FN0360 Ethics and Governance

Lecture One
The Corporate Structure, Ownership
and Agency
Tim Nichol
 Objectives
• The objectives of this lecture are to
• discuss the nature and implications of Berle
and Means’ “Corporate System”;
• introduce the concept of corporate
governance;
• examine the corporate structure and the
nature and role of shareholders and directors.
• Discuss corporate ownership and control
 Need for Study of Ethics and
governance
• Role of/Resource controlled by companies
• Role of individuals in corporate decision
making
• Persistence of corporate scandals – fraud,
theft, abuse of power, self-enrichment
• Importance of public confidence
• Need to develop awareness of future
managers
 The Corporate System
“Grown to tremendous proportions, there may
be said to have evolved a “corporate system”
– as there was once a feudal system – which
has attracted to itself a combination of
attributes and powers, and has attained a
degree of prominence entitling it to be dealt
with as a major social institution
A.A.Berle and G.A Means
 Implications
• Company is a legal device providing a means
by which private individuals could gather
together to perform business transactions.
But
• the company has also become a method of
property tenure; and
• a fundamental means of organizing economic
life
 The company as a means of organising
economic life
• The concept of a separate legal personality :
ability of the company to create legal relations
• limited liability of shareholders provide a
means of limiting shareholder risk and so
encourage participation
 System of Property Tenure
Accumulation of wealth by companies
• only 24 counties in 2007 had GDP greater than
the 2008 earnings of Wal Mart
• the top 50 companies had earning greater
than the GDP of 124 countries appearing on
the IMF listing of national GDP
• Concentration of economic and potentially
political power
 Nature of Corporate Governance:
Concerns
• the structure within which management
decisions are made;
• the composition of the group making those
decisions; and
• the relationship between those making
management decisions, the owners of
companies and external stakeholders
 Corporate Structure
Shareholders
↓
Contractual Relationship
↑
Company ← Contract Board of
Directors
↑
Other Relationships
Contractual Other Legal Relations Other Relations
 Analysis of Shareholding in some
European Countries

Austria Belgium France Germany UK

Public Sector 4.8 3 11 7 0
Individuals 11.3 19 6 15 14
Private Non Financial 22.6 8 15 42 2
Private Financial 27.5 17 29 15 51
Foreign Investors 33.8 53 39 21 33
 Board Choices
• a unitary or a double board structure;
• a choice of executive and/or non-executive
directors; and
• the separation or combination of the role of
Chairman and Chief Executive Officer.
 Unitary Board Structure : UK
Board run by Chairman
• Led by CEO • Led by Senior Non-
• Composed of Executive Executive Director
Directors • Majority independent
• Consist of 50% of the Non-Executive Director
Board • Consist of 50% of the
Board
Two Tier Structure : Germany
Supervisory Board
Shareholder Employees
50% 50%

↑
Management Board
Executive Directors
 Concept of ownership
• Exercise legal rights to use
• Enjoy beneficial rights
• Recognise legal obligations of ownership
• Usually benficial/legal rights fused to give
ownership and control
Questions regarding share ownership
• public companies provide alternative levels
of participation by shareholders in
management; and
• the motives underpinning share ownership
may not be similar to those underpinning
the acquisition of other assets.
 Ownership/Control Situations
1. Control through almost complete ownership
• exists only in private companies
• all shares are held by an individual or a small
group of individuals
• All are involved in the management of the
company
• de jure and de facto control over the assets
 2. Majority Control

• first point of separation between control and

ownership
• Democratic principle ‘one share one vote’
• 51% gives control
• Consenting minority excluded from control
 3. Control through a legal device

• legal devices gives control even where

majority ownership is not possible
• examples were provided by Berle and Means
include pyramiding, the use of non-voting
stock, differing voting rights and voting trusts
 Pyramiding
• company A takes a 51% stake in company B
• company B then acquires company C by purchasing
51% of the shares
• C to acquires 51% of the shares of company D
• in de facto terms company A will control companies
B,C and D
• direct shareholding company A has in company D is
less than 13.26% ( that is 51%x51%x51%)
 4. Minority Control

• individual or small group of shareholders hold

sufficient interest in the company to exercise control
• De facto control in these circumstances is based on
the ability of the minority to attract support from the
majority shareholders
• proxy system is crucial in effecting the exercise of
such control.
 5. Management Control

• ownership is widely dispersed : no single shareholder or

group of shareholders have sufficient shares to dominate the
company, even as minority shareholders
• no one shareholder or group can gather around them the
necessary voting power to exercise control over management
• control over the assets and the direction of the company lies
with the directors of the company, none of whom have
significant ownership interests in the company
• shareholders excluded from the exercise of control over
company assets
 The Motives of Shareholders
• “ The corporate stockholder has certain well-defined interests
in the operation of the company…In general, it is to his
interest, first that the company should be made to earn the
maximum profit compatible with a reasonable degree of risk:
second, that as large a proportion of these profits should be
distributed as the best interests of the business permit, and
that nothing should happen to impair his right to receive his
equitable share of those profits which are distributed: and
finally, that his stock should remain freely marketable at a fair
price”
•
A.A.Berle and G.A. Means The Modern Corporation and
Private Property Page 114
 Management Abuse of Control
• the unlawful appropriation of assets by the directors;
• the use of corporate assets for the directors’ private use
• directors may pay themselves excessive sums
• remuneration schemes may cause the directors to make decision that
maximize their position rather than the long term position of the
company;
• directors may dilute the ownership of the shareholders through the
inappropriate use of share option schemes; and
• where the directors themselves are controlling majority/minority
shareholders, related party transactions may be used to legally channel
funds away from the company.
 The Agency Problem
“ the management, in the absence of gross
incompetence or serious misfortune, has open to it a
wide range of discretionary behaviour in which it
can, without fear of punitive action by stockholders,
pursue policies which serve its own interests at the
expense of the owners”.

R J Larner Management Control and the Large

Corporation
 Regulatory Response
• UK Combined Code;
• the composition of the board means that it is not numerically
dominated by Executive directors;
• the majority Non-Executive directors are required to be
‘independent’ of the company;
• the Non-Executive directors dominate or exclusively staff sub-
board committees;
• a Senior Non-Executive director is appointed to represent the
other Non-Executive directors and hold meetings with the
major shareholders;
• specific provisions are provided dealing with the relationship
between the institutional investors and the company.
 Alternative Views
• “On the one hand, the owners of passive property, by surrendering
control and responsibility over the active property, have surrendered the
right that the corporation should be operated in their sole interest ..At
the same time, the controlling groups, by means of the extension of
corporate powers, have in their own interest broken the bars of tradition
which requires that the corporation be operated solely for the benefit of
the owners of passive property. Eliminating the sole interest of the
passive owner, however, does not necessarily lay the basis for the
alternative claim that new powers should be used in the interests of the
controlling groups …The control groups have, rather, cleared the way for
the claims of a group far wider than either the owners or the control. They
have placed the community in a position to demand that the modern
corporation serve not alone the owners or the control but all society”
(Berle and Means page 312)