I have been writing a series of papers that examines what systems theory is and whether it can be used to think through problems of corporate liability. This blog post provides an overview of two of the three published papers (both published in the second half of 2023).
Current models of the company derived from agency theory and its off-shoot team production theory are not satisfactory in thinking through liability problems. Agency theory is not satisfactory because it is reductionist and sees the company as a nexus of contracts centred upon the shareholder-manager relationship. Team production theory is not satisfactory because it sees the company’s internal hierarchy as having the main task of resolving intra-corporate disputes (that is, among input providers). The theory has no purpose when there are no such disputes and is not concerned with external claims.
Von Bertalanffy developed systems theory to overcome reductionism in the biological sciences. He expanded his theory into the work General Systems Theory published in 1968 on the basis that reductionism had become a problematic feature across all of the sciences. This problem impacted upon scientists’ ability to understand phenomena because they were being studied in isolation and without due regard to important internal and external (to the environment) connections. General Systems Theory sees living things – including plants, animals, business organisations and economies – as comprising elements, purposes, boundaries, connections, and feedback loops.
Belinfanti and Stout (2018) used systems theory to model the individual company. They explained that different corporate roles evolve in order to reduce complexity in terms of the digestion of information required for decision-making and the scope of decision-making. Corporate roles are connected to each other by the corporate hierarchy. In ‘Corporate Liability: A Systems Approach’ in M Petrin and CA Witting (eds) Research Handbook on Corporate Liability (Edward Elgar, 2023), chapter three, I develop this understanding and I incorporate further insights from organisation theory. I explore how the managerial hierarchy is structured and how it operates before turning to issues of corporate liability.
One way to think about liability issues is to think about how regulatory fines and compensation awards levied against the company can be seen as feedback from the environment, which leads to internal change. Vicarious liability works in this way, liability judgments communicating to the company the need to organise itself to reduce employee wrongdoing. Internal organisation happens through the managerial hierarchy – which connects senior managers, middle managers, and front-line employees. Companies achieve internal reform through changes in policies, procedures, cultures and routines (collectively called ‘integrating mechanisms’). Vicarious liability extends to employees but not to independent contractors because the latter individuals are not responsive to the liable-company’s managerial hierarchy.
‘Companies, Groups and Supply Chains: Structures and Responsibility in Tort Law and Beyond’ (2023) 29 Tort Law Review 224-42 [‘TLR’] follows up on both the above chapter and ‘Corporate Groups: System, Design and Responsibility’ (2021) 80 Cambridge Law Journal 581. The latter piece applied systems thinking to the problems of the corporate group. The point I make in the TLR is that both individual companies and corporate groups feature a managerial hierarchy. In corporate groups, this is a hierarchy comprising the parent company, second-tier ‘segmental parent companies’, and third-tier operating companies. The parent creates group structures and exercises indirect control through group-wide integrating mechanisms. (But it is worthwhile noting that, where necessary, the parent company can intervene in the affairs of the subsidiary. Because most subsidiary companies are wholly owned, intervention occurs by a parent company senior executive telephoning senior executives in subsidiary companies and indicating what is desired. If necessary, the subsidiary board can ‘rubber-stamp’ any policy change. What controls is the managerial hierarchy and not the group’s board structure.)
A hot topic in corporate law scholarship is the problem caused by use of outsourcing and supply chains, which take advantage of low-cost labour in developing countries. This is typical in industries such as the clothing industry. The issue is whether ‘lead firms’ in advanced jurisdictions should be made responsible for imposing minimum operating standards along their supply chains. In considering this, some commentators have likened supply chains to corporate groups – assuming hierarchy and control to be present in lead firms – so that it is sensible to impose governance rules on lead firms. This sort of thinking is behind the proposed EU Corporate Sustainability Due Diligence Directive (CSDDD).
The TLR article seeks to explode ideas about the ability of lead firms to effectively ensure proper labour conditions and protections along the supply chain via ‘contractual governance’. There is no analogy between the hierarchical structure in a corporate group and the horizontal structure in a supply chain. Even if lead firms have a great degree of market power, they have no levers of structural control because there is no identifiable ‘organisation’. Supply chains are always changing. As cheaper suppliers are located, the chain forms and reforms. The lead firm typically contracts directly with a handful of first-tier suppliers only. Yet supply chains can be long and extend across multiple countries (across geographical space, languages, and cultures). No managerial hierarchy exists through which reform can be effected.
All of this makes the proposed CSDDD – which seeks to impose human rights, labour and environmental standards along contractual chains that branch out from larger companies headquartered or operating in the EU – a very ambitious piece of legislation. In fact, my TLR article argues that it is too ambitious and will not work. It is interesting that the CSDDD proposal is now running into problems. As at the time of writing, the German Government has indicated that it will not support its passage through EU law-making institutions. The reason – asserted by the German FDP party, which is in the ‘Traffic-Light’ Coalition Government – relates to the great cost and expense that the CSDDD will cause to EU based businesses.
My TLR article indicates that the cost and expense would be incurred for very little positive result. Responsibility for human rights, labour and environmental conditions in developing countries cannot be reformed from the EU through supply chains. This becomes clear when one uses systems theory to compare vertical business structures (organisations) with horizontal business structures (supply chains) and to examine the operation of feedback loops and managerial response processes.
Keywords: Groups, companies, supply-chains liability, theory
AUTHOR INFORMATION
Professor Christian Anton Witting is Professor of Law at the National University of Singapore and the Deputy Editor of Singapore Journal of Legal Studies.
Email: lawcwit@nus.edu.sg