3.4.1.4 The participatory governance of the CIC and accountability

Like other limited liability companies, the governance of the CIC is regulated by the provisions of UK company legislation regarding limited liability companies. Likewise, CIC directors are subject to the rights and duties stipulated in the Companies Act of 2004 and the Companies Act of 2006, as well as to additional duties included in the CIC Regulations of 2005. Due to the asset-lock scheme and the CIC test, a CIC is obliged to serve – primarily – the interests of its community beneficiaries, i.e. the community constituencies addressed in its constitutional objectives. Accordingly, in the terms of the CIC Regulations of 2005, the CIC directors and members are encouraged to consider the community stakeholders and beneficiaries that they serve including the persons affected by the CIC’s activities. Such a requirement is expressed in Article 26(1) (a) and (b), which stipulates that a CIC shall report annually on ‘the company’s activities during the financial year (that) have benefited the community’.

Article 26(1)(b) continues that a CIC shall report annually on ‘the steps, if any, which the company has taken during the financial year to consult persons affected by the company’s activities, and the outcome of any such consultation’ in an encouraging rather than obligatory way.1 It is a statutory requirement for the CIC to provide a description of the steps that the CIC has taken to involve and consult stakeholders and persons who are affected by a CIC’s activities.2 Such description is submitted annually in a pre-arranged CIC report template provided by the CIC Regulator to any CIC. However, the CIC Regulations of 2005 have adopted what is considered a ‘light touch’ regulatory oversight, which rejects a tight and hierarchical supervision of the CIC’s activities regarding the CIC’s community objectives and asset-lock.3

In contrast, ‘external regulatory command and control structures’ are replaced in the CIC regulatory framework ‘by (semi) enforced self-control mechanisms’ that allow for ‘cooperation between the regulator and the regulated’.4 This means, according to Nicholls, a UK scholar, that the Regulator is not expected to apply an extended form of control and supervision over a CIC’s activity regarding compliance with the CIC test and asset-lock. Instead, CICs are encouraged to develop and apply self-controlled mechanisms and standards that safeguard the community character.5 The light touch regulatory regime applicable to CICs is also subject to the principles of proportionality, accountability, consistency, transparency and targeted focus, as noted by Nicholls.6

The legislative proposal regarding the CIC reveals that the UK Government, while drafting the CIC legislation, considered the active involvement of community stakeholders in the CIC’s corporate governance to be a very significant characteristic of the CIC.7 Accordingly, Regulatory Guidance was produced to indicate the best practices of involving community stakeholders in decision- making and the ways in which the CIC’s corporate governance structures could balance the interests of different stakeholder groups. Additionally, a statutory requirement obliges any CIC to seek the views and engage with community stakeholders.8 However, the UK Government’s proposal concerning the increase of the power of stakeholders in the corporate governance of the CIC ‘generated the greatest opposition of all the Government’s proposals’ in the public consultation regarding the CIC legislation and regulatory framework.9

In this debate, supporters claimed that a statutory provision is imperative to safeguard the involvement of stakeholders in the CIC’s affairs. In contrast, opponents claimed that such a provision is complex and difficult to monitor and that it may eventually become an inhibitor to the potential users of the CIC legal form.10 The debate resulted in the UK Government’s decision to issue a compromise. CIC’s were encouraged to ‘take appropriate steps to engage with their stakeholders’, while ‘the Regulator will promulgate good practice in engaging stakeholders’ and ‘companies will have to report on whether they comply, or explain why they do not’.11 This was captured in a statutory obligation for the CIC to describe, in an annual CIC report template provided by the Regulator, the steps that the CIC has taken to consult stakeholders and the persons who are affected by the CIC’s activities.12

The extent of involvement of stakeholders in the corporate governance of CICs varies in the UK. The diversity is also reflected in existing CIC reports. An empirical study, undertaken by Nicholls, examined 80 published CIC reports.13 It demonstrated that the aforementioned special CIC report template does not facilitate the consistent annual presentation of data provided by the CICs. It is noted by Nicholls that the completion of the CIC report regarding community and stakeholder involvement may be a practical and ‘symbolic’ action of the CICs with a view to maintain their CIC status.14 Subsequently, whatever is reported may not fully reflect what actually happens in practice. The diversity is observed in the content of the various CIC reports, which are of varied quantity and quality.15 Accordingly, the study of stakeholder participation in the governance of the CIC requires an in-depth examination, which involves the direct engagement of actors involved in this governance phenomenon.16

In explaining the discrepancy between the CIC’s practice and the reported outcomes, on the basis of the empirical findings of Spear et al., Nicholls, provides that certain emerging governance challenges take place due to an ‘entrepreneurial bias’ of social entrepreneurs.17 The governance challenges encountered by hybrid social enterprises exist due to the phenomenon of ‘entrepreneurialism’.18 Entrepreneurialism constitutes the developing of skills that are needed to run a business in organisations, which may combine commercial and social activities. Scholarship notes that these challenges, which may result in a governance failure, constitute barriers that could hamper social enterprises in achieving a balance in their hybrid governance structure.19

The entrepreneurial bias of the social entrepreneurs induces them to focus more on implementation of operations rather than transparency and effective reporting. The entrepreneurial bias, according to Spear et al. and Nicholls, shifts the focus of social entrepreneurs from being accountable to community beneficiaries to first recruiting board members with the right skills and experience, second managing membership and third balancing social and financial goals.20

With respect to the first, i.e. recruiting board members with the right skills and experience, Low suggests that the boards of hybrid social enterprises are more likely to exhibit a stewardship model and recruit members on the basis of skills and expertise rather than on the basis of a representative status. 21Doherty et al. confirm the diversity of boards of social enterprises in general, and the probability of recruiting members based on skills and expertise.22 They note that the board members of social enterprises are not predominantly representatives of the stakeholders that they aim to benefit.23 They also note that the governance structures of social enterprises are always determined by the applicable legal forms and reporting obligations. Accordingly, the board members are always exposed to institutional pressures to achieve financial sustainability, social value and stakeholder engagement.24

The tendency of social enterprises to adopt a stewardship model in their governance is conceptualised by Spear et al. and Nicholls as part of the entrepreneurial biases of the social entrepreneurs.25 However, it is understood that the stewardship model will make more sense for the governance of the hybrid social enterprise. The stewardship governance model will make more sense particularly in instances where social enterprises exhibit predominantly for- profit aspects. These are instances where ownership is exercised and a certain margin of asset (including profit) distribution is allowed to shareholders by law. Accordingly, the stewardship model mandates the decision-makers (managers) and shareholders to be partners based on the notion of trust, with an overarching objective to increase the organisational performance. All is done in a way that articulates and safeguards the social purpose of the social enterprise.26 Alternatively, if social enterprises exhibit predominantly non-profit characteristics, i.e. there is an absence of ownership and an absolute profit-distribution constraint is imposed, the democratic and stakeholder model of governance makes more sense for the governance of the hybrid social enterprise.

Mason et al. also indicate that a stewardship model for social enterprises moves away ‘from the inclusive representation at board level of a range of key stakeholders regardless of their strategic utility’.27 They claim that a stewardship model for social enterprises moves ‘towards a skill set (of managers and/or directors) that can more effectively manage the entire operation’ of the social enterprise. They proceed by explaining that a mix of representative and sufficiently skilled managers and/or directors is crucial for social enterprises.28 However, a significant trade-off in between ‘enabling stakeholder democracy and adapting to the demands of the market, forcing a change in philosophy at board level’ is a consequence that the social enterprise will always have to deal with.29 This situation, according to Mason et al., affects the legitimacy that social enterprises enjoy from their beneficiaries and stakeholders.30

With respect to the second, i.e. managing membership, in the empirical studies conducted by Spear et al. a significant challenge is also noted – especially in those social enterprises that are democratically governed on the basis of a membership regime, such as the CIC limited by guarantee – which is the problem of inactive membership, i.e. the members, who become gradually inactive in exercising their membership duties.31 According to Spear et al., in democratically owned and participatory-governed organisations inactive membership results in an impulse of such organisations to be governed ultimately by an ‘oligarchy’ of directors.32 This practice may lead to the decline of the company’s legitimacy, accountability and trust towards its members and stakeholders.

With respect to the third, i.e. balancing social and financial goals, Ebrahim et al. and Battilana and Lee, note that governance challenges emerge due to the hybrid character of the social enterprise that pursues a societal mission using market mechanisms.33 According to the scholarship, social enterprises deal with governance challenges regardless of their tailor-made legal form that seeks to accommodate their hybrid features. Scholarship notes that the CIC in particular could be challenged by a ‘mission drift’ when attempting to ‘generate enough revenues but without losing sight of their social purpose’.34 The mission drift challenge is due to: (i) the daily trade-offs of social enterprises, such as the ‘potential cost of attracting market investors for financing growth’ at the expense of a social mission, and (ii) no strict legal ‘requirement for empowering stakeholders other than investors’, which allow the governing bodies of the CIC to maintain a focus on the CIC’s providers of capital.35 Spear et al. also notice this type of governance challenge for social enterprises.36

Ebrahim et al. contemplate on the issue of accountability towards multiple stakeholders in social enterprises.37 The theories of Freeman and Reed suggest the prioritisation of such stakeholders in the governance of organisations, i.e. social enterprises, which could provide the appropriate resources for the viability of the organisation.38 Examples of such resource-providers are clients, customers, employees, volunteers, (impact) investors, and other financiers. Owing to the fact that social enterprises normally operate in markets that function poorly, social enterprises often have to deal with the scarcity of resources.39 Consequently, the decision-makers of social enterprises may seek the co-optation of those stakeholders that control the access to resources.40 This is what Ebrahim et al. call ‘upward accountability’, i.e. the prioritisation of the interests and the demands of resource providers into the participatory governance of social enterprises.41

However, social enterprises are also dependent on fulfilling of their social objectives.42 To that end, ‘upward accountability’ differs from ‘downward accountability’, i.e. the prioritisation of the interests and the demands of beneficiaries and community stakeholders into the governance of social enterprises in pursuit of the social purpose.

Although tensions may exist between the accountability demands of ‘upward’ and ‘downward’ stakeholders according to Ebrahim et al., both are equally significant for the sustainability of a social enterprise, such as the CIC.43 It is understood that ‘upward accountability’ is imperative for a social enterprise’s survival, whereas ‘downward accountability’ is necessary for implementing and maintaining the social purpose in a social enterprise.

Downward accountability also requires the adoption of stakeholder ‘enforcement’ mechanisms, i.e. representation and participation stakeholder mechanisms, in regard of the governing bodies, which safeguard the transparency and the scrutiny over the decisions made by social enterprises.44 According to Mason et al., it is imperative that the decision-makers of the social enterprises facilitate such routine processes.45

Community stakeholders who have an interest in the realisation of the CICs’ objectives, may assume membership of any CIC limited by shares or limited by guarantee either by being involved in its incorporation or during its active period. Various studies address the multi-stakeholder nature of social enterprises in connection to their membership and ownership regime.46 Membership could offer particular rights and obligations to extend community stakeholders’ participation and as such to increase the CIC’s legitimacy towards the community.47 These are, for instance, the rights of stakeholders to participate in the decision-making processes of the annual general meeting (hereafter ‘general meeting’) to appoint and to scrutinise the directors, to make decisions on financial distributions and liquidation of the company, as well as on changing the AoA, and finally, to be given access to information relevant to the company’s affairs.

Membership allows for a substantial role and a level of involvement of any type of stakeholder with the view to safeguard the community objectives. In particular, CICs are prohibited from permitting any person to appoint a director in exceptional circumstances other than a member and/or director and/or the Regulator.48 Such obligation allows for a certain level of stakeholder influence in decision-making. Additionally, the CIC members bear the most significant responsibility, namely to uphold the community objectives of the company through a monitoring role over the directors’ activities and through facilitating the supervisory task of the Regulator.49

The role ‘decision-maker’ entails the participation of stakeholders in the main decision-making processes of the CIC through the exercise of voting rights and the adoption of the most appropriate governance model in, for example, the board of directors and the CIC’s general meetings. Accordingly, community stakeholders may shape and direct the governance model of the CIC towards the use of a democratic and stakeholder-based governance model, which accommodates the interests of various representative stakeholder sub- groups of the community on an equal basis. Alternatively, a stewardship governance model could be used, which facilitates the appointment of trustful managers and decision-makers who are bound by the overarching community objective of increasing organisational performance.50

The role ‘consultant’ entails the participation of stakeholders in various stakeholder consultation mechanisms adopted by CICs with different characteristics. Consultation could be undertaken with the view of furthering the organisation’s downward accountability to its community beneficiaries and stakeholders by means of stakeholder mechanisms, which accommodate scrutiny over the decision-making processes, enhance transparency, and increase the legitimacy of the CIC to the community that it serves.51

The role ‘recipient of information’ entails the participation of stakeholders in the acquisition of information regarding the CIC affairs and decision-making especially when stakeholder participation through membership and decision- making is not an option. Such a role reduces existing asymmetries of information regarding decisions that are decided and/or pending to be decided between the decision-makers and the community stakeholders.52 Accordingly, decisions, which may seem inappropriate or incompatible to community stakeholders, i.e. concerning the use of various business methods for the maximisation of a community and/or social benefit are thus legitimised and balanced.53