What's shareholder value when the board fires the owners?

Long-suffering supporters of Liverpool FC had something to cheer about, even if they lost the first game under new ownership to their cross-town rivals, Everton. It wasn't an unreserved delight. Having bemoaned the club's American owners for years – what could Americans know about football! – the club had been bought by another American. The ignominious exit of Tom Hicks and George Gillett was cheered nonetheless, after they left the club heavily in debt, unable to buy new players, and off to the worst start to a season in living memory, hanging on at the bottom of the league table. Hicks and Gillette were forced to sell their shares after losing support of a majority of the Liverpool FC board. Good for football, perhaps, and almost certainly good for Liverpool Football Club. But what does it tell us about corporate governance, when owners lose support of boards? The lesson is nuanced but clear.

Leave to one side the court cases: Both the High Court in London that backed the sale and the court in Dallas, Texas, that sought to block it, considered the finer points of property rights and contract. Those are important, but only in law. The story of boards lies elsewhere.

The Liverpool FC saga is a rare drama, where we can watch corporate governance unfold in a pure form. It didn't follow the script.

For more than a quarter of a century, the field of corporate governance has built up a central view – expressed in codes of conduct, in a voluminous academic literature based on agency theory, and in much of the public policy debate: boards work for shareholders. Agency theory gives both economic and moral justification to shareholder value as the central purpose of corporations. It sees the job of the board as making sure managers maximise shareholder return and not siphon off economic rents.

In public companies, with thousands or even tens of thousands of shareholders, deciding what constitutes shareholder value is less than straightforward. In this case, however, there can be no doubt. Yet the board voted – 3 to 2 – to reject explicit demands from shareholders. The two dissenting voices were the owners. Not representatives of the owners, not someone at the end of a long chain of fiduciary and beneficiary relationships. The owners. The board refused to stand down even when the owners voted by100 per cent to zero to dismiss them. Instead, the board fired the owners.

With big loans coming due and not renewable, most of the value Hicks and Gillett may have once enjoyed as shareholders was gone. Failing to find new funds would certainly have thrown Liverpool FC into administration, taking matters out of the hands of the board. But doing so might, just might, have left the owners with a small chance of salvaging some value, at some time, for themselves.

Yet the board chose in selling the club to New England Sports Ventures to ignore shareholders' wishes, even in the face of a probable lawsuit, against directors personally, for breach of trust. Why?

In law, the board's primary duty of care is to the company and its "members", that is, the owners. It seems unlikely, however, that the board based its decision purely on analysis of the ambiguities of the Companies Act of 2006. They took, I suspect, an ethical stance. What was, then, the "right thing to do"?

Ethical debate splits on how even to ask the question. Duty-based ethics demand that directors submit to a priori claims, ignoring the consequences. The board had a moral obligation, one might then contend, to Hicks and Gillette. That interpretation of duty is, however, precisely what the fans so noisily rejected. The duty of directors, they might argue between choruses of "You'll Never Walk Alone", was to the club, the fans, the tradition. This is a stakeholder view of duty, and it differs deeply, fundamentally from the duty to owners.

Utilitarianism – which underpins the concept of utility in neo-classical economics and with it aspects of company law – gives a different way to decide. It asks directors to weigh the outcomes of options and then decide. The value Hicks and Gillett perceived was higher without the forced sale. But sitting uncomfortably at the bottom of the Premier League table, Liverpool FC was already contemplating the spectre of relegation. Key players would surely leave in the January transfer window. A fall into administration would cost the club nine points, making relegation palpable if not quite inevitable. So a wider utility function – let's call it strategic and not shareholder value – gives the board ethical backing to go against the wishes of the owners for the sake of a greater value for the business.

Which of these ethical considerations motivated the decisions of the Liverpool FC board? Only those inside could know, and they might not have followed a clearly analytic route to their choice.

Unlike this case, very few corporate decisions go to the courts for final approval. Boards carry the final responsibility. So it matters for all companies how boards determine what's right. This case shows that when push comes to shove – as it once did on the terraces at Anfield and seems to have done in the boardroom this month – directors don't always back shareholder value. Sometimes they back the business.

Source document: The Guardian's account of the transfer speaks more of football than corporate governance.