Friday 17 February 2017 6:00 am

We need a nuclear weapon to end bad behaviour in business: Revoking limited liability

Slowly but surely a consensus is forming around some of Theresa May’s proposals for reform of corporate governance.

In executive remuneration this means a recognition of the need for simpler structures and an end to complex share schemes. In the matter of corporate relations with stakeholders, it means a concerted effort to beef up Section 172 of the Companies Act, which requires boards to take account of the interests of customers, suppliers and employees.

True, there is still some hard work ahead to put flesh on the bones of these ideas, but we are still much further behind with the third and critical priority of bringing unlisted companies more closely into the corporate governance net. At the IBE we believe this might be achieved by a review of what the government itself calls the “privilege” of limited liability.

Read more: Firms should embrace the PM's radical corporate governance reform proposals

Limited liability is a cornerstone of corporate finance because it protects shareholders from being responsible for a company’s debt. This enables them to invest with more confidence and thereby provide the capital that companies, small and large, need to grow and thrive. It would be quite wrong to drop the concept overnight, but it is surely sensible to ask the question of whether it is an inalienable right or instead a privilege that might in extreme circumstances be revoked.

The idea is relevant because it would apply equally to both listed and unlisted companies in a way that most of the current corporate governance framework does not. Getting to grips with privately held companies is important because, as the case of BHS reminds us, some of them are large with considerable social impact. Conversely many of our largest listed companies are not really “British” at all, but in practice multinationals which happen to be listed here even though they have relatively small impact on our society.

The loss of limited liability would be a dramatic prospect for any company since it would mess up its finances completely. Shareholders would rush for the exit and creditors would demand prompt repayment. So giving the government power to remove it is like giving it a nuclear weapon. The idea, however, is not that the government would use this weapon often or even at all. It is more that its mere existence would act as a deterrent to egregious behaviour just as was the case in the nuclear sphere during the Cold War.

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What we need in the first instance is a government-led conversation with the business community and other stakeholders about whether, and if so in what circumstances, limited liability should be withdrawn. Wilful flouting of the Companies Act might be a justification, but there would also need to be a remedy that companies could take to avoid such draconian punishment. Complete replacement of the board might be the answer.

For most companies which act within the law and behave responsibly, in particular smaller companies, life would not change much at all. Those hell-bent on cheating might recognise the danger and behave differently. It is worth remembering that the threatened loss of limited liability would produce repercussions in the credit markets which would serve as a stark warning to those normally inclined not to worry about reputation or a blip in their share price. Similarly companies at risk from a flawed culture might be more inclined to get their act together.

None of this can be settled overnight or in the immediate aftermath of the current Green Paper. The consultation that ends this week is likely to produce some ideas that can be implemented quickly. Change to the way limited liability is perceived would certainly require very careful discussion to forge a real consensus. That will take effort, but a government which takes a long-term view of the health of the economy and the corporate sector should not give up and move on as soon as it has engineered a few useful headlines.