From balanced enterprise to hostile takeover: how the law forgot about management
Published online by Cambridge University Press: 18 December 2018
We show that professional management began to emerge in UK companies during the first half of the twentieth century, a development which was widely theorised and accepted. However, the managerially-led enterprise was accommodated rather than protected by company law, making it vulnerable to changes in the law. The Cohen Report of 1945 paid no attention to these developments, and led to the introduction, in the Companies Act 1948, of important, but previously little appreciated, changes in the name of enhancing the accountability of directors to shareholders. The shareholders’ statutory right to remove the directors by simple majority overturned existing structures overnight and was an important driver of the hostile takeover, which emerged shortly afterwards. This deprived management of the necessary autonomy to balance the competing interests at stake in the enterprise and to foster innovation. The emergence of the current system of shareholder primacy can be traced back to these developments.
- Research Article
- Copyright © The Society of Legal Scholars 2018
We are grateful to the following for comments and feedback on this article: Christopher Bruner, Robert Burrell, Brian Cheffins, Simon Deakin, Ewan McGaughey, Jo Maltby, David Millon, Marc Moore, John Quail, Navajyoti Samanta, Jeroen Veldman, participants in a 3CL seminar at the University of Cambridge and in a Management and Organisational History Seminar at the University of York, delegates at a SMART conference at the University of Oslo on ‘Sustainable Business Models’, and the anonymous referees. All errors remain our own.
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82 See for example Scrutton J in Nelson v James Nelson & Sons Ltd  2 KB 471 describing the power given to the directors to appoint a managing director as ‘a very ordinary one in articles’.
83 Companies Act 1906, Table A, Art 72; Companies Act 1929, Table A, Art 68.
84 Directors would only be liable for ‘gross’ negligence, essentially a lack of good faith: Lagunas Nitrate Company v Lagunas Syndicate  2 Ch 392 per Lindley LJ.
85 In Craven-Ellis v Canons Ltd  2 KB 403 at 413–414, Greene LJ took the view that ‘A managing director is in a very different position to that of a mere manager since he is able to attend and vote at meetings of the board, and from the point of view of the company it was of importance that the person managing its affairs should be in a position to do this’.
86 See for example Burton , above n 23, p 5, noting that sometimes the roles of managing director and manager were combined, and that it was essential for full reporting to the board to occur.
87 In re Newspaper Proprietary Syndicate Ltd  2 Ch 349.
88 Southern Foundries (1926) Ltd v Shirlaw  AC 701; Goodwin v Brewster (1951) 32 TC 80.
89 Per Lord Reid in Harold Holdsworth & Co (Wakefield) Ltd v Caddies  1 All ER 725 at 738.
90 (1908) 99 LT 524.
91 In re County Palatine Loan and Discount Company. Cartmell's Case (1874) LR 9 Ch App 691 per Sir G Mellish LJ.
93 Report of the Committee on Company Law Amendment (Cm 6659, 1945) (Cohen Report).
94 Cheffins (2008), above n 7, pp 344–345, noting that by 1969, retail investors no longer owned a majority of the shares of UK public companies. High tax rates encouraged individuals to sell their shares and invest in other, more tax-efficient assets, including pensions and life insurance: see ibid, pp 81–82 and 341–349.
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98 The Cohen Report, above n 93, para 5, stated that its proposals for information disclosure would ‘ensure that as much information as is reasonably required shall be made available both to the shareholders and creditors of the companies concerned and to the general public’.
100 Ibid, para 119. This recommendation was specifically targeted at protecting shareholders, who were lacking ‘information as to the financial position and results of the undertakings in which they are interested’.
101 Ibid, para 101. This was a particularly controversial topic, and much time was spent discussing it.
103 It did propose giving the courts power to require, and making it easier for shareholders to demand, a Board of Trade investigation into the management of the company where this was ‘in the public interest’: Cohen Report, above n 93, para 156. However, there was no proposal to allow any group other than the shareholders to demand an investigation, and discussions about the introduction of public shareholders (see for example Minutes of Evidence, above n 43, Appendix M at 169) or company commissioners (see for example ibid, para 8134) during the hearings made no impact on the final report.
104 Minutes of Evidence, above n 43, para 7038.
106 See for example Mr Wilmot's description of shareholders as ‘proprietors of the business’ (ibid, para 1743) and his reference to the ‘original conception of control of the company by its proprietors’ (ibid, para 3682).
107 Clift, above n 97, p 44.
108 See Memorandum by the General Federation of Trade Unions Minutes of Evidence, above n 43, Appendix SS, and, for example, ibid, para 11274.
109 Company Law Amendment, Draft Questionnaire for Discussion, Cohen Committee Archive, CL3, BT 146/5.
110 Cohen Report, above n 93, para 5, emphasis added.
111 Ibid, para 7. The Committee's figures showed that, in a sample of large companies, 87.7% of the shareholders owned less than 300 shares (ibid, para 124).
117 Under Companies Act 1929, s 114, shareholders owning not less than one tenth of paid up capital carrying the right to vote were allowed to requisition an extraordinary general meeting, and the requisition had to state objects of meeting. Directors had to comply within 21 days, failing which the requisitionists could convene it themselves, with the company repaying their costs. This allowed shareholders to propose resolutions, including special resolutions. However, the Committee concluded that this power had become ‘largely illusory because with the great increase in the number of shareholders it has become difficult for any single shareholder, or even for a group of shareholders, to seek the support of their fellow members’: see Cohen Report, above n 93, para 128.
118 Cohen Report, above n 93, para 128, implemented by CA 1948, s 140 with slight changes to the time periods.
120 See Minutes of Evidence, above n 43, Appendix X at 350.
122 Cohen Committee Archive, CL 11A BT 146/5 (submission of by Stephen Gordon of Lawrence, Messer and Co).
123 Unfortunately, the minutes of the first 13 meetings of the Committee, BT 146/3 are missing from the National Archives.
124 Cohen Committee Archive, CL 72, BT 146/5.
126 Ibid, CL 142 (memorandum circulated for consideration at meetings to be held on Tuesday 1 August and Wednesday 2 August, dated 14 July 1944, para 11(6)).
130 Minutes of Evidence, above n 43, para 10190 (Evidence of Samuel Cash, partner in Vizards).
132 Cohen Report, above n 93, para 92.
133 Ibid. Ultimately CA 1948, s 193 introduced a rule requiring directors to disclose to, and obtain approval from, the general meeting for any payment made to them ‘by way of compensation for loss of office, or as consideration for or in connection with his retirement from office’. Failure to comply would result in the director holding the payment on trust for shareholders who sold their shares.
134 See for example the observation of Professor Goodhart that ‘it is possible… for directors to continue in office longer than may be desirable’ (Minutes of Evidence, above n 43, paras 5257 and 9481). Cohen pointed out that removal of life directors would require at the very least an extraordinary resolution (ibid, para 5148). See also the representations from the London Stock Exchange (ibid, para 6185 and Cohen Committee Archive, CL108A, BT 146/5).
135 Minutes of Evidence, above n 43, para 10194.
136 As Horace Samuel, who gave evidence to the Committee but did not discuss removal of directors, put it in his 1933 book, ‘Directorates thus tend to constitute the vested interest of a group, and being a vested interest, are almost as difficult to dislodge as the pocket-boroughs of the eighteenth century’: Samuel, H Shareholders’ Money (London: Pitman, 1933) p 120Google Scholar.
137 Hansard HC Deb, vol 438, cols 585–586, 6 June 1947.
140 Hansard HL Deb, vol 146, col 969, 1 April 1947 (Viscount Maugham).
141 Hansard HC Deb, vol 438, col 619, 6 June 1947 (Sir Hugh Lucas-Tooth, MP).
142 Hansard HL Deb, vol 145, col 862, 24 February 1947.
146 Hansard HL Deb, vol 146, cols 727–728, 25 March 1947; HC Deb, vol 441, cols 194–195, 28 July 1947; HL Deb, vol 151, cols 955–975, 5 August 1947.
147 Maltby, above n 95, at 47 and 54.
148 As Bruner puts it, ‘stronger social welfare protection… permitted the UK corporate governance system to focus more intently on shareholders without precipitating social backlash’: Bruner, C Corporate Governance in the Common Law World (Cambridge: Cambridge University Press, 2013) p 143CrossRefGoogle Scholar. For detailed discussion of the Labour Party's evolving approach to takeovers and mergers during the 1960s and 1970s, see ibid pp 151–160. It was only during the 1980s, with the rolling back of many of those reforms, as well as the weakening of trade unions, that those social consequences became clearer. We are grateful to an anonymous referee for suggesting this point.
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153 Gower, above n 36, at 1185–1186.
154 However, this approach to management appears to have persisted among those managers in a Northern City interviewed by Nichols in 1961–1962: see Nichols, above n 38, ch 17.
155 This was the Bank of England's working definition of a takeover from 1959, included in ‘Take-over bids, note of meeting at Bank of England on Friday 10 July 1959’, cited in Roberts, R ‘Regulatory responses to the market for corporate control in Britain in the 1950s’ (1992) 34 Business History 183 at 184CrossRefGoogle Scholar.
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157 Hannah, above n 131, at 67.
158 See JB Tabb Accountancy Aspects of the Takeover Bids in Britain 1945–1965 (unpublished PhD Thesis, University of Sheffield, 1968) p 10; Hannah, above n 131, at 71.
159 See Tabb, above n 158, p 11. In 1906, Lever exceptionally launched hostile bids for a number of his competitors who had refused to form a cartel with him, and another hostile bid was launched by John Knight Ltd in 1920.
160 In Guinnane et al's 1892 sample only one company required all directors to stand for re-election at each annual meeting: see Guinnane et al, above n 46, p 243.
161 Franks et al, above n 55.
162 Cohen Report, above n 93, para 92.
163 See eg Companies Act 1929, Table A, Art 77; Companies Act 1906, Table A, Art 83; Companies Act 1862, Table A, Art 63.
164 Guinnane et al, above n 46, p 244. Similarly, many companies provided that anyone seeking the office of director, except retiring directors or those chosen by the board, had to provide advance notice, potentially giving the directors ‘time to line up the votes to block anyone whom they did not favour from securing a seat on the board’: see ibid.
165 Clauses in the articles requiring consent of managing directors to particular decisions were enforced at the instance of a shareholder-director in Quin & Axtens Ltd v Salmon  AC 442. This effectively limited the powers of the board, because as Lord Loreburn put it, ‘the directors cannot manage it in a particular way – that is to say, they cannot do certain things if Mr Salmon or Mr Axtens objects’ (ibid, at 443).
166 Guinnane et al, above n 46, p 244.
167 In the Court of Appeal decision in Quin & Axtens, Farwell LJ considered the provision in the articles to be ‘a most usual and proper requirement, because a business does require a head to look after it, and a head that shall not be interfered with unnecessarily’. The effect was that ‘to oust the directors, a special resolution would be required’: see  1 Ch 311 at 319.
168 For discussion see Bruner, above n 148, pp 39–40 and 208–209.
169 Hannah, above n 8.
170 CA 1929, ss 95 and 98 required companies to maintain and make public a register of members. However, s 101 provided that trusts of shares did not have to be entered on the register, making it difficult to identify beneficial ownership. The Cohen Committee made proposals to require nominee shareholdings to be indicated and beneficial interests of more than 1% to be disclosed (above n 93, paras 78–81), but these recommendations did not become law.
171 As in the bids by Daily Mirror for Amalgamated Press in 1958 and Viyella International for Jersey Kapwood in 1966: see Tabb, above n 158, p 191.
172 Ibid, at 188, identifying at least 13 partial bids between 1948 and 1965. For example, in its bid for Drake & Mount, Longman only offered to buy the first 10,000 shares tendered. There was no regulation of partial bids until the introduction of the City Code in 1968.
173 As in the bid of Westminster Bank for Diners’ Club Ltd in 1965: see ibid at 189.
174 As in the 1961 bid by City Centre Properties Ltd for Manchester Royal Exchange: see ibid at 192. The Revised Notes of 1963 required the bidder to disclose the level of acceptances, but this rule was subsequently broken by British Oxygen which declared its bid for Murex unconditional but delayed disclosure of the level of acceptances by six hours: ibid at 262.
175 Bull and Vice show how, provided they acted in good faith, a majority shareholder could then use their control to withdraw surplus cash from the company by selling assets to it: Bull, G and Vice, A Bid for Power (London, Elek, 3rd edn, 1961) p 227Google Scholar. The shareholder's ‘sell out’ right was not introduced until 1986.
176 See for example the bid by Broadmead for Murdoch & Co in 1957 or the 1958 bid by Reynolds for British Aluminium, in which Reynolds warned shareholders publicly that it was close to gaining control, and that once it had control of the company, it would instate a ‘prudent’ dividend policy: Tabb, above n 158, p 60.
177 In 1963, Courtaulds took control of Bairns-Wear Ltd and cut the dividend from 10% to 5%: see ibid at 246.
178 From a sample of 45 takeovers between 1947 and 1960 (which did not distinguish between voluntary and involuntary takeovers), Singh found that ‘around half’ of the directors of the acquired company were dismissed within two years of the takeover, but that ‘the incidence of dismissal seems on the whole to have little relationship either to the size or the profitability of the acquired firm’: Singh, A Takeovers: Their Relevance to the Stock Market and the Theory of the Firm (Cambridge: Cambridge University Press, 1971) p 149Google Scholar. These figures form a marked contrast to the findings of Franks et al, above n 55, in relation to takeovers between 1919 and 1939. We are unaware of any quantitative study of director removal during the UK 1960s takeover wave, but indirect support for the development of a new threat to the position of directors and management can be found in the growth of structural defensive measures between 1950 and 1965, a dynamic which came to an end as institutional investors mounted opposition to this (ibid p 603, Table 10.8), as well as the post-bid defensive measures in companies such as the Savoy Hotel, and those which came before the courts in Hogg v Cramphorn Ltd  Ch 254. By the 1980s, board removal appears to have been routine following a hostile takeover: in a study of hostile takeovers in the UK from 1985–1986, Franks and Mayer found that 90% of directors were replaced within two years of the bid, whilst for accepted bids the figure was 50%: Franks, J and Mayer, C ‘Hostile takeovers and the correction of managerial failure’ (1996) 40 Journal of Financial Economics 163 at 167–168CrossRefGoogle Scholar.
179 This appears to have happened for the first time in the takeover by Fraser of Binns in 1953. The directors held 29% of the shares, preventing Fraser from using the squeeze out rules (CA 1948, s 209 required the bidder to have acquired 90% of the shares), but they capitulated once Fraser acquired a majority of the shares, and sold their shares to him at the lower price of his first bid: see Bull and Vice, above n 175, pp 109–110.
180 The directors of the Savoy Hotel Ltd appear to have been the first to have tried this: see Bull and Vice, above n 175, pp 29–46.
181 For discussion of the scope of defensive measures under common law and under the City Code see Johnston, A ‘Takeover regulation: historical and theoretical perspectives on the City Code’ (2007) 66 Cambridge Law Journal 422CrossRefGoogle Scholar. One further possibility was to give the directors weighted voting rights on a resolution to remove them, as permitted by the case of Bushell v Faith  1 All ER 53. However, there is no evidence that this mechanism was used in the UK as a pre-emptive defence against hostile takeovers. If adopted on incorporation, this would reflect the agreement between the founders (and indeed such clauses are widely understood as a means of protecting agreements within quasi-partnership companies), but it would be difficult to introduce such a clause after listing, as this would require a special resolution to alter the articles, and institutional shareholders would be strongly opposed to a measure that would entrench board members. This hostility can be seen from their opposition to the use of non-voting shares, which were used for a brief period as a defensive measure during the 1950s and 1960s, but were gradually eliminated by strong opposition from institutional investors and disapproval from the stock exchange: Franks et al, above n 55, p 604. This hostility presumably explains why multiple voting rights are legally permissible but rarely seen in practice in UK listed companies: see Armour, J et al. ‘Law and financial development: what we are learning from time-series evidence’ (2009) 6 BYU L Review 1435 at 1459 fn 87Google Scholar, noting that there was ‘no legal or regulatory prohibition of multiple voting rights’ between 1970 and 2005.
182 In 1960, British Drug Houses responded to a bid by doubling its dividend, whilst in 1962, Waterlow & Sons Ltd responded by selling off its head office and distributing the proceeds to shareholders: see Tabb, above n 158, pp 61–62.
183 The first example of this appears to be the contested takeover in 1955 of Millspaugh by Hadfields. The rival bidder was defeated once Hadfields obtained a majority of the shares. See Bull and Vice, above n 175, pp 166–183.
184 Report of the Company Law Committee (Cmnd 1749, June 1962), Note of Dissent, paras 6 and 9 (Jenkins Committee).
185 Hannah, above n 131, at 69–71 and 75.
187 Bull and Vice, above n 175, pp 16–18. For details of marginal tax rates of top rate taxpayers during this period, see Cheffins (2008), above n 7, p 342.
188 The Wilson Report concluded that the extent of direct contact between institutions and companies ‘varies greatly’: see Committee to Review the Functioning of Financial Institutions (Cmnd 7937, 1980), para 900. In 1989, in a Bank of England discussion paper, Charkham concluded that while dialogue did occur ‘on occasion’, most shareholders had ‘all but abdicated’ their responsibilities under the system of ‘shareholder supremacy’: J Charkham ‘Corporate governance and the market for companies: aspects of the shareholders’ role’ Bank of England Discussion Paper No 44, November 1989, 4.
189 We are grateful to John Quail for suggesting this point. Franks et al, above n 55, p 586, highlight the importance of ‘the growing influence of institutional investors… in establishing the United Kingdom's unusually active market in corporate control’.
190 Hannah, above n 131, at 5 fn 69.
191 Jenkins Committee, Note of Dissent, above n 184, paras 4 and 7.
192 Cheffins (2008), above n 7, pp 76 and 363. At p 332, Cheffins notes that the new right of the majority to dismiss directors before the end of their term was stricter than the stock exchange requirements.
193 Bruner, above n 148, p 147.
194 Moore, above n 3, p 212.
195 In 1954, The Economist argued that if companies have financed themselves through retained earnings, but those ‘resources are successfully employed to yield their best economic return, the companies never will be will be, or need not be, “victims” at all, for the bidder will defeated. But if the assets are not yielding a proper return, then even the bidder who “merely” wishes to take possession of them will generally be performing an economic service to the community’: The Economist, 23 January 1954, p 254. In 1961, Bull and Vice approved of the argument that ‘the bidder makes the most efficient use of a company's assets’, whilst ‘many boards in the past have tended to adopt excessively long-term schedules’: Bull and Vice, above n 175, pp 25–26.
196 In 1953, the Bank of England had expressed opposition to the emerging hostile takeover, but by 1958 had given its approval: see Roberts, above n 155, at 187 and 191.
197 Jenkins Committee, above n 184, para 265.
198 Ibid, Note of Dissent, para 9: ‘Efficient directors who have treated their shareholders fairly and frankly should have little to fear from a raider’ and should not be allowed to protect themselves against this ‘remote risk’ by issuing non-voting shares and ‘converting themselves into a self-perpetuating oligarchy’.
201 Johnston, above n 181.
203 Ireland, P ‘Defending the rentier: corporate theory and reprivatization of the public company’ in Gamble, A, Kelly, G and Parkinson, J (eds) The Political Economy of the Company (Oxford: Hart, 2001) pp 144–145Google Scholar.