Incomplete contracts

Once the state chooses to outsource public services, the outsourcing instrument – usually a public or concession contract – becomes the key mechanism for the extension of public control over their private delivery. The success of outsourcing then ‘hinges on the viability of the outsourcing contract as a fully effective junction of instruction’ between public authority and private provider. But given the complexity of many public services, the contractual governance mechanism has some inevitable limitations. Bar perhaps in the simplest procurement of public goods, it is quite impossible or impossibly costly to anticipate all contingencies and service obligations in detail in the contracting instrument.

Certain contingencies are unpredictable (such as a natural disaster or economic crisis), and others are difficult to foresee (such as unexpected or unaccounted needs). Yet other elements are ambiguous precisely because they relate to quality-related service standards that are non-contractible, as is often the case in relation to personalized services – as in the care sector, where services rely heavily on qualities such as maintaining a sense of patients’ personal dignity, trust between patients and carers, and continuity of care. These often depend on standards that relate to organizational values as much as the more tangible conditions of their delivery, such as the employment conditions of carers. While the latter can at least potentially be specified in a public contract to some extent, the former are harder to define and enforce contractually. This poses a double challenge of predicting both contingencies and how a specific provider might react to them.

Given the incomplete nature of complex public contracts, the need for adaptation will arise as gaps and ambiguities in the contract emerge. Ideally, the contracting parties will fill these out by informally renegotiating their relationship without negatively impacting the quality of service delivery. But an important factor to consider in this context is that successful adaptation can be considerably more difficult in the case of public contracts compared to private contracts. The reason lies not in any distinction related to scale or complexity, nor in how much uncertainty there is to tackle, or in what form. On these issues, private and public contracts give rise to broadly similar difficulties. What is different is the typical incentive structures in the contracting relationship.

Primary objectives

Where the state decides that the market cannot provide certain goods or services in sufficient quantities or quality, or in a sufficiently just distribution, it considers whether to take political responsibility for their provision as a public service. This includes, most obviously, security, education and healthcare, but also potentially other essentials like transport, water, energy and electronic and postal communications. In deciding whether to assume any particular responsibility, it determines the public need and the opportunity costs of meeting this need as a public service, balanced against other priorities and the quantity, quality and distribution of the same goods or services by the market. Whether and to what extent it should intervene is a political choice for which it must be accountable politically.

The extent of these political choices varies. In healthcare, for example, the US model historically encourages markets in health insurance and healthcare services, while European states tend to take political responsibility for health as a public service as part of a state-funded system. How these choices evolve is not always linear or predictable. A change in political leadership or an external trigger like a global crisis can bring about sudden shifts. For example, COVID-19 caused many governments to take on unprecedented levels of responsibility for the provision of healthcare equipment and services. Conversely, the global financial crisis in 2008 led many states to shed responsibilities to rein in spending.

Just because the state assumes responsibility for a service does not mean that it must become the provider. It also decides whether to deliver the service directly (in-house) or to contract for its delivery by private actors (outsourcing), usually through some form of competitive tendering process (public procurement). We can understand this decision through the lens of discretion and agency. Many of these services are highly complex. They necessitate discretion in delivery that cannot be efficiently assumed centrally and is, then, necessarily delegated to agents. By selecting either a public or private delivery model, the state determines who should exercise that discretion and what form of governance regime to impose on them.

Policy design

The incorporation of sustainable corporate ownership into public procurement would require careful planning. The state would have to provide contracting authorities with a clear understanding of its expectations under a new policy, noting especially what is, and is not, expected and possible for contracting authorities to do under the current public procurement legal framework. This policy would also have to be reflected in adjustments to various contracting guidance documents, including the national procurement policy statement, to support these strategic changes. We can expect some of these changes to be relatively uncomplicated. They would effectively refocus the regime on criteria that reflect governance in sustainable corporate ownership, enabling and encouraging contracting authorities to include these criteria in their public procurement as part of their tender evaluation procedure and/or as a condition to tender (reserved procedure), as long as to do so can be considered to align with the overarching delivery of value for money. In doing so, the state would give contracting authorities the option to specify that private firms contracted to deliver public services demonstrate corporate governance reflecting elements of sustainable ownership and, under certain circumstances, give preference to those that do. In practice, it would be necessary to ask suppliers, when they submit a tender or pre-tender questionnaire, to include their constitutional documentation (in the case of a company, their articles of association) and any other relevant company documentation (for example, shareholder agreements) as evidence of any elements of sustainable ownership design which are incorporated there, including in relation to criteria of corporate purpose (beneficiary rights), decision-making power (control rights) and profit distribution (economic rights).

We can assume that aspects of this transitioning process are relatively low-cost. The state would change its tendering strategy, and while this might require some policy or even legal changes, further demands on resources would be limited, broadly speaking, to providing education and information regarding the new regime. Once a commitment to a new policy has been made, it would be relatively easy to implement in practice initially. The greater challenge would be to ensure the benefits of such a policy are fully realized in the medium term and long term.

Reversing financialization

The state may seek to reverse financialization in the corporate economy by awarding more public contracts to private providers in sustainable ownership. In this way, it may address an important secondary purpose of nurturing a less financialized corporate governance model and more sustainable design of corporate ownership in the wider economy while, at the same time, improving the outsourcing of public services – aspiring to create win-win. Initially at least, providers in sustainable ownership may rely on the largesse of the state by receiving payment for public service delivery as a form of nurturing, so that by delivering public contracts, they expand their capacity to operate as economically independent firms. This may, in the case of small firms or startups, act as a form of incubation to help them grow initial capacity to become established and eventually able to deliver not just more public contracts but also private contracts. In the case of larger and already established firms in sustainable ownership, it may nurture their continued capitalization and growth. We see the potential for a positive feedback loop between improving public service outsourcing and diversifying the wider economy by introducing more sustainable corporate ownership designs. The government's current procurement policies addressing VCSE organizations and SMEs already recognize some of these win-win opportunities (see Chapter One), highlighting that governance in these organizations can help deliver ‘smarter, more thoughtful and effective public services [while also rendering] the economy more innovative, resilient and productive’. A reframing of the existing policies could further strengthen and expand this by encouraging contracting authorities to favour a wider range of sustainable corporate forms (see Chapter Five) to deliver a wider range of public services.

Financialized corporate governance creates problems in the wider economy and for society that reach far beyond the delivery of public services. Unlike in past economic crises, the economic issue since the global financial crisis in 2008 is less about mass unemployment and more to do with the fact that many in employment remain poor, their wages stagnating as those who own capital extract an increasing share of the economy.

Contracts

The state may reduce problems in public service outsourcing by designing governance solutions that impact directly on the public outsourcing relationship with a view to reducing exploitative and extractive behaviour. A starting point in developing these solutions is, once again, the public outsourcing contract, which offers the state direct (private) governance leverage over its private provider. To ensure that outsourcing delivers both primary and secondary objectives (see Chapter One), contracting authorities will want to optimize the effectiveness of the public contract as a governance tool. By ensuring that public contracts are drafted appropriately, the state can minimize the risk of exploitation, formalization and even unwanted dependencies. In practice, however, the decision of how to approach the drafting and management of public outsourcing contracts always involves a balancing of different factors, including complexity and resource intensity, intended and unintended effects, and choice between long-term and short-term perspectives. In particular, the state has a balance to strike between, broadly speaking, a relatively formal and detailed contract design and one that allows for greater flexibility and adjustment.

The state may try to anticipate and avoid conflict and exploitation of incomplete outsourcing contracts by introducing more detailed contractual provisions. It can introduce more detailed metrics and targets against which performance and outputs will be measured and assessed – for example, by strengthening the use of KPIs to measure performance, to make it both more difficult for providers to avoid obligations under the contract and easier for the public authority to hold providers to account during or at the end of the delivery. For large public contracts, the new public procurement legislation reinforces this by requiring contracting authorities, where possible, to set and publish at least three KPIs. It runs a risk, however, that by designing overly complex contracts, the state expends public resources disproportionately without necessarily improving underlying issues related to, for example, power imbalances that can impact negatively on public contracting. The very conditions (for example, risk assurances, accounting requirements, clawback clauses) that are intended to hold providers to account and avoid exploitation can be those that are easier to address and absorb by larger and incumbent providers than smaller organizations and new entrants, thus undermining attempts at diversifying public service provision.

As the new UK procurement law comes into operation, addressing public outsourcing problems remains a difficult and gradual process where, despite their versatility, traditional governance tools in contract design, public markets and regulation all have demonstrable imperfections. Reintroducing public ownership, replacing contractual governance with a public governance regime, is an important alternative intervention, but it bears uncertainties as to whether, in the long term, the state can effectively provide ambitious public welfare without entering into extensive strategic partnerships with private actors. Far from shrinking its responsibilities, the state often uses private actors to achieve, through outsourcing, ambitions that demand additional capacity and capabilities. This is a perfect example of the interdependence of and synergies between market and state in delivering a common good.

Trying to identify alternative governance solutions, this book asks whether innovation is possible by expanding an already existing, but currently rather limited and confined, policy to co-opt corporate governance in sustainably owned firms into the contractual governance of public outsourcing instruments in order to reduce (though not fully avoid) the risk of exploitative and extractive behaviour by private partners. An extended policy, expanding the government's current initiatives to support VCSE organizations, would more fully accommodate the flexibilities available in corporate law to design supplementary governance solutions to common problems in public service outsourcing: it would encourage, even expect, contracting authorities to consider, in their outsourcing decisions, the sustainable corporate ownership design of their suppliers, with the aim of improving outsourcing while nurturing more sustainable corporate market actors.

Corporate organizations in sustainable ownership cover a spectrum of governance options, all of which temper financialization and avoid purely extractive design. These organizations are more diverse than those operating as VCSE organizations in the social economy; they include purposedriven profit-distributing firms, stakeholder-controlled companies, foundation ownership and mutually owned firms. UK company law leaves room for individual companies to reconfigure beneficiary rights, control rights and economic rights in the corporate organization ‘away’ from the investorcentric default model and towards economic, environmental and social sustainability objectives. To what extent corporate organizations make sensible use of this flexibility is a matter of some complexity, but it seems crucially important for government to assume a role through its public procurement in nurturing this experimentation in sustainable corporate ownership designs, enabling new forms to establish themselves and grow, including in the social and wider economy.

A new UK public procurement law

In 2023, the UK Parliament agreed on new public procurement legislation, moving beyond the previous public procurement regime based on European Union (EU) law. Public procurement legislation imposes on the public sector, and bodies with designated public responsibility, obligations to observe structured tender procedures when they contract out public services, especially those above a certain value threshold. It also provides remedies for aggrieved providers that lose out as a consequence of illegal contract awards. These public procurement rules have a variety of objectives, but mostly their aim is to ensure open and transparent tender procedures to maximize the benefit of market competition for the state when it buys goods or services from private suppliers. Where procedures lack transparency or are otherwise uncompetitive, this may restrict the state's choices and lead to suboptimal provider selection, meaning the public sector may not secure value for money, and therefore maximize public benefit, in its procurement.

The new UK public procurement law is one of the first major pieces of legislation to make use of greater freedom following Brexit, with the UK no longer being bound by EU law. The government presented the law as a chance mainly to simplify public procurement, to improve transparency and reduce bureaucracy, to adapt the regime to the UK's current procurement needs and to secure better access, especially for small and local providers, to public markets. The law repeals the existing regulations based on EU law and in their stead sets out new rules and procedures for public contracting authorities (including central government departments, their arm’s-length bodies and the wider public sector) in the selection of providers for the award of public contracts with a value above the relevant thresholds. It also includes provisions for contracts that fall below those thresholds.

Public procurement law is a complex and technical area of regulation, hardly a popular talking point. Yet in the debates over this new legislation, strong political sentiments and a profound unease with the way in which public contracting has developed in the UK in recent years, in ways that undermine attempts at delivering public value, quickly became apparent. UK government spending on public procurement has risen sharply in recent decades, and it currently accounts for roughly one third of all public spending in the UK.

Purpose

Corporate purpose determines beneficiary rights – that is, in whose interests the organization is expected to run. UK company law permits but does not require companies to define a specific corporate purpose in their articles of association. If no such purpose is specified, it defaults, as discussed in Chapter Two, to a position that defines the fiduciary duty of the company directors in terms of promoting ‘the success of the company for the benefit of its members as a whole’ – that is, prioritizing its shareholders. These default rules grant substantive beneficiary rights exclusively to the company's shareholders, and while this encourages an inclusive perspective by asking directors to have regard to other corporate stakeholders’ interests, it does not actively prevent a company from adopting a financialized governance model, where its purpose becomes simply to extract profit for shareholders (see further Chapter Two).

For a contracting authority, this design offers little reassurance that the supplier company will not act opportunistically where it is in the shareholders’ interest to do so. Of course, companies may nonetheless publish a commitment, perhaps in a public statement on their website, to delivering public services. Serco, for instance, identifies ‘a set of four values - Trust, Care, Innovation, Pride – that shape our individual behaviours and hence the way the company behaves’ and commits to creating ‘innovative solutions that make positive impact and address some of the most urgent and complex challenges facing the modern world’. Importantly, however, these are ‘soft’ commitments only and have no impact on the legal design of the organization, nor are they enforceable. Firms wishing, under UK law, to commit to a wider corporate purpose have several options. They may choose to incorporate their venture under a tailored corporate form available for certain social and community enterprises – for example, as a community interest company (see Box 5.1), a cooperative society or community benefit society, or in some cases an adapted company limited by guarantee (which may have members but has no shareholders). They may alternatively choose to incorporate as company limited by shares but, again, adapt this format to suit their mission by defining and incorporating a tailored purpose clause for their venture into the company's articles of association, thus imposing on company directors a legal duty to promote and prioritize the defined corporate purpose.

Public ownership

Problems and associated costs of outsourcing (including its regulation) may lead the public sector to conclude that it would in fact be cheaper and better to bring a public service back under public control. Even just by threatening to take the service in-house, the state can exercise some leverage over existing private contractors. Public sector organizations, therefore, tend to increasingly see the option of bringing services back into public ownership as a strategic governance tool that might improve the delivery of public services and support the long-term development of public capabilities, notwithstanding the broader direction of travel, which has seen a significant rise in outsourcing. Indeed, insourcing happens for a variety of reasons, including in some cases where outsourcing has worked well, enabling the public sector, by temporarily handing the service over to the private sector, to improve its capabilities and to eventually reabsorb it into public management.

Evidence across the UK suggests, however, that re-internalization is currently much more common for services outsourced by local authorities than for centrally outsourced services and that it is often dependent on both sector and context. A relatively rare and therefore important recent example of insourcing in UK central government relates to the decision by the UK Ministry of Justice in 2020 to re-internalize probation services, which had been privatized no earlier than 2015. In announcing the move to insourcing, the Ministry cited the need for greater ‘flexibility, control and resilience’ as a result of the COVID-19 pandemic, in a sector that suffered from multiple outsourcing failures. On the other hand, growing calls for taking prison services directly back into public hands, for similar reasons, have so far been resisted by government.

By taking a service back in-house and under public governance, the state eliminates the risk of exploitation that results from being locked into a public contract that is badly designed, highly formalized and impossible to renegotiate. It can, as a result, also assume greater control over ongoing resource allocation, which it may find helpful – for example, where, in the context of economic austerity, public contract payments are effectively ring-fenced from public budget reductions. In some cases, insourcing may help local governments to generate additional income directly by commercializing certain service elements.

Introduction

This chapter links to other discussions in this book by identifying different interpretations of sustainability and sustainable development, in conversations about economic and political reform, and their relevance for law and legal governance. It considers that sustainability is currently understood in terms of two rather distinct conceptual perspectives: one version centring, broadly speaking, on ensuring sustainable economic growth and on socially embedding global markets (sustainable-capitalism); the other insisting that more fundamental changes and systemic revisions, including of the growth objective itself, are necessary (sustainable-systems). The purpose of the chapter is to trace these versions of sustainability through current reform proposals in the area of corporate law and governance, which have as their objective to make companies operate more sustainably.

The chapter begins by sketching out the two perspectives on sustainability. Sustainable-capitalism is built fundamentally on an optimistic view of our existing systems and their operating principles, and their ability to address, if appropriately engaged and policed, sustainability challenges. Figuratively speaking, this perspective assumes that, much like we might trim a hedge or tree to adjust it to its environment, so we must trim our established systems to align them with our political concern for sustainable development. In both scenarios, however, while we might trim them, we leave their existing organisms intact. Sustainable-systems, on the other hand, insists that the scope and urgency of sustainability challenges today make a fundamental overhaul of central aspects in our current systems necessary; replacing some of the existing narratives of post-industrial capitalism, and its operating principles, with an alternative set of narratives and principles. Figuratively speaking, rather than trimming a hedge or tree – a process of curbing excess through intervention – this view on sustainability encourages that we should sow, and grow, alternative seeds (operating principles) that will yield alternative organisms (systems).

Based on these sketches, the chapter argues that while express linkages between corporate governance and sustainability are a relatively recent phenomenon, it is clear that these conceptual distinctions do matter in the framing of sustainable corporate governance reform. How we choose to frame sustainability – whether we understand it in the (stylised) terms of a sustainable-capitalism or sustainablesystems perspective – directly influences how we set about shaping a sustainable corporate governance framework.