimes, and hammer away at it, and it does not break up at all. But when we ask the Lord Jesus about it, He puts power into our arm of thought and the stone flies to shivers the next time we tap it, and we say, “Here is something I never thought to find! Here is a mass of gold within this quartz! Here is a diamond concealed within this common pebble—how came it there?” Lord, enlighten our darkness! Put Your fingers on these eyes, that they may behold wondrous things out of Your Law. You know the old Arab story of the Muslim who crossed his eyes with a magic ointment and straightway, instead of the common house in which he lived, he saw a palace sparkling with diamonds, radiant with rubies, adorned with emeralds and gold! After such manner the Lord opens up to us a passage of Scripture, by anointing our eyes with eye-salve that we may see! What sights have we beheld in the Word of God! We have been lost in wonder, love and praise! But the Lord does this to us when we are alone with Him. “When they were alone, He expounded all things unto His disciples.”

Now, Brothers and Sisters, I leave this part of the subject and conclude when I notice that, in order to get this precious exposition from Christ, we must regard Him as being the ultimate and final Interpreter. “He expounded all things to His disciples.” Those men had settled it in their hearts that they would believe whatever He said. His ipse dixit was to stand to them instead of argument—He, Himself, was to them the Word of God, the Revelation of the Most High, the mystic glass into which they looked and saw the Truth of God in all its Glory! When they were willing to have it so, they were instructed. The key of Scripture is Christ! The only Infallible Interpreter of “the Word “is Jesus, the Word! Him we may follow in every case with the utmost safety. There is more Truth of God in the Person of Christ than there is in all the books that have been written! We hear and read of this and that, “body of divinity”—but there is only one body of divinity—and that is the body of Jesus Christ!

Christ Jesus is our divinity. We hear of theology, sometimes. What is it? Theology, that is the Word of God, and what is that but Christ? Get, then, to be familiar with Him as with a friend, and you shall know what He means. I have heard of a wise man of whom they said in his biography, that to be acquainted with him was a liberal education. That if you went and stayed with him, you might put all your books away, for he was a walking encyclopedia. I can hardly think that of any mere man, but I am sure it is true of Jesus! Communion with Him is illumination! He is that choicest book in the Christian’s library which has more teaching in it than all besides! The hem of Christ’s garment is better than all the robes of philosophy!

There is more to be learned from His footprints than from the most profound reasoning of the most learned men. I commend to you, Brothers and Sisters, and to myself, also, that we continually sit at Jesus’ feet. Remember, it was of this that Jesus said, “Mary has chosen the good part.” She chose to be a learner. She chose to learn from the lips of Christ, Himself. May this good part fall to our lot, for if we are such learners as this, then our salvation is sure. He that is taught of God is taught aright and taught savingly! By such teaching our joy and pleasure will be greatly increased. There is little joy in the bare externals of the Truth of God—the joy lies within.

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Many a man has come to the Truth as poor children in the street on a Christmas night. They come to a house and look through the window and see the fire blazing merrily upon the hearth, but the snow is deep and their little feet are pinched with cold. If they could enter that cozy parlor, they would have warmth and comfort, but in the street all is miserable. O you that are outside the Truth of God, peering through its windows, you get none of the joy of it! Pass through the Door, which is Christ, by a loving faith, and then its entrance shall give you light! The joy and mirth of the Truth of God are with the family of God who bask in the light of His Countenance! It is for your salvation! It is for your delight!

It is for your security, too, for He that knows the Truth will triumph over temptation. He who has been taught of Christ can meet the objections of the ungodly. There is more argument for the Gospel in Christ, Himself, than in all Apologies and Evidences that were ever written. Many defenses of the Gospel have now been prepared and we are thankful for them—but if you get to Christ, Himself, you do not need such protections! It is to me an unnecessary work when I read defenses of Inspiration and of the Gospel. Confirmed Believers do not require them! I know the Gospel to be true! I am assured of it in my inmost soul! If anybody were to write a book about the excellences of my mother and ask me to be a subscriber, I should say, “I know more about it than you do. I do not need to read, or listen to arguments. I am quite beyond it, for I know her loving care for me.” The love of Christ shed abroad in the heart is its own evidence! Do they tell us there is no Christ? No Christ? Then all life must be a dream, for we know Him and have seen Him with the mind’s eye!

Sometimes they say there is no Heaven, as Atheist did in Bunyan’s, “Pilgrim’s Progress.” “What?” says Christian to his companion, “Did not we see it from the top of Mount Clear when the shepherds lent us their optic glass?” Thus the Lord brings eternal things and especially His dear Son so vividly before our consciousness that we laugh to scorn the wisdom of the skeptic, which is but folly! Let us be earnest to get heavenly instruction from Christ, for then we shall be useful—and that is the end we aim at. If you do not know the inner Truth of God, what good can you do? Here you live in this world among blind men and they say, “Lead us!” But if the blind lead the blind, they shall both fall into the ditch.

No! No! You must get your own eyes opened and must know Christ and be known of Him—then you can help the poor blind sinner and you can guide Him to Jesus! No one knows of what usefulness you will be capable of when you have been taught of the Lord! God do so unto you, for Jesus’ sake. Amen.

Adapted from The C. H. Spurgeon Collection, Ages Software, 1.800.297.4307

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